Appraisal and Ratings Fraud Documented

From Mario Kenny — see comments posted to blog

As we have stated repeatedly, the logistics were simple: (a) inflate the value of the mortgage backed securities with fraudulently obtained Triple AAA Ratings and (b) inflating the value of the home with fraudulent and negligent use of false comparable and ignoring time factors. The economics of lending changed “upside down” — by hiding a mountain of toxic waste loans behind a thin veneer of high quality borrowers, Wall Street was able sell securities at many times their actual value producing unprecedented and unconscionable profits. They were in essence stealing the identity of both the high quality and low quality borowers to sell securities without regard to whether the loans would end in foreclosure.

April ,2008
Christopher Cox
Securities and Exchange Commission
Washington, D.C. 20549
Dear Chairman Cox:
We represent the National Community Reinvestment Coalition (”NCRC”), which
is an association of more than 600 community-based orgarizations that promote access to
basic banking services, including credit and savings, to create and sustain affordable
housing, job development, and vibrant communities for America’s working families. The
NCRC has and continues to be a voice for communities around the country damaged by
the aggressivee xpansiona nd subsequentim plosion of the residential mortgage-backed
securities (”RMBS”) market. The NCRC is concerned that nationally recognized
statistical rating organizations (”NRSROs’), more commonly known as credit rating
agencies (”CRAs”), substantially contributed to the housing and foreclosure crisis by
making public misrepresentationsa bout the soundnessa nd reliability of RMBS ratings.
NCRC believes the NRSROs rating system failure has harmed the communities served by
the NCRC because it fueled imprudent mortgage lending and irresponsible secondary
market purchases of RMBS, which, in tum, contributed to high default and foreclosure
rates. In reaction to this market turmoil. access to credit is now severelv restricted in
these same communities.
By this letter, the NCRC asks the SEC to thoroughly investigate the NRSROs, in
particular Fitch, Inc. (”Fitch”), Moody’s Investors Service, Inc. (”Moody’s”) and the
Standarda nd Poor’s Division of the McGraw Hill CompaniesI,n c. (”S&P”), because
these institutions gave ratings to RMBS that were unwarranted given information that
was known or available at the time of the rating and should have been considered under
these NRSROs’ own procedures. It is NCRC’s position that Fitch, Moody’s and S&P
dominate the ratings market and all had or should have had access to loan files,
underwriting standards and loan product information so that they could each conduct
their own due diligence for fraud and/or poor underwriting. All three NRSROs
acknowledged they did not review this information:
R r l v a N & DnNE P L L c
ChristopheCr ox
Page 2
In a November 28,2007 report entitled The Impact of Poor
Underwriting Practices and Fraud in Subprime RMBS
Performance (”Fitch Report”), Fitch determined that based upon a
review of a loan sample from one of the RMBS pools it had
previously rated, “poor underwriting and fraud may account for as
much as one-quarter of the underperfofinance of recent vintage
RMBS.” Fitch Report at2. Fitch had not previously identified the
high levels of fraud and poor underwriting in the pools it rated and
represented that it would “utllize the insights from its review to
improve the RMBS rating process.” Id. (Copy of Fitch Report
In a March 25,2008 report entitled A Short Guide to Subprime
(”Moody’s Report”), Moody’s acknowledged that there were
“indications of a decline in subprime loan standards in the years
leading up to the present crisis,” but that Moody’s did not
“anticipate the magnitude of delinquencies and losses on the
underlying loans.” Moody’s Report at2-3. As a result, Moody’s
has “updated its methodology for rating subprime RMBS to
account for this unexpectedly poor loan performance.” Id. at3.
Among the updates, Moody’s noted its recent increased risk
assumptions for high risk loan products, including loans with low
or no documents and high loanto-value (LTV) and combined
loan-to-value (CLTV) loans. Id. (Copy of Moody’s report
In a February 7,2008 report entitled S&P Steps to Further Manage
Potential Conflicts of Interest, Strengthen the Ratings Process, and
Better Serve the Markets (”S&P Report”), S&P representedit
would “implement procedures to collect more information about
the processesu sed by issuersa nd originators to assessth e accuracy
and integrity of their data and their fraud detection measures so
that we can better understand their data quality capabilities.” S& P
Report at 2. (Copy of S&P Report attached).
Thesea dmissionsb y Fitch, Moody’s and S&P demonstrateth at theseN RSROs
did not consider information that was crucial to ensure the accuracy and integrity of
ratings which they had representedt o the public were reliable.
RrLNaaN & DnnE PLLc
ChristopheCr ox
Page 3
The SEC as well has recognizedthe impact of the flawed NRSRO rating system
on the RMBS market. In your September2 6,2007 testimonybeforet he U.S. Senate
Committee on Banking, Housing and Urban Affairs, you stated that the NRSROs
underestimated the incidence of mortgage delinquencies in 2006 andnoted that the
NRSROs had identified several factors for their flawed ratings. These factors, including
fraud in the mortgage origination process and deterioration in loan underwriting
standards,w ere well known as credit risks long before the NRSROs began large-scale
downgrades of their ratings in the second half of 2007. More recently, as a member of
the President’s Working Group on Financial Markets (”PWG”), you, along with the
Secretary of the Treasury, and the Chairmen of the Federal Reserve Board and the
Commodity Futures Trading Commission, jointly concluded in a March 13, 2008 Policy
Statement (the “PWG Policy Statement”) that one of the principal underlying causes of
the turmoil in financial markets was “flaws in credit rating agencies’ assessmentos f
subprime residential mortgage-backed securities (RMBS) and other complex credit
products….” PWG Policy Statement at 1. The PWG found that the turmoil was
triggered by a “dramatic weakening of underwriting standards for U.S. subprime
mortgages, beginning in2004 and extending into early 2007.” The PWG also found that
“[flaulty assumptions underlying rating methodologies and the subsequent re-evaluations
by the credit rating agencies (CRAs) led to a significant number of downgrades of
subprime RMBS, even of recently issued securities.” Id. at2.
As the agency charged with oversight of the NRSROs, the SEC is responsible for
ensuring that a flawed rating system does not continue to harm investors and the public
interest. In the preamble to the Credit Rating Agency Reform Act of 2006 (the “Act”),
Congress stated that the purpose of the Act was “to improve ratings quality for the
protection of investors in the public interest by fostering accountability, transparency, and
competition in the credit rating industry.” The SEC has the authority to determine
whether the NRSROs’ credit ratings were or are “in material contravention” of their
procedures.1 5 U.S.C. $ 78o-7(c). The NRSROsp ublicly representedb etween2 004 and
late 2007 that they had procedures in place to ensure that their RMBS ratings were
accurate and sound. As even the PWG concluded, theywere not. The SEC also has
authority, as you testified on September 26,2007, to determine whether the NRSROs
were “unduly influenced by issuers and underwriters of RMBS to divert from their stated
methodologies and procedures for determining credit ratings in order to publish a higher
rating.” The NCRC believes that a rating system that allows the NRSROs to be paid by
the same institutions issuing the RMBS ensures a conflict of interest.
RrlvnN & DnNE PLLc
ChristopheCr ox
Page 4
In your September 26,2007 testimony, you confirmed that the SEC is conducting
a non-public examination of the NRSROs as part of its licensing authority. The NCRC
believes that much more is needed to fix the broken ratings system. To promote the
purpose of the Act to foster accountability, transparency and competition in the credit
rating agency, the NCRC asks the SEC to investigate Fitch, Moody’s and S&P and the
other NRSROs currently licensed by the SEC to determine whether:
1) they materially diverted from their standards, or committed a fraud on
the market, by misrepresenting that they had sound and accurate
procedures in place to accurately rate RMBS;
2) their failure to consider mortgage fraud, decreasing underwriting
standards and high-risk loan products was a material diversion from
their standards, or a fraud on the market; and/or
3) they were unduly influenced by issuers and/or underwriters to give
unwarranted ratings to RMBS.
Based on this investigation, the SEC should release the aggregate results so that
the public, and the lending and investment communities can better understand the
NRSRO process and any shortcomings that need to be corrected. At the same time, the
SEC should use its statutory authority under the Act to censure, deny or suspend
registration of any NRSRO that has not complied with the Act, or any other statute
enforcedb y the SEC. 15 U.S.C. $ 78o-7(d). The SEC should suspendth e licenseo f any
NRSRO that cannot demonstrate that it is following its own procedures and is reviewing
information necessary to ensure that a rating is accurate and reliable. Further, the SEC
should impose civil penalties and seek appropriate equitable relief where appropriate to
address NRSRO violations of the Act, and any other statute enforced by the SEC. The
SEC should also collaborate with the federal banking agencies and the FTC to ensure that
consumers receive appropriate redress for the harms created as a result of imprudent loan
ori gination and securit ization.
The NCRC also asks that the SEC issue additional rules as required by the Act
that clearly define acts or practices by NRSROs that are unfair, coercive or abusive.
l5 U.S.C. $ 78o-7(i). The SEC shouldc onsultw ith not only the RMBS issuers,le nders,
servicers and investors, but with members of the advocacy community, including the
NCRC, to assist in this process. The rules should, at a minimum, prohibit the NRSROs
from rating RMBS without adequately evaluating the level of fraud, the sufficiency of
underwriting standards and concentration of high-risk products in an RMBS pool. The
RrlvnN & DaNE p r r c
ChristopheCr ox
Page 5
SECs houlda lsor equiret hat the NRSROsm aintaina ndp rovided ocumentsto the SEC
sufficientt o demonstratteh at theyh avea dequatelcyo nsideredfr aud,u nderwriting
standardas ndc oncentratioonf high-riskp roductsa sa part of their rating. l5 U.S.C.
$ 78o-7(a)(1)(B)(x).
TheN CRC looksf orwardt o workingw ith the SECo n thesei ssues.B y working
togethert,h e SECa ndt he NCRC cann ot only ensureth att he purposeo f the Act is
fulfrlled, but that communities across the country will be better served by the credit rating
system.W e will be contactingy our office to setu p a meetingt o discussth e NCRC’s
Cc: John Taylor, President and CEO, NCRC
David Berenbaum. Executive Vice President. NCRC
.4 /’t)
/’/ f- / (, (_ l-r/(–. –
Jolfn P. Relman
Bradley H. Blower
Counsel to the NCRC
Structured Finance

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