The allegations are pretty simple. As part of each securitization, Goldman had to produce a registration statement and prospectus. In theory, as any investor knows, you are supposed to read the prospectus before buying a security. The claim is that these statements and prospectuses (someone help me with that plural) contained false statements regarding the underwriting standards used when making the underlying mortgages. The bulk of the complaint (pages 12-28) goes originator by originator and compares the statements made about that originator’s lending practices in the prospectus to information that has since emerged about how these lenders actually made loans.
One thing that struck me was how open these prospectuses were about what was going on. For example, here’s a passage on Countrywide’s “no income/no asset” loans:
Under the Streamlined Documentation Program, appraisals are obtained only if the loan amount of the loan being refinanced had a Loan-to-Value Ratio at the time of origination in excess of 80% or if the loan amount of the new loan being originated is greater than $650,000. In addition, under the Streamlined Documentation Program, a credit report is obtained but only a limited credit review is conducted, no income or asset verification is required, and telephonic verification of employment is permitted. the maximum Loan-to-Value Ratio under the Streamlined Documentation Program ranges up to 95%. [. . .]
Under the Stated Income/Stated Asset Documentation Program, the mortgage loan application is reviewed to determine that the stated income is reasonable for the borrower’s employment and that the stated assets are consistent with the borrower’s income. The Stated Income/Stated Asset Documentation Program permits maximum Loan-to-Value Ratios up to 90%.
And so on and so on. Then there are other originators for whom Goldman used language such as the following:
SunTrust underwriting guidelines are designed to evaluate the borrower’s capacity to repay the loan, to evaluate the credit history of the borrower, to verity the availability of funds required for closing and cash reserves for fully documented loans, and to evaluate the acceptability and marketability of the property to be used as collateral. SunTrust may consider a loan to have met underwriting guidelines where specific criteria or documentation are not met if, upon analyzing the overall qualitative evaluationg of the loan package, there are acceptable compensating factors that can be used.
I love that phrase, “are designed to evaluate.” Strictly speaking, it means ” our underwriting guidelines are meant to evaluate ability to repay, but they may not . . . and sometimes we don’t follow them anyway.”
I quote these things at length because they go to an issue I’ve discussed before: who is to blame? Originators because they told Goldman they were applying underwriting standards that they weren’t in fact applying? Goldman because it knew the originators weren’t applying those standards but pretended it didn’t know in the prospectuses? Or investors because the prospectuses said exactly what was going on (“no income or asset verification is required . . . SunTrust may consider a loan to have met underwriting guidelines where specific criteria or documentation are not met”) and they bought the securities anyway?
Plaintiffs conclude, “The massive foreclosure rate and extraordinary delinquencies have further confirmed defendants’ misrepresentations concerning the lending practices detailed above.” But this is not strictly true. Massive foreclosures and extraordinary delinquencies are completely consistent with the lax lending practices detailed openly in the prospectuses themselves. But this doesn’t mean that plaintiffs don’t have a case: all they have to prove is that actual underwriting standards did not even live up to the descriptions in the prospectuses, which may turn out to be true.