MBS Transparency: Devil in the Detail of Free Writing Prospectus & XBRL

Finding the Devil in the Detail of Financial Statements

It has often been said that “the devil is in the detail.”  Somewhere, buried among all the data in mortgage backed securities (MBS) lie the devils that destroyed the American economy.  Every issuer of MBS which are really pools of residential or commercial loans packaged together and sold as a single asset—is required to file a free writing prospectus (FWP), which lists the detail about every mortgage in the pool.

Dissecting the Non-Standard Free Writing Prospectus (FWP)

An FWP contains endless columns of pure data, most of which don’t even track from page to page. And each FWP is different: The banks have no uniform information that they’re required to present in their filing. Even issuers do report the same data, they use entirely different languages.

As a loan moves through the many participants in the MBS supply chain, each member of the chain — originators, retail banks, wholesale banks, issuers, servicers and ratings agencies — decides what to report publicly and when to report it.

The participants report different formats, data labels (or tags), different ways of tracking the status of the collateral and even different models for tracking the identity of the individual loans.  Therefore, a loan can receive as many as five unique IDs between its origination and when it is bundled into an MBS. There has been no centralized regulator that validates or collects all of this data. There is no central repository that can be queried.  Therefore, it is difficult to track the status of a single loan in an MBS — even if it is in default — because each participant has different and disconnected components of the data.

One of the only ways to assess the devil of risk hiding in the detail is to build a spreadsheet identifies in a common format the risk (and therefore quality) of the individual loans pooled into an MBS, giving  the ability to evaluate loan location, borrower’s proof of income, interest rate, appraisal value, pre-payment risk, credit score, etc.   If you were willing to do your homework in such a way on hundreds or perhaps thousands of loans, you could then compare the FWPs in a way that would have been nearly impossible before.   And, if you had done this early enough – say, 2007 – you could have seen a nationwide crisis in the making.   As adjustable-rate mortgage rates ballooned, countless home-owners would default on their loans, rending the securities built on them worthless.

Lack of Transparency Created Advantages for a Few

Those who did their homework in 2007 did not share their findings because they wanted a trading edge. If more people had access to the same data-crunching tools, this crisis could have perhaps been mitigated if not avoided: Risky MBS could have been exposed, and banks would want to protect their reputations and stop offering them. With complete data including much more frequent sharing of loan status, the market may have self-regulated as risk-fearing investors fled from firms holding or issuing the risky securities.

Technology and Process Can Enable Transparency

Hypothetically, if all businesses used XML to tag their every move, from each car sold by GM to every MBS held by AIG, companies would not be able to keep investors in the dark as easily the way Enron did.  The Sarbanes Oxley legislation was aimed at holding executives accountable and providing stimulus to “application controls” and “general controls” on technology to ensure accuracy.  However SOX does not address transparency in reporting.

Enter XBRL, a set of tags that standardizes financial information. XBRL completes the picture and picks up where SOX regulations end.  XBRL was conceptualized by an accountant in 1998 as a way  automate tedious reporting auditing processes.  Today, handfuls of companies report their information in XBRL to the SEC, the real power will be realized only when all companies use it to track of report their numbers to investors and regulators.

When regulators required filings in XBRL it found that the time it took auditors to review a bank’s quarterly financial information dropped from about 70 days to two.

In December 2008, the SEC announced that by June, 2009 every company with a market capitalization over $5 billion is required to submit all filings XBRL. And publicly traded companies and mutual funds must follow by 2011.   In the end, every investor will have the same ability as  a hedge fund manager to export, manipulate, aggregate and analyze financial data. Blogs changed news reporting because now anyone can be is a reporter. With XBRL, anyone can be a financial analyst.

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Michael F. Arrigo

Michael is Managing Partner & CEO of No World Borders, a leading healthcare management and IT consulting firm. He serves as an expert witness in Federal and State Court and was recently ruled as an expert by a 9th Circuit Federal Judge. He serves as a patent expert witness on intellectual property disputes, both as a Technical Expert and a Damages expert. His vision for the firm is to continue acquisition of skills and technology that support the intersection of clinical data and administrative health data where the eligibility for medically necessary care is determined. He leads a team that provides litigation consulting as well as advisory regarding medical coding, medical billing, medical bill review and HIPAA Privacy and Security best practices for healthcare clients, Meaningful Use of Electronic Health Records. He advises legal teams as an expert witness in HIPAA Privacy and Security, medical coding and billing and usual and customary cost of care, the Affordable Care Act and benefits enrollment, white collar crime, False Claims Act, Anti-Kickback, Stark Law, physician compensation, Insurance bad faith, payor-provider disputes, ERISA plan-third-party administrator disputes, third-party liability, and the Medicare Secondary Payer Act (MSPA) MMSEA Section 111 reporting. He uses these skills in disputes regarding the valuation of pharmaceuticals and drug costs and in the review and audit of pain management and opioid prescribers under state Standards and the Controlled Substances Act. He consults to venture capital and private equity firms on mHealth, Cloud Computing in Healthcare, and Software as a Service. He advises ERISA self-insured employers on cost of care and regulations. Arrigo was recently retained by the U.S. Department of Justice (DOJ) regarding a significant false claims act investigation. He has provided opinions on over $1 billion in health care claims and due diligence on over $8 billion in healthcare mergers and acquisitions. Education: UC Irvine - Economics and Computer Science, University of Southern California - Business, studies at Stanford Medical School - Biomedical Informatics, studies at Harvard Medical School - Bioethics. Trained in over 10 medical specialties in medical billing and coding. Trained by U.S. Patent and Trademark Office (USPTO) and PTAB Judges on patent statutes, rules and case law (as a non-attorney to better advise clients on Technical and Damages aspects of patent construction and claims). Mr. Arrigo has been interviewed quoted in the Wall Street Journal, New York Times, and National Public Radio, Fortune, KNX 1070 Radio, Kaiser Health News, NBC Television News, The Capitol Forum and other media outlets. See https://www.noworldborders.com/news/ and https://www.noworldborders.com/clients/ for more about the company.

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