Bankers who made billions of dollars packaging home loans into bonds during the prime years of the housing boom provided false information to investors about the quality of those bonds, a comprehensive study by economists at Columbia University and the University of Chicago has found.
The study, which took an in-depth look at data for over 1.5 million mortgages made between 2005 and 2007, found bankers packaged many loans with risky features -- such as having been taken out by a speculator or being subordinated to another loan -- into bonds that they claimed contained no such risky mortgages.
The study also found there were many cases where data available to the bond underwriters clearly showed that loans being boxed into so-called mortgage backed-securities had these risky features. Contrary to the conventional wisdom in the banking industry, neither the borrower who took out the mortgage nor the mortgage broker who originally handled the transaction had lied as to the riskiness of the loan, the study found.
“The results in our paper indicate the presence of sizeable asset misrepresentations even among the most reputable underwriters,” economists Tomasz Piskorski, Amit Seru and James Witkin wrote in the paper. Concerns about reputation or incentives did not seem to deter bankers from bad behavior, the researchers said.
“In addition, this behavior also escaped regulators who were in charge of safeguarding rights of investors,” they wrote.
The misrepresentations were widespread, the economists found. About a third of all loans taken out on second homes in Florida during the boom period, the analysis concluded, were then sold off to investors within bonds that claimed to contain no such mortgages.
Investors suffered heavy losses because they were holding bonds that contained so many mislabeled mortgages, the economists wrote. Mislabeled loans defaulted at a rate 60 to 70 percent higher than properly classified mortgages, according to the study.
The study is likely to feed directly into ongoing litigation by investors and bond insurers, including Fannie Mae and Freddie Mac. Those institutions are suing dozens of banks for misrepresentations made on mortgage-backed securities sold prior to the housing meltdown in 2007, demanding those banks buy back the bonds.
Bonds packaged by Lehman Brothers, Washington Mutual and Countrywide Financial were among those that contained the most misclassified loans, the researchers found. Securities put together by HSBC, Merrill Lynch, Deutsche Bank, Nomura, UBS and Credit Suisse also contained misrepresentations, but at a lower rate, the economists found.
“Assuming that our estimates are broadly applicable to the entire stock of outstanding non-agency securitized loans [made] just prior to the crisis,” the economists wrote, banks could be forced to buy back up to “upwards of $160 billion” in bonds from investors.