This is Where Things Get Positively Evil

After the housing bubble, the credit crisis, and the foreclosure mess, is there something else looming out there to derail our financial system?

If you believe Felix, the answer is yes - and the money quote in this post's title comes from him:

You thought the foreclosure mess was bad? You’re right about that. But it gets so much worse once you start adding in a whole bunch of parallel messes in the world of mortgage bonds. For instance, as Tracy Alloway says, mortgage-bond documentation generally says that if more than a minuscule proportion of notes in a mortgage pool weren’t properly transferred, then the trustee for the bondholders can force the investment bank who put the deal together to repurchase the mortgages. And it’s looking very much as though none of the notes were properly transferred.

But that’s not even the biggest potential problem facing the investment banks who put these deals together. It also turns out that there’s a pretty strong case that they lied to the investors in many if not most of these deals.

Felix trots out a report by Clayton Holdings that shows the high percentage of mortgages that weren't passing underwriting standards. These were mortgages destined to be part of Mortgage Backed Securities.

Felix points out that Clayton rejected more than half of a set of loans bound for a Citigroup MBS. Rejected sounds good until you realize that this was a mere sampling of the loans involved. Meaning if half of the sample was rejected - there's a very good chance that a similar percentage of the remaining loans deserved to be rejected.

Did this stop the deal?

NoOOooooo

Instead Citi leans on the sellers for a better price - and does the deal anyway. The billion dollar question is did Citi properly inform its investors of this highly important information adequately enough?

Here's Felix (emphasis in original):

Now here’s the scandal: the investors were never informed of the results of Clayton’s test. The investment banks were perfectly happy to ask for a discount on the loans when they found out how badly-underwritten the loan pool was. But they didn’t pass that discount on to investors, who were kept in the dark about that fact.

Investors? You may now contact the attorney of your choice.