"it had postponed a planned launch of a new index tracking against prime RMBS."

From Paul Jackson on Housingwire:

"It was such a small press statement, but one imbued with indelible meaning — Markit, the financial technology firm that manages indices for the subprime and commercial mortgage securities markets, said earlier this week that it had postponed a planned launch of a new index tracking against prime RMBS.

“Following extensive discussions with major market participants, plans to launch a synthetic U.S. prime mortgage-backed securities index have been put on hold,” [1] the statement read. “The potential benefits of the proposed index will be re-assessed in 2009.”

That’s it. But there is much more behind the words, when you consider that synthetic credit indices have been assailed this year by critics who say the derivatives trading powered by them helped push the financial markets to the brink of outright disaster in this past year( DON'T AGREE ). In the case of the subprime market, Markit’s ABX index was launched in 2006 to track the private-party subprime RMBS market — and it allowed some hedge funds an easy mechanism to short the market for subprime mortgages( SOMEBODY HAD TO TAKE THE OTHER PART OF THE TRADE, DIDN'T THEY? ).

We’ve covered the ABX here extensively at HousingWire in the past 12 months. [2] See earlier coverage.

Critics say that enabled a crash, while fund managers say they were simply using the industry’s first transparent tool to make bets on mortgages they knew were bad. “The derivatives trade here worked in both directions, it goes both ways,” said one trader that spoke with HW, but asked not to be identified. “Those saying we’re being too pessimistic can always trade with their optimism, if they felt inclined to do so.” ( THAT'S TRUE )

[3] TheStreet.com’s Dan Freed has much more on the delay at Markit, suggesting that the delay came as regulators expressed concerns about putting a “weapon of mass destruction” into play in the prime mortgage market. ( BY SHOWING REALITY? )

“Financial companies around the world … collectively hold trillions of dollars worth of prime mortgage securities on their books, but they have a great deal of latitude( FUDGING ) in how they price them,” Freed writes in the story. “A prime mortgage index would take away a lot of this latitude, as banks carrying mortgages on their books at a significantly higher price than the index would have a lot of explaining to do to their auditors. That could lead to new writedowns on a massive scale.” ( WOW )

Market critics have suggested recently that the ABX has become a victim of a classic “macroeconomic short,” meaning that the value of the securities has been pushed well below their actual value( THAT'S THE OPPOSITE OF THE SCENARIO ABOVE, ISN'T IT ? SO SUBPRIME ARE BELOW AND PRIME ARE HIGHER THAN THEIR ACTUAL VAKUE? ) based on default rates and expected cash-flows. At least one hedge fund, T2 Partners LLC, has come out publicly and said it is [4] snapping up subprime RMBS wherever it can( WHERE IS IT DOING THIS AND HOW? IT'S ACTUALLY A GOOD SIGN ), based on this premise. Of course, only time will tell if the bet is well-timed or not — but the point here is that primary dealers are clearly worried about messing with the mechanics of a prime mortgage market that is already facing challenges of its own in recent weeks.

And, compared to subprime, the prime securitized mortgage market is BIG one, too. The securitization rate for loans originated in the first three quarters of 2008 rose to 78 percent, up from 74 percent in the year-ago period and 61 percent in 2001, according to a Bloomberg report Friday morning that cited data from industry newsletter Inside MBS & ABS (no link available, yet). In other words: the originate-and-sell model is alive and well in prime markets( SOME PEOPLE ARE PREDICTING ITS DEMISE. NOT ME ), and establishing a synthetic index could provide leverage for exposure that no primary dealer is likely to be comfortable with( THAT'S NOT A GOOD SIGN, IS IT? ).

TheStreet.com’s Freed notes that there is no confirmation as of yet as to whether regulators are involved in the index or not. But here’s guessing that the rollout of this particular Markit index will meet much more scrutiny than its subprime cousin( SCRUTINY, WHICH I CALL OBSERVATION, IS WHAT THEY SHOULD BE DOING )."

This is a very interesting post.

"The case underscores the potential for growing litigation that centers on the role of issuers and disclosures made to investors"

Here's some good news from my perspective, from Paul Jackson on Housingwire:

"The mortgage litigation machine is now turning its attention towards RMBS issuers as investors allege fraud and misrepresentation by firms that sold off loans into securitization trusts, with a new putative class-action suit filed Thursday in New York against Goldman Sachs Group Inc. (GS: 67.74 -2.83%) and some of the firm’s individual directors. The case, filed in Southern District Court in New York on Dec. 11 by the San Diego-based law firm of Coughlin Stoia Geller Rudman & Robbins LLP, a well-known securities litigation firm, argues that Goldman made false statements or omitted key information regarding the nature of the mortgages it sold into 17 different trusts during 2007."

The lead plaintiff in the case is a pension fund administered by NECA-IBEW, an electrician’s labor union that purchased securities in the deals in question, and has since seen the value of investments plummet.

The case underscores the potential for growing litigation that centers on the role of issuers and disclosures made to investors, regarding loans that were often originated by monoline mortgage bankers and commercial banks and then sold to the issuing party for securitization; it also underscores the often complex relationships that exist between mortgage originators and participants in the secondary market.

In the Goldman case, NECA-IBEW alleges that Goldman misled investors on the underwriting standards used by various originators, including — who else? — Countrywide Financial; other claims center on the use of inflated appraisals by originating entities for the trusts. Many of the loans in the trusts named in the lawsuit are of the reduced-doc, no-doc, stated-income variety, which NECA-IBEW says are rife with fraud.

“The lenders or lenders’ agents knew that the borrowers either could not provide the required documentation or the borrowers refused to provide it,” the complaint read in part.

“The underwriting, quality control, and due diligence practices and policies utilized in connection with the approval and funding of the mortgage loans were so weak that borrowers were being extended loans based on stated income … with purported income amounts that could not possibly be reconciled with the jobs claims on the loan application or through a check of free “online” salary databases.”

Read the full complaint.

A wave of litigation
For Coughlin Stoia et al, the law firm in San Diego, the case is the second such high-profile class-action suit brought against a secondary mortgage market issuer this year. In October, the firm also sued Citigroup Inc. (C: 7.70 +1.72%) and its mortgage units on behalf of a retirement fund managed by Ann Arbor, Michigan, under similar claims.

In the Goldman case, very few of the mortgages were actually originated by the Wall Street firm itself — instead, mortgages were either originated by companies including Countrywide Financial, American Mortgage Network, Fifth Third Mortgage, and Green Point and then sold to Goldman, or funneled to the issuer via conduit lending channels. Investors in both lawsuits against Citi and Goldman claim that weak quality control by issuers and rampant fraud by third-party brokers and borrowers misled investors as to what was being bought.

The cases also underscore just how far the mortgage securities mess reaches, even in the United States, where many of the firms purchasing AAA-rated mortgage securities were municipalities and pension funds.

Bank of America Corp. (BAC: 14.93 +0.13%) agreed to a settlement on Oct. 6 with fifteeen state attorneys general over claims of predatory lending by Countrywide, in a deal that will see the nation’s largest lender and servicer modify as many as 400,000 loans. That loan modification agreement led to a separate lawsuit from investors, alleging that Countrywide’s pooling and servicing agreements with investors did not permit mass-scale loan modifications unless Bank of America purchased each modified loan out of a securitized pool at par value.

While the claims are different across cases, it’s clear that investors aren’t taking the loss of their investments lying down. And legal experts that spoke with HousingWire have said, emphatically, to expect a wave of litigation surrounding secondary mortgage market contracts in the next year.

“Prosecutors will not be wanting for work, or lacking in class-action claims,” said one source, an attorney that asked not to be identified in this story.

It’s unclear what sort of liability Goldman, or likely other issuers as well, may face as a result of suits surrounding its issuance practices for RMBS deals. But experts have suggested that fraud in Alt-A loans originated during recent years is overwhelmingly common.

“Our data point to the likelihood that a significant number of the loans originated between 2002 and 2008 are ticking time bombs,” said Ann Fulmer, a vice president at fraud detection specialist Interthinx. “When they explode, the costs will be overwhelming.”

In October, Fulmer warned of an “ominous” outcome for existing mortgages. Despite tightened underwriting standards and low origination volumes, misrepresentation indicators for loans reviewed in 2007 averaged 22.54 percent of all loans from the top ten fraud-heavy states, she said.

An Interthinx study of applications originated in the last half of 2007 showed that over 42,000 — representing $11 billion — contained materially misstated borrower income. Potential misrepresentation rates are rising, as well, the company said, accounting for nearly 24 percent of loans reviewed in 2008. Fulmer said the rising incidence fo fraud, even in a down market, tends to reflect the desperation of sellers, over-mortgaged borrowers, commission-starved mortgage professionals as well as nouveau “investors” trying to cash in on foreclosed properties — and, of course, ever-present criminal profiteers.

Write to Paul Jackson at paul.jackson@housingwire.com.