February 20, 2013
Asset Quality Misrepresentation in RMBS Market
Piskorski, Seru & Witkin have posted Asset Quality Misrepresentation by Financial Intermediaries: Evidence from RMBS Market, in which they “identify misrepresentations by comparing the characteristics of mortgages in the pool that were disclosed to the investors at the time of sale with actual characteristics of these loans at the same time and show that such misrepresentations constitute a significant proportion of the loans.” (2) In particular, they
identify two, relatively easy-to-quantify, dimensions of asset quality misrepresentation by intermediaries during the sale of mortgages. The first misrepresentation concerns loans that are reported as being collateralized by owner-occupied properties when in fact these properties were owned by borrowers with a different primary residence (e.g., a property acquired as an investment or as a second home). The second form of misrepresentation concerns loans that are reported as having no other lien when in fact the properties backing the first (senior) mortgage were also financed with a simultaneously originated closed-end second (junior) mortgage. (3)
The paper has some extraordinary findings:
- there “are instances where, in the process of contractual disclosure by the sellers, buyers received false information on the characteristics of assets.” (2)
- “loans with misrepresented borrower occupancy status have about a 9.4% higher likelihood of default (90 days past due on payments during the first two years since origination), compared with loans with similar characteristics and where the property was truthfully reported as being the primary residence of the borrower.” (3-4)
- “loans with a misrepresented higher lien . . . have about a 10.1% higher likelihood of default . . ..” (4)
- lenders were “aware of the presence of second liens, and hence their misreporting likely occurs later in the supply chain.” (5)
The conclude that these “results suggest that RMBS investors had to bear a higher risk than they might have perceived based on the contractual disclosure.” (4)
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