Mortgage Backed Securities — the Next Wave

Gon­zalo Lira On The Sec­ond Leg Down Of America’s Death Spi­ral
Tyler Durden’s pic­ture
Sub­mit­ted by Tyler Dur­den on 10/14/2010 10:19 –0500

* Bank of Amer­ica
* Fan­nie Mae
* Florida
* Fred­die Mac
* GMAC
* Gon­zalo Lira
* Hous­ing Bub­ble
* Insur­ance Com­pa­nies
* Lehman
* Mort­gage Backed Secu­ri­ties
* Mort­gage Loans
* Naked Cap­i­tal­ism
* Pres­i­dent Obama
* rat­ings
* Rat­ings Agen­cies
* White House

Sub­mit­ted by Gon­zalo Lira

The Sec­ond Leg Down of America’s Death Spiral

I swear to God Almighty: Mort­gage Backed Secu­ri­ties are America’s Herpes—the gift that keeps on oozing.

Last Fri­day, Bank of Amer­ica announced that it was sus­pend­ing all fore­clo­sure pro­ceed­ings, pre­sum­ably until fur­ther notice. Other banks have already sus­pended fore­clo­sures in a whole truck­load of states. A nation­wide mora­to­rium on fore­clo­sures might soon happen—which would be a big deal: Global Finan­cial Cri­sis, Part II—Longer, Wider and Uncut.

But the main­stream media—surprise-surprise—has down­played the whole she­bang. They’re throw­ing terms out there into the ether, but devoid of con­text or expla­na­tion: “Robo-signings”, “fore­clo­sure mills”, forged sig­na­tures, “dou­ble book­ing”, MERS—it’s con­fus­ing as all get-out.

So the main­stream media just men­tions it casually—“and in other news tonight …”—like it’s no big deal: A couple-three lines, lots of com­pli­cated, unfa­mil­iar terms, an atti­tude like it’s a brouhaha over paper­work of all things!—and then zappo-presto-change-o!: They’re show­ing video footage of a cute koala nurs­ing in the arms of a San Diego zookeeper.

But even the koalas know that some­thing awful is head­ing America’s way. Smart lit­tle crit­ters, they’re head­ing for the tree­tops, to get away from this mess.

So what the hell is going on with the God for­saken mort­gage mess in the United States?

It’s got a lot of bells and whis­tles, but it’s basi­cally quite sim­ple: It’s all about the fuck­ing Mort­gage Backed Secu­ri­ties (MBS). Again.

So this is what hap­pened, more or less—the short version:

In the crazed frenzy to get as many mort­gages secu­ri­tized dur­ing the Oughts, banks took short­cuts with the paper­work nec­es­sary for the Mort­gage Backed Secu­ri­ties. The rea­son was because every­one in the chain of this secu­ri­ti­za­tion mania got a lit­tle piece of the action—a lit­tle slice of the MBS pie in the shape of commissions.

So in the name of “improved effi­cien­cies” (and how many hor­ror sto­ries are we find­ing out, car­ried out in the name of “improved effi­cien­cies”), banks dig­i­tized the mort­gage notes—they didn’t phys­i­cally endorse them, like they were sup­posed to by the var­i­ous state and Fed­eral laws.

Plus—once the wave of fore­clo­sures broke, and the holes in this bureau­cratic paper­work became evi­dent and relevant—some of the big law firms han­dling the fore­clo­sures for the banks started doing some doc­u­ment fab­ri­ca­tion and sig­na­ture forgery, in order to cover up the mistakes—which is def­i­nitely illegal.

Long story short (since this is the short ver­sion): A lot of the fore­closed prop­er­ties might not have been fore­closed legally. The peo­ple evicted might still have a right to their old houses. The new buy­ers might not actu­ally own the REO’s they bought off the banks. The banks could be on the hook for tril­lions of dol­lars, and in the sights of lit­er­ally mil­lions of lawsuits.

In short: This could become another mas­sive ooz­ing sore, com­plete with yellow-green pus drip-drip-dripping out of some unmen­tion­able places on the Body Economic.

Now—the long version:

Home­own­ers can only be fore­closed and evicted from their homes by the per­son or insti­tu­tion who actu­ally has the loan paper—only the note-holder has legal stand­ing to ask a court to fore­close and evict. Not the mortgage—the note, which is the actual IOU that peo­ple sign, promis­ing to pay back the mort­gage loan.

Before Mort­gage Backed Secu­ri­ties, most mort­gage loans were issued by the local Sav­ings & Loan. So the note usu­ally didn’t go any­where: It stayed in the offices of the S&L down the street.

But once mort­gage loan secu­ri­ti­za­tion hap­pened, things got sloppy—they got sloppy by the very nature of Mort­gage Backed Securities.

The whole pur­pose of MBS’s was for dif­fer­ent investors to have their dif­fer­ent risk appetites sati­ated with dif­fer­ent bonds. Some bond cus­tomers wanted super-safe bonds with low returns, some oth­ers wanted riskier bonds with there­fore higher rates of return.

There­fore, as every­one knows, the loans were “bun­dled” into REMIC’s (Real-Estate Mort­gage Invest­ment Con­duits, a spe­cial vehi­cle designed to hold the loans for tax pur­poses), and then “sliced & diced”—split up and put into tranches, accord­ing to their like­li­hood of default, their inter­est rates, and other characteristics.

This slic­ing and dic­ing cre­ated “senior tranches”, where the loans would likely be paid in full, if past his­tory of mort­gage loan sta­tis­tics was to be believed. And it also cre­ated “junior tranches”, where the loans might well default, again accord­ing to past his­tory and sta­tis­tics. (A whole range of tranches were cre­ated, of course, but for pur­poses of this dis­cus­sion, we can ignore all those count­less other variations.)

These var­i­ous tranches were sold to dif­fer­ent investors, accord­ing to their risk appetite. That’s why some of the MBS bonds were rated as safe as Trea­sury bonds, and oth­ers were rated by the rat­ings agen­cies as risky as junk bonds.

But here’s the key issue: When an MBS was first cre­ated, all the mort­gages were pristine—none had defaulted yet, because they were all brand new loans. Sta­tis­ti­cally, some would default and some oth­ers would be paid back in full—but which ones specif­i­cally would default? No one knew, of course. If I toss a coin 1,000 times, sta­tis­ti­cally, 500 tosses the coin will land heads—but what will the result be of, say, the 723rd toss specif­i­cally? I dunno.

Same with mortgages.

So in fact, it wasn’t that the riskier loans were in junior tranches and the safer mort­gage loans were in the senior tranches: Rather, all the loans were in all the tranches, and if and when a mort­gage in a given bun­dle of mort­gages defaulted, the junior tranche hold­ers would take the losses first, and the senior tranche holder take the loss last.

But who was the owner of the junior tranche bond and the senior tranche bond? Two dif­fer­ent peo­ple. There­fore, the mort­gage note was not actu­ally signed over to the bond holder. In fact, it couldn’t be signed over. Because, again, since no one knew which mort­gage would default first, it was impos­si­ble to assign a spe­cific mort­gage to a spe­cific bond.

There­fore, how to make sure the safe mort­gage loan stayed with the safe MBS tranche, and the risky and/or default­ing mort­gage went to the riskier MBS tranche?

Enter stage right, the famed MERS—the Mort­gage Elec­tronic Reg­is­tra­tion System.

MERS was the repos­i­tory of these dig­i­tized mort­gage notes that the banks orig­i­nated from the actual mort­gage loans signed by home­buy­ers. MERS was jointly owned by Fan­nie Mae and Fred­die Mac (yes, those two, again, I know, I know: Like the chlamy­dia and the gon­or­rhea of the finan­cial world—you cure ‘em, but they just keep com­ing back).

The pur­pose of MERS was to help in the secu­ri­ti­za­tion process. Basi­cally, MERS directed default­ing mort­gages to the appro­pri­ate tranches of mort­gage bonds. MERS was essen­tially the oper­at­ing table where the dig­i­tized mort­gage notes were sliced and diced and rearranged so as to cre­ate the Mort­gage Backed Secu­ri­ties. Think of MERS as Dr. Frankenstein’s oper­at­ing table, where the beast got put together.

How­ever, legally—and this is the impor­tant part—MERS didn’t hold any mort­gage note: The true owner of the mort­gage notes should have been the REMIC’s.

But the REMIC’s didn’t own the note either, because of a fluke of the rat­ings agen­cies: The REMIC’s had to be “bank­ruptcy remote”, in order to get the pre­cious rat­ings needed to ped­dle Mort­gage Backed Secu­ri­ties to insi­tu­tional investors.

So some­where between the REMIC’s and the MERS, the chain of title was broken.

Now, what does “bro­ken chain of title” mean? Sim­ple: When a home­buyer signs a mort­gage, the key doc­u­ment is the note. As I said before, it’s the actual IOU. In order for the mort­gage note to be sold or trans­ferred to some­one else (and there­fore turned into a Mort­gage Backed Secu­rity), this doc­u­ment has to be phys­i­cally endorsed to the next per­son. All of these sig­na­tures on the note are called the “chain of title”.

You can endorse the note as many times as you please—but you have to have a clear chain of title right on the actual note: I sold the note to Moe, who sold it to Larry, who sold it to Curly, and all our nota­rized sig­na­tures are actu­ally, phys­i­cally on the note, one after the other.

If for what­ever rea­son, any of these sig­na­tures is skipped, then the chain of title is said to be bro­ken. There­fore, legally, the mort­gage note is no longer valid. That is, the per­son who took out the mort­gage loan to pay for the house no longer owes the loan, because he no longer knows whom to pay.

To repeat: If the chain of title of the note is bro­ken, then the bor­rower no longer owes any money on the loan.

Read that last sen­tence again, please. Don’t worry, I’ll wait.

You read it again? Good: Now you see the can of worms that’s open­ing up.

The bro­ken chain of title wouldn’t have been an issue if there hadn’t been an unusual num­ber of fore­clo­sures. Before the hous­ing bub­ble col­lapse, the peo­ple who defaulted on their mort­gages wouldn’t have both­ered to check to see that the paper­work was in order.

But as every­one knows, fol­low­ing the hous­ing col­lapse of 2007–‘10-and-counting, there’s been a boat­load of foreclosures—and fore­clo­sures on a lot of peo­ple who weren’t sloppy bums who skipped out on their mort­gage pay­ments, but smart and cau­tious peo­ple who got squeezed by circumstances.

These peo­ple started con­test­ing their fore­clo­sures and evic­tions, and so started look­ing into the chain of title issue … and that’s when the paper­work became impor­tant. So the chain of title became impor­tant. So the botched paper­work became a non-trivial issue.

Now, the banks had hired “fore­clo­sure mills”—law firms that spe­cial­ized in foreclosures—in order to han­dle the mas­sive vol­ume of fore­clo­sures and evic­tions that occurred because of the Hous­ing Cri­sis. The fore­clo­sure mills, as one would expect, were the first to spot the bro­ken chain of titles.

Well, hell, whad­daya know—turns out that these fore­clo­sure mills might have faked and fal­si­fied doc­u­men­ta­tion, so as to fraud­u­lently repair the chain-of-title issue, thereby “prov­ing” that the banks had judi­cial stand­ing to fore­close on a delin­quent mort­gage. These fore­clo­sure mills might have even forged the loan note itself—

—wait, why am I hedg­ing? The fore­clo­sure mills actu­ally, delib­er­ately and cat­e­gor­i­cally faked and fal­si­fied doc­u­ments, in order to expe­dite these fore­clo­sures and evic­tions. Yves Smith at naked cap­i­tal­ism, who has been all over this story, put up a price list for this “ser­vice” from a com­pany called DocX—yes, a price list for forged doc­u­ments. Talk about your one-stop shopping!

So in other words, a mas­sive fraud was car­ried out, with the inevitable inno­cent bystander get­ting caught up in this fraud: The guy who got fore­closed and evicted from his home in Florida, even though he didn’t actu­ally have a mort­gage, and in fact owned his house free-and-clear. The fam­ily that was fore­closed and evicted, even though they had a per­fect mort­gage pay­ment record. Et cetera, depress­ing et cetera.

Now, the rea­son this all came to light is not because enough peo­ple were get­ting screwed that the banks or the gov­ern­ment or some­one with power saw what was going on, and decided to put a stop to it—that would have been nice, to see a shin­ing knight in armor, rid­ing on a white horse.

But that’s not how Amer­ica works nowadays.

No, alarm bells started going off when the title insur­ance com­pa­nies started to refuse to insure the title.

In every sale, a title insur­ance com­pany insures that the title is free-and-clear: That the prospec­tive buyer is in fact buy­ing a prop­erly vet­ted house, with its title issues all in order. Title insur­ance com­pa­nies stopped pro­vid­ing their ser­vice because—of course—they didn’t want to expose them­selves to the risk that the chain-of-title had been bro­ken, and that the bank had ille­gally fore­closed on the pre­vi­ous owner.

That’s when things started get­tin’ inner­estin’: That’s when the Attor­neys Gen­eral of var­i­ous states started snoop­ing around and mak­ing noises (elec­tions are com­ing up, after all).

The fact that Ally Finan­cial (for­merly GMAC), JP Mor­gan Chase, and now Bank of Amer­ica have sus­pended fore­clo­sures sig­nals that this is a seri­ous problem—obviously. Banks that size, with that much expo­sure to fore­closed prop­er­ties, don’t sus­pend fore­clo­sures just because they’re good cor­po­rate cit­i­zens who want to do the right thing, with all the paper­work in strict order—they’re halt­ing their fore­clo­sures for a reason.

The move by the United States Con­gress last week, to sneak by the Inter­state Recog­ni­tion of Nota­riza­tions Act? That was all the bank­ing lobby—they wanted to shove down that law, so that their fore­clo­sure mills’ forged and fraud­u­lent doc­u­ments would not be scru­ti­nized by out-of-state judges. (The spine­less cow­ards in the Sen­ate car­ried out their Master’s will by a voice vote—so that there’d be no reg­istry of who had voted for it, and there­fore no account­abil­ity, the cor­rupt pricks.)

And Pres­i­dent Obama’s pocket veto of the mea­sure? He had to veto it—if he’d signed it, there would have been polit­i­cal hell to pay, plus it would have been chal­lenged almost imme­di­ately, and likely over­turned as un-Constitutional in short order. (The jug-eared mil­que­toast didn’t even have the gump­tion to veto it—he pocket vetoed it.)

As soon as the White House announced the pocket veto—the very next day!—Bank of Amer­ica halted all fore­clo­sures, nationwide.

Why do you think that hap­pened? Because the banks are screwed—again. By the same fuck­ing thing as the last time—the fuck­ing Mort­gage Backed Securities!

The rea­son the banks are fucked again is, if they’ve been fore­clos­ing on peo­ple they didn’t have the legal right to fore­close on, then those peo­ple have the right to get their houses back. And the peo­ple who bought those fore­closed houses from the bank might not actu­ally own the houses they paid for.

And it won’t mat­ter if a par­tic­u­lar case—or even most cases—were on the up-and-up: It won’t mat­ter if most of the fore­clo­sures and evic­tions were truly because the home­owner failed to pay his mort­gage. The fraud com­mit­ted by the fore­clo­sure mills casts enough doubt that now, all fore­clo­sures come into ques­tion. Not only that, all mort­gages come into question.

Peo­ple still haven’t fig­ured out what this all means—but I’ll tell you: If enough mortgage-paying home­own­ers real­ize that they may be able to get out of their mort­gage loan and keep their house, scott-free? Shit, that’s basi­cally a license to halt pay­ments right the fuck now. That’s basi­cally a license to tell the banks to fuck off.

What are the banks gonna do—try to fore­close and then evict you? Show me the paper, moth­er­fucker, will be all you need to say.

This is a major, major cri­sis. This makes Lehman’s bank­ruptcy look like a spring rain, com­pared to this hur­ri­cane. And if this isn’t han­dled right—and han­dled right quick, in the next cou­ple of weeks on the outside—this cri­sis could also spell the end of the mort­gage busi­ness alto­gether. Of bank­ing alto­gether. Hell, of civil soci­ety. What do you think hap­pens in a coun­try when the cit­i­zens real­ize they don’t need to pay their debts?

If this isn’t han­dled right, then this will be the sec­ond leg down, in the Amer­i­can Death Spiral.

Oh dear Lord, he said, calm yet despon­dent. Look at it, he said. I mean just look at it! Have you ever seen any­thing like it?!?

No, said the koala—truthfully. And you know, uh … it’s … It’s pretty dis­gust­ing, actu­ally. So would you mind putting that thing away?

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Note: Next post, I’ll dis­cuss a possible—I empha­size, a possible—silver bul­let that will fix this whole Mort­gage Mess—but it’ll have to be done soon, and have to be car­ried out fast, and sold under the guise that it’s this great new pro­gram that everybody—and I mean everybody—will sim­ply just love to be a part of!—

—Stream­lined Refinance.