High & Low Finance: Court Case Offers a Peek Into Mortgage Security Pricing

The private mortgage-backed securities market grew to be a virtually inscrutable giant. Each securitization contained thousands of mortgages and as many as dozens of different securities, some of which could emerge unscathed even if others produced total losses for investors.

Five years after it began to blow up, that market can be seen as having failed twice — once before the housing crisis began and again when the crisis was at its peak. Investors put money into deals that never should have been financed, then they panicked when the credit crisis arrived and dumped securities that really were likely to pay off. A market that had been full of foolish buyers had no buyers. The banks loudly proclaimed that prices were irrationally low, but few if any of them were willing to buy.

It was the government that stepped in and saved the market, in a program — called PPIP, for Legacy Securities Public-Private Investment Program — that has turned out to be a success. The government put up most of the money to enable money managers to buy distressed merchandise. This week the Treasury Department reported that it had recovered all of the money it invested, with much more likely to come.

That report came a couple of days after the Justice Department and the Securities and Exchange Commission filed criminal and civil charges against a former securities salesman who was accused of defrauding the institutional investors who invested their own and the government’s money in the PPIP program. He did that, the government said, by lying to them.

Mortgage-backed securities “are generally illiquid and discovering a market price for them is difficult,” the S.E.C. said in its civil case against the broker, Jesse Litvak, who formerly worked for Jefferies Company. “Participants trading in the M.B.S. market must rely on informal sources, including their broker, for this information.”

How, I wondered, can that be? The corporate bond market used to be like that. But after Arthur Levitt, the S.E.C. chairman in the 1990s, complained, steps were taken to rectify the situation. Now you can learn from the Trace system operated by Finra, the Financial Industry Regulatory Authority, about trades in any bond.

But no one at Finra seems to have given the mortgage-backed securities market even a moment’s worth of attention until 2009, when the market crashed. Even then, it was not until 2011 that Finra began to require brokers to submit every trade. Now if the S.E.C. wants to see every trade in a particular security, it can do so.

But you and I cannot.

Starting in July, more information about trading in mortgage securities guaranteed by Fannie Mae and Freddie Mac will become available, which is good but not nearly as important. We already have a pretty good idea of how those securities trade. But private-label securities — backed only by the mortgages in each securitization — are different from one another, and it is not as easy to estimate the value of one based on trading in a different one.

Had trading data on such securities been public, institutional investors such as the ones that the government claims were defrauded would have been able to see the trades Jefferies made when it acquired the bonds it marked up and sold to them. Any lies, like those Mr. Litvak is accused of telling, would have been unmasked immediately.

The Dodd-Frank law, by the way, requires more disclosure of trades in all kinds of swaps, including swaps based on mortgage-backed securities, and those disclosures are starting to appear as the Commodity Futures Trading Commission writes rules. But that law completely ignored the mortgage-backed securities themselves, so trading in them remains secret.

Now that the S.E.C. and the Justice Department have officially asserted that investors in such securities are at the mercy of their brokers, perhaps they will press Finra to require release of the information.

Doing so would be almost costless, since the data is already being gathered.

But such a move would be fiercely resisted both by Wall Street and by some of the institutional investors that would be protected. The opposition from brokers is easy to understand: profit margins always fall when the customers have better information. The brokers have also persuaded some money managers to oppose release, on the ground that their strategies would be revealed if everyone could see that there was more activity in a particular type of security.

Floyd Norris comments on finance and the economy at nytimes.com/economix.

Article source: http://www.nytimes.com/2013/02/01/business/court-case-offers-a-peek-into-mortgage-security-pricing.html?partner=rss&emc=rss