Sunday, September 1, 2013

BoA showed why asset level transparency needed for RMBS deals

Bloomberg reported on how Bank of America included questionable mortgages in its RMBS deals in the run-up to the financial crisis.

BofA was able to do this because RMBS deals were and still are opaque.

Investing requires transparency.

Regular readers know that the investment process has three steps:

  1. Independent analysis of the data disclose to assess the risk of and value a security;
  2. Soliciting prices from Wall Street that it would be willing to buy/sell the security at; and
  3. Comparing Wall Street's prices with the result of the independent assessment to make buy/hold/sell investment decisions.
Without transparency, Step 1 of the investment process cannot be completed.

If the investment process cannot be completed, then the only thing that buyers or sellers of an opaque security are doing is gambling on the contents of a brown paper bag.

It is this simple fact that buyers were willing to blindly gamble on the contents of a brown paper bag that let BofA offload its questionable mortgages into a security.

Regular readers also know that the only way to encourage investors to come to the RMBS market is by providing observable event based reporting.  With observable event based reporting, any activity like a payment or delinquency involving the underlying collateral is reported before the beginning of the next business day.

Observable event based reporting is necessary so investors can know what they own or what they are buying.

Absent observable event based reporting, buyers and sellers of RMBS securities are simply gamblers.

Bank of America Corp.’s traders fought off efforts by the firm in 2007 to include risky Alt-A mortgages in a securitization. That wasn’t enough to spare investors from being cheated, according to the U.S. 
The Department of Justice accused the company in a lawsuit yesterday of misleading investors about the quality of loans tied to $850 million in mortgage-backed securities. 
The complaint chronicles friction among bank staff in 2007 and 2008 as they excluded risky Alt-A loans while leaving in wholesale debts once scorned as “toxic waste” by the firm’s then-chief. 
“None of these loans are suitable for a prime jumbo A-credit securitization,” one trader wrote in an e-mail, expressing discomfort with adding the low-documentation Alt-A debts to the pool. 
“Like a fat kid in dodgeball, these need to stay on the sidelines,” another trader wrote, according to the Justice Department’s complaint.

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