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They Really Did Know the Loans Were Bad…

posted by Ethan Cohen-Cole

A firm which few know of – Clayton holdings—will likely soon be at the center of a wide variety of lawsuits and individual complaints. Clayton’s job was to validate the innards of mortgage backed securities (MBS) when made available for sale. The typical setup would have an issuer of a MBS call Clayton and ask them to take a 10 percent sample of the loans, and evaluate whether the loans met the portfolio criteria (had documents been filed, credit scores as reported, etc.). If the loans were incorrect, they could either be taken from the pool and replaced with a good one, an exception made, or a substitute placed into the sample and evaluated instead.

Clayton holdings staff testified last month that 255,802 mortgages out of 911,000 evaluated did not meet portfolio screening criteria. The bank underwriters waived more than 100,000 of them (>39%); that is, even though the mortgages failed the criteria, the banks included them in the MBS pools anyway.

So much for the idea that the issuers didn’t know the loans were bad…


The procedures Clayton followed to review loans is described in detail in the book "Chain of Blame". Without getting into details, Clayton allegedy employed independent contractors, some of whom had little experience and training, and its supervisors then allegeldy pressured the contractors into not finding problems with the loans they were reviewing. If that's true, then the percentage of loans that did not meet portfolio screening criteria is probably much higher than the reported percentage.

Good thing for Clayton that it was granted both civil and criminal immunity (if memory serves) in exchange for it's testimony...

There's an obvious flaw in the Clayton sampling method. If a loan got kicked out of one deal, it would just be placed in another. The chance that a loan would get kicked out of 3 deals was .1% (10%*10%*10%). With diligence like this, there was never a loan that couldn't find a home.

The problem seen in the post is that certain people are employed by Clayton into doing a job that they have less experience in and as a result they have problems with regards to the result of that specific task.

As an ex banker- I suggest you read all the details on clayton b/cause there is a bit of misinfo out there. Beleive they and others were hired by their clients to examine data against UW guidlines and tolerances outside of guidelines- see the Clayton letter to FCIC. Their results at that time did not differentiate between the two. Tolerances increassed over time as guidelines went down. So a tolerance violation (excpetion) is not a UW guidleine violation (exception)per se....which makes Clayton's info much less valuable than one might think (on its face). In case you were unaware this story is three years old.

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