Monday, June 13, 2011

The Foreclosure Mess - Monday, June 13, 2011

I have an old-fashioned viewpoint: when you do something wrong, you own up. You take responsibility for your actions. If appropriate, you apologize and make redress.

One of the things that has amazed me, and then has made me angry, is that almost no one has stood up and taken their share of the blame for the financial crisis. Surprisingly, Greenspan, the Maestro, did, for one brief moment, acknowledge error. His assumption that markets would self police and manage their own risk proved wrong, and he, at least briefly, admitted it. Not many others have done so.

As I began to study the crisis to try and figure out what happened (I began "reading around" shortly after the crisis hit in the Fall of 2008), it was clear that the investment banks and the big four mortgage servicer banks (Bank of America, JPMorgan Chase, Citibank, and Wells Fargo) had played very bad games, and they were neither taking responsibility for it, nor were they being held to account.

I can (sort of) forgive Paulson and Geithner for negotiating bad deals with the banks - deals that gave the banks just what they needed but exacted no "pound of flesh" or tough give-backs as part of the deal. The sky was falling. The markets were in collapse. They had to get credit flowing again. But why were the bank stress tests so forgiving? Why have there been almost no fraud or criminal investigations at the federal level? Why has there been no serious relief for homeowners? Why has Treasury not pursued the banks for their multiple paperwork disasters in properly conveying notes and mortgages into the securitization trusts?

As an Obama supporter, this continues to baffle me. Do the banks control the Democrats as well as the Republicans? Is Geithner just too close to the banks? Is he worried that the banks are too fragile and pushing them hard might topple them and hurt the economy? Is this part of Obama's often-used strategy of simply waiting and letting the problem come to him, so he is not seen as starting the fight? I just do not know. Neither the President nor Geithner are stupid. They must know there are big paperwork problems with proving up the perfected security interests for the notes and mortgages in the trusts? Can't they see that the rate of new and completed foreclosures has fallen off big time in the last few months, and that the very high probability reason is that the banks don't have the papers in order to be able to foreclose, and now that the defense bar is wide awake and armed with great strategies, the banks are being picked off in court right and left? Do they really think this problem is going away? Or did they not want to be the ones to pick the fight, hoping or knowing that some aggressive state attorney general would take up the fight, and the feds/the Democrats/Obama would not have to be the ones to pick the fight.

I am truly not sure of the answer. But if the President and Secretary Geithner were praying for an aggressive state AG to take on the banks, their prayers have been answered. Attorneys General Schneiderman (New York) and Biden (Delaware) have answered the call, and are taking on the banks on this very issue of proper conveyance of notes and mortgages into the trusts. Yves Smith at naked put up the story this morning. Here's the link here. She (Yves Smith) is an extremely smart and articulate blogger, formerly worked at Goldman Sachs, has written a powerful book Econned, which I highly recommend, knows the ins and outs of the Street, and has been all over this story since the crisis and before. If this topic interests you, look back through her archives, do some searches. She puts together better investment/mortgage securitization material than I ever saw at Harvard Business School.

This could be a very big deal. Yves' research shows that at some point around 2002, the securitization industry stopped following the note and mortgage conveyance rules they had set up in their standard PSA (Pooling and Servicing Agreement, the central agreement in all the private securitizations conveying the many notes and mortgages into the trust, setting up the servicing agreement with the banks servicer, and thereby laying down conditions for foreclosure, if necessary.) She doesn't know why they did this, and bank representatives furiously dispute the truth of her claims. But I'm convinced she is right. A VP at a major servicer confirmed to me that they the bank HQ held on to the original notes, instead of sending them to the trust, as required by the PSA.

Although case law is just being formed on some of these questions, recent decisions look like they will confirm the argument Yves presents that New York trust law will govern, and that the specific terms of the PSA must be honored. The industry organization, the ASF (American Securitization Forum) has argued that despite the PSA provisions, the original note need not be present,and that the individual mortgage note does not need to have every intervening assignment visible, and can, in fact, be endorsed in blank. It simply does not look like this argument will prevail, and now that two AGs are calling for the original documents from the trusts, it is possible, not certain, that the truth will come to light, and the banks will finally be held accountable.

If the papers are not there, or are seriously deficient, what does this mean? It means that the RMBS market (Residential Mortgage-Backed Securities market) might have to be renamed the RNMBS market (Residential Non-Mortgage-Backed Securities market). Six years worth of mortgage securitizations could unravel, which would literally break the banks and throw millions of titles into dispute. Do I think this will happen? Probably not. But it might. And I think there is a better than even chance that one bank will go down, and that will probably be Bank of America.

The arrogance of the banks has been just stunning. Stopping foreclosures for a time, when the robosigning scandal hit, then starting them back up a short time later, saying, in every case, that thorough investigations revealed no problems. But why would the servicers need to robosign, if the papers were there? And remember: Trustee banks sign a sworn affidavit every year, affirming that all the notes and mortgages, in the proper form required by the PSA, are present in the Trust files. The Statute of Limitations has mostly run out on fraud charges, but not for contract formation failure, and not for the trustee banks with their annual affirmations.

I believe we must go through this, in whatever painful form it will take. Perhaps the auto-bailout/packaged bankruptcy is a good model. Restructure. Clean up. Clear the market. Move forward.

And finally, the banks will be held to account. Not for the frightful risks they took with other people's money. Not for screwing their own customers consistently by trading against them in the same securities they were touting and selling. Not for creating financial instruments that took crap mortgages (which they knew were crap) and magically turned this into AAA paper, They will be caught on the low-status back room stuff - the paperwork processing and conveyance of notes and mortgages to the trusts. But I now believe they will be held to account.

And remember: Al Capone was taken down for tax evasion!

Remember: they got Al Capone on tax evasion.

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