January 13, 2010
To: SEC Investor Advisory Committee
From: Robert E. Rothstein
As a licensed real estate professional for nearly 40 years, I have had the privilege of serving as an agent, broker, appraiser, development consultant, expert witness for litigation support, and in recent years as a risk analyst, developing tools that accurately forecast risk to RMBS investors by as much as three to five years in advance.
From this perspective, the following comments are respectfully submitted to the Investor Advisory Committee for consideration:
1. Given that a) the collapse of the US economy began with losses suffered by Residential Mortgage-Backed Securities (RMBS) investors, and b) the residential real estate industry represents among the largest components of the US economy, it will be difficult to engineer a substantive or sustainable economic turn around without first solving the problems of risk management for RMBS investors.
2. Systemic resistance to implementing risk forecasting tools that would provide accuracy and adequate disclosure exists within the mortgage banking industry at virtually all levels, from origination to securitization. Resistance is even evident within the some of the regulatory agencies, as well.
3. Resistance within the banking industry stems from several sources, but banks have profited handsomely by trading on the trust of private and institutional investors and passing blind, mismanaged and mislabeled risk upstream to RMBS investors.
Any change to the business methods of the past decade will mean a disruption in the flow of capital from mortgage banking. However, to a large extent, even though the private sector no longer invests in mortgage backed securities, so long as government subsidy exists to prop up the real estate markets around the US by buying GSE-produced mortgage securities, there will be little incentive for banks to change their practices.
4. Following many personal meetings and phone conferences over this past year with board members or senior management of ABA (bankers), MBA (mortgage bankers), and NAR (Realtors), as well as NRSROs and state and federal regulatory agency management and staff, it is very clear that industry opposition will make it difficult or maybe impossible for the SEC and other regulatory agencies to pass rules to protect RMBS investors unless the investors demand the necessary changes.
5. One potential answer is to compel the use of Collateral Risk Scoring for residential mortgage loan packages prior to their purchase by RMBS investors. This would be similar to Credit Risk Scoring (i.e. FICO) but primarily applies to the property and loan package. Unfortunately, without being compelled to do so, banks will refuse to use Collateral Risk Scores.
Collateral Risk Scoring may eventually be done at the NRSRO level. However, at the present time it is possible to do this at the point of loan origination using tools that I have developed. These risk forecasting tools have been granted two US patents, validated by an independent actuary for mathematical integrity, successfully applied during expert testimony in court and mediation venues and refined over more than two decades of field application.
6. In conjunction with the Realtor MLS in Phoenix, AZ, we have a pilot Collateral Risk Scoring service (CRS) currently available for use. The members of the Commission are invited to test the system at their convenience.
7. This CRS system would require about $25 million and 90 days to set up in markets that comprise some 65% of the countrys population, and would be self sufficient within the first year via a $30 fee paid by mortgage consumers at the time of application.
With some added modeling, these tools can also be used to identify certain types of mortgage fraud at the time of loan application, versus months after a fraudulent loan is closed and the funds and criminals gone.
8. I would be pleased to discuss in further detail with the Advisory Committee, the SEC or others, implementation of the tools in markets outside of Phoenix.
This past August, the SEC was kind enough to invite me to their Washington DC office for a discussion of ways to apply the patented tools to forecast mortgage risk and protect RMBS investors. I was honored to meet with a group of very bright and dedicated professionals from two divisions of the SEC.
I laud the Securities and Exchange Commission for their efforts to take substantive steps to protect securities investors and rid the mortgage investment arena of systemic weaknesses.
I thank you for the opportunity to communicate these ideas and welcome your comments or questions.
(Please cut and paste link into browser if clicking doesn't open the web page)
Collateral Risk Scoring
Accurate and transparent risk forecasting for mortgage lenders, insurers, regulatory agencies RMBS investors
Grade long term risk to mortgage investors as loans are originated
Stress test mortgages currently held in portfolio to identify relative risk of loss
Add flexibility to mortgage originations when restrictive underwriting creates a brittle climate
Screen for mortgage fraud at the time of application
Validation study (05/09): http://housingupdate.com/valid2/msi-validation052409.pdf
Support letters from industry and government: http://housingupdate.com/riskletters/
Registration for pilot project running in conjunction with the Phoenix Realtors:
Produce a risk report for a loan application. Grading of existing loan portfolios can be undertaken via consulting agreement