Who do you believe?

I seem to be asking that question more and more. My latest instance concerns an article by Luigi Zingales.  He reports on a paper by three economists which seems to show that mortgage fraud was endemic to the financial industry.

The paper compares the characteristics of securitized mortgages as they were disclosed to investors at the time of sale with these loans’ characteristics as they were recorded in the banks’ proprietary databases.  Zingales writes (my emphases):

If the massive wave of defaults on securitized mortgages was purely the result of bad luck, we would expect that the characteristics reported to investors would not differ from those recorded in the banks’ databases. This is especially true of characteristics that are relevant to default risk, such as whether the borrower was an owner or an investor, or whether there was a second lien on the property. In fact, the authors find that more than 6% of mortgage loans misreport the borrower’s occupancy status, while 7% do not disclose second liens. Of course, any database contains errors. Are these errors large enough to be worrisome? And how can we be sure that the banks knowingly misrepresented this information, rather than that they merely were sloppy in reporting it? The authors provide some interesting evidence in this context. They show, for example, that the misrepresentation is correlated with higher defaults down the line: delinquent payments on misreported loans are more than 60% higher than on loans that are otherwise similar. Thus, the errors do not seem to be random, but purposeful. What the authors do not find is also interesting. The degree of misrepresentation seems to be unrelated to the incentives provided to the top management and to the quality of risk-management practices inside these firms. In fact, all reputable intermediaries in their sample exhibit a significant degree of misrepresentation. Thus, the problem does not seem to be limited to a few bad apples, but is pervasive. This makes a solution more difficult to achieve. After all, if the financial industry’s leaders are misleading investors, it is the culture of the entire industry that needs to be changed.

The above raises all sorts of questions as to the accuracy of the analysis. But, based on many similar tales, I'm inclined to think it's credible.