Right, but the originating lenders got paid back in full when they sold the loans off. They didn’t care if the borrowers ever paid off the loans. They made their money up front.
First, this is a different issue that what Hellestal is talking about. He’s saying that certain information was right in the prospectuses for anyone to see. I’m calling bullshit on that until there is a specific cite. If you are citing a study of subprime loans for this proposition, them please explain the connection since I’m not seeing it.
Second, there is no doubt about the fact that deception was systemic. But this is different than saying that institutions creating MBSs necessarily understood the level of deception. Certainly they understood that the underwriting on many if not most loans going in to some of these instruments was sloppy at best. However that is different than knowing specifically just how bad the underwriting was and the precise level of deception for any given loan being included.
IOW, to a great extent, much of what happened was less intentional fraud and more willful ignorance. However from a legal liability point of view, the law will often treat them the same. Gross negligence or willful disregard is often regarded as an intentional act.
From:
PROSPECTUS
NovaStar Mortgage Funding Corporation
And from:
Prospectus Supplement
(To prospectus dated March 3, 2004)
NovaStar Mortgage Funding Trust, Series 2004-1
NovaStar Mortgage, Inc. $1,727,250,100
Seller and Servicer
NovaStar Mortgage Funding Corporation
Page i, Prospectus Supplement
Prospectus, Page 17
Prospectus, Page 18
Now a few examples from the supplement.
Prospectus Supplement, Page S-20.
Documentation Percent of Principal Balance
Full Documentation 49.99%
Stated Income 40.11
No Documentation 7.35
Limited Documentation 2.56
It states clearly that a full half of the loans were based on stated income, low-doc, or limited-doc loans.
Half.
There’s more info here about the total number of loans. Next is Risk Classification on the same page.
Grade Percent by Total Principal Balance
A+ 0.04%
A 0.14
Alt A 21.29
M1 53.44
M2 18.88
M3 4.11
M4 2.05
FICO Enhanced 0.05
There’s more info here about the number of loans in each category and their total principal amount.
Page S-11 gives the breakdown of fixed-rate versus ARM. For most of the Groups, the ARM loans were the majority of loans issued, up to 80% of group volume. On page S-28, we get the ARM loan types.
Mortgage Loan Type Percent of ARM Principal Balance
ARM 2-28 6-month LIBOR 84.78%
ARM 3-27 6-month LIBOR 7.88
ARM 2-28 Interest Only 5.85
ARM 3-37 Interest Only 0.82
ARM 5-25 0.53
ARM 6-Month LIBOR 0.07
ARM 3 Year 0.06
Interest only loans were about 6% of the ARM loans.
On page S-7, it indicates that the upper tranches of the certificates, Classes A-1A, A-1B, A2, A-3A, and A-3B all had to receive AAA (Aaa) status from S&P and Moody’s.
To get an idea of change over time, we can look at the 2005-1 Prospectus Supplement from one year later, and comparing Interest Only ARM loan percentages to see the trend. On page S-27 of the 2005-1 NovaStar Prospectus Supplement, we see the IO (Interest Only) loans taking up about 17% of the total ARM section, a much bigger slice than just one year previously.
Not only were loan standards terrible, they were rapidly becoming even worse.
This is, of course, not my original research. I knew exactly where to look, and exactly what to find, because I didn’t stop paying attention to the mortgage market in the 1980s.
No comment necessary.
There have been countless stories from the crisis, scads of information available to anyone who is actually interested in looking. One of the most interesting is from Michael Burry, who was one of the first people on the planet, if not the very first, to buy CDS on these bonds in order to short the market. His was one of the smaller operations, yet he earned a profit of 700 million for his own investors and another 100 for himself.
He got his idea from actually opening the prospectuses and reading them.
He was convinced at the time that he must have been the only person to have actually done this, other than the lawyers who drafted them. I bet he was very nearly right. Burry was profiled in Michael Lewis’s The Big Short, and I’m going to quote just enough of this to get the point across, because it’s apparently impossible to believe otherwise. This is one of his emails explaining his methodology:
Obviously, I took my cue from from Burry on this.
Lewis then describes Burry’s confusion with the complete lack of standards. (It was still early in the game.)
This isn’t totally precise from Lewis. Many of these loans had minimum payments, but the payments weren’t sufficient to cover interest.
During more responsible times, lenders would only issue interest-only or negative-amortization loans to borrowers who were fully capable of accepting that risk. The situation during the housing bubble was much different.
This was documented, even at the time.
Do you have a link for the prospectus so that I can verify this information? Also what was the rating on this MBS? Was it AAA, because if not, it’s not relevant to my argument.
BTW. on documentation. Assuming that your reading is correct, at least 90% had proper income documentation.
Sorry for the triple post, but a quick search on Novastar found this:
I think you’ll need a financial document database to access the files. Burry says he used 10K Wizard. Mine came from Worldscope.
As I said in my post, the top tranches were rated AAA. This rating was required in the prospectus for them to be sold.
Page S-7
And then on down into lower ratings.
More generally: it was typical for about 70 or 80% of the tranches backed by any given pool of mortgages to have AAA rating. This figure is in the Financial Crisis Inquiry Report, page 72.
yes, but it’s all irrelevant if they lied about everything isn’t it - which was also my point.
You were trying to say that investors didn’t read the prospectuses. No one who knows anything at all about the financial markets would be stupid enough to even suggest that - especially when talking about sophisticated investors. So to the extent that certain information was in fact disclosed then it has to be assumed that either said information indicated a security fell within certain acceptable tolerances OR that there was other information in the prospectus which counterbalanced that negative information. In the latter case we don’t know since we don’t have the full picture.
But the whole example is really moot since your source is completely untrustworthy as indicated in my last post which you conveniently ignore.
In this thread, I’ve already cited someone who decided to short subprime after reading the prospectuses, which he found to be so terrible that he doubted anyone else had read them except for the lawyers who drafted them.
You’re making a claim that was already debunked several posts before you wrote it.
He made hundreds of millions of dollars based on his decisions of picking the worst bonds from the information that was available. Does he count as “stupid” because he could hardly believe anyone would purchase these things after reading about them? Would you seriously claim that he did not “know anything at all about the financial markets” because he made too much money? I’ll grant that he’s a weird guy, not a traditional player, but your hasty assertion here is false, and transparently so, for anyone who has actually been reading my posts.
“Sophisticated investors”? Really?
That someone qualifies as a “sophisticated investor” in the technical sense patently does not mean that they are sophisticated in their investment behavior. It’s a term-of-art, not a factual description.
Sophisticated investors were among the very people who bought mortgage bonds based on prospectuses which indicated the terrible quality of the underlying pools. Sophisticated investors were among the very people who weren’t careful enough to suspect that the information as presented – which was already very bad – might have been been hiding an even worse reality. Sophisticated investors were among the very people who loaded up on bonds backed by mortgages which, based on your own admission earlier in the thread, they would have found nearly impossible to double-check the quality of. Sophisticated investors were among the very people who loaded up on large amounts of terrible assets, in the hope of having both a safe triple-A security and also a high rate of return, as if the investing world had created a magical free lunch through securitization.
Sophisticated investors were among the very people who lost metric fuck-tons of money for their institutions due to their own thoughtlessness and negligence and utter lack of financial sophistication.
Can I imagine that these people might be so careless as to purchase AAA securities without bothering to look at accompanying paperwork? Yes. Absolutely. No question about it. They’re people and people tend to do stupid ridiculous shit, no matter how intense their training, or how extensive their expertise, or how large the pile of funds they have under management. I will admit right here that I might be suffering the halo effect when I doubted that the institutional investors who purchased this toxic waste actually read the prospectuses. The prospectus plus supplement is more than 200 pages of legalese. It’s easy for me to latch onto the idea that they were lazy and didn’t want to bother with that, because I already have a generally unfavorable impression of them. Maybe that’s wrong. Maybe a large percent of them did read the paperwork… while totally failing to understand the nature of the disaster they were reading about. If they did read them, it was a superficial reading only. All form, no content. I must admit this is possible.
What I refuse to do is to be so silly as to believe that possession of a label, no matter how it is earned, is enough justification to believe that they won’t make stupid lazy mistakes, most especially including neglecting to critically read paperwork that might seem a mere formality for a AAA asset. I’ve seen too much of humanity to ever be that naive.
I ignored it because it’s not relevant to any argument I’ve made in this thread.
I’m not surprised in the least that the prospectuses might have had false information. What I’ve been saying from the beginning is that the information in them indicated terrible pools which any reasonable person who had read that information should have avoided. The pools as presented were terrible. The possibility that the pools were even worse than they were presented does not change the fact that they were still terrible as presented.
Hellestal: “The prospectuses said the mortgages were toxic. That’s one reason why people shorted the market.”
“Counterargument”: “Ah ha! They lied in their paperwork! That means the info in them was completely untrustworthy!”
How exactly is this supposed to be relevant? They lied about it, but the lies still smelled like shit. Even after they buttered it up, it was still really really bad. Some of the very first CDS to short these bonds on a large scale, maybe even the very first CDS ever issued on these bonds, came directly from reading these prospectuses. The issuers were liars? Okay, sure. They were liars. But even the lies were unappealing for someone who bothered to critically read the available information, someone who was sophisticated in actual fact rather than just qualifying for a nice legal distinction. Even the lies weren’t worth buying into.
My original post on this topic said this:
I can’t see a single thing you’ve posted that contradicts that very simple, very straightforward, very plain assertion.
You have cited ONE example from 2004 and from a company that is currently subject to a class action for fraud. That is hardly the basis for ANY kind of argument. If you can’t see why, I don’t see that any explanation will be useful.
As for the content of prospectuses, I have already indicated that the disclosure of certain negative information may have been deemed within acceptable tolerances. For example in the NovaStar example you jumped on the fact that only half had full documentation but I pointed out that 90% had proper income documentation. Generally income documentation is regarded as the most critical factor for obvious reasons.
However since I was never involved in the underwriting of loans but only on the legal side in drafting documentation, I can’t really comment on what would have been regarded as acceptable by investors and it seems that you have even less experience in this regard though you seem insistent on pretending otherwise.
Which means it’s your turn to cite one example where such would be impossible. The burden of proof is now on you to make a counterclaim. Simply saying there is only one citation is insufficient.
Especially since he also offered an expert opinion. That’s something else you could do, too.
It doesn’t work that way. H’s argument is that there was no fraud and that investors were just stupid. The evidence to the contrary however has been so overwhelming from the hundreds of class actions to Congressional reports to documentaries and on and on that simply responding becomes as futile an exercise as trying to respond to a conspiracy theory about 9/11 or the moon landing.
No, I don’t actually see where he said there was no fraud. Instead it seems like he said that whatever fraud might have been going on, the prospectuses still contained enough information that diligent investors could have read them and determined certain MBS issues were not safe investments. That means you could do what some (small number–Burry was not the only one) of investors did and short them, or you could invest in them with the knowledge they are basically junk bonds. But considered as junk bonds highly rated MBS are not a good investment as they weren’t paying the premium rate a junk bond would.
And you don’t see any inherent contradiction there I suppose.
Not really, no.
The contradiction is that the other investors either did not read the prospectuses or were stupid. IOW, there was no fraud just stupid investors. If you want me to qualify that, we can say that the fraud was de minimis and the other investors were just stupid.
Let make something else clear. There were certainly people like Goldman Sachs and I think JP Morgan (would have to double check JPM) who made money on the decline in the mortgage market. But they did this by seeing the bubble in the real estate market and taking advantage of that.
Also, to some extent, many investors who made money on the decline understood the extent of the fraud involved in the MBS market and took advantage of that as well.
But to say that they made their money by reading prospectuses “more carefully” is unrealistic at best. If the information contributed to investment decisions at all, it was only a speck on a back drop of other much more persuasive evidence as noted above and I seriously doubt it was much of a consideration at all - any claims to the contrary not withstanding.
Let me try to explain the purpose of a prospectus. It’s designed to provide investors with a means of understanding the potential risks involved in an investment. Moreover, it’s meant to provide a full disclosure of all such relevant risks.
Therefore, to the extent that it succeeds in doing this, all investors reading a prospectus should come to similar conclusions regarding the risks involved and should make similar decisions as to whether or not to invest BUT that is only true if certain other factors are also true.
One of those obviously is risk tolerance. But the one that is most relevant here would be an assessment of the economic factors relevant to issues discussed in the prospectus. So for example interest rate trends, trends in real estate prices, etc.
Therefore 2 people can read the same prospectus and have 2 completely different views of the value of the investment depending on how they assess factors that relate to issues that will affect the value of the investment. But it should be clear that this is very different from simply reading a prospectus more carefully.
This is GQ, and as you’ve done in several threads you appear to only want to talk about pre-2008 malfeasance which honestly has little to do with this thread. I’m pointing out a simple fact, Hellestal never made the argument that no fraud was committed.
You’re basically saying it can be “assumed” from the “penumbras” of what he said, and it really can’t. Everything else in your last two posts is irrelevant and seems to be a response to things no one ever said.
No one is saying that people over-invested in anything because they didn’t read the prospectuses, just pointing out that if they had read the prospectuses there were clear indicators in there of the growing problem. There were other even clearer indicators the real estate industry (and all financial instruments associated with it) were in trouble that were not even buried in a prospectus, those were also completely ignored. But again, beside the point. No one appears to be saying there is no fraud, I guess you really want someone to say that because that’s an argument you like to have, but no one has said that.
Also, no one has said “there is no fraud just stupid investors.” While the majority of the market is made up of stupid investors, that has nothing to do with whether or not fraud occurred.
We’ve gone off topic long ago so I’m not sure what your point is there.
As for there not being any fraud, I’ve already addressed that, but let me make it clear. Let’s assume there was no fraud. Anyone reading a prospectus should come to the same conclusions as anyone else given the same assumptions about the underlying factors affecting the particular investment. To the extent that 2 people come to different conclusions after reading the same prospectus it is NOT due to a “more careful reading” but to different opinions relating to those underlying factors.
Please note that such differing opinions may be due to superior knowledge of a particular industry and its inner working, e.g., prevalence of fraudulent transactions, inflated pricing, etc. However this NOT the same as reading a prospectus more carefully.
As for impugning my conduct in other threads, I resent that and challenge you take any complaints you have to the pit where I will be happy to defend myself.
That you’re continuing to harp on something that has nothing to really do with MInsky’s theories. What do you not understand about that? That is my point.
Right, no one said there was not any fraud. We are in agreement.
Nonsense statement. No one is claiming to know how every investor who bet against MBSes determined they wanted to do so, and there is patently no way to know how any individual reads or interprets a prospectus. We can presume there were and are many investors who never read prospectuses, many who do not read them carefully, and many who read them and come to differing conclusions from one another among a host of other possibilities. No one is asserting to know how all individual investors behave or think. So as a matter of fact, yes–some investors definitely behave differently from other investors because they read a prospectus more carefully than a given comparable investor.