Former lead prosecutor in the Savings and Loan fraud Bill Black and derivative expert/author Janet Tavakoli have been saying for the last couple years that the financial problems were not caused solely due to unforeseen circumstances but the largest fraud in history. Information about the nature of mortgage backed securities that confirms this view has trickled out for years now, but we appear to have reached a tipping point where it is now flooding.
It’s becoming widely known that 1) banks submitted improper affidavits when foreclosing, which is fraud on the court but they are spinning it as “paperwork inconsistencies” that only affected deadbeats that should be foreclosed on anyway. This is the primary issue that has been talked about thus far over the last few weeks, and — despite the fact of numerous anecdotal accounts that people were unjustly foreclosed on — they seem to have mostly contained it. Unfortunately it turns out that the foreclosure mills hired to do the dirty work 2) committed fraud to maximize their fees, including at least one business that foreclosed on people that were not in default. Between these two it is a no brainer that a foreclose moratorium should be enacted, which will greatly hurt banks’ bottom lines. However, this is just the tip of the iceberg.
3) It is becoming clear that due to the securitization process no one’s mortgage that was packaged (over 70% of all outstanding mortgages) was properly transferred to the trusts. This means that all outstanding MBS technically isn’t backed by anything. No one really knows how to resolve this, as legally it is impossible to just brush away and any Federal “solution” would severely impede on state property and securities’ laws. The size of this problem is much larger than the foreclosure one but is very hard to pin down what it means.
Which brings me to the newest “smoking gun” — 4) evidence that the banks knew that the mortgages did not meet underwriting standards when creating the MBS, but sold them off anyway. Felix Salmon has a lot on this, and Parker-Spitzer had a segment on it. The implications of this are straightforward: the banks will be open to many lawsuits and have to take back much of the $1.5 trillion+ securities they sold. This report suggests that Bank of America could lose half of its book value even without fraud litigation and penalties.
Some combination of these reasons has 5) caused the state AGs of all 50 states to investigate and a Federal Home Loan Bank to sue. I find the latter part to be important because despite the FHLB’s supposed independence, they have stepped in to protect the real estate market under political pressure. The fact they are suing could make the calls for Fannie and Freddie to look at all their MBS in detail be more likely to come to fruition.
In light of these (at least) five major and relatively independent issues, I would note that the Titanic sunk due to six of its flood compartments flooding.
I am not sure what is going to happen…obviously if the banks were forced to buy back all the securities then they would be insolvent again. Some of this is outright fraud with clear legal consequences and some of it will vary by state. However I will say that this article “One nation, under fraud” not only has a catchy title, but a correct one as well. The stories and quotes in there have to be read to be believed…and even then.
Update: Marshall Auerback has a passionate call for the government to use its resolution authority to inspect all the major banks’ books and break up the ones that are insolvent after fraud is taken into account (this would be all of them). He is cavalier about what to do next other than sell of the assets to smaller institutions, but is absolutely correct that the status quo guarantees continued economic fragility.
Update #2: There actually is a 6) that is present in the Daily Caller article linked above.
When banks bought bunches of mortgages to create now-infamous mortgage-backed securities, they did so by forming trust companies to hold the mortgages themselves and forward money to the investors who bought the securities…When the companies were created, they had to abide by what’s called a pooling and servicing agreement, which defined the steps they had to take to acquire mortgages and send mortgage payments to the correct investors. The agreements allow the companies to enjoy tax-free status with the IRS, because the payments they receive aren’t considered income due to the fact that the role of the trusts is to send virtually all of the money to someone else.
The IRS has strict rules regarding these companies, and when the rules are broken, there’s a slight penalty. From 0%, the tax rate on payments received by a trust company that broke the rules jumps to 100%. One of the rules states that a trustee is supposed to acquire any mortgages it will hold within three months of the formation of the trust. There’s an exception for replacing a mortgage with another mortgage, but remember, the notes and assignments involved have either been destroyed or are so erroneously marked that they’re fraudulent. Even if the notes and assignments were all accurate and still in existence, the status of the mortgages in question has changed dramatically. Countless payments that were being made in 2005 have stopped in the aftermath of the housing bubble. The trusts can’t acquire anything close to the number of healthy mortgages they claim to hold, and even if they could, the IRS would take the payments or money from foreclosure sales away. Trusts haven’t been selling mortgage-backed securities. They’ve been selling nothing-backed securities. And as people discover this fact, the value of both the “mortgages” that banks only think they own and the nothing-backed securities will become $0, unless homeowners decide to get their jollies by giving banks money for no reason.
…and 7)
It gets worse. The equally-infamous credit-default swaps that bankrupted AIG will come roaring back with a vengeance as the foreclosure process grinds to a halt. Credit-default swaps are financial instruments called derivatives, which are assets with values determined by other assets. When a mortgage isn’t really a mortgage, a derivative based on that mortgage is suddenly called into question. Banks own trillions in derivatives. They also own derivatives of derivatives. Amazingly, they even own derivatives of derivatives of derivatives. The total dollar value of all derivatives in the American financial system is listed by the Office of the Comptroller of the Currency at an absolutely incomprehensible $233 trillion. And much of that will simply vanish into thin air, crashing major banks into the ground.