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FINANCIAL CRISIS INQUIRY COMMISSION REPORT
By the end of , more than of all tranches of CDOs had been down-
graded. Moody’s downgraded nearly all of the Aaa and all of the Baa CDO
tranches. And, again, the downgrades were large—more than of Aaa CDO
bonds and more than of Baa CDO bonds were eventually downgraded to junk.
LEGAL REMEDIES: “ON THE BASIS OF THE INFORMATION”
The housing bust exposed the flaws in the mortgages that had been made and securi-
tized. After the crisis unfolded, those with exposure to mortgages and structured
products—including investors, financial firms, and private mortgage insurance
firms—closely examined the representations and warranties made by mortgage orig-
inators and securities issuers. When mortgages were securitized, sold, or insured,
certain representations and warranties were made to assure investors and insurers
that the mortgages met stated guidelines. As mortgage securities lost value, investors
found significant deficiencies in securitizers’ due diligence on the mortgage pools un-
derlying the mortgage-backed securities as well as in their disclosure about the char-
acteristics of those deals. As private mortgage insurance companies found similar
deficiencies in the loans they insured, they have denied claims to an unprecedented
extent.
Fannie and Freddie acquired or guaranteed millions of loans each year. They dele-
gated underwriting authority to originators subject to a legal agreement—representa-
tions and warranties—that the loans meet specified criteria. They then checked
samples of the loans to ensure that these representations and warranties were not
breached. If there was a breach and the loans were “ineligible” for purchase, the GSE
had the right to require the seller to buy back the loan—assuming, of course, that the
seller had not gone bankrupt.
As a result of such sampling, during the three years and eight months ending Au-
gust , , Freddie and Fannie required sellers to repurchase , loans total-
ing . billion. So far, Freddie has received . billion from sellers, and Fannie has
received . billion—a total of . billion. The amount put back is notable in
that it represents of billion in credit-related expenses recorded by the GSEs
since the beginning of through September .
In testing to ensure compliance with its standards, Freddie reviews a small per-
centage of performing loans and a high percentage of foreclosed loans (including
well over of all loans that default in the first two years). In total, Freddie re-
viewed . billion of loans (out of . trillion in loans acquired or guaranteed)
and found . billion to be ineligible, meaning they did not meet representations
and warranties.
Among the performing loans that were sampled, over time an increasing percent-
age were found to be ineligible, rising from for mortgages originated in to
in . Still, Freddie put back very few of these performing loans to the origina-
tors. Among mortgages originated from to , it found that of the delin-
quent loans were ineligible, as were of the loans in foreclosure. Most of these
were put back to originators—again, in cases in which the originators were still in op-
