Saturday, October 9, 2010

To dump or not to dump

The Foreclosure Fraud Saga continues (tired of me talking about it yet?). Above is a great summary from FOX news.

The crisis isn’t easy to understand, but boiled down it basically comes down to this: Banks need proper documentation to repossess a home from a family. They need documents about everything from the family’s financial situation to its history of missed payments to its assets. And they need to verify that the information in those documents is correct. But they didn’t. They hired individuals to sign thousands of mortgage papers — legal affidavits, swearing to a judge that they had personal knowledge of the information within — without checking a thing.

Basically the banks committed fraud - on a massive scale. And they have been caught.

Bank of America has now suspended foreclosures in all 50 US states. And there are calls for all institutions in the United States to follow suit.

Janet Tavakoli, the founder and president of Tavakoli Structured Finance Inc, sounded some of the earliest warnings on the structured finance market. In an interview with the Washington Post she calls these developments "the biggest fraud in the history of capital markets."

Takakoli gives a wonderful synopsis. She observes that when the financial crisis broke out, the first thing the banks did was run to Congress and ask for accounting relief. They asked to be able to avoid pricing this stuff at the price where people would buy them. By allowing this to happen, no one can now tell you the size of the hole in their balance sheets.

The United States government has thrown a lot of money at the problem but TARP was just the tip of the iceberg. The US governemnt has given these banks guarantees on debts and low-cost funding from the Federal Reserve but a lot of these mortgages just cannot be saved.

Had this problem been acknowledged in 2005, the mess could have been cleaned up for a few hundred billion dollars. But that wasn't done. Banks were lying and committing fraud, and the regulators were covering them.

Now a bad problem has become a hellacious one.

The financial system is still very fragile. The fear is that these developments will be a disaster for the economy and will trigger another credit freeze. But Takakoli disagrees and sees a solution for the crisis.

  • In order to make the financial system healthy, we need to recognize the extent of our losses and begin facing the fraud. Then the market will be trustworthy again and people will start to participate.

    This can be done with a resolution trust corporation, the way we cleaned up the S & L's. The system got back on its feet faster because we grappled with the problems. The shareholders would be wiped out and the debt holders would have to take a discount on their debt and they’d get a debt-for-equity swap. Instead we poured TARP money into a pit and meanwhile the banks are paying huge bonuses to some people who should be made accountable for fraud.

    The financial crisis was a product of our irrational reaction, which protected crony capitalism rather than capitalism. In capitalism, the shareholders who took the risk would be wiped out and the debt holders would take a discount but banking would go on.

Faithful readers will recall this blog has long said there should never have been any 'too big to fail' sacred cows.

It would have meant a very severe, painful and difficult recession, but correction could have started and the rebuilding begun in earnest.

Will we see a solution similar to what we saw in the Savings and Loan crisis? Or will bailouts continue to be the order of the day?

In that the Federal Reserve Chairman is one who has publically staked his reputation on the belief that the Great Depression of 1929 could have been prevented by dumping buckets of money from a helicopter, and that the US Treasury has staked the nation's wealth on the 'too big to fail' concept, I'm guessing the latter option will win out.

The realization of just how big this issue is has finally started to seep into national consciousness.

Rep. Brad Miller (D-N.C.) provided a clear explanation to The Washington Post yesterday:

  • There is massive potential liability for the securitizers, which are mostly the biggest banks.

    The contract was that if mortgages didn’t meet certain requirements, then the securitizer would buy them back.

    The mortgage servicers and trustees have exclusive control over the paperwork.

    Both the investors, the people who own the mortgage-backed securities, and the homeowners, really depend on them.

    There’s been lots of litigation where investors try to get securitizers to buy back the bad mortgages because they were flawed, but that litigation has been stymied by procedural objections.

    If the private investors can break through that defense and require the mortgages that don’t meet the requirements to be bought back, the liabilities for the biggest banks will be enormous.


Enormous doesn't begin to cover it.

Worse, since the biggest banks have been deemed 'too big to fail', there is simply no way I see the Federal Reserve and the US Treasury shifting gears now. Therefore I doubt Ben will be setting the helicopter down anytime soon.



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  1. Sitting down here in Phoenix, the real estate industry is once again freaking out. Homes that may have been vacant for over a year, may now stay vacant until the foreclosure mess is worked out - another year, 2 or??

    The latest stats are almost 40,000 homes in some stage of foreclosure with about a third being held by BofA.

    What will happen when the foreclosure issues are resolved - thousands of homes flood the market, prices go down lower than ever thought possible.

    We are sitting in a home that would cost at least $ 600,000 US if located in Victoria (where we are from) but sold for $ 128,000 US one year ago.

    I agree with your predictions, the same is coming for Canada (maybe not as bad as here) but still catastrophic.

  2. Thanks for sharing from Phoenix.

  3. And thanks for the link squidly77.

  4. So, the banks sold the mortgage to bigger banks, who then rebundled and tranched the original mortgages as CDO's. These CDO's were then sold worldwide to anyone looking for higher yield, governments, pension funds, local governments etc. The purchasers of the CDO's also purchased credit default swaps as insurance against the CDO's defaulting. The problem is that the sellers of the credit default swaps don't have the money to pay for the CDO's that now have no collateral.