Isaac Gradman, writing in The Big Picture blog, has a very well done long-form piece on RMBS litigation. (TBP) Readers will note that we have covered RMBS litigation extensively, here, here, here, and here.
Of note were some quotes from the ever entertaining Judge Rakoff:
Even more striking was the straightforward manner in which Rakoff cut through the continued efforts of Flagstar to frame the claims in a backward-looking, results-oriented manner based on the borrower’s payment or employment history post-origination. Manal Mehta of Sunesis Capital highlights the following three passages as directly debunking the banks’ logic for their minimal private label putback reserves:THE COURT: I don’t understand the relevance of what the witness just said at all. At the time the borrower applies to the bank for the loan, there is no way of knowing whether he’s going to be paying for the next three years or not, so you have to assess the risk as it stands at the moment of application, true?
THE COURT: The information that was available at the time was that, in fact, it appeared that he had substantially misrepresented his income, and his income was less, considerably less than he had represented, yes?
THE COURT: But I am still missing the point. It is true, of course, that someone who may have made all sorts of misrepresentations on their loan application may still wind up paying the mortgage for a while. They may have hit the lottery or they may have a relative who helped them out or a hundred other possibilities. But the relevant thing is, in assessing risk, is the risk at the time the loan was approved, yes?
From my perspective, Rakoff has nailed it. The reps and warranties made by originators and issuers were made as of the date the securitization trust closed and the securities were sold to investors. The question is whether a reasonable underwriter using an objective methodology should have found that the borrower was likely to repay the mortgage. Whether the borrower ultimately paid is immaterial – underwriting is all about trying to control the risk at the outset. In other words, even a blind underwriter can sometimes find a bone (a risky borrower who actually does repay the mortgage), but that doesn’t mean it was acceptable for him or her to ignore underwriting guidelines just to push more loans through to closing.