REQUIRED READING: Albert Einstein is credited with saying that "the definition of insanity is doing the same thing over and over and expecting different results." The due-diligence process used by the secondary mortgage market is a terrific example of Einstein’s definition. For the past 20-plus years, lenders and investment bankers that have sought to securitize loans have made representations and warranties based on a process that has proven, over and over again, to be flawed in epidemic proportions.
Despite evidence that the due-diligence process has been ineffective for the past two decades, little has changed. The industry is missing a great opportunity to restructure and reform the process. Doing so would require a new way of thinking about and approaching due diligence, but the rewards would be great in terms of reduced risk, time and cost.
Lawsuits by investors, insurers and other victims of the mortgage meltdown have prompted comprehensive studies on the loans contained in mortgage securitizations. Those studies show that as many as 75% of the loans in the securitizations failed to adhere to the guidelines for which the security was warranted. Yet the due-diligence process that was intended to protect investors continued to provide positive statements about these pools.
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