US Subprime Mess : Fagin, not Little Nell

I have long been irritated by the incessant sound of violins in the background when many (politicians, especially) talk about US Foreclosures. There are far too many people who feel the defaulters are poor-but-honest Dickensian characters, ruthlessly exploited by a predatory financial system.

Dickensian, perhaps, but Fagin is a more accurate model than Little Nell.

Fitch Ratings has added to research on this topic with a small but thorough examination of 45 files from early defaulters on some RMBS of vintage 2006. The conclusions?

Fitch believes that poor underwriting quality and fraud may account for as much as one-quarter of the underperformance of recent vintage subprime RMBS.

Fitch recognizes that, even in good quality pools, there will be some loans that default. However, when some pools of subprime mortgages have very high projected default rates, it is important to understand the impact that loans originated with poor underwriting practices and fraud can have. Moreover, Fitch intends to utilize the insights from its review to improve the RMBS rating process. Fitch believes that conducting a more extensive originator review process, including incorporating a direct review by Fitch of mortgage origination files, can enhance the accuracy of ratings and mitigate risk to RMBS investors. Fitch will be publishing its proposed criteria enhancements shortly. Additionally, a more robust system of representation and warranty repurchases may be desirable.

Characteristics by percentage of the 45 files reviewed included (loans may appear in more than one finding):

66% Occupancy fraud (stated owner occupied — never occupied), based on information provided by borrower or field inspector
51% Property value or condition issues — Materially different from original appraisal, or original appraisal contained conflicting information or items outside of typically accepted parameters
48% First Time Homebuyer — Some applications indicated no other property, but credit report showed mortgage information
44% Payment Shock (defined as greater than 100% increase) — Some greater than 200% increase
44% Questionable stated income or employment — Often in conflict with information on credit report and indicated to be outside “reasonableness” test
22% Hawk Alert — Fraud alert noted on credit report
18% Credit Report — Questionable ownership of accounts (name or social security numbers do not match)
17% Seller Concessions (outside allowed parameters)
16% Credit Report — Based on “authorized” user accounts
16% Strawbuyer/Flip scheme indicated based on evidence in servicing file
16% Identity theft indicated
10% Signature fraud indicated
6% Non-arms length transaction indicated

Update From a Countrywide investor presentation – with hat-tips to Naked Capitalism, WSJ Marketbeat blog & Peridot Capitalist – comes the table:

Reason for Foreclosure Percentage
Curtailment of Income 58.3%
Illness/Medical 13.2%
Divorce 8.4%
Investment/Unable to Sell 6.1%
Low Regard for Prop. Ownership 5.5%
Death 3.6%
Payment Adjustment 1.4%
Other 3.5%

which certainly provides food for thought, not to mention fodder for a thousand masters’ theses. Want to meet a cute grad student? Default on your mortgage!

The reasons given in the table apply, so says Countrywide, to the 80.3% of cases where the cause of foreclosure is known; they do not indicate how they know this. Countrywide also claims that there is “very little deviation between full doc and stated income” … but read that like a lawyer! It’s not at all clear what that sentence means!

It should also be noted that the two studies do not even claim to be studying the same thing; and that the Countrywide data is “Based on Foreclosure data from Countrywide’s Servicing Portfolio” … which could include conforming mortgages. Sixty percent of their “production” (which is presumably related, somehow, to the composition of their Servicing Portfolio) is agency-eligible (see page 18 of PDF).

Very interesting to note as well that one of the conclusions (page 31 of PDF) is that portfolio limits on the GSEs must be lifted, and loan limits for Fannie, Freddie & FHA be increased in order to bring back liquidity.

Update, 2008-2-12: Econbrowser‘s James Hamilton brings to my attention a Fed Research paper by Gerardi, Shapiro & Willen dated December 3, 2007: Subprime Outcomes: Risky Mortgages, Homeownership Experiences, and Foreclosures:

This paper provides the first rigorous assessment of the homeownership experiences of subprime borrowers. We consider homeowners who used subprime mortgages to buy their homes, and estimate how often these borrowers end up in foreclosure. In order to evaluate these issues, we analyze homeownership experiences in Massachusetts over the 1989–2007 period using a competing risks, proportional hazard framework. We present two main findings. First, homeownerships that begin with a subprime purchase mortgage end up in foreclosure almost 20 percent of the time, or more than 6 times as often as experiences that begin with prime purchase mortgages. Second, house price appreciation plays a dominant role in generating foreclosures. In fact, we attribute most of the dramatic rise in Massachusetts foreclosures during 2006 and 2007 to the decline in house prices that began in the summer of 2005.

Update, 2008-2-13: And, in fact, a lot of Americans are underwater on their mortgages:

Thirty-nine percent of people who purchased a home two years ago already owe more than they can sell it for, according to a Feb. 12 report from, a real estate data service. Only 3.2 percent who bought five years ago are in that situation, the report said.

Almost half of the borrowers who took out subprime mortgages in the last two years won’t have any equity left if home prices drop an additional 10 percent, New York-based UBS AG analysts led by Laurie Goodman wrote in a report yesterday.

Leave a Reply

You must be logged in to post a comment.