Asset Quality Misrepresentation by Financial Intermediaries: Evidence from the RMBS Market

We document that contractual disclosures by intermediaries during the sale of mortgages contained false information about the borrower's housing equity in 7–14% of loans. The rate of misrepresented loan default was 70% higher than for similar loans. These misrepresentations likely occurred late in the intermediation and exist among securities sold by all reputable intermediaries. Investors — including large institutions — holding securities with misrepresented collateral suffered severe losses due to loan defaults, price declines, and ratings downgrades. Pools with misrepresentations were not issued at a discount. Misrepresentation on another easy-to-quantify dimension shows that these effects are a conservative lower bound.