Except me, of course….
I’m referring to the “why”.
There’s an old-school journalism standard – it’s called the “Five Ws”:
Some add a sixth, an “H” – “How?”
We know the answers to five of the six “W”s on Foreclosuregate:
- Who: Major financial institutions, including all of the “big banks” and investment banks, both in the United States and overseas.
- What: First, they failed to perfect their security interests as required by law, and they included bad loans in securitization pools on purpose, both of which are violations of either fiduciary duty, old-fashion fraud, or both. Now they’re filing bad paperwork with courts across the land, constituting perjury, fraud upon the courts, counterfeiting and more.
- Where: Everywhere. There are now 40 State Attorneys General that are looking into coordinated action on the second part of this scandal, as it is resulting in people being evicted from their homes under questionable pretense.
- When: The first part took place from 2003 to 2008, roughly. The second is happening now.
- WHY: The question nobody is asking – or answering.
I’ll take this one, because it’s simple, it’s obvious, and it’s documented. I also talked about it in some detail at the end of 2007, where I wrapped up the year and put out my 08 forecast. I said at the time:
Lets say that you have 1,000 mortgages that youve written to all sorts of people. Their actual risk if defaulting on their mortgages is reasonably low, especially when you look at all 1,000 of them as a pool, instead of each individual mortgage. Lets say for the sake of argument that the actual risk premium that is, the reasonable cost of the money compared to a risk free investment such as US Treasury bonds, is 200 basis points that is, a 2% higher interest rate fairly compensates for the risk you wont pay.
So I have a pool of mortgages that was made when the 10 year Treasury bond was yielding 5%, and the fair return on that pool is 7%. All is good.
Or is it?
Well, no. See, everyone who touches that pool wants a piece of the action. If Im an investment bank I cant possibly do this work for free, so I want 25 basis points of that 200 for my profit in putting all these together and managing them.
Then there is the company that services the loans. They take the payments from each homeowner and make sure that theyre correctly accounted for. This requires staff, phones, computers, etc. They too want to be paid lets call that another 25 basis points.
So now we have 150 basis points left of margin over the 10 year Treasury rate. If we sold slices of this debt off, at best we could allow a coupon that reflected that 150 basis points.
Unfortunately greed got into the equation.
The banks figured out that they could structure these 1,000 mortgages into different tranches with different characteristics. If you take all the money coming in and look at this as one big pool, that gives everyone only one thing to buy. But if we take that pool and split it up into a bunch of different levels of risk, we can now offer slices that have different levels of return.
For instance, we could draft some documents that say that if the total amount of money due isnt paid (by everyone) that the first risk of people not paying would fall on a certain class of the buyers. These buyers would get a much higher coupon payment, but theyd take much higher risk, because no matter which Joe doesnt pay their mortgage, these people would eat it preferentially, while those above them with a lower grade of risk would keep getting their payments.
This is the essence of the Mortgage-backed security, or MBS.
But remember no matter how you slice this whole deal up only 200 basis points of profit is in there over treasuries to make. You can change who eats the losses and how much the various fingers in the pie get to siphon off, but you cant change the total amount of profit available.
OR CAN YOU?
Wall Street figured out that YOU CAN IF YOU ARE WILLING TO CHEAT.
All you have to do is find someone who will run your deal through a computer program and grade the quality of its debt. If you can find someone who will claim that the total risk of the deal is lower than it actually is, you make out like a bandit, because instead of 200 basis points of actual profit you suddenly find another 50 or 100!
The problem is that the real risk DID NOT CHANGE.
See the problem? I hate to drag up a nearly-three-year old posting on this, but it’s right there under your nose, and it was always going to lead to something like what we’ve had happen in the second instance.
ALL YOU HAVE TO DO IS BE WILLING TO CHEAT.
And the more-complicated and obfuscated the better, because that obfuscation reduces the risk you will get caught – at least in the short term.
Unfortunately nothing fixes a Ponzi Scheme beyond the short term.
This is what you, and investors, were sold as the premise underlying the paper that was written going out the next 30 years – the proffered term of the loans. Investors were sold this by the banks, homebuyers were sold it by mortgage brokers and Realtors, and books were published by so-called “experts” that all devolved, in the end, to the making of this claim:
That of course was never going to happen, and it didn’t.
But all bankers have a copy of Excel on their desktop. They also have calculators, and most of them have an HP12c, which makes this simple too: 1.10 <ENTER> 29 yx = 15.8631. Multiply that by the starting value of the house, and there’s your number.
Basic mathematics folks.
So what we have here are two answers to “Why?”
The deals were un-economic unless someone cheated. That is, there’s only so much risk-adjusted “spread” in a particular lending transaction. The common law of business balance says that nobody ever works for free, and as a consequence the more hands that touch a deal the more that profit is dissipated among those hands. In a competitive market where multiple entities compete for business this means that the true yield available to at least some of the investors would always have to understate the risk of default, and therefore someone was always going to get screwed. On balance there’s nothing unlawful about that, so long as you properly and fairly disclose everything about the deal – there’s nothing that stops you from buying a thing that is disadvantageous to you. We take this risk every day when we, for example, buy a pack of cigarettes. The “pleasure” (such as it were) from smoking may come with a horrific cost (lung cancer); it was only when the Tobacco Companies tried to conceal this risk that they were held responsible.
As the pyramid grew higher, the number of good borrowers was exhausted. To keep the charade going it was necessary to fund loans to “patsies” – the infamous “fog-a-mirror” lending. That would have been ok too, except that the lenders actively concealed the fact that the loans they were stuffing into the securities did not meet the standards under which they sold those resulting MBS to investors.
So between #1 and #2, we have two things that would not be illegal if they were properly and fully disclosed, but if they were fairly and fully disclosed there would have been no money in securitizing these loans, as nobody would have bought them.
To sell them, they had to cheat. And when the “caught” part of the cheating became apparent as housing prices started to collapse, they attempted to cheat again to cover up the earlier cheating, which is what you’re seeing now.
I wish I could tell you there’s a simple way out of this. There isn’t. Someone is going to get hosed; the question is “who”?
Right now, if we let the banksters get away with this, the answer will be you. You will be the one who is hosed when your pension fund and annuity collapse. You will be the one who is hosed when you try to sell your home five years from now and find you can’t get a title insurance policy, as the chain of title has been hopelessly corrupted. And you will be the one who is hosed as The Fed and The Federal Government try to throw more deficit spending and “Quantitative Easing” into the economy in a desperate attempt to fill in what is in fact a black hole in the center of these institutions’ balance sheets, resulting in insane devaluation of the dollar and commodity price ramps that double (or more) the cost of your food and fuel.
The only fair resolution is for the institutions that did the cheating to eat the consequences. That means unwinding all the “Bogus Assignee for Intervening Assets” games, all the notes that were not actually conveyed, and all the loans that were intentionally stuffed into securities with full knowledge, or willful blindness, that they did not meet the underwriting criteria put forward in the offering circulars or pooling and servicing agreements.
This will inevitably drop those loans back on the “Big Banks.” They will then have to eat whatever loss is embedded in those loans. In many cases the losses will be 50% of the face value of the loan or more. It is also the only reasonable way to get both borrowers and lenders in the same room to negotiate whatever is in the best interest of both parties.
The banks will not be able to sustain these losses. But Dodd-Frank, the new “Financial Reform” law, has a solution to this – the new Resolution Authority. A cramdown of debt-to-equity can be performed. It will wipe out shareholders and some classes of bondholders but it is the only fair resolution on a financial basis.
We also must look to criminal law where there is a referable charge for those people – including those all the way up the line to the executive suites – who knew of these events and did nothing to stop them, instead choosing to pocket phantom profits that in fact never existed.
We cannot allow this to go further folks. It is entirely unreasonable to expect the American People to fund another bailout to the tune of over a trillion dollars. It is equally unreasonable to expect the American People to sit still while the bailout we did fund went not to clean up the mess, but to try to paper it over and lie about what had happened and what was to come. And if we don’t get on the ass of the politicians, prosecutors and judges now you can bet the banksters will try to find some way through the legislature to make this all retroactively legal by bribing them with campaign “contributions”, as they have many times in the past.
The fact is that we are incapable of absorbing this on a continuing basis as a nation. We are currently running deficits of more than 10% of our GDP every year, and have for the last three years, solely to cover up this fraud, as the “stuck” and intentionally mismarked paper is causing catastrophic damage to the normal lending and clearing functions in our economy, in addition to holding prices ridiculously high for both housing and commercial real estate.
The time is now folks. There’s an election on and candidates are trying to dance around the periphery of this issue without answer the final “W” – WHY – and acting on that.
We, as citizens, must hold their feet to the fire.