Dienstag, Oktober 05, 2010

A $9.5 Trillion Fraud...

There are some simple rules for financial folks who prepare financial instruments for investors: do your homework is one of them.

If a financial instrument has legal requirements and you do not follow those legal requirements, you commit fraud: you are selling something as something that it is not.

Consider this:the volume of mortgage backed securities in August 2010 was around $9.5 trillion.

Now consider this: it appears that the basis of mortgage-backed securities - the ownership of the mortgage itself, which is clearly defined as based on a transfer with real-world signatures - has been systematically destroyed. If this is true - and the class-action suites seem to indicate that this is indeed a problem - that means that anyone holding a mortgage-based security needs to determine if that security is actually bona-fide, i.e. that the legal requirements were actually fulfilled, rather than relying on the word of companies that have apparently not done what they have said they did.

This is developing into the world's largest fraud. $9.5 trillion? That's real money, folks.

Here is the key quote:

We've said for some time that document fabrication is widespread in foreclosures. The reason is that the note, which is the borrower IOU, is the critical instrument to establishing the right to foreclose in 45 states (in those states, the mortgage, which is the lien on the property, is a mere "accessory" to the note).

The pooling and servicing agreement, which governs the creation of mortgage backed securities, called for the note to be endorsed (wet ink signatures) through the full chain of title. That means that the originator had to sign the note over to an intermediary party (there were usually at least two), who'd then have to endorse it over to the next intermediary party, and the final intermediary would have to endorse it over to the trustee on behalf of a specified trust (the entity that holds all the notes). This had to be done by closing; there were limited exceptions up to 90 days out; after that, no tickie, no laundry.

It gets better:

Evidence is mounting that for cost reasons, starting in the 2004-2005 time frame, originators like Countrywide simply quit conveying the note. We are told this practice was widespread, probably endemic. The notes are apparently are still in originator warehouses. That means the trust does not have them (the legalese is it is not the real party of interest), therefore it is not in a position to foreclose on behalf of the RMBS investors. So various ruses have been used to finesse this rather large problem.

The foreclosing party often obtains the note from the originator at the time of foreclosure, but that isn't kosher under the rules governing the mortgage backed security. First, it's too late to assign the mortgage to the trust. Second. IRS rules forbid a REMIC (real estate mortgage investment trust) from accepting a non-performing asset, meaning a dud loan. And it's also problematic to assign a note from the originator if it's bankrupt (the bankruptcy trustee must approve, and from what we can discern, the note are being conveyed without approval, plus there is no employee of the bankrupt entity authorized to endorse the note properly, another wee problem).

In other words, the companies involved have sold people something that isn't what it is claimed to be. While this might appear to be a technicality, it fulfills the definition of fraud. Those who believe that they own the mortgages cannot enforce their rights: they have been defrauded.

Playing with public trust - corners were cut here apparently because of the volume of business, which is an explanation, but not an excuse - is deadly for anyone involved in the financial services industry. Trust is the most difficult thing to replace and the most damning indictment. Fraud is not a victimless crime, as investors here are going to find out.

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