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Create A BlogPutting Foreclosures in Perspective |
Posted at Keepin' it real by George Mantor
Nov. 9, 2009
"If you don't read the newspaper, you're uninformed. If you read the newspaper, you're mis-informed."
— Mark Twain
When considering the implications of the current foreclosure situation, it is vital to understand that we are being misinformed about the forces behind the high rate of mortgage defaults.
Nor, are we hearing the truth about the lack of success in getting mortgages modified.
Or, why foreclosing entities either cannot or will not produce a valid chain of title in foreclosure proceedings even though they know it will cost them the case and sanctions by the courts.
Or, why mortgage servicing companies routinely default borrowers with perfect payment histories.
And just as baffling, why would a smart lender make a dumb loan and then lose the means by which to repossess the asset?
Could these possibly be the dumbest or sloppiest people on the planet? Far from it. There are, as it turns out, many ways for financial institutions to make money and when they can, they do.
I finally figured it out. At first, I thought there was only one reason to play hide the notes. Were they reselling the same loans to multiple investors? As it turns out, yes.
Were they double funding loans? Yes.
Were they creating phony borrowers? Yes.
Did they shove loans down people’s throats, when they knew full well that they couldn’t make the payments? Yes.
Did they themselves rate them triple A and sell them to investors who were anticipating a steady and secure revenue stream from the payments? Yes.
This isn’t just about mortgages, this is something much larger.
It goes to the very heart of what happened to our prosperity. By reclassifying liabilities as assets, Wall Street was able to sell debt as an investment.
They promised investors a highly rated, risk free investment that pays more than the money market rate. And, who doesn’t want that? As it turns out, way more people than there were highly rated, low risk investments.
The answer: gather up a lot of debt, give it a triple A rating, sell the revenue stream, and then place a wager that the bad loans would default. All you need is paper to package and sell. Think of a giant paper shredder. All you have to do is put paper in one end and glorious money pours out the other.
Nor was the derivative business limited to packaging mortgages. It doesn’t matter what kind of paper, mortgage notes, student loans, car loans, credit card debt, business debt, leases of all manner, and when there wasn’t enough, copies of mortgage notes, pieces of mortgage notes, promises of mortgage notes, made-up borrower mortgage notes, newspapers, telephone books, any kind of paper.
There was only one mantra: never, ever let that gaping maw run out of paper or it will eat everything around it. Then you get fired. So, if its paper it wants, it is paper it will get.
Any kind of debt will do because the debt doesn’t matter. No risk is too great because there is no risk. They sell the crappy loan and then make a bet that it will default. It’s called a Credit Default Swap (CDS).
A CDS is the most widely traded type of derivative, and these investments represent the biggest financial market in the world. CDS resemble insurance policies, but there is no requirement to actually hold any asset or suffer any loss, so CDS are widely used just to increase profits by gambling on market changes
According, to the Bank of International Settlements [BIS], the aggregate derivative positions of banks grew from $100 trillion in 2002 to — believe it — $516 trillions in 2007; that is over 500 per cent in five years!
The BIS recently reported that total derivatives trades exceeded one quadrillion dollars – that's 1,000 trillion dollars.
This is curious when you realize that the gross domestic product of all the countries in the world is only about 60 trillion dollars.
The answer is that gamblers can bet as much as they want. They can bet money they don't have, and that is where the huge increase in risk comes in. There is no regulation of these instruments and they do not show as liabilities on the balance sheets of the institutions.
A Derivative is a financial instrument whose value is not its own, but derived from something else, on some underlying asset or transaction, such as commodities, equities (stocks) bonds, interest rates, exchange rates, stock market indexes, why, even inflation indexes, index of weather. Basically, they are just bets. You can "hedge your bet" that something you own will go up by placing a side bet that it will go down. "Hedge funds" hedge bets in the derivatives market.
Nor, did mortgage defaults cause the crisis. Mortgage securities made up only $7 trillion of the huge derivative market.
To the extent that any information is available on what brought us to this point, it is mostly bloggers.
Most of the blogging perceives the foreclosure problem as the result of sub-prime loans, irresponsible borrowers, and mortgage resets.
Such a superficial view reveals a complete lack of understanding of how the securitization of mortgages makes Wall Street all of that money out of nothing at all. You have to follow the money.
An important distinction is that the consumer was not the driving force behind this money binge, but the profits Wall Streets was making on Derivatives.
They knew for a certainty that these loans would go bad, so they bought Credit Default Swaps that would pay them, even though they already sold the loan to the investor. They bet huge amounts of money that the borrower would default. And, given what they knew about the borrower’s ability to repay and the built in payment reset, it was only a matter of time.
Underwriter to boss: “This borrower earns less than the monthly payment.”
Boss: “Excellent, just what we’ve been looking for. Give it a triple A rating and that should complete the package of guaranteed to fail loans. Double the bet.”
This raid has been in the planning stages for a long time. It should also be noted that the pieces of this very complex formula were put in place well before there was a substantial increase in value.
Both the creation of Mortgage Electronic Registrations Systems and the unraveling of restrictive legislation that would have prevented this have been underway for two decades.
The increases in value were an unanticipated bonus that allowed for multiple refinances. But remember, housing makes up only a small part of the CDS market.
Nor, is betting on shaky mortgages to fail anything unique. It’s called naked short selling, and they use it all the time to manipulate stock prices and take over boards.
It turns out it isn’t really illegal to make copies of stock certificates and flood the market with them. According to the Securities Transfer Association of 341 shareholder votes taken in 2005, every single one produced evidence of over voting. More shares were voted than existed.
When it comes to sub prime mortgages, they make so much money betting on sure things that they even have the servicing companies default borrowers with perfect payment histories. The default triggers the payout of the credit default swap.
And, if they modify the loan, they don’t get the payout; so now you know why all that loan modification paperwork gets lost all of the time.
As it turns out, in most cases, there isn’t even a legally authorized individual with the authority to modify the terms of a note that is part of a security package. The future of loans that may have been unlawfully modified creates even more uncertainty.
When you break it all down, it looks like Wall Street took a lesson from Broadway. The Producers is about a Broadway producer and his accountant who realize they can make more money with a musical that was guaranteed to fail than one that would succeed. But, “Springtime for Hitler” turned out to be an astonishing success. When the investors came for their profits, there were too many investors to pay back.
Wall Street, where life imitates art.
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1. RE: Putting Foreclosures in Perspective
This makes perfect sense. Thank you for shedding light on this topic. The banks aren't stupid. If it's possible for someone who only has a 2 year college degree to figure out the loans aren't going to be repaid, it's certainly possible for a MBA from Princeton to make the same assumption.