Cost-cutting

Beat the Press Archive | The American Prospect

NPR had a very good piece this morning detailing how investment banks accepted and passed on mortgage loans that they knew to be bad. According to its report, one investment bank had a contract with New Century, a leading issuer of subprime mortgages, that it would reject no more than 2.5 percent of its loans. Of course, such a contract would be an invitation to submit bad loans.

I’m trying to figure out why anyone would have such a contract term. On the one hand it simplifies due non-diligence by the investment bank — they just have to set their criteria so that no more than 2.5% of the loans being handed over for bundling get rejected. And for New Century i simplifies the financing stream, because they know that they will be on the hook for no more than 2.5% of the volume of paper they generated. So: profit. (The investment bank gets the flow of underlying paper to kite CDOs with and rake in all the various fees, commisions blah blah blah; New Century gets reliable financing.)

But having such a fixed number suggests something else to me, namely that there’s something in either the marketing pitch for the resulting securities or in the rating program for certifying the securities as AAA that depended on the percentage of rejected loans in the package. And that would be slam-dunk go-to-jail-and-stay-there conspiracy to commit securities fraud.

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