Rogues of Wall Street

CHAPTER 6 The Mortgage Mess

In January 2013, the US Justice Department slapped Standard & Poor's with a civil law suit for fraud,¹ accusing the credit rating agency of inflating the ratings of securitized mortgage products in the years leading up to the 2008 Financial Crisis. However, the beginnings of the mortgage mess trace back to 2006 and 2007 and some of the key risk indicators that, in retrospect, should have been cause for greater circumspection on the part of some risk managers.

Much of the criticism aimed at Wall Street at the time of the financial crisis and since has been related to its role in the mortgage industry. Creating and trading in securities consisting of groups of mortgages had become a major profit center for banks. It was in no small part the critique of this particular activity that led to the Volcker rule and the proposal to ban proprietary trading for investment banks.

Mortgage Securitization

The key to the mortgage growth or securitization lay in the fact that the greatest risk for a bank is the credit risk it takes on when it executes its basic function—lending money to clients. The implosion of the savings and loans industry was largely due to the large number of loan defaults in the 1980s. After this, broadly speaking, there was no longer the same readiness amongst financial institutions to take over the singular risk of lending money to individuals for the means of purchasing a house. Securitization, then, became a primary means by which ...