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Throughout 2006, New Century Financial Corporation, one of the nation's largest subprime mortgage lenders, engaged in systematic accounting fraud to conceal the deteriorating quality of its loan portfolio. The SEC later charged that the company's top officers misled investors as the business collapsed, failing to disclose dramatic increases in early loan defaults, loan repurchases, and pending loan repurchase requests. New Century made undisclosed changes to its accounting for loan repurchases in both the second and third quarters of 2006 that violated generally accepted accounting principles, allowing the company to improperly avoid substantial repurchase expenses and materially overstate its financial results.
As early payment defaults surged in 2006, New Century faced an enormous undisclosed backlog of loan repurchase demands from investors who discovered the mortgages they purchased were based on false documentation and overstated borrower qualifications. Rather than accurately reporting these mounting losses, executives implemented accounting changes designed to mask the magnitude of the problem. The company's public disclosures generally sought to assure investors that its business was not at risk and was performing better than peers, even as internal data showed the opposite.
When New Century finally began disclosing the truth in February 2007, the market reacted with shock. A February 7, 2007 announcement wiped out over $600 million in market value in a single day as the stock dropped 36 percent from $30.16 to $19.24 per share. Following subsequent revelations, over $1.6 billion in market capitalization was eliminated. The SEC, U.S. Attorney's Office, and NYSE all launched investigations. In April 2007, New Century filed for bankruptcy as the slumping housing market caused defaults to spike across its portfolio. The fraud at New Century exemplifies how subprime lenders engaged in predatory origination practices, sold fraudulent loans into securitization markets, then used accounting manipulation to conceal the fraud—all while ratings agencies gave AAA ratings to securities backed by these toxic mortgages and regulators failed to detect or prevent the systematic deception.