Investors Beware: Flaws in the Residential Mortgage Securitization Process

Abstract

This article focuses on some of the less discussed flaws in the securitization process. In particular, the authors focus on: 1) the enforcement of representation and warranty violations, 2) defects in the deal closing process, and 3) defective transaction surveillance and reporting. The authors make the case that, even if you knew the prepayment rates, default transition rates and severities, you could not necessarily determine the cash flows and hence the yield on the security. Even if the deal modeling is correct (and, as the authors have shown, there can be issues) and the documents are internally consistent, there is a total lack of transparency in reporting on modifications and liquidations. More irritating, it is very difficult to tie out the cash coming into the deal with what is actually distributed to investors.