Tuesday, October 19, 2010
As I've repeatedly pointed out, the big banks intentionally signed up as many borrowers as possible, even if there was no way they could repay their loans.
For example, I recently wrote:
But there might have been another reason that loaning to borrower who couldn't repay was the prevalent business model.
[Professor William] Black explained that fraud by a financial company usually involves the company:1) Growing like crazy2) Making loans to people who are uncreditworthy, because they’ll agree to pay you more, and that’s how you grow rapidly. You can grow really fast if you loan to people who can’t you pay you backand3) Using extreme leverage.This combination guarantees stratospheric initial profits during the expansion phase of the bubble.
But it guarantees a catastrophic subsequent failure when the bubble loses steam.
And collectively - if a lot of companies are playing this game - it produces extraordinary losses (more than all other forms of property crime combined), and a crash.
In other words, the companies intentionally make loans to people who will not be able to repay them, because - during an expanding bubble phase - they'll make huge sums of money. The top executives of these companies will make massive salaries and bonuses during the bubble (enough to live like kings even even if the companies go belly up after the bubble phase).
[Simon] Johnson confirmed that a high housing default rate was part of the banks' models. The financial giants knew they would make huge sums during the boom, and then transfer their losses to the American people during the bust.
As foreclosure expert Neil Garfield notes, mortgages are worth a lot more if they default than if they perform.
Specifically, a mortgage worth $300,000 if the homeowner repays in full might be worth $9 million to the various owners of synthetic cdos and credit default swaps if the owner defaults.
We know - as alleged by the SEC:
Paulson & Co. effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (CDS) with Goldman Sachs to buy protection on specific layers of the ABACUS capital structure.Paulson also advised Los Angeles apartment mogul Jeff Greene to do something similar. Greene was heavily involved in the subprime market, and he bought the worst of the mortgage backed securities, and then bet against the bonds using CDS.
But Garfield says that it is broader than just a couple of investors like Paulson and Greene. He believes that was basically the business model for the entire mortgage industry.
He said that the big banks that packaged mortgage backed securities had an incentive to suck in really bad mortgages. If a certain percentage of the mortgages default, the cdo and cds side bets pay many times more than the actual mortgage could possibly pay.
Similarly, Southern California foreclosure attorney Jeff Barnes writes:
Foreclosure fraud investigators should drill down on the extent to which these incentives motivated the mbs packagers to include mortgages which did not meet underwriting standards.
[We have acquired] computerized mortgage loan investigation and securitized mortgage loan trust software and special computer terminals which can track a mortgage loan’s history including its assignment to specific tranches inside of a trust. The information being revealed by this unique research tool is both fascinating and disturbing.
A sample of what our researchers are finding: loans which were assigned to multiple tranches within one securitized mortgage loan trust; the assignment of the loan to different trusts; the divison of the loan into parts across tranches, and more. What this means to foreclosure defense discovery is nothing short of monumental.
If a loan is assigned to different tranches and/or different trusts, with each tranche or trust having its own series of credit enhancements and insurances, this means the possibility of multiple levels of insurance for the same loan, which goes to prove what we have been arguing for years: that upon securitization, the mortgage loans were insured with multiple layers of insurance so that when the loan went into default, those in the placement chain could reap untold profits by having the same risk paid over and over and over again through multiple claims or reserves. Anyone who read through the SEC v. Goldman Sachs lawsuit knows this.
As such, any foreclosure defense should now hammer, hard, on ALL available credit enhancements, insurances, tranche assignments, and all agreements relating thereto. We will make a predition here: that very soon, there are going to be a series of cases where it is revealed, in discovery, that mortgage loans were paid 2, 3, 4, or more times on default and that the foreclosing party is simply trying to get paid a 5th or more time by stealing the borrower’s house under false pretenses and with material omissions and improper objections as to discovery related to setoffs (which objections we predict will be overruled once the judiciary is educated as to these matters). Once that happens, we see a literal tsunami of fraud upon the court claims and damage claims against the current foreclosure perpetrators.
They should also investigate the extent to which these incentives motivated mortgage originators to create "liar's loans", "ninja loans", "neutron loans", and "toxic waste".
See this on how credit default swaps can be used like buying fire insurance on someone else's house and then burning down the house, and this explanation by Ellen Brown (starting about half way into video).