by Sean Olender on 9 December 2007 in The San Francisco Chronicle
New proposals to ease our great mortgage meltdown keep rolling in. Bankers pay lip service to families while scurrying to avert lawsuits and prison. First the Treasury Department urged the creation of a new fund that would buy risky mortgage bonds as a tactic to hide what those bonds were really worth. (Not much.) Then the idea was to use Fannie Mae and Freddie Mac to buy the risky loans, even if it was clear that U.S. taxpayers would eventually be stuck with the
bill. But that plan went south after Fannie suffered a new accounting scandal, and Freddie's existing loan losses shot up more than expected.|
Now, just unveiled Thursday, comes the "freeze," the brainchild of Treasury Secretary Henry Paulson. It sounds good: For five years, mortgage lenders will freeze interest rates on a limited number of "teaser" subprime loans. Other homeowners facing foreclosure will be offered assistance from the Federal Housing Administration.
But unfortunately, the "freeze" is just another fraud - and like the other bailout proposals, it has nothing to do with U.S. house prices, with "working families," keeping people in their homes or any of that nonsense.
The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value - right now almost 10 times their market worth.
The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.
And, to be sure, fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies - all the way up to senior management - knew about it.
I can hear the hum of shredders working overtime, and maybe that is the new "hot" industry to invest in. There are lots of people who would like to muzzle subpoena-happy New York Attorney General Andrew Cuomo to buy time and make this all go away. Cuomo is just inches from getting what he needs to start putting a lot of people in prison. I bet some people are trying right now to make him an offer "he can't refuse."
Despite Thursday's ballyhooed new deal with mortgage lenders, does anyone really think that it can ultimately stop fraud lawsuits by mortgage bond investors, many of them spread out across the globe?
The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC.
The problem isn't just subprime loans. It is the entire mortgage market. As home prices fall, defaults will rise sharply - period. And so will the patience of mortgage bondholders. Different classes of mortgage bonds from various risk pools are owned by different central banks, funds, pensions and investors all over the world. Even your pension or 401(k) might have some of these bonds in it.
Perhaps some U.S. government department can make veiled threats to foreign countries to suggest they will suffer unpleasant consequences if their largest holders (central banks and investment funds) don't go along with the plan, but how could it be possible to strong-arm everyone?
What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back. The time to look into this is before the shredders have worked their magic - not five years from now.
Those selling the "freeze" have suggested that mortgage-backed securities investors will benefit because they lose more with rising foreclosures. But with fast-depreciating collateral, the last thing investors in mortgage bonds ought to do is put off foreclosures. Rate freezes are at best a tool for delaying the inevitable foreclosures when even the most optimistic forecasters expect home prices to fall.
In October, Goldman Sachs issued a report forecasting an incredible 35 to 40 percent drop in California home prices in the coming few years. To minimize losses, a mortgage bondholder would obviously be better off foreclosing on a home before prices plunge.
The goal of the freeze may be to delay bond investors from suing by putting off the big foreclosure wave for several years. But it may also be to stop bond investors from suing. If the investors agreed to loan modifications with the "real" wage and asset information from refinancing borrowers, mortgage originators and bundlers would have an excuse once the foreclosure occurred. They could say, "Fraud? What fraud?! You knew the borrower's real income
and asset information later when he refinanced!"
The key is to refinance borrowers whose current loans involved fraud in the origination process. And I assure you it was a minority of borrowers whose loans didn't involve fraud.
The government is trying to accomplish wide-scale refinancing by tricking bond investors, or by tricking U.S. taxpayers. Guess who will foot the bill now that the FHA is entering the fray?
Ultimately, the people in these secret Paulson meetings were probably less worried about saving the mortgage market than with saving themselves. Some might be looking at prison time.
As chief of Goldman Sachs, Paulson was involved, to degrees as yet unrevealed, in the mortgage securitization process during the halcyon days of mortgage fraud from 2004 to 2006.
Paulson became the U.S. Treasury secretary on July 10, 2006, after the extent of the debacle was coming into focus for those in the know. Goldman Sachs achieved recent accolades in the markets for having bet heavily against the housing market, while Citigroup, Morgan Stanley, Bear Sterns, Merrill Lynch and others got hammered for failing to time the end of the credit bubble.
Goldman Sachs is the only major investment bank in the United States that has emerged as yet unscathed from this debacle. The success of its strategy must have resulted from fairly substantial bets against housing, mortgage banking and related industries, which also means that Goldman Sachs saw this coming at the same time they were bundling and selling these loans.
If a mortgage bond investor sues Goldman Sachs to force the institution to buy back loans, could Paulson be forced to testify as to whether Goldman Sachs knew or had reason to know about fraud in the origination process of the loans it was bundling?
It is truly amazing that right now everyone in the country is deferring to Paulson and the heads of Countrywide, JPMorgan, Bank of America and others as the best group to work out a solution to this problem. No one is talking about the fact that these people created the problem and profited to the tune of hundreds of billions of dollars from it.
I suspect that such a group first sat down and tried to figure out how to protect their financial interests and avoid criminal liability. And then when they agreed on the plan, they decided to sell it as "helping working families stay in their homes." That's why these meetings were secret, and reporters and the public weren't invited.
The next time that Paulson is before the Senate Finance Committee, instead of asking, "How much money do you think we should give your banking buddies?" I'd like to see New York Sen. Chuck Schumer ask him what he knew about this staggering fraud at the time he was chief of Goldman Sachs.
The Goldman report in October suggests that rampant investor demand is to blame for origination fraud - even though these investors were misled by high credit ratings from bond rating agencies being paid billions by the U.S. investment banks, like Goldman, that were selling the bundled mortgages.
This logic is like saying shoppers seeking bargain-priced soup encourage the grocery store owner to steal it. I mean, we're talking about criminal fraud here. We are on the cusp of a mammoth financial crisis, and the Federal Reserve and the U.S. Treasury are trying to limit the liability of their banking friends under the guise of trying to help borrowers. At stake is nothing short of the continued existence of the U.S. banking system.
SUBJECT: MORTGAGE MELTDOWN
The clowns in charge of things understandably feel that they have to do something -- or pretend to -- in the face of what is shaping up to be not just a credit "crunch," but a potentially lethal illness in the credit system per se -- that is, in the very process of trading in paper that claims to represent faith in the future creation of wealth. That process underlies all of modern finance.
Investments, currencies, economies, and nations hang in the balance.
President Bush, seeming very much the clown-in-chief, led the way last week by proposing a mortgage crisis bail-out that would appear to have no chance whatsoever of working as advertised. He called it, arrestingly, the Hope Now Alliance. It blithely assumed that those "servicing" mortgages -- that is, collecting the monthly payments -- have the ability to suspend scheduled upward re-sets of adjustable mortgages for five years for certain select homeowner
payees -- so that theoretically said homeowners could avoid foreclosure.
What might have worked in 1934, when the originators of mortgages were local banks that also "serviced" them (i.e. collected the monthly payments) is unlikely to avail today since the mortgages have been sold off in bunches to pension funds, hedge funds, money markets, and foreign investment funds -- none of which have an interest or the ability to renegotiate loans with millions of schlemiels from Cleveland to Denver to Fresno -- while the companies "servicing"
these contacts are mere errand boys, with no say over the terms of anything they collect on.
So, what if these loans are not "restructured," that is, renegotiated on new terms by both parties on what is, after all, a contract? What if the government just "declares" that the current terms are void? Since the mortgage contracts have been bundled into bonds and sold off, it means that the value of the bonds is no longer what they were sold to represent. So, while a command to suspend mortgage re-sets might give comfort to schlemiels who
used bad judgment in signing mortgage contracts for houses they couldn't afford, it will further impair the value of the bonds dispersed throughout the investment markets and increase disarray in the basic system of creating future credit. That is, if it worked as advertised.
But how can it work? The president said that this relief action would apply only to those who were current in their payments or no more than 60 days behind. Is it possible that a federal bureaucracy that could not even helicopter bottled water to desperate people trapped in plain sight on highway overpasses in New Orleans in 2005 can process millions of sheaves of relief applications in 60 days? Or even concoct the forms and print them?
Even if the paperwork could be designed, printed, and distributed overnight, in reality, the applications would collect in the in-boxes for decades. Meanwhile there would be no way to meaningfully establish time-based qualifications for relief. The absurd process would quickly only cast more doubt on the market value of the bonds sitting "out there" while it would create a monumental disincentive for any financial enterprise to lend money for future mortgages
(or perhaps anything else). So the New Hope Alliance would have the dual effect of killing the housing "industry" and the credit markets. It could easily have a third and not inconsiderable effect of destroying the credibility of the currency of the nation engaging in such obviously foolish political theatrics. And if the dollar goes, the entire global system of currencies could enter a state of dangerous instability.
These are some of the hazards of suspending law as applied to financial markets, which can only function on the basis of contract law. Once contract law goes out the window, so does the faith of parties with reserve capital in lending out capital at interest. If the interest rate can be changed arbitrarily or capriciously by third parties, then those with capital would be better off buying gold or impressionist paintings or Manhattan apartments or private armies
for protecting their Hampton estates, than lending money at interest established by contract.
Anyway, this argument is academic because the Hope Now Alliance is just a political sham. The purpose of it is not to save the hapless occupants of over-leveraged houses, but first to buy a little more time so that the worker bees in the financial industry can justify awarding each other multi-million-dollar Christmas bonus packages, and second, to postpone the "workout" of all this bad investment as far into the future as possible.
I have been wrong in the past about timing things, but I don't see any way on God's green earth that such a workout of mis-investment can be put off until somebody else is sworn in to lead the government in January 2009. The capital allocation system is already listing and groaning like a leaky ship in a hurricane.
Maybe all the players really know that keeping the ship afloat until Christmas is really the best they can hope for. Christmas means a lot in this country. It represents all Americans' old hope that miracles can happen. Bums turn out to be Santa Claus. Old curmudgeons are transformed overnight into loving uncles. Angels save us when we jump despairingly into icey torrents. And Goldman Sachs executives pass out multi-million-dollar checks to the wizards who "innovated"
an ingenious way for the rest of their country to commit financial suicide.
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