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risk?’” Johnson recalled. The agencies thought the due diligence firm’s data were
“great,” but they did not want the information, Johnson said, because it would pre-
sumably produce lower ratings for the securitizations and cost the agency business—
even in , as the private securitization market was winding down.
When securitizers did kick loans out of the pools, some originators simply put
them into new pools, presumably in hopes that those loans would not be captured in
the next pool’s sampling. The examiner’s report for New Century Financial’s bank-
ruptcy describes such a practice. Similarly, Fremont Investment & Loan had a pol-
icy of putting loans into subsequent pools until they were kicked out three times, the
company’s former regulatory compliance and risk manager, Roger Ehrnman, told the
FCIC. As Johnson described the practice to the FCIC, this was the “three strikes,
you’re out rule.”
Some mortgage securitizers did their own due diligence, but seemed to devote
only limited resources to it. At Morgan Stanley, the head of due diligence was based
not in New York but rather in Boca Raton, Florida. He had, at any one time, two to
five individuals reporting to him directly—and they were actually employees of a per-
sonnel consultant, Equinox. Deutsche Bank and JP Morgan likewise also had only
small due diligence teams.
Banks did not necessarily have better processes for monitoring the mortgages that
they purchased. At an FCIC hearing on the mortgage business, Richard Bowen, a
whistleblower who had been a senior vice president at CitiFinancial Mortgage in
charge of a staff of -plus professional underwriters, testified that his team con-
ducted quality assurance checks on the loans bought by Citigroup from a network of
lenders, including both subprime mortgages that Citigroup intended to hold and
prime mortgages that it intended to sell to Fannie Mae and Freddie Mac.
For subprime purchases, Bowen’s team would review the physical credit file of the
loans they were purchasing. “During and , I witnessed many changes to the
way the credit risk was being evaluated for these pools during the purchase
processes,” Bowen said. For example, he said, the chief risk officer in Citigroup’s Con-
sumer Lending business reversed large numbers of underwriting decisions from
“turn down” to “approved.”
Another part of Bowen’s charge was to supervise the purchase of roughly bil-
lion annually in prime loan pools, a high percentage of which were sold to Fannie
Mae and Freddie Mac for securitization. The sampling provided to Bowen’s staff for
quality control was supposed to include at least of the loan pool for a given secu-
ritization, but “this corporate mandate was usually ignored.” Samples of were
more likely, and the loan samples that Bowen’s group did examine showed extremely
high rates of noncompliance. “At the time that I became involved, which was early to
mid-, we identified that to percent of the files either had a ‘disagree’ deci-
sion, or they were missing critical documents.”
Bowen repeatedly expressed concerns to his direct supervisor and company exec-
utives about the quality and underwriting of mortgages that CitiMortgage purchased
and then sold to the GSEs. As discussed in a later chapter, the GSEs would later re-
