Misrepresentation of loans pooled into mortgage-backed securities was widespread during the housing crisis and not just limited to a few banks, according to a white paper from the Columbia Business School and the University of Chicago, The Wall Street Journal reported Feb. 20.
The paper, authored by Columbia’s Tomasz Piskorski and James Witkin and Chicago’s Amit Seru, examined the two most common types of loan misrepresentations.
The first type was loans for properties represented as owner-occupied when they were not. Of the loan samples reviewed by the authors, more than 6 percent of mortgages reported to be for owner-occupants actually were given to borrowers whose primary residence was elsewhere. The Journal reported that those loans had a default rate 60 percent higher than those for owner-occupied properties.
The second misrepresentation involved properties where the loan was represented as being the only mortgage on the residence when, in fact, the residence carried a second mortgage. The authors discovered that 7 to 13.6 percent of loans claiming no junior liens actually carried them. Those loans had default rates 70 percent higher than average loan default rates.
The paper concluded that private-label securities not backed by the government-sponsored enterprises were the worst performing loans at the time of the housing crisis and that investors were not made sufficiently aware of the true nature of the loans in which they were investing. As a result, they “had to bear a higher risk than they might have perceived based on the contractual disclosure,” the Journal reported.
Multiple banks already have agreed to numerous legal settlements over loan misrepresentations, and this latest paper confirms that misrepresentation of loan quality was widespread, the Journal reported. “This was not limited to one or two bad apples,” the authors stated.
In the paper, the authors also noted that the Dodd-Frank Act may not sufficiently address the potential for future loan misrepresentation and called for even great disclosures.
Read the paper on mortgage fraud.