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 Arrigo, an expert witness, and healthcare executive, brings four decades of experience in the software, financial services, and healthcare industries. In 2000, Mr. Arrigo founded No World Borders, a healthcare data, regulations, and economics firm with clients in the pharmaceutical, medical device, hospital, surgical center, physician group, diagnostic imaging, genetic testing, health I.T., and health insurance markets. His expertise spans the federal health programs Medicare and Medicaid and private insurance. He advises Medicare Advantage Organizations that provide health insurance under Part C of the Medicare Act. Mr. Arrigo serves as an expert witness regarding medical coding and billing, fraud damages, and electronic health record software for the U.S. Department of Justice. He has valued well over $1 billion in medical billings in personal injury liens, malpractice, and insurance fraud cases. The U.S. Court of Appeals considered Mr. Arrigo's opinion regarding loss amounts, vacating, and remanding sentencing in a fraud case. Mr. Arrigo provides expertise in the Medicare Secondary Payer Act, Medicare LCDs, anti-trust litigation, medical intellectual property and trade secrets, HIPAA privacy, health care electronic claim data Standards, physician compensation, Anti-Kickback Statute, Stark law, the Affordable Care Act, False Claims Act, and the ARRA HITECH Act. Arrigo advises investors on merger and acquisition (M&A) diligence in the healthcare industry on transactions cumulatively valued at over $1 billion. Mr. Arrigo spent over ten years in Silicon Valley software firms in roles from Product Manager to CEO. He was product manager for a leading-edge database technology joint venture that became commercialized as Microsoft SQL Server, Vice President of Marketing for a software company when it grew from under $2 million in revenue to a $50 million acquisition by a company now merged into Cincom Systems, hired by private equity investors to serve as Vice President of Marketing for a secure email software company until its acquisition and multi $million investor exit by a company now merged into Axway Software S.A. (Euronext: AXW.PA), and CEO of one of the first cloud-based billing software companies, licensing its technology to Citrix Systems (NASDAQ: CTXS). Later, before entering the healthcare industry, he joined Fortune 500 company Fidelity National Financial (NYSE: FNF) as a Vice President, overseeing eCommerce solutions for the mortgage banking industry. While serving as a Vice President at Fortune 500 company First American Financial (NYSE: FAF), he oversaw eCommerce and regulatory compliance technology initiatives for the top ten mortgage banks and led the Sarbanes Oxley Act Section 302 internal controls I.T. audit for the company, supporting Section 404 of the Sarbanes Oxley Act. Mr. Arrigo earned his Bachelor of Science in Business Administration from the University of Southern California. Before that, he studied computer science, statistics, and economics at the University of California, Irvine. His post-graduate studies include biomedical ethics at Harvard Medical School, biomedical informatics at Stanford Medical School, blockchain and crypto-economics at the Massachusetts Institute of Technology, and training as a Certified Professional Medical Auditor (CPMA). Mr. Arrigo is qualified to serve as a director due to his experience in healthcare data, regulations, and economics, his leadership roles in software and financial services public companies, and his healthcare M&A diligence and public company regulatory experience. Mr. Arrigo is quoted in The Wall Street Journal, Fortune Magazine, Kaiser Health News, Consumer Affairs, National Public Radio (NPR), NBC News Houston, USA Today / Milwaukee Journal Sentinel, Medical Economics, Capitol ForumThe Daily Beast, the Lund Report, Inside Higher Ed, New England Psychologist, and other press and media outlets. He authored a peer-reviewed article regarding clinical documentation quality to support accurate medical coding, billing, and good patient care, published by Healthcare Financial Management Association (HFMA) and published in Healthcare I.T. News. Mr. Arrigo serves as a member of the board of directors of a publicly traded company in the healthcare and data analytics industry, where his duties include: member, audit committee; chair, compensation committee; member, special committee.

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