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http://blogs.reuters.com/felix-salmon/2010/10/13/the-enormous-mortgage-bond-scandal/....
Here’s how it would work:
First, the bank would put in a winning bid for the pool of mortgages, with the intention of slicing it up into mortgage bonds and selling those bonds off to investors at a profit.
After submitting the winning bid, the bank would commission Clayton to take a closer look at a representative sample of loans in the pool. Clayton controlled as much as 70% of the market for this service, which is known as third-party due diligence. But Clayton’s not at fault here, and the problem is likely to apply no matter who performed this service.
The size of the representative sample would vary according to the size of the loan pool; it could be anywhere between 5% and 35% of the loans in the pool. Essentially, Clayton would go back to the loans, one by one, and re-underwrite them after the fact, checking that the originator’s underwriting standards were in fact being upheld.
Clayton would either accept or reject the loans it was looking at, according to whether or not they met underwriting standards. Here’s the results of what it found for one bank, Citigroup; the chart comes from this document filed with the Financial Crisis Inquiry Commission. I’m just using Citi as an example, here; all banks behaved in basically exactly the same way.
Look at the first line. Clayton reviewed 1,280 loans on behalf of Citigroup in the first quarter of 2006. Of those, it accepted 554 outright: they lived up to the originator’s underwriting standards. It also waived another 144, on the grounds that there were mitigating factors (a large downpayment, say). And it rejected 582 for a rejection rate of 45%.
This kind of information was valuable to Citigroup: it showed them that the quality of the loan pool was much lower than you’d think just by looking at the ostensible underwriting standards.
Armed with this information, Citigroup would do two things. First of all, it would take those 582 rejects and put most of them back to the underwriter. Essentially, they said, the loans weren’t as advertised, and they didn’t want them. But Citi would still keep some of them in the pool.
But remember that Clayton had tested only a small portion of the loans in the pool. So Citi knew that if there were a bunch of bad loans among the loans that Clayton tested, there were bound to be even more bad loans among the loans that Clayton had not tested. And those loans it couldn’t put back to the originator, because Citi didn’t know exactly which loans they were.
If there had been any common sense in the investment banks, that would have been the end of the deal. But there wasn’t. Rather than simply telling the originator that its loan pool wasn’t good enough, the investment banks would instead renegotiate the amount of money they were paying for the pool.
This is where things get positively evil. The investment banks didn’t mind buying up loans they knew were bad, because they considered themselves to be in the moving business rather than the storage business. They weren’t going to hold on to the loans: they were just going to package them up and sell them on to some buy-side sucker.
In fact, the banks had an incentive to buy loans they knew were bad. Because when the loans proved to be bad, the banks could go back to the originator and get a discount on the amount of money they were paying for the pool. And the less money they paid for the pool, the more profit they could make when they turned it into mortgage bonds and sold it off to investors.
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"The enormous mortgage-bond scandal" refers to a series of fraudulent practices carried out by major financial institutions in the United States, particularly leading up to the 2008 financial crisis. These practices involved packaging and selling large volumes of risky mortgages as investment products, misleading investors and ultimately contributing to the collapse of the housing market.
The enormous mortgage-bond scandal was caused by a combination of factors, including the deregulation of the financial industry, lax lending standards, and a high demand for mortgage-backed securities. Financial institutions were incentivized to engage in risky practices in order to generate higher profits and meet investor demand.
The enormous mortgage-bond scandal had a devastating impact on the economy. The collapse of the housing market led to widespread foreclosures and a significant decrease in home values. This, in turn, had a ripple effect on the financial industry and led to the 2008 financial crisis, which had a global impact on the economy.
Yes, several major financial institutions and individuals involved in the enormous mortgage-bond scandal faced consequences. Some were fined by regulators, while others faced legal action and criminal charges. However, many argue that not enough individuals were held accountable for their actions.
Since the 2008 financial crisis, there have been several measures put in place to prevent another enormous mortgage-bond scandal. These include stricter regulations on the financial industry, improved oversight and transparency, and reforms to the mortgage lending process. However, some experts argue that more needs to be done to prevent a similar crisis from happening in the future.