Today I am still puzzled how easy real estate flippers came with false appraisals on overvalued land.
Step 1
The banks lent too much to the true value of the underlying security and the seller we went with the excess cash basis (often repeat the process as a buyer), then Seller in the next cycle.
Step 2
In the simple case of the lending bank has a strong interest in checking the accuracy of the estimate (or the hiring of its own reliable expert) has to borrowmoney on a land purchase and taking back a mortgage. Some argue that structured finance dilutes everyone's incentive to check for fraud. The argument notes that the bank sells the paper to a special purpose vehicle (SPV) and the SPV sell securities to investors.
Step3
The risk of fraud is borne by the investors who do not or cannot check on the validity of any appraisals. The investors rely on rating agencies to rate the default risk and the rating agencies are operating under Conflicts because they are paid by the SPV and receive consulting fees from the SPV. The bank (and the originating broker) and the SPV does not have to worry, because they take charge and take the risk.
Step4
The investors at the end holding the bag. The argument seems too simple. Most of the SPV to sell tranches and the lowest tier, the so-called equity tranche is not rated and very risky. Those who buy the equity, typically hedge funds, have an increased risk of loan defaults andshould, therefore, an increased incentive to monitor the quality of the loans.
In fact, one could argue that the equity buyers and a stronger incentive than a bank, will not sell the paper and check for the default risk of the loans, because the hedge funds have more risk with each standard. There have been long time rumors in the real estate market mirrors. Why did the hedge funds are not checked out the rumors, or at least the equity price of the rumors account? Moreover,many of the banks, which passed the risk to the SPV, SPV then bought shares in their own hedge funds (and these funds are now) in distress. Why did the banks do not have the right incentives to purchase the paper back to ensure that the paper, which was invested in the special purpose entities, they do sound was? In short, I will continue to be frustrated by the stories of easy money (also done by thugs) on real estate mirrors the country in the overvalued appraisals.