| Rating agency failure. The agencies were hired and paid by each deal’s issuer to rate the deal, and were expected to deliver an AAA rating, or risked the loss of future lucrative engagements, so had an obvious lack of objectivity and inherent conflict of interest. The ratings were based on the apparent underpinnings of the deal (i.e. property values and creditworthiness of the payors), which were not tested. Lack of equity cushion compounded by significant market decline built a trap for investors and borrowers from which neither could escape, making default and loss inevitable. Lack of standardization or regulation of the servicing process. Differing interpretations and execution of Servicers’ obligations and internal policies made for very different administration of loan-level management. This became even more problematic when loans were service-transferred elsewhere. Transfers of loans from the originators to the ultimate purchasers were often not properly perfected, allowing for potential chaos when it was necessary to document ownership. Inability of borrowers to make payments for various reasons resulting in escalating default rates. Prepayment penalties were essential to the structure of subprime securitizations from the investors’ perspective, but trapped borrowers in loans they could not afford in a declining market. Since they were unable to sell or refinance, default was not uncommonly the only option. Decentralization of decision-making power among servicers, trustees, bond insurors and mortgage insurors, further complicated by differing and mis-interpretations and rigidity of contractual obligations regarding adjustment and loan modification often resulted in foreclosure, even when the net result was a serious loss to the investors. Rigidity of REMIC structure further limited the options of servicers and trustees, since a violation of REMIC rules would trigger major tax problems. Disconnect between borrowers, lenders, servicers, investors. Borrowers rarely understood that their servicer was not the owner of their loans; servicers were not equipped to take any proactive measures to avoid default and foreclosure, and often did nothing until the loans were at least 90 days delinquent. Inability and unwillingness of servicers to manage large numbers of defaulted loans. When the deals were made, default percentages were low. Servicers calculated their profitability based on assumptions of low default rates, computerized management of loans in most instances, and were not eager to drastically increase their staffs to handle the burgeoning numbers of defaults. |
Securitization in Depth
Part 3 of 4