Asset Quality Misrepresentation by Financial Intermediaries: Evidence from the RMBS Market

Abstract

We quantify the extent to which buyers received false information about the true quality of assets in contractual disclosures by intermediaries during the sale of mortgages in the $2 trillion nonagency market. We construct two measures of misrepresentation of asset quality --misreported occupancy status of borrower and misreported second liens --by comparing the characteristics of mortgages disclosed to the investors at the time of sale with actual characteristics of these loans at that time that are available in a dataset matched by a credit bureau. About one out of every ten loans has one of these misrepresentations. These misrepresentations are not likely to be an artifact of matching error between datasets that contain actual characteristics and those that are reported to investors. At least part of this misrepresentation likely occurs within the boundaries of the financial industry (i.e., not by borrowers). The propensity of intermediaries to sell misrepresented loans increased as the housing market boomed. These misrepresentations are costly for investors, as ex post delinquencies of such loans are more than 60% higher when compared with otherwise similar loans. Lenders seem to be partly aware of this risk, charging a higher interest rate on misrepresented loans relative to otherwise similar loans, but the interest rate markup on misrepresented loans does not fully reflect their higher default risk. Using measures of pricing used in the literature, we find no evidence that these misrepresentations were priced in the securities at their issuance. A significant degree of misrepresentation exists across all reputable intermediaries involved in sale of mortgages. The propensity to misrepresent seems to be largely unrelated to measures of incentives for top management, to quality of risk management inside these firms or to regulatory environment in a region. Misrepresentations on just two relatively easy-to-quantify dimensions of asset quality could result in forced repurchases of mortgages by intermediaries up to $160 billion.Acknowledgments:

Securitization, Ratings, and Credit Supply

“…7 See http://faculty.haas.berkeley.edu/bgreen/files/RatingsWP2017.pdf. These extensions are also in line with empirical studies on ratings shopping and manipulation: Ashcraft et al (2011), Tang (2011), Griffin, Nickerson, andTang (2013), Becker andMilbourn (2011), He, Qian, andStrahan (2011), Kraft (2015), and Piskorski, Seru, and Witkin (2015).…”

One and the Same? A Systematic Literature Review of Residential Property Investor Types

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Financial Consequences of Identity Theft: Evidence from Consumer Credit Bureau Records

“…Second, our paper contributes to the literature on fraud in financial markets. While much of this literature focuses on the parties that commit fraud, such as financial advisors (Dimmock, Gerken, and Graham, 2017;Dimmock and Gerken, 2012;Egan, Matvos, and Seru, 2017;Qureshi and Sokobin, 2015), CEOs (Khanna, Kim, and Lu, 2015;Agrawal, Jaffe, and Karpoff, 1999), and firms (Piskorski, Seru, and Witkin, 2015;Povel, Singh, and Winton, 2007;Zingales, 2010, 2014), we examine the effects of fraud on victims' credit outcomes. Our study complements research on the effects of fraud on investment decisions by individuals and households (Gurun, Stoffman, and Yonker, 2018;Giannetti and Yang, 2016).…”