Subprime Mortgage Lender Gets Its Day in Court
The economic fallout from the collapsed housing market has already begun to show itself, but the legal issues have hardly begun to emerge. New Century Financial Corp, which was once the nation's second-largest subprime lender, filed bankruptcy last year. NPR reports that a court-appointed examiner of New Century's bankruptcy case has brought to light appalling (and possibly criminal) business practices.
The 500-page report apparently details New Century's operational methods during the peak of the housing boom and goes so far as to suggest that the company's lending practices show the credit crisis in its embryonic form - that is, New Century's business practices constitute the basis of why the economy is suffering so much.
So what did New Century do?
Besides all the usual risky lender strategies that were typical of subprime lenders during the boom period (failing to verify borrower income, requiring no down payment, offering inappropriate loans, etc.), New Century allegedly engineered a shocking deal with investment banks.
According to the examiner's report, New Century had an arrangement with certain investment banks that allowed those banks to reject no more than 2.5% of the loans New Century originated. After being purchased by investment banks, loans were pooled, packaged and sold to investors on Wall Street.
It seems that, throughout the lending and investing process, players ignored the built-in protections meant to ensure that investors buy quality loans.
One woman formerly employed as a mortgage quality checker for a firm that sold loans to investment banks spoke to NPR about her experiences during the subprime lending boom. Though she rejected many loans because of insufficient income, a lack of income verification and other risk factors, her supervisors apparently overrode her decisions about 75% of the time, allowing the bad loans to enter the market en masse.
Testimony like this suggests that companies like New Century were more interested in the quantity of loans and the speed with which they could be originated, secured and sold on the secondary market than their quality.
And, according to one expert's analysis of the situation, speed would have been in the best interest of anyone who was knowingly engaging in mortgage fraud in order to earn big profits. In the short term, bad loans cannot be distinguished from good loans, meaning that as long as companies can "pass the trash," or keep selling the rotten loans to other investors, profits can be made.
But the bubble has burst: bad loans are being exposed as more and more families default on their mortgages and investors realize their investments are worthless. The New Century report showed that corruption existed throughout the company and within its privately contracted auditor, KPMG.
It seems KPMG, which was responsible for verifying the quality of New Century loans, was just as negligent in its oversight as New Century. What's more, evidence suggests that company executives were given millions of dollars in bonuses based on numbers from inaccurate accounting statements.
So what does all this mean for the companies involved?
Currently, the SEC (Securities Exchange Commission) and Department of Justice are investigating the behavior of New Century and KPMG. If evidence of fraud is found, criminal charges are likely, and all parties have the potential to be found liable for the massive financial losses plaguing the mortgage market today.
