Mortgage Securities Fraud? We Shall See

The stock market has been tumbling since announcements by HSBC and other banks that there is great concern about exposure to subprime mortgage defaults. Could this be the beginning of a potential giant mortgage securities fraud investigation? Maybe.

Subprime mortgages are loans given to potential home buyers who are not creditworthy or have almost no cash to put down as collateral. According to some reports, up to 35 percent of all mortgage securities issued in 2006 were of the subprime variety which to us seems very high.

These subprime mortgages are then packaged with investment grade mortgages and sold as securities by banks to investors. The loan originators, banks, attorneys and everyone else who is involved have been reaping huge returns in recent years on mortgage securities. However, owners of pooled mortgage securities only mark the securities to market when a rating agency changes its rating. There are whispers on the Street that institutional investors may be reporting inflated values for their pooled mortgage securities.

The risky mortgage bond market is in a free fall. New Century, a major subprime mortgage lender that does business with HSBC, Morgan Stanley, CitiGroup and Goldman Sachs is on the brink of bankruptcy, has all but been delisted by the NYSE and is being investigated by the SEC.

But where is the mortgage securities fraud you ask? If the underlying subprime mortgages that make up a tranche of a CDO or other mortgage backed security were issued in a fraudulent manner. And the banks and brokerage firms who sold the security to an institution did not do their due diligence on said loans when they were included in the pooled mortgage security. The banks and brokerage firms may be exposed to potential legal claims. We shall see how it all plays out.