Gretchen “Gets It” but misses the mark

It’s no secret that I admire Gretchen Morgenson of the New York Times. Her articles have penetrated deeper and deeper into the realities and logistics of the Great Financial Meltdown. But she continues to drag myth alongside of reality. True, it is difficult to get your mind around the idea that Wall Street managers WANTED bad mortgages, but that simple piece of truth is unavoidable. In the article below she draws ever nearer to this truth, saying that the real question is “what did they know and when did they know it?”
She even spots the extremely important fact that the worse the loan the more money was made by Wall Street. My objection is why not ask the next obvious question, to wit: “If Wall Street’s profits went up as the quality of mortgages went down, isn’t the obvious incentive to create increasingly bad paper?” And in what world has Wall Street ever done anything to diminish profits on moral grounds?
But her spotting is defective. She sees a 5 point spread (Yield Spread Premium) between what was paid for the loans and the price charged to investors. She correctly points out that the most Wall Street usually gets on trades like this is around 2 points. But think about it. Could such a small spread actually account for the ensuing mayhem that resulted?
What she fails to point out is the actual logistics. Investors, and for that matter, even the rating agencies, were never given the actual loans to look at and kick the tires. They were given descriptions of the loans which were incorporated into a narrative that portrayed the loans in a much better light than anything a loan underwriter would agree with. The final description of the loans was so loaded with misrepresentations that even a small amount of due diligence would have revealed major discrepancies that would have stopped this money machine from operating, for good.
Gretchen’s error is reflected in most articles by journalists and government officials. They all miss a major part of the transaction. Do the math. How could a five point spread account for the actual 8-10 point spread that was used to massage the description of the pool? There is a whole other SIV transaction that everyone is ignoring. The size of it will astonish you.

If for the purpose of one extreme example we isolate a single loan transaction, you can see how it works.

John Smith, an unemployed, homeless migrant worker with a gross income of $500 per month is pulled off the street by a “loan adviser.” The salesman gets John to sign a bunch of papers and tells him to go move into a $500,000 house. The interest rate on the loan is 18%, which is $90,000 per year. John doesn’t have to pay anything for the first 3 months and then only $100 per month for the first year, when he must pay a higher amount, still not as much as the monthly interest of $7,500 per month, let alone amortization, taxes, and insurance.

Now go to the investor who has been promised, for this example 9% annual return. The investor gives the investment banker $1,000,000 dollars believing that the investment banker is taking a 2% fee ($20,000). In other words, the investor is expecting $980,000 of his money to be invested. But that is NOT what happened — not ever, in ANY example. The investor, expecting a 9% annual return on his $1 million is therefore expecting $90,000 per year in income.

So in our over-simplified example the investment banker goes to the mortgage aggregator, and says give me the crappiest mortgage you have that says the interest is $90,000 per year. The aggregator (Countrywide, for example) sells the John Smith Mortgage to a structured investment vehicle off-shore for $500,000. The SIV sells the John  Smith Mortgage to another entity (Seller) created by the investment bank for $980,000. The Seller sells the John Smith Mortgage to an “investment pool” for $1 million.

Watch Carefully! What just happened is that the John Smith mortgage was created that would never be paid. The interest rate on that mortgage was 18% and the principal was $500,000. So the annual interest to be paid by borrower was $90,000. The investor gave $1 million to the investment banker and thus “bought” the $90,000 in “income” from John Smith.

The surface transaction that Gretchen and others are looking at is that last transaction where the investment banker appears to pick up a few points as a fee. The underlying transaction, the substance of the real deal, is that the investment banker took $1 million from the investor and funded a $500,000 mortgage, thus creating a yield spread premium total of $500,000. In other words, the investment banker, in our oversimplified example, made a profit EQUAL TO THE MORTGAGE PRINCIPAL.

Not all the borrowers were John Smith. They ranged from him to people with the ability to pay anything. But the Mary Jones Mortgage where she had a credit score of 815 and assets of over $10 million was a key ingredient to this fraud. May Jones Mortgage was put in the top level of the “pool.” She was the gold plating covering dog poop underneath.

The identity of Mary Jones and her credit score HAD to be there, HAD to be used without her permission in order to sell the John Smith Mortgage. I think that is called identity theft. I think it was interstate commerce and I think it was a pattern of conduct. I think that is racketeering, breach of the the Truth in Lending Act and Securities Fraud, based upon appraisal (ratings) fraud at both ends (borrower and investor) of the transaction.

And let’s not forget that all these sales and transfers were undocumented. The only thing that moved was the money. And of course there are all those third party insurance and bailout payments that were never credited to the investor or the borrower. The investment banker kept those too.

——————————————————————————————–
July 24, 2010

Seeing vs. Doing

By GRETCHEN MORGENSON

“WHAT did they know, and when did they know it?” Those are questions investigators invariably ask when trying to determine who’s responsible for an offense or a misdeed.

But for the Wall Street banks whose financing of the subprime mortgage machine placed them at the center of the credit crisis, it’s becoming clear that a third, equally important question must be asked: “What did they do once they knew what they knew?”

As investigators delve deeper into the mortgage mess, they are finding in too many cases that Wall Street firms did nothing when they learned about problem loans or improprieties in lending. Rather than stopping practices of profligate originators like New Century, Fremont and Ameriquest, Wall Street financiers, which held the purse strings for these companies, apparently decided to simply look the other way.

Recent cases have provided glimpses of this conduct. Last week, the Financial Industry Regulatory Authority accused Deutsche Bank Securities, a unit of the huge German bank, of misleading investors about how many delinquent loans went into six mortgage securities worth $2.2 billion that the firm underwrote. Deutsche Bank underreported the delinquency rates among loans when it created the securities in 2006, Finra contends, and then sold them to investors.

Deutsche Bank also understated historical delinquency rates in 16 subprime securities it packaged in 2007, Finra said. Even after it discovered the errors, the authority added, Deutsche Bank continued to report the misstated figures on its Web site, where investors checked the performance of past mortgage pools.

Deutsche Bank settled without admitting or denying the allegations; it paid $7.5 million. The firm said Friday that it had cooperated and was pleased to have the matter behind it.

James S. Shorris, acting chief of enforcement at Finra, said that this was just the first of such cases and that he oversees a team of more than a dozen people investigating firms involved in mortgage securities.

While the Finra case showed Deutsche Bank failing to report problem loans in its securities, investigators in other matters are learning that some firms used information about lending misconduct to increase their profits from the securitization game — without telling investors, of course.

Here is what investigators have learned, according to two people briefed on the inquiries who spoke anonymously because they were not authorized to discuss them publicly. The large banks that provided money to mortgage originators during the mania hired outside analytics firms to conduct due diligence on the loans that Wall Street bought, bundled into securities and sold to investors.

These analysts looked for loans that failed to meet underwriting standards. Among the flagged loans were those in which appraisals seemed fishy or the mortgages went to borrowers with credit scores far below acceptable levels. Loans on vacation properties erroneously identified as primary residences were also highlighted.

The analysts would take their findings back to the Wall Street firms packaging the securities; the reports were not made available to investors.

In 2006-07, amid the mortgage craze, more loans didn’t meet the criteria. But instead of requiring lenders to replace these funky mortgages with proper loans, Wall Street firms kept funneling the junk into securities and selling them to investors, investigators have found.

Cases brought against Wall Street firms by Martha Coakley, attorney general of Massachusetts, have brought some of these practices to light. “Our focus has been on the borrower,” she said in an interview last week, “but as we’ve peeled back the onion we’ve gotten the picture of the role Wall Street played through the financing of these loans.”

But some on Wall Street went further than simply peddling loans they knew were bad, according to the people briefed on some investigators’ findings. They say the firms used these so-called scratch-and-dent loans to increase their profits in the securitization process.

When due-diligence reports turned up large numbers of defective loans — known as exceptions — the banks used this information to negotiate a lower price on the mortgages they bought from the original lenders.

So, instead of paying 99 cents on the dollar for the problem loans, the firm would force the lender to accept 97 cents or perhaps less. But the firm would still sell the mortgage pool to investors at 102 cents or higher, as was typical on high-quality loan pools.

Wall Street enjoyed the profits these practices generated. And because lenders were financed by the Wall Street firms bundling the mortgages into securities, they were hesitant to reject too many dubious loans because doing so would slow the securitization machine.

FOR their part, Wall Street loan packagers were loath to imperil their relationship with lenders like New Century; as long as Wall Street’s lucrative mortgage factories were humming, it needed loans to stoke them. Forcing New Century to eat its bad loans might prompt it to take its business elsewhere.

The bottom line: the more problematic the loans, the better the bargaining power and the higher the profits for Wall Street.

To be sure, the securities’ offering statements noted, in legalese, that the deals might contain “underwriting exceptions” and those exceptions could be “material.” But as investigators get closer to understanding how Wall Street used these exceptions to jack up its earnings, that disclosure defense may ring hollow.

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19 Responses

  1. Jan van Eck- extremely well spoken summation of the entire problem. While we are all posing hundreds of thousands of works, yours are short, and to the point. Now, if we can just discover PROOF of the insurance payouts. I am about ready to start coldcalling people and bribing them to get me some proof. We all know it is a fact, but….

  2. Een with all these abuses, in my view the worst theft is that the insurance policies, styled as “non-recourse” to the assets, so that the insurers did not obtain the actual Notes as compensation for the insurance payout, paid off to the New York Hustlers who did not credit the Obligors on the Notes. So the Notes get to be re-sold to others, the bottom-feeders, who then proceed to foreclose on the houses. The Hustler Crowd collect “at least” three times over: once, with the funds skimmed of the original securitization; once, with the insurance payoff proceeds; once, with the foreclosures and resale of the actual houses.

    It is an astounding transfer of the nation’s wealth from millions of folks to a numerically small group of New Yorkers, a hustle so diabolical that nobody in the judiciary has figured it out. Reason? Nobody is going to mess with a Judge’s mortgage, so it remains outside their frame of reference.

  3. The whole article here. Sorry to post so many posts but
    finally someone is talking!

    MSNBC’s Dylan Ratigan Urges Homeowners to Stop Paying Mortgages As a Leftist Protest

    Read more: http://newsbusters.org/blogs/tim-graham/2010/06/27/msnbcs-dylan-ratigan-urges-homeowners-stop-paying-mortgages-leftist-prot#ixzz0uozW7BDy

  4. MSNBC’s Dylan Ratigan Urges Homeowners to Stop Paying Mortgages As a Leftist Protest

    Read more: http://newsbusters.org/blogs/tim-graham/2010/06/27/msnbcs-dylan-ratigan-urges-homeowners-stop-paying-mortgages-leftist-prot#ixzz0uozW7BDy

  5. Daniela Mars …
    THAT WAS GREAT!

  6. and this one also!

  7. Watch this video !!!!

  8. 2 Anonymous…. think we all have a pretty good idea of what went and is going on here… but there are plenty of people out there that were used and abused as Neil points out … the big oop’s here is that they have lost their jobs or are in eminent risk of losing their job.

    These are people who did not have liar ,no doc , sub-prime loans, and many with high equity to loan obligations on their homes and lived within their means…

    If as you as you suggest that putting everyone in a pool of “low credit score” to induce profit… then the American people are dealing with something far more diabolical then ever imagined.

  9. What a scam…We just had 6 more signs go up in the neighborhood. Homes that once were $350 to $400 K are now selling at $150 K. I do not see why this
    Obama administration cannot see that something must be wrong. Anyone who is still in my neighborhood is the now the new target even if they have the ability to pay. We are being forced into foreclosure or bankruptcy. Maybe best to join the crowd and just walk away.

    Call Obama’s H.O.P.E. program. They will suggest that you cut back on the food budget.
    Call Obama’s H.A.M.P. program, you will find you are .1% from qualification.
    Call Consumer Credit Counseling (Division of H.U.D.) They will refer you to websites with free legal advice.

    Finally, all of the above will ask what is your hardship ?…Here’s the hardship you idiots, I was scammed by the thieves in Washington who contrived a plan to fleece my life savings and retirement. Not to mentioned I am over $ 250 K upside down on my home loan.

    These people need to get a real job !

  10. What happened to 9/11 protection law?
    the same time that happened to wtc#7 controlled demolition ..
    we were sold out.
    the judges were bought.
    the Gov is in this up to their neck.
    IN THIS ECONOMIC MAELSTROM IF THERE ARE CUTS TO BE MADE THEN START WITH THE DESERVING NECKS OF THE TREASONOUS !

  11. And, still no one knows where any money is going – that is, current payments and foreclosure recoveries.

    What happened to 9/11 protection law?

  12. And to PJ

    All were solicited by their credit score – you were targeted for higher profit. Low credit scores meant higher profits.

    We were set-up. And all consequence will continue to destruct the US economy.

    Current administration is finished.

  13. Hate to say it – as I am always one for details and digging as to what really went on – but THE A MAN – is right again.

    Need to speak out in unison. This is something that just has not yet been done – at least minimally done.

    All posted here is great – and largely right – but – have always said – WE NEED MORE.

    THE A MAN – still elect you to rally!!!

  14. This is the only way we can get it done.

    http://latimesblogs.latimes.com/lanow/2010/07/bell-protesters-pay-visit-to-council-members-business-home.html

    until this is done to the judges and the banksters we are doomed.

    NEVER AGAIN

  15. Neil
    So what happen’s when Mary Jones losses her job and savings due to the fraudulant activity and she can not pay her mortgage… How many Mary Jones, John Does etc. out there… perhaps they should start sueing their lender, servicer and all others involved for racketeering, identity theft and security fraud!

    “The identity of Mary Jones and her credit score HAD to be there, HAD to be used without her permission in order to sell the John Smith Mortgage. I think that is called identity theft. I think it was interstate commerce and I think it was a pattern of conduct. I think that is racketeering, breach of the the Truth in Lending Act and Securities Fraud, based upon appraisal (ratings) fraud at both ends (borrower and investor) of the transaction.”

  16. NO NOT SUE. CRIMINAL CHARGES. ECONOMIC GENOCIDE CRIMES AGAINST HUMANITY TREASON ETC…..
    JAIL TIME. THESE LICENSED CRIMINALS NEED TO BE PUT IN GUANTANAMO OR FED TO THE SHARKS

    AND YES NEIL I DONT THINK EVEN YOU GET IT. NO LESS THAT CRIMES AGAINST HUMANITY TREASON THE DEATH PENALTY TO THESE JUDGES AND BANKSTERS.

    NEVER AGAIN.

  17. we need to start suing the Judges !!!!!!!!!!!!

  18. I THINK IT IS TIME TO START LOOKING AT CHARGES AGAINST THE NOTORIOUS JUDGES ETC… AND BANKS ALONG THE LINES OF CRIMES AGAINST HUMANITY ETC….

    I THINK I READ OF A PENDING CASE AGAINST WARREN BUFFET AND BILL GATES HERE ON THIS BLOG IN EUROPE.

    UNFORTUNATELY THE ROMAN POLANSKI EXTRADITION (WHATEVER YOU THINK OF HIM THAT IS WHY IT IS UNFORTUNATE) CASE EXPOSED THE DIMINISHED POWER OF THE UNITED STATES JUDICIAL SYSTEM AND THAT THERE ARE POWERS IN EUROPE WHO WANT TO HAVE FUN WITH THE U.S. JUDICIAL SYSTEM.

    MAYBE IN THE HAGUE OR IF WE CAN DO IT HERE IN THE UNITED STATES.

    NEVER AGAIN.

  19. Keep it simple sam

    1. close to a million foreclosures this year alone

    2. Recall (loan modification short sales) are not working

    3. Record profits for banks.

    4. Record losses Houses.

    WHAT MORE DOES THE JUDGE NEED TO FIGURE THIS OUT?

    THE JUDGES MAKE SADAM HUSSEIN AND OSAMA BIN LADIN LOOK LIKE BOY SCOUTS.

    SADAM HUSSEIN IN HIS WILDEST DREAMS DID NOT DO ETHNIC (ECONOMIC) CLEANSING LIKE THE OBAMA ADMINISTRATION AND THE JUDGES.

    MAYBE MILOSOVIC OF YUGOSLAVIA IS AS GOOD AS THE JUDGES AND OBAMA..

    WHAT ARE THE JUDGES GONNA CLAIM WHEN THEY MEET JUSTICE? IGNORANCE? THEY WILL MEET JUSTICE EITHER IN THIS WORLD OR THE NEXT. I FEEL SORRY FOR THE CHRISTIAN JUDGES BECAUSE IN CHRISTIANITY THERE IS AN ETERNAL HELL.

    WOULD ANYBODY HAVE SIGNED THE DOTTED LINE TO THE LOAN OR REFINANCE IF THEY KNEW THAT THE ONLY INCENTIVE THE BANKSTERS HAD WAS TO MAKE A COMMISION?

    WE BELIEVED WE WERE GETTING A SOFT MONEY LOAN WHEN WE WERE REALLY GETTING A HARD MONEY LOAN SHARK LOAN.

    NEVER AGAIN

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