July 2012

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FEATURE SECONDARY MARKET T prevent mortgage fraud. The federal government carries on with the Financial Fraud Enforcement Task Force, the primogenitor of several other task forces, including the much-hyped Residential Mortgage-Backed Securities Task Force. ask forces are popular these days. Last fall the Troubled Asset Relief Program and Consumer Financial Protection Bureau (CFPB) stood up a task force to diligence task force—or so Digital Risk LLC would have it. Appearing at a Mortgage And now there is the due Bankers Association (MBA) con- ference in May, the risk analytics company called for the creation of an all-inclusive task force to de- velop a uniform set of standards for mortgage risk due diligence. Their premise: The real estate one—including ratings agencies, issuers, investors, underwriters, even competitor companies—back to the table to find a solution. "While there is market pres- boom-and-bust—and all that fed into the Great Recession—un- wound so much of the trust inves- tors placed in residential mortgage- backed securities. Chain links came apart up and down a chain-link fence of high-risk originations, casting doubt on the roles of rat- ings agencies, small-time mortgage brokers, and investors alike. Their solution: Bring every- lem may lie for the task force. Ratings agencies dismiss trans- parency problems today, citing important reforms to their con- troversial issuer-pays model. Ed Sweeney, a spokesman for S&P, credited the agency with "many changes" in a past interview, including "significant enhance- ments to the criteria" deployed to qualify residential mortgage- backed securities. "Overall, the changes make it sure to loosen lending standards, without a true understanding of risk elements, the certainty lend- ers require cannot be achieved and mortgage capital will remain limited," Peter Kassabov, CEO with Digital Risk, said in a state- ment announcing the task force. He described the force as one that "would not only restore confidence in underwriting procedures," but also "help the mortgage lending industry feel more confident that it has actionable, reliable data to make quality lending decisions." 76 | THE M REPORT recruiting willing players to set new due diligence standards? Or—with the likes of agencies interested in reform for laws like the Real Estate Settlement Procedures Act (RESPA)—will the heavy hand of federal regulation step in to police the industry? 'Not a Panacea' I s a task force on due diligence needed? It's hard to say, and issue at the center of a storm over due diligence practices— namely ratings agencies. In 2011, the Financial Crisis Inquiry Commission released a report that described the agencies—in- cluding Fitch Ratings, Moody's Investors Service, and Standard & Poor's—as "key enablers of the financial meltdown." And that's where a prob- But the solution sidesteps an everyone seems to have an opinion about what's needed to prevent the next mortgage crisis and still preserve today's home- ownership market. There's not even a real more difficult for these securities to receive high ratings," he told us. Can the task force succeed in familiar narrative. The ratings agencies inflated ratings for junk mortgage-backed securities, rat- ing many of these at AAA and duping investors, who funneled their cash into the mortgage finance system and pulled out when values plummeted for these securities. Rick Sharga, EVP of tive parleyed by the commission, which nodded in the direction of systemically important financial institutions and ratings agencies. The commission laid claim to the notion that "these institutions acted recklessly, taking on too much risk, with too little capital, and with too much dependence on short-term funding." The claims center around a consensus about how the crisis started. Four years forward, the mortgage industry, policymakers, and government officials veer left and right over the source of the problems. Peter J. Wallison, co- director of financial policy stud- ies at the conservative-leaning American Enterprise Institute, chalked up the crisis in a white paper in 2011 to government- sponsored homeownership initia- tives at Fannie Mae and Freddie Mac to keep credit requirements low for borrowers. He took issue with a narra- to the Securities and Exchange Commission (SEC), reforms largely steamed forward under the Federal Reserve, which proposed amendments to Regulation Z under RESPA last year. The rule modification aimed to implement an ability-to-repay model required under the Dodd-Frank Act. For its part, the private sector stepped up to address wide- spread deficiencies outside the ratings agencies, in the mortgage brokerage and origination com- munities. Companies like Lender Processing Services proffered technology solutions built on risk management and forensic analy- sis to mitigate instances of fraud and, more specifically, a failure to check one's own homework on mortgage loans. Sharga differs when it comes to technology for mortgage risk due diligence. "While technology presents the opportunity to solve problems, it's not a panacea," he tells us. "So throwing technology into the mix if it's not well-de- veloped tends to make the mess more efficient." Search for Consensus L Carrington Mortgage Holdings, says that "the ratings agencies proved to be horribly inefficient and often incorrect, and in many cases appeared to be issuing rat- ings on many products that they didn't understand." He tallies up "disastrous results" to a lack of skin in the game for these agencies, which fell under intense public scrutiny afterward for allegations of sell-to- the-best-client business models. Apart from a string of law- suits, owing in no small measure entire effort is to build consen- sus from within for a future without unnecessary risk—or at least the kind that blew up the housing bubble. "In the past [investors] relied istening to Alex Santos, president of Digital Risk, the on ratings, but in the future, while there may be reliance on ratings, they're also going to do a strong consensus that inves- tors will do a lot of homework themselves," he says. "And that homework involves crunching data. And the task force is to bring everyone together to make standards around how we're go- ing to check that data." He positions such a task force as a feasible alternative to SECONDARY MARKET ANALYTICS SERVICING ORIGINATION

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