Reuters: Credit Unions Fail As a Result of Buying Mortgage Bonds

As regulators conclude their long investigation into the cloud of companies and the maze of paths of paperwork and money the real victims are being revealed. We know Pension funds got hit hard and are now underfunded strictly as a result of buying worthless mortgage bonds from investment bankers who promised them protection and transparency but instead proved to be the predator. Now regulators are suing Morgan Stanley for defrauding two credit unions that failed as a result of taking a loss on those bonds — a loss that was a gain to the investment banker.

But they still don’t have it exactly right. The regulators are now freely describing mortgages that were “faulty”, “defective”‘ or “non-conforming”. They are describing bonds whose indentures were violated. Yet the government still stands on the sidelines when we look at the damage caused to millions of homeowners who have been forced from their homes and lost everything. The guise is “personal responsibility” — meaning that homeowners are to blame for what happened to them. Meanwhile the question of ownership of who owns the loan and the balance of the loan are being circumvented through destructive litigation, led by judges who are ill-informed mostly because lawyers have failed to learn securitization of debt.

Thus the government has failed to lead the way to stopping Foreclosures. It is still a basic axiom in the offices of regulators, the courtrooms of the judiciary and in mainstream media that individual borrowers are the people who must take responsibility and pay for the fraud. They should have known better. They should have read the documents. But this “logic” flies in the face that two branches of government have already recognized is that the one party who is at a disadvantage in a mortgage loan transaction and credit generally is the borrower — not the lender.

This issue was officially decided by the Federal Government in The Federal Truth in Lending Act was enacted for just that purpose and reason. The Federal Real Estate Settlement Procedures Act was enacted for just that purpose. And the many states that have enacted deceptive lending statutes that freely borrow from TILA and RESPA. Lawyers need to include this in their pleadings, memorandums and oral arguments to start where we should start — at the beginning. If those mortgages are being settled with the creditors who loaned the money because the loans were defective, and they are being settled with shared risk of loss, then why should our attitude toward borrowers be any different as to the same defective mortgages?

A good starting point would be to find the list of defective mortgages to see if your mortgage is in the
list of mortgages claimed to have been securitized, where the mortgages were described as defective, and where the mortgage bonds were described as fraudulent. Fraudulent appraisals are being ignored in the courtroom despite the clear provisions TILA that makes the appraisal and the viability of the loan the responsibility of the lender. Foreclosure defense attorneys are missing an important part of their argument when they fail to start with the responsibilities of the lender, the reasons why those standards were not applied, and the fact that the real lenders in millions of table-funded (predatory per se– I.e. Presumptively predatory) were being defrauded in two ways — non-conforming defective loans and mortgage bonds.

Of course the agencies could make thing easy by forcing publication of a list of REMIC trusts that have been subject to settlements relating to fraudulent and deceptive lending, and fraudulent and deceptive sale of mortgage bonds. But the truth is that the false axioms of the cloud of companies acting under cover of false claims of securitization are settling in the minds of judges, lawyers and regulators that somehow tens of millions of mostly unsophisticated people conspired to defraud the system. How likely is that? Or is it more likely that mortgage companies were pushing, coercing, lying, and deceiving the borrowers — just as the the lawsuits against the investment banks state? And just as they have done in the past?

Those lawsuits frequently allege that the underlying mortgages were non-compliant and unenforceable. If the investment bankers and investors, insurers and government agencies can agree that those mortgages were not enforceable, why is it that lawyers have not brought that message with them into the courtroom? And when they do, why are judges ignoring the argument. It has already been decided at the highest levels of government that the homeowner is hopelessly outgunned at closing. Why assume anything different? When those laws were passed , the number of loan options was 4 or 5. During this period of mortgage madness and meltdown, the number of mortgage products climbed to over 400 options. Borrowers didn’t do that. It was the mortgage originator who had no risk of loss because the money of the investor was what ended up on the table at closing.

Morgan Stanley

http://www.reuters.com/article/2013/09/24/us-morganstanley-creditunion-lawsuit-idUSBRE98N02E20130924

Peeling the Onion: Morgan Stanley Forced to Produce Documents Corroborating Illegal Acts

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What’s the Next Step? Consult with Neil Garfield

For assistance with presenting a case for wrongful foreclosure, please call 520-405-1688, customer service, who will put you in touch with an attorney in the states of Florida, Tennessee, Georgia, California, Ohio, and Nevada. (NOTE: Chapter 11 may be easier than you think).

Editor’s Comment and Practice Tips: There are two things you should know going into foreclosure defense. One is that the best decisions on the trial and appellate level came from cases where both sides were institutional in nature. So if the adversaries were both banks, or one was a managed fund, or perhaps a Homeowners or Condominium Association, the Court was a lot more receptive to the same arguments they routinely rejected from Borrowers. That alone suggests some strategies both for investors and homeowners (particularly those hard hit by the mortgage meltdown). The second is that an increasing number of courts are, in the words of one judge who WAS ruling routinely against borrowers, “getting tired of the sloppiness” with which the loan deals were originated, allegedly transferred and claimed as owned by one of a number of parties. They are entering more orders requiring proof of loss, proof of payment and proof that any financial transaction took place in which the forecloser was either the recipient (payee) or the payor of actual money that exchanged hands.

We have seen how the same homeowner with the same property has been assaulted by two completely different “holders”, neither of whom were creditors, each claiming to be producing the original note — and there it was in all its glory, two “original” notes both of which had been printed the previous day on a very good printer. We have seen how the appraisals went further and further off the reservation under pressure from the banks and how the applications were changed under pressure from the banks to close the deal regardless of outcome or viability of the loan.

Strategically I have been encouraging practicing attorneys to pay close attention to the dozens of lawsuits filed against the banks by institutional plaintiffs — pension funds that bought bogus mortgage bonds, government agencies whose findings might be incorporated as fact in your case (especially if the case settled), HOA’s and banks fighting over priority of liens. The facts alleged are fairly uniform — all leading to the conclusion that the loans were neither underwritten in conformity with industry standards (leading to fraud or breach of contract actions) nor supported by documentation that is enforceable (i.e., the mortgage lien was never perfected and the note was incorrectly fabricated and executed without consideration from the named payees or nominees.

The latest rumble over the lack of prosecution on this mortgage mess has produced the resignation of the guy at DOJ who was supposed to be prosecuting these cases. Maybe the change will come. But by this time int he Savings and Loan scandal of the 1980″s there were more than 800 people sitting behind bars with others on probation. The PBS piece “Untouchables” has kicked up a fore storm over the issue of criminal prosecution. Those cases too should be watched carefully and your wording in your pleading ought to be as close to their wording in their lawsuits especially where they have already survived the usual motion to dismiss.

Robert Schiller the economist who created the black letter basis for measuring economic data relating to the housing industry says we are far from done with the damages and debris left by the mortgage meltdown. And out of 105 economists who participated in an independent survey very few had anything good to say about housing or the economy — with the two inextricably entwined. Fixing housing is not merely about stopping foreclosures or increasing modifications. At the heart of the mortgage meltdown was fraud.

And fraud comes in two flavors — civil and criminal. Both require receivers and restitution if prosecuted properly. Investors and homeowners alike are entitled to receive as much restitution as possible that can be clawed back by properly appointed court receivers. Both were decided by appraisal fraud, by deceptive disclosures in which the actual lender was intentionally concealed so that the investment bank could claim ownership and buy insurance payable to the bank instead of the investors, buy credit default swaps with the same result, and apply for Federal bailout with the same result.

Housing won’t be fixed until the corruption of title caused by a nominee on the mortgage and nominee on the note is fixed and settled. The economy won’t be fixed until investors get their share of the insurance and bailouts. The consumer sector won’t be fixed until all that is done, because it is only after the money is allocated to the investors that we can know the actual balance due, if any, on any of the loans.

One thing we know at this point is that most foreclosures (at least 65% according to the San Francisco study) are initiated by “strangers to the transaction” who were not creditors, holders or anything else that would entitle them to enforce the closing documents on a loan that came not from the named payee but from another source entirely. We know that the “credit bid” submitted at auction was pure fiction and fraud and should be corrected in the property records. And we know that the the proceeds of insurance, credit default swaps and federal bailout should be applied to the receivables owed to the investors. Lastly, we know that when those monies are allocated the balance due on those receivables will be far less than what has been or will be demanded from borrowers in past, present and future foreclosures.

 

NY Times: Morgan Stanley Forced to Reveal Truth

Current Bank Plan Is Same as $10 million Interest Free Loan for Every American

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“I wonder how many audience members know that Bair’s plan is more or less exactly the revenue model for all of America’s biggest banks. You go to the Fed, get a buttload of free money, lend it out at interest (perversely enough, including loans right back to the U.S. government), then pocket the profit.” Matt Taibbi

From Rolling Stone’s Matt Taibbi on Sheila Bair’s Sarcastic Piece

I hope everyone saw ex-Federal Deposit Insurance Corporation chief Sheila Bair’s editorial in the Washington Post, entitled, “Fix Income Inequality with $10 million Loans for Everyone!” The piece might have set a world record for public bitter sarcasm by a former top regulatory official.

In it, Bair points out that since we’ve been giving zero-interest loans to all of the big banks, why don’t we do the same thing for actual people, to solve the income inequality program? If the Fed handed out $10 million to every person, and then got each of those people to invest, say, in foreign debt, we could all be back on our feet in no time:

Under my plan, each American household could borrow $10 million from the Fed at zero interest. The more conservative among us can take that money and buy 10-year Treasury bonds. At the current 2 percent annual interest rate, we can pocket a nice $200,000 a year to live on. The more adventuresome can buy 10-year Greek debt at 21 percent, for an annual income of $2.1 million. Or if Greece is a little too risky for you, go with Portugal, at about 12 percent, or $1.2 million dollars a year. (No sense in getting greedy.)

Every time I watch a Republican debate, and hear these supposedly anti-welfare crowds booing the idea of stiffer regulation of Wall Street, I wonder how many audience members know that Bair’s plan is more or less exactly the revenue model for all of America’s biggest banks. You go to the Fed, get a buttload of free money, lend it out at interest (perversely enough, including loans right back to the U.S. government), then pocket the profit.

Considering that we now know that the Fed gave out something like $16 trillion in secret emergency loans to big banks on top of the bailouts we actually knew about, you might ask yourself: How are these guys in financial trouble? How can they not be making mountains of money, risk-free? But they are in financial trouble:

• We’re about to see yet another big blow to all of the usual suspects – Goldman, Citi, Bank of America, and especially Morgan Stanley, all of whom face potential downgrades by Moody’s in the near future.

We’ve known this was coming for some time, but the news this week is that the giant money-managing firm BlackRock is talking about moving its business elsewhere. Laurence Fink, BlackRock’s CEO, told the New York Times: “If Moody’s does indeed downgrade these institutions, we may have a need to move some business around to higher-rated institutions.”

It’s one thing when Zero Hedge, William Black, myself, or some rogue Fed officers in Dallas decide to point fingers at the big banks. But when big money players stop trading with those firms, that’s when the death spirals begin.

Morgan Stanley in particular should be sweating. They’re apparently going to be downgraded three notches, where they’ll be joining Citi and Bank of America at a level just above junk. But no worries: Bank CFO Ruth Porat announced that a three-level downgrade was “manageable” and that only losers rely totally on agencies like Moody’s to judge creditworthiness. “A lot of clients are doing their own credit work,” she said.

• Meanwhile, Bank of America reported its first-quarter results yesterday. Despite that massive ongoing support from the Fed, it earned just $653 million in the first quarter, but astonishingly the results were hailed by most of the financial media as good news. Its home-turf paper, the San Francisco Chronicle, crowed that BOA “Posts Higher Profits As Trading Results Rebound.” Bloomberg, meanwhile, summed up results this way: “Bank of America Beats Analyst Estimates As Trading Jumps.”

But the New York Times noted that BOA’s first-quarter profit of $653 million was down from $2 billion a year ago, and paled compared to results of more successful banks like Chase and Wells Fargo.

Zero Hedge, meanwhile, posted an amusing commentary on BOA’s results, pointing out that the bank quietly reclassified nearly two billion dollars’ worth of real estate loans. This is from BOA’s report:

During 1Q12, the bank regulatory agencies jointly issued interagency supervisory guidance on nonaccrual policies for junior-lien consumer real estate loans. In accordance with this new guidance, beginning in 1Q12, we classify junior-lien home equity loans as nonperforming when the first-lien loan becomes 90 days past due even if the junior-lien loan is performing. As a result of this change, we reclassified $1.85B of performing home equity loans to nonperforming.

In other words, Bank of America described nearly two billion dollars of crap on their books as performing loans, until the government this year forced them to admit it was crap.

ZH and others also noted that BOA wildly underestimated its exposure to litigation, but that’s nothing new. Anyway, despite the inconsistencies in its report, and despite the fact that it’s about to be downgraded – again – Bank of America’s shares are up again, pushing $9 today.

Fraudulent Foreclosure Remedy: Return of the Home

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     “….employees and agents of a number of banks had used the system to “repeatedly” submit court documents on mortgage holders, “containing false and misleading information that made it appear that the foreclosing party had the authority to bring a case when in fact it may not have [had]“.

Editor’s Comment: 

If you read the release below carefully you’ll discover that Morgan Stanley has literally agreed to pay any fine requested by the Federal Reserve.  The Fed has again determined that the banks are using false, faulty, fraudulent and forged documents in connection with the processing of foreclosures, modification requests and anything else related to the bogus mortgages that have long since been paid. 

I strongly urge all readers of this blog to write letters to the Federal Reserve, the OCC, OTS, Fannie Mae and Freddie Mac to stop pretending that the acceptance of fines is an adequate substitute for the return of stolen property. 

It is astonishing to me that the apathy and confusion in the media and marketplace have allowed and even promoted the concept that the theft of these homes using fraudulent documents is somehow resolved by the payment of money based on the recurring assumption that the underlying obligation is still due, that the default actually exists, and that the enforcement through foreclosure is a foregone conclusion. 

In nearly all cases the enforcement of the note and mortgage is far from a foregone conclusion.  In fact, the reason why none of these cases have actually reached trial where evidence was required to be submitted, is that the original documents signed by the borrower are fatally defective.  These defects are not merely technical. These defects reveal the fact that at the option of the securitization participants, they shifted the risk of loss from the borrower to the investor and eventually to the US taxpayer.  The right to use collateral pledged to a complete stranger to the transaction was void from the beginning, waived several times, and unenforceable since the original debt was paid off completely.

Any lawyer that goes into court without understanding these facts is going to concede issues that will doom his client to failure and loss of the home.  Any lawyer that puts these facts in issue, especially if accompanied by third party reports and services provided by this blog and many other sources, will be forcing the judge to either allow litigation to proceed into the discovery stage (at which point the case will settle), or face an appeal where there were clearly issues of fact that the judge disallowed based upon bias and prejudice. 

Homeowners should understand by now that they are not deadbeats.  They are victims of a fraudulent scheme to sell bogus securities to pension funds which in turn are now limited in their ability to pay benefits to the same victims who were depending upon that income to pay for the house they acquired in transactions that did not comply with Federal or State lending laws.  This is not a matter where the identity of the creditor and compensation to various undisclosed parties were omitted.  In this case we now know with certainty that these disclosures required under law, were actively hidden from both the borrower and the investor even after many borrowers confronted the banks and servicers with clear evidence that there were two parts to each transaction, to wit: the closing with the borrower, and the closing with the investor.  None of the foreclosures reveal the terms of repayment to the investor as per that portion of the total documentation that set forth repayment to the investor/creditor (i.e. the so-called securitization documents with which the participants in the securitization chain were in constant non-compliance). 

Special message to the borrowers:  You are not a deadbeat if you refuse to make a payment that is not due.  The securitization method used by Wall Street merely employed your signature for the purpose of making profits that actually exceeded the total amount of your mortgage.  If you want to oversimplify the matter then think of it this way: who should get the “free house”, a bank that never loaned the money and was paid many times over or a homeowner who invested their last pennies into a deal that was fraudulently presented?  If you put it another way, had you known that the appraisal was inflated and that there were at least a half-dozen levels of fees, commissions and trading profits being earned on your transaction, would you still have entered into the transaction?  More specifically, if you knew that the fees and profits generated exceeded the principal due on your mortgage, would you have entered into the transaction?  I invite you to consider the possibility that you were not a borrower incurring a legitimate debt but rather a victim in a con game that was so well played that you still believe you owe money that your own tax and pension dollars have long since paid off.  Here’s another way of thinking about it; imagine that you have been paying your “debt” from your checking account while at the same time the bank was withdrawing the same amount or more from your savings account for the same debt.  Now they wish to declare you in default because you refuse to pay from your checking account.  Your answer should not be “you’re right, I’m a deadbeat.” Your answer should be, “You’re a thief and I’m reporting you to the police.”

So now you’ve gone to the police and they’ve verified the skullduggery of the banks.  The remedy that the police are asking you to accept is that the police will receive a fine or contribution of $100 and you’re still expected to pay out of your checking account or they’ll take the house, and guess what, they’re still going to continue taking money out of your savings account.

Morgan Stanley to be fined in electronic mortgage system and foreclosure scandal

Bank criticized over Saxon unit’s automatic robo signing of foreclosures

By Leo King

The US Federal Reserve has issued a punishing court order to Morgan Stanley, as it prepares to fine the bank over the use of automated ‘robo signing’ of documents relating to foreclosures for struggling US mortgage payers. It ordered the bank to make significant process, data and systems improvements.

The issue relates to a troubled electronic mortgage registry created by a range of the largest banks, which is allegedly plagued with errors. Those that have brought claims against the banks have said access to the database was deliberately restricted by the banks, and that mortgage foreclosures were often based on incorrect data entered by the banks as they rushed to offload the loans.

The court order issued this week concerns the Saxon business, which Morgan Stanley has sold to mortgage servicing group Ocwen Financial. The Fed said Morgan Stanley retained responsibility for the impact of Saxon’s actions. Saxon had issued over 225,000 residential mortgage loans.

Robo-signing typically involves employees of mortgage servicing companies automatically signing off foreclosure papers without checking them, in the interests of fast processing the papers.

The practice was allegedly supported by the Mortgage Electronic Registration Systems (MERS), which opponents claim may have resulted in unfair foreclosures for many home buyers. The database was created in 1995 to simplify the recording of mortgage sales and to allow banks to more easily sell on loans.

According to recent complaints by New York State against a number of banks, as well as being used fraudulently, the database was also “plagued with inaccuracies and errors”. New York State Attorney General Eric Schneidermann said that employees and agents of a number of banks had used the system to “repeatedly” submit court documents on mortgage holders, “containing false and misleading information that made it appear that the foreclosing party had the authority to bring a case when in fact it may not have [had]“.

“The banks created the MERS system as an end-run around the property recording system, to facilitate the rapid securitization and sale of mortgages,” said Schneiderman in February.

“Once the mortgages went sour, these same banks brought foreclosure proceedings en masse based on deceptive and fraudulent court submissions, seeking to take homes away from people with little regard for basic legal requirements or the rule of law.”

This week, the Federal Reserve issued its court order, known as a consent order, against Morgan Stanley. The order demands that the bank hire an independent consultant to review its foreclosures, and said the bank was required to “provide remediation to borrowers who suffered financial injury as a result of wrongful foreclosures or other deficiencies identified in a review of the foreclosure process”.

Should Morgan Stanley decide to re-enter the mortgage servicing business while the consent order is in effect, it will be “required to implement enhanced corporate governance, risk-management, compliance, borrower communication, servicing, and foreclosure practices” that were “comparable” to enforcement actions against other banks over the same issue.

The consent order against Morgan Stanley orders the bank to create a proper plan around acceptable usage of MERS, including strict processes around proper data entry on MERS and around the appointment of officers authorized by MERS.

Additionally, Morgan Stanley and Saxon were ordered to create a proper plan for the use of strong management information systems to inform correct decision-making around mortgages and foreclosures. The systems also needed to monitor compliance with legal requirements, ensure the accuracy of records around money owed and any foreclosure proceedings, and provide all information officers need from borrowers.

High-risk residential mortgages have remained a key focus of attention since the financial crisis, because many troubled and complex financial products were based on them.

Last year, the Federal Reserve issued a similar consent order against Goldman Sachs. The robo signing scandal has engulfed a swathe of the largest US banks, with others including Bank of America, Citi, JP Morgan and Wells Fargo also being investigated.

In the Morgan Stanley case, the Federal Reserve said that in 2009 and 2010 Saxon had begun 60,313 foreclosures on home buyers judged to be struggling to pay their mortgages. It accused the company of engaging in “a pattern of misconduct and negligence in residential mortgage loan servicing and foreclosure”.

Morgan Stanley had not commented at the time of writing, but has agreed to pay whatever fine the Fed sets.

EFFECTIVE USE OF WHAT THE MORTGAGE GIANTS SAY ABOUT EACH OTHER

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The Federal Housing Finance Agency (FHFA) filed suit against 17 lead defendants. Lawyers and pro se litigants and anyone with a mortgage subject to a possible claim that the loan was securitized should be interested and follow the allegations AND the wrangling over discovery. There are forms in there that can and should be used by litigants. When counsel for pretender lenders proffers facts not in evidence then your objection should be coupled with “that’s not what they said when they were litigating with FHFA.” And then quote what they DID say in writing versus the oral proffers of counsel who can later say he was “mistaken.”
Complaints have been filed against the following lead defendants:

  1. Ally Financial Inc. f/k/a GMAC, LLC
  2. Bank of America Corporation
  3. Barclays Bank PLC
  4. Citigroup, Inc.
  5. Countrywide Financial Corporation
  6. Credit Suisse Holdings (USA), Inc.
  7. Deutsche Bank AG
  8. First Horizon National Corporation
  9. General Electric Company
  10. Goldman Sachs & Co.
  11. HSBC North America Holdings, Inc.
  12. JPMorgan Chase & Co.
  13. Merrill Lynch & Co. / First Franklin Financial Corp.
  14. Morgan Stanley
  15. Nomura Holding America Inc.
  16. The Royal Bank of Scotland Group PLC
  17. Société Générale

The following Reports to the Congress from the Federal Housing Finance Agency (FHFA) present the findings of the agency’s annual examinations of Fannie Mae and Freddie Mac (Enterprises), the 12 Federal Home Loan Banks (FHLBanks), and the Office of Finance. This report meets the statutory requirements of the Federal Housing Enterprises Financial Safety and Soundness Act of 1992, as amended by the Housing and Economic Recovery Act of 2008 (HERA).  The views in this report are those of FHFA and do not necessarily represent those of the President.

To request hard copies of FHFA Reports to Congress, contact: FHFA’s Office of Congressional Affairs and Communications
Phone: (202) 414-6922 or send e-mail to:   FHFAinfo@FHFA.gov

 

MERS: A FAILED ATTEMPT AT BYPASSING STATE AND FEDERAL AUTHORITY

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Fannie-Freddie’s Hypocritical Suit Against Banks Making Loans that GSEs Helped Create

Fannie-Freddie’s Hypocritical Suit Against Banks Making Loans that GSEs Helped Create

EDITOR’S NOTE:  Practically everything that the government is doing with respect to the economy and the housing market in particular is hypocritical. If we look to the result to determine the intent of the government you can see why nothing is being done to improve DOMESTIC market conditions. By removing the American consumer from the marketplace (through elimination of available funds in equity, savings or credit) the economic prospects for virtually every marketplace in the world is correspondingly diminished. The downward pressure on economic performance worldwide creates a panic regarding debt and currency. By default (and partially because of the military strength of the United States) people are ironically finding the dollar to be the safest haven during a bad storm.

 The result is that the federal government is able to borrow funds at interest rates that are so low that the investor is guaranteed to lose money after adjusting for inflation. The climate that has been created is one in which investors are far more concerned with preservation of capital than return on capital. In a nutshell, this is why the credit markets are virtually frozen with respect to the average potential consumer, the average small business owner, and the average entrepreneur or innovator who would otherwise start a new business and fuel rising employment.

 While it is true that the lawsuits by Fannie and Freddie are appropriate regardless of their past hypocritical behavior, they are really only rearranging the deck chairs on the Titanic. Ultimately there must be a resolution to our current economic problems that is based in reality rather than the power to manipulate events. The scenario we all seek  would cleanup the rising title crisis, end the foreclosure crisis, and restore a true marketplace in the purchase and sale of real estate. We have all known for decades that the housing market drives the economy.

 There is obviously very little confidence that the government and market makers in the United States are going to seek any resolution based in reality. Therefore while investors are parking their money in dollars they are also driving up the price of gold and finding other innovative ways to preserve their wealth. As these innovations evolve it is almost certain that an alternative to the United States dollar will emerge. The driving force behind this innovation is the stagnation of the credit markets and the world marketplace. My opinion is that the United States is pursuing a policy that virtually guarantees the creation of a new world reserve currency.

 The creation of MERS was a private attempt to substitute private business plans for public laws. It didn’t work. The lawsuits by the government-sponsored entities together with lawsuits from investors who were duped into being lenders and homeowners who were duped into being borrowers in a rigged market are only going to result in money judgments and money settlements. With a nominal value of credit derivatives at over $600 trillion and the actual money supply at under $50 trillion there is literally not enough money in the world to fix this problem. The problem can only be fixed by recognizing and applying existing law to existing transactions.

 This means that MERS, already discredited, must be treated as a nonexistent entity in the world of real estate transactions. Nobody wants to do that because the failure to disclose an actual creditor on the face of a purported lean or encumbrance on land is a fatal defect in perfecting the lien. This is true throughout the country and it is obvious to anyone who has studied real property transactions and mortgages. If you don’t have the name and address of the creditor from whom you can obtain a satisfaction of mortgage, then you don’t have a mortgage that attaches to the land as a lien. It is this realization that is forming a number of lawsuits from the investors who advanced money for mortgage bonds. Those advances were the funds that were used to finance pornographic Wall Street profits with the balance used to fund absurd mortgage products.

 This is basic property law and public policy. There can be no confidence or consistency in the marketplace without a buyer or a lender knowing that they can rely upon the information contained in a government title Registry at the county recording office. Any other method requires them to take the word of someone without the authority of the government. This is a fact and it is the law. But the banks are successfully using politics to sidestep the basic essential elements of law. Under their theory the fact that the mortgage lien was never perfected would be ignored so that bank and non-bank institutions could become the largest landholders in the country without ever having spent a dime on loaning any money or purchasing the receivables. Politics is trumping law.

 The narrative and the debate are being absolutely controlled by Wall Street interests. We say we don’t like what the banks did and many say they don’t like banks at all. But it is also true that the same people who say they don’t like banks are willing to let the banks keep their windfall and make even more money at the expense of the taxpayer, the consumer and the homeowner. There are trillions of dollars available for investment in business expansion, government projects, and good old American innovation to drive a healthy economy. It won’t happen until we begin to drive the debate ourselves and force government and banking to conform to rules and laws that have been in existence for centuries.

from STOP FORECLOSURE FRAUD…………….

Lets NOT forget both Fannie and Freddie, like most of the named banks they are suing, each are shareholders of MERS.

Again, who gave the green light to eliminate the need for assignments and to realize the greatest savings, lenders should close loans using standard security instruments containing “MOM” language back in April 26, 1999?

This was approved by Fannie Mae and Freddie Mac which named MERS as Original Mortgagee (MOM)!

Open Market-

“U.S. is set to sue dozen big banks over mortgages,” reads the front-page headline in today’s New York Times. The “deck” below the headline explains that that the Federal Housing Finance Agency, which oversees the government-sponsored enterprises Fannie Mae and Freddie Mac, is “seen as arguing that lenders lacked due diligence” in the loans they made.

A more apt description would probably be that Fannie and Freddie are suing the banks for selling them the very loans the GSEs helped designed and that government mandates encourage — and are still encouraging them to make. These conflicted actions are just one more of the government’s contributions to the uncertainty that is helping to keep unemployment at 9 percent.

Strangely the author of the Times piece, Nelson Schwartz, ignores the findings of a recent blockbuster

[OPEN MARKET]

MOTION TO DISMISS DENIED: FRAUD ALLEGED V MORGAN STANLEY

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It is interesting how the same allegations made by an institution are taken more seriously. In fact, the Court leaves in the prayer for punitive, consequential and future damages. Here MBIA is suing Morgan Stanley for lying about the risks and the nature of what they were buying. It’s all about the mortgages. Below I’ve selected some of the more interesting passages from the order denying Morgan Stanley’s Motion to Dismiss. While Judges routinely dismiss or otherwise are dismissive of homeowner complaints about the exact same thing by the exact same parties, they tend to take it more seriously when another institution says the same thing.

I remind the readers that we have repeatedly predicted the ankle-biting complaints amongst the giants that participated in the Ponzi scheme, whether knowingly or not. The obvious move by MBIA raises the question of why the same move has not been vigorously prosecuted by AIG, which played such a central role in funding the ill-gotten escape hatch for bankers.

“a vast number of of mortgage loans were made to borrowers who could not reasonably be expected to be able to repay their mortgage debt.”

As to MBIA Third PArty Guarantee and Payment: “This guarantee of repayment of principal and interest for the RMBS notes increased their marketability.”

“MBIA contends that these misrepresentations and failures ‘fundamentally distorted the risk profile represented to MBIA and raised the likelihood of losses’. Had MBIA known the truth it would not have issued the certificate insurance policy.” [Editor's Note: Had ANYONE known the truth there would have been no mortgage bonds to  sell, no loans to make, no borrowers signing on the dotted line. Even here, the Judge assumes the Morgan acquired the loans when all indications are that it never did so. The Judge's assumption is most likely the result of a bad assumption by the writer's of the complaint for MBIA. The truth is that the loans never made it into the pools, there was nothing to insure, and the entire proposition is "all or nothing" with the emphasis on the NOTHING.]

“Morgan Stanley argues in essence that MBIA’s fraud claim must be dismissed because it is duplicative of the breach of contract claim. It is not. A fraudulent inducement claim may be sustained when it is alleged that misrepresentations contained in documents collateral to the contract were made to induce the Plaintiff to enter into the contract in the first place…” [Editor's comment: Applying exactly this logic to the borrower, the "contract" was fraudulently induced by misrepresenting the appraised value of the property, misrepresenting the underwriting of the loan including parties and terms and viability, and misrepresenting the risk that the "lender" was taking (none). Thus our assertion on these pages that the primary claim is fraud in the inducement, as to damages, and quiet title, as to the lien, is corroborated by these simple statement of obvious black letter law by this Judge.]

Mortgage Companies Settle Suits on Military Foreclosures

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EDITOR’S NOTE: After years of revealing on this blog the many illegal foreclosures on property owned by service people who were on active duty, putting their lives on the line for their country, and laws that have long been in effect that such actions cannot be taken against military personnel, the banks are going to pay up for the damage they caused to the families of these brave souls. The simple fact is that the banks knew, we know they knew and they did it anyway because they didn’t care and they thought they could get away with it. It’s the same as all the other foreclosures with one important difference: this time they attacked not only the core of American society, they aimed at the core of our defense. To my way of thinking it is as close to treason as you can get without crossing the boundary.

Mortgage Companies Settle Suits on Military Foreclosures

By

Two mortgage servicing companies have agreed to settle federal complaints that they wrongfully foreclosed on the homes of at least 178 military service members and to set aside a minimum of $22 million to compensate those victims.

The Justice Department announced on Thursday that it had simultaneously filed and settled lawsuits against the two companies — a subsidiary of Bank of America formerly known as Countrywide Home Loans Servicing, and Saxon Mortgage Services, a subsidiary of Morgan Stanley.

The companies were accused of knowingly and repeatedly violating the Servicemembers Civil Relief Act, a federal law that extends an array of financial and legal protections to military personnel. Specifically, the companies were accused of ignoring a provision of the law that required them to get court orders before foreclosing on active-duty service members.

Without admitting wrongdoing, the former Countrywide unit agreed to pay $20 million to approximately 160 victims of illegal foreclosures from January 2006 to May 2009. It also agreed to reimburse victims of any other illegal military foreclosures found to have occurred from May 2009 to the end of last year.

Further, it promised to upgrade its training and report future violations of the civil relief act to the Justice Department.

Although most of the improper foreclosures began before Bank of America acquired Countrywide, “it is our responsibility to make things right,” said Terry Laughlin, an executive vice president at the bank. He added, “These errors are not acceptable, and we certainly regret them.”

According to Thomas E. Perez, assistant attorney general for the Justice Department’s civil rights division, the Countrywide settlement is “easily the largest amount ever recovered“ by the Justice Department for violations of the civil relief act.

Saxon was accused of illegally foreclosing on approximately 18 service members, “some of whom were severely injured in the line of duty or suffer from post-traumatic stress disorder,“ according to Mr. Perez.

Without admitting wrongdoing, Saxon agreed to pay $2.35 million to victims of those foreclosures, made from January 2006 to May 2009. It also agreed to pay the victims of any subsequent wrongful military foreclosures, through the end of last year, and to upgrade its training programs.

“First and foremost, we want to apologize to those military families that were affected by any mistakes made in the foreclosure process,” said Mark Lake, a spokesman for Morgan Stanley. “Our servicemen and women deserve the highest level of customer service.”

He said that Saxon “has taken meaningful steps to ensure it has appropriate policies and procedures in place to comply fully” with the civil relief act.

Both companies agreed to repair any damage their improper foreclosures had caused to the credit scores of the affected homeowners.

There have been widely publicized violations of the civil relief act since well before January 2006, the starting date for these settlements. Indeed, the Saxon investigation was based on a complaint by Sgt. James B. Hurley, an Iraq veteran who lost his home in western Michigan in an improper foreclosure in 2005. Saxon and its co-defendant in that case, Deutsche Bank, reached a confidential out-of-court settlement with the Hurleys early this year.

Mr. Perez said the 2006-9 period was chosen because it encompassed the sharp spike in national foreclosure activity that began in late 2006.

The settlement terms expand that window to the end of 2010.

The two mortgage companies have set up a direct hot line for service personnel who believe they are eligible for relief under the settlements. That number is (800) 896-7743, mailbox 6 for the former Countrywide unit and mailbox 995 for Saxon.

NY STARTS NEW INVESTIGATION OF MEGABANKS ON MORTGAGES and FORECLOSURES

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BANKS LOOKING TO NY FED FOR PROTECTION

EDITOR’S NOTE: Maybe this will wipe that arrogant smirk off their faces. Again the investigations are renewed after it seemed they were giving up. Just as the financial regulatory agencies followed up an SEC settlement with Goldman, they all, including the SEC, started another barrage of subpoenas. Now the NY Attorney General is going the same thing, starting up anew after Andrew Cuomo, his predecessor, had dealt with the banks up to point that was good step in the right direction but fell far short of the relief needed and the restitution required.

The language of the world of prosecution has changed from “derivatives” to questionable securitization practices” signaling a large shift in the depth of their understanding of what happened and even whether the securitization of loans was and remains an illusion, leaving the homes free from encumbrance and the debts largely paid by bailout, insurance, guarantees and other hedge contracts.

IN THE END, YOU CAN’T PAY THE DEBT OFF AND THEN DECLARE IT IN DEFAULT (UNLESS THE CONTRACT ALLOWS YOU TO DO THAT AND SPELLS OUT THE PROCEDURE). THEY PAID THE DEBTS, CONTINUED THE PAYMENTS AND DECLARED DEFAULTS ON LOANS THAT WERE WERE PAID OFF AND/OR STILL RECEIVING PAYMENTS FROM THIRD PARTIES. THEY ARE TRYING TO STEAL FROM BOTH ENDS AND IT IS WORKING. IN MANY CASES BOTH WERE TRUE. THERE IS NO DEFAULT AND THERE WAS NO DEFAULT, AND THE FORECLOSURES UP TILL NOW HAVE BEEN A FARCE AND A FRAUD WITH JUDGES, UNSCHOOLED IN THE WAYS OF WALL STREET, SNOOKERED INTO PLAYING ALONG WITH IT.

BOTTOM LINE: The housing crisis could be over in twelve minutes and the budget deficit could be over in a year with a full economic recovery underway if we just stop listening to the spin of the megabanks, about how if we put them in jail the financial system will be crushed — and we start looking at real evidence about what really happened.

May 16, 2011

New York Investigates Banks’ Role in Fiscal Crisis

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The New York attorney general has requested information and documents in recent weeks from three major Wall Street banks about their mortgage securities operations during the credit boom, indicating the existence of a new investigation into practices that contributed to billions in mortgage losses.

Officials in Eric T. Schneiderman’s, office have also requested meetings with representatives from Bank of America, Goldman Sachs and Morgan Stanley, according to people briefed on the matter who were not authorized to speak publicly. The inquiry appears to be quite broad, with the attorney general’s requests for information covering many aspects of the banks’ loan pooling operations. They bundled thousands of home loans into securities that were then sold to investors such as pension funds, mutual funds and insurance companies.

It is unclear which parts of the byzantine securitization process Mr. Schneiderman is focusing on. His spokesman said the attorney general would not comment on the investigation, which is in its early stages.

Several civil suits have been filed by federal and state regulators since the financial crisis erupted in 2008, some of which have generated settlements and fines, most prominently a $550 million deal between Goldman Sachs and the Securities and Exchange Commission.

But even more questions have been raised in private lawsuits filed against the banks by investors and others who say they were victimized by questionable securitization practices. Some litigants have contended, for example, that the banks dumped loans they knew to be troubled into securities and then misled investors about the quality of those underlying mortgages when selling the investments.

The possibility has also been raised that the banks did not disclose to mortgage insurers the risks in the instruments they were agreeing to insure against default. Another potential area of inquiry — the billions of dollars in credit extended by Wall Street to aggressive mortgage lenders that allowed them to continue making questionable loans far longer than they otherwise could have done.

“Part of what prosecutors have the advantage of doing right now, here as elsewhere, is watching the civil suits play out as different parties fight over who bears the loss,” said Daniel C. Richman, a professor of law at Columbia. “That’s a very productive source of information.”

Officials at Bank of America and Goldman Sachs declined to comment about the investigation; Morgan Stanley did not respond to a request for comment.

During the mortgage boom, Wall Street firms bundled hundreds of billions of dollars in home loans into securities that they sold profitably to investors. After the real estate bubble burst, the perception took hold that the securitization process as performed by the major investment banks contributed to the losses generated in the crisis.

Critics contend that Wall Street’s securitization machine masked the existence of risky home loans and encouraged reckless lending because pooling the loans and selling them off allowed many participants to avoid responsibility for the losses that followed.

The requests for information by Mr. Schneiderman’s office also seem to confirm that the New York attorney general is operating independently of peers from other states who are negotiating a broad settlement with large banks over foreclosure practices.

By opening a new inquiry into bank practices, Mr. Schneiderman has indicated his unwillingness to accept one of the settlement’s terms proposed by financial institutions — that is, a broad agreement by regulators not to conduct additional investigations into the banks’ activities during the mortgage crisis. Mr. Schneiderman has said in recent weeks that signing such a release was unacceptable.

It is unclear whether Mr. Schneiderman’s investigation will be pursued as a criminal or civil matter. In the last few months, the office’s staff has been expanding. In March, Marc B. Minor, former head of the securities division for the New Jersey attorney general, was named bureau chief of the investor protection unit in the New York attorney general’s office.

Early in the financial crisis, Andrew M. Cuomo, the governor of New York who preceded Mr. Schneiderman as attorney general, began investigating Wall Street’s role in the debacle. But those inquiries did not result in any cases filed against the major banks. Nevertheless, some material turned over to Mr. Cuomo’s investigators may turn out to be helpful to Mr. Schneiderman’s inquiry.

SECRET BANKING ELITE: WHERE THE REAL DECISIONS ARE MADE

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Notable Quotes:

“The men share a common goal: to protect the interests of big banks in the vast market for derivatives, one of the most profitable — and controversial — fields in finance. They also share a common secret: The details of their meetings, even their identities, have been strictly confidential.”

“big banks influence the rules governing derivatives through a variety of industry groups. The banks’ latest point of influence are clearinghouses like ICE Trust, which holds the monthly meetings with the nine bankers in New York.”

“The banks also required ICE to provide market data exclusively to Markit, a little-known company that plays a pivotal role in derivatives. Backed by Goldman, JPMorgan and several other banks, Markit provides crucial information about derivatives, like prices.”

“None of the three clearinghouses would divulge the members of their risk committees when asked by a reporter. But two people with direct knowledge of ICE’s committee said the bank members are:

  • Thomas J. Benison of JPMorgan Chase & Company;
  • James J. Hill of Morgan Stanley;
  • Athanassios Diplas of Deutsche Bank;
  • Paul Hamill of UBS;
  • Paul Mitrokostas of Barclays;
  • Andy Hubbard of Credit Suisse;
  • Oliver Frankel of Goldman Sachs;
  • Ali Balali of Bank of America; and
  • Biswarup Chatterjee of Citigroup.”

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EDITOR’S ANALYSIS: For those of us tracking the strategies employed in courtrooms across the country and various foreclosure tactics, it has been obvious that there has been a single governing hand that is controlling the action. Hidden under the rubric of a risk control committee, this group actually makes all key decisions that affect the largest segment of the marketplace and thus the rest of the markets. These banks are operating for themselves, not in the interests of performing the service that Wall Street was always intended to do — create increasingly fluid access to the capital markets for businesses to innovate, start, grow, finance and merge.

They operate without any regulation. Quite the contrary. The decisions from this group actually effect both legislation that is proposed and passed and the rules and regulations of agencies that are supposed to be acting as referees to make sure the players don’t run amok. They dictate to government rather than the other way around and they create the strategies affect every individual in this country and many other countries. They are in essence a single virtual bank acting as though they are separate, each with profit centers that are strictly controlled by this elite group.

The upcoming WikiLeaks disclosures may have some references to this group which is comprised of the largest banks in the world and which exclude other large banks from membership, like Bank of New York/Mellon. Together they control the direction of the recession and how power is exercised by governments and central bankers around the world. That is because together they control nominal wealth many times the total currency in the world and “market value” that is roughly equal, at a minimum, to 2/3 of the GDP of the entire world.

We are at a crossroad whether we want to admit it or not. Either we simply give up and let bankers rule the world, or we stop them, disassemble them and bring them down to a size where they can be and are in fact regulated. But the choice is not up to government which now is owned by them as well. The choice is entirely up to the people — all the people — who ultimately, for the moment, have the power to dismiss the exercise of this kind of ultra vires power and bring things back to normal. Whatever we do, we are headed for turbulent times. The only real question is whether those turbulent times will be leading us down a path of abandoning our nation of laws or whether it will be as Teddy Roosevelt did, devoted to taking back the power for the people, by the people.

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A Secretive Banking Elite Rules Trading in Derivatives

By LOUISE STORY

On the third Wednesday of every month, the nine members of an elite Wall Street society gather in Midtown Manhattan.

The men share a common goal: to protect the interests of big banks in the vast market for derivatives, one of the most profitable — and controversial — fields in finance. They also share a common secret: The details of their meetings, even their identities, have been strictly confidential.

Drawn from giants like JPMorgan Chase, Goldman Sachs and Morgan Stanley, the bankers form a powerful committee that helps oversee trading in derivatives, instruments which, like insurance, are used to hedge risk.

In theory, this group exists to safeguard the integrity of the multitrillion-dollar market. In practice, it also defends the dominance of the big banks.

The banks in this group, which is affiliated with a new derivatives clearinghouse, have fought to block other banks from entering the market, and they are also trying to thwart efforts to make full information on prices and fees freely available.

Banks’ influence over this market, and over clearinghouses like the one this select group advises, has costly implications for businesses large and small, like Dan Singer’s home heating-oil company in Westchester County, north of New York City.

This fall, many of Mr. Singer’s customers purchased fixed-rate plans to lock in winter heating oil at around $3 a gallon. While that price was above the prevailing $2.80 a gallon then, the contracts will protect homeowners if bitterly cold weather pushes the price higher.

But Mr. Singer wonders if his company, Robison Oil, should be getting a better deal. He uses derivatives like swaps and options to create his fixed plans. But he has no idea how much lower his prices — and his customers’ prices — could be, he says, because banks don’t disclose fees associated with the derivatives.

“At the end of the day, I don’t know if I got a fair price, or what they’re charging me,” Mr. Singer said.

Derivatives shift risk from one party to another, and they offer many benefits, like enabling Mr. Singer to sell his fixed plans without having to bear all the risk that oil prices could suddenly rise. Derivatives are also big business on Wall Street. Banks collect many billions of dollars annually in undisclosed fees associated with these instruments — an amount that almost certainly would be lower if there were more competition and transparent prices.

Just how much derivatives trading costs ordinary Americans is uncertain. The size and reach of this market has grown rapidly over the past two decades. Pension funds today use derivatives to hedge investments. States and cities use them to try to hold down borrowing costs. Airlines use them to secure steady fuel prices. Food companies use them to lock in prices of commodities like wheat or beef.

The marketplace as it functions now “adds up to higher costs to all Americans,” said Gary Gensler, the chairman of the Commodity Futures Trading Commission, which regulates most derivatives. More oversight of the banks in this market is needed, he said.

But big banks influence the rules governing derivatives through a variety of industry groups. The banks’ latest point of influence are clearinghouses like ICE Trust, which holds the monthly meetings with the nine bankers in New York.

Under the Dodd-Frank financial overhaul, many derivatives will be traded via such clearinghouses. Mr. Gensler wants to lessen banks’ control over these new institutions. But Republican lawmakers, many of whom received large campaign contributions from bankers who want to influence how the derivatives rules are written, say they plan to push back against much of the coming reform. On Thursday, the commission canceled a vote over a proposal to make prices more transparent, raising speculation that Mr. Gensler did not have enough support from his fellow commissioners.

The Department of Justice is looking into derivatives, too. The department’s antitrust unit is actively investigating “the possibility of anticompetitive practices in the credit derivatives clearing, trading and information services industries,” according to a department spokeswoman.

Indeed, the derivatives market today reminds some experts of the Nasdaq stock market in the 1990s. Back then, the Justice Department discovered that Nasdaq market makers were secretly colluding to protect their own profits. Following that scandal, reforms and electronic trading systems cut Nasdaq stock trading costs to 1/20th of their former level — an enormous savings for investors.

“When you limit participation in the governance of an entity to a few like-minded institutions or individuals who have an interest in keeping competitors out, you have the potential for bad things to happen. It’s antitrust 101,” said Robert E. Litan, who helped oversee the Justice Department’s Nasdaq investigation as deputy assistant attorney general and is now a fellow at the Kauffman Foundation. “The history of derivatives trading is it has grown up as a very concentrated industry, and old habits are hard to break.”

Representatives from the nine banks that dominate the market declined to comment on the Department of Justice investigation.

Clearing involves keeping track of trades and providing a central repository for money backing those wagers. A spokeswoman for Deutsche Bank, which is among the most influential of the group, said this system will reduce the risks in the market. She said that Deutsche is focused on ensuring this process is put in place without disrupting the marketplace.

The Deutsche spokeswoman also said the banks’ role in this process has been a success, saying in a statement that the effort “is one of the best examples of public-private partnerships.”

Established, But Can’t Get In

The Bank of New York Mellon’s origins go back to 1784, when it was founded by Alexander Hamilton. Today, it provides administrative services on more than $23 trillion of institutional money.

Recently, the bank has been seeking to enter the inner circle of the derivatives market, but so far, it has been rebuffed.

Bank of New York officials say they have been thwarted by competitors who control important committees at the new clearinghouses, which were set up in the wake of the financial crisis.

Bank of New York Mellon has been trying to become a so-called clearing member since early this year. But three of the four main clearinghouses told the bank that its derivatives operation has too little capital, and thus potentially poses too much risk to the overall market.

The bank dismisses that explanation as absurd. “We are not a nobody,” said Sanjay Kannambadi, chief executive of BNY Mellon Clearing, a subsidiary created to get into the business. “But we don’t qualify. We certainly think that’s kind of crazy.”

The real reason the bank is being shut out, he said, is that rivals want to preserve their profit margins, and they are the ones who helped write the membership rules.

Mr. Kannambadi said Bank of New York’s clients asked it to enter the derivatives business because they believe they are being charged too much by big banks. Its entry could lower fees. Others that have yet to gain full entry to the derivatives trading club are the State Street Corporation, and small brokerage firms like MF Global and Newedge.

The criteria seem arbitrary, said Marcus Katz, a senior vice president at Newedge, which is owned by two big French banks.

“It appears that the membership criteria were set so that a certain group of market participants could meet that, and everyone else would have to jump through hoops,” Mr. Katz said.

The one new derivatives clearinghouse that has welcomed Newedge, Bank of New York and the others — Nasdaq — has been avoided by the big derivatives banks.

Only the Insiders Know

How did big banks come to have such influence that they can decide who can compete with them?

Ironically, this development grew in part out of worries during the height of the financial crisis in 2008. A major concern during the meltdown was that no one — not even government regulators — fully understood the size and interconnections of the derivatives market, especially the market in credit default swaps, which insure against defaults of companies or mortgages bonds. The panic led to the need to bail out the American International Group, for instance, which had C.D.S. contracts with many large banks.

In the midst of the turmoil, regulators ordered banks to speed up plans — long in the making — to set up a clearinghouse to handle derivatives trading. The intent was to reduce risk and increase stability in the market.

Two established exchanges that trade commodities and futures, the InterContinentalExchange, or ICE, and the Chicago Mercantile Exchange, set up clearinghouses, and, so did Nasdaq.

Each of these new clearinghouses had to persuade big banks to join their efforts, and they doled out membership on their risk committees, which is where trading rules are written, as an incentive.

None of the three clearinghouses would divulge the members of their risk committees when asked by a reporter. But two people with direct knowledge of ICE’s committee said the bank members are: Thomas J. Benison of JPMorgan Chase & Company; James J. Hill of Morgan Stanley; Athanassios Diplas of Deutsche Bank; Paul Hamill of UBS; Paul Mitrokostas of Barclays; Andy Hubbard of Credit Suisse; Oliver Frankel of Goldman Sachs; Ali Balali of Bank of America; and Biswarup Chatterjee of Citigroup.

Through representatives, these bankers declined to discuss the committee or the derivatives market. Some of the spokesmen noted that the bankers have expertise that helps the clearinghouse.

Many of these same people hold influential positions at other clearinghouses, or on committees at the powerful International Swaps and Derivatives Association, which helps govern the market.

Critics have called these banks the “derivatives dealers club,” and they warn that the club is unlikely to give up ground easily.

“The revenue these dealers make on derivatives is very large and so the incentive they have to protect those revenues is extremely large,” said Darrell Duffie, a professor at the Graduate School of Business at Stanford University, who studied the derivatives market earlier this year with Federal Reserve researchers. “It will be hard for the dealers to keep their market share if everybody who can prove their creditworthiness is allowed into the clearinghouses. So they are making arguments that others shouldn’t be allowed in.”

Perhaps no business in finance is as profitable today as derivatives. Not making loans. Not offering credit cards. Not advising on mergers and acquisitions. Not managing money for the wealthy.

The precise amount that banks make trading derivatives isn’t known, but there is anecdotal evidence of their profitability. Former bank traders who spoke on condition of anonymity because of confidentiality agreements with their former employers said their banks typically earned $25,000 for providing $25 million of insurance against the risk that a corporation might default on its debt via the swaps market. These traders turn over millions of dollars in these trades every day, and credit default swaps are just one of many kinds of derivatives.

The secrecy surrounding derivatives trading is a key factor enabling banks to make such large profits.

If an investor trades shares of Google or Coca-Cola or any other company on a stock exchange, the price — and the commission, or fee — are known. Electronic trading has made this information available to anyone with a computer, while also increasing competition — and sharply lowering the cost of trading. Even corporate bonds have become more transparent recently. Trading costs dropped there almost immediately after prices became more visible in 2002.

Not so with derivatives. For many, there is no central exchange, like the New York Stock Exchange or Nasdaq, where the prices of derivatives are listed. Instead, when a company or an investor wants to buy a derivative contract for, say, oil or wheat or securitized mortgages, an order is placed with a trader at a bank. The trader matches that order with someone selling the same type of derivative.

Banks explain that many derivatives trades have to work this way because they are often customized, unlike shares of stock. One share of Google is the same as any other. But the terms of an oil derivatives contract can vary greatly.

And the profits on most derivatives are masked. In most cases, buyers are told only what they have to pay for the derivative contract, say $25 million. That amount is more than the seller gets, but how much more — $5,000, $25,000 or $50,000 more — is unknown. That’s because the seller also is told only the amount he will receive. The difference between the two is the bank’s fee and profit. So, the bigger the difference, the better for the bank — and the worse for the customers.

It would be like a real estate agent selling a house, but the buyer knowing only what he paid and the seller knowing only what he received. The agent would pocket the difference as his fee, rather than disclose it. Moreover, only the real estate agent — and neither buyer nor seller — would have easy access to the prices paid recently for other homes on the same block.

An Electronic Exchange?

Two years ago, Kenneth C. Griffin, owner of the giant hedge fund Citadel Group, which is based in Chicago, proposed open pricing for commonly traded derivatives, by quoting their prices electronically. Citadel oversees $11 billion in assets, so saving even a few percentage points in costs on each trade could add up to tens or even hundreds of millions of dollars a year.

But Mr. Griffin’s proposal for an electronic exchange quickly ran into opposition, and what happened is a window into how banks have fiercely fought competition and open pricing. To get a transparent exchange going, Citadel offered the use of its technological prowess for a joint venture with the Chicago Mercantile Exchange, which is best-known as a trading outpost for contracts on commodities like coffee and cotton. The goal was to set up a clearinghouse as well as an electronic trading system that would display prices for credit default swaps.

Big banks that handle most derivatives trades, including Citadel’s, didn’t like Citadel’s idea. Electronic trading might connect customers directly with each other, cutting out the banks as middlemen.

So the banks responded in the fall of 2008 by pairing with ICE, one of the Chicago Mercantile Exchange’s rivals, which was setting up its own clearinghouse. The banks attached a number of conditions on that partnership, which came in the form of a merger between ICE’s clearinghouse and a nascent clearinghouse that the banks were establishing. These conditions gave the banks significant power at ICE’s clearinghouse, according to two people with knowledge of the deal. For instance, the banks insisted that ICE install the chief executive of their effort as the head of the joint effort. That executive, Dirk Pruis, left after about a year and now works at Goldman Sachs. Through a spokesman, he declined to comment.

The banks also refused to allow the deal with ICE to close until the clearinghouse’s rulebook was established, with provisions in the banks’ favor. Key among those were the membership rules, which required members to hold large amounts of capital in derivatives units, a condition that was prohibitive even for some large banks like the Bank of New York.

The banks also required ICE to provide market data exclusively to Markit, a little-known company that plays a pivotal role in derivatives. Backed by Goldman, JPMorgan and several other banks, Markit provides crucial information about derivatives, like prices.

Kevin Gould, who is the president of Markit and was involved in the clearinghouse merger, said the banks were simply being prudent and wanted rules that protected the market and themselves.

“The one thing I know the banks are concerned about is their risk capital,” he said. “You really are going to get some comfort that the way the entity operates isn’t going to put you at undue risk.”

Even though the banks were working with ICE, Citadel and the C.M.E. continued to move forward with their exchange. They, too, needed to work with Markit, because it owns the rights to certain derivatives indexes. But Markit put them in a tough spot by basically insisting that every trade involve at least one bank, since the banks are the main parties that have licenses with Markit.

This demand from Markit effectively secured a permanent role for the big derivatives banks since Citadel and the C.M.E. could not move forward without Markit’s agreement. And so, essentially boxed in, they agreed to the terms, according to the two people with knowledge of the matter. (A spokesman for C.M.E. said last week that the exchange did not cave to Markit’s terms.)

Still, even after that deal was complete, the Chicago Mercantile Exchange soon had second thoughts about working with Citadel and about introducing electronic screens at all. The C.M.E. backed out of the deal in mid-2009, ending Mr. Griffin’s dream of a new, electronic trading system.

With Citadel out of the picture, the banks agreed to join the Chicago Mercantile Exchange’s clearinghouse effort. The exchange set up a risk committee that, like ICE’s committee, was mainly populated by bankers.

It remains unclear why the C.M.E. ended its electronic trading initiative. Two people with knowledge of the Chicago Mercantile Exchange’s clearinghouse said the banks refused to get involved unless the exchange dropped Citadel and the entire plan for electronic trading.

Kim Taylor, the president of Chicago Mercantile Exchange’s clearing division, said “the market” simply wasn’t interested in Mr. Griffin’s idea.

Critics now say the banks have an edge because they have had early control of the new clearinghouses’ risk committees. Ms. Taylor at the Chicago Mercantile Exchange said the people on those committees are supposed to look out for the interest of the broad market, rather than their own narrow interests. She likened the banks’ role to that of Washington lawmakers who look out for the interests of the nation, not just their constituencies.

“It’s not like the sort of representation where if I’m elected to be the representative from the state of Illinois, I go there to represent the state of Illinois,” Ms. Taylor said in an interview.

Officials at ICE, meantime, said they solicit views from customers through a committee that is separate from the bank-dominated risk committee.

“We spent and we still continue to spend a lot of time on thinking about governance,” said Peter Barsoom, the chief operating officer of ICE Trust. “We want to be sure that we have all the right stakeholders appropriately represented.”

Mr. Griffin said last week that customers have so far paid the price for not yet having electronic trading. He puts the toll, by a rough estimate, in the tens of billions of dollars, saying that electronic trading would remove much of this “economic rent the dealers enjoy from a market that is so opaque.”

“It’s a stunning amount of money,” Mr. Griffin said. “The key players today in the derivatives market are very apprehensive about whether or not they will be winners or losers as we move towards more transparent, fairer markets, and since they’re not sure if they’ll be winners or losers, their basic instinct is to resist change.”

In, Out and Around Henhouse

The result of the maneuvering of the past couple years is that big banks dominate the risk committees of not one, but two of the most prominent new clearinghouses in the United States.

That puts them in a pivotal position to determine how derivatives are traded.

Under the Dodd-Frank bill, the clearinghouses were given broad authority. The risk committees there will help decide what prices will be charged for clearing trades, on top of fees banks collect for matching buyers and sellers, and how much money customers must put up as collateral to cover potential losses.

Perhaps more important, the risk committees will recommend which derivatives should be handled through clearinghouses, and which should be exempt.

Regulators will have the final say. But banks, which lobbied heavily to limit derivatives regulation in the Dodd-Frank bill, are likely to argue that few types of derivatives should have to go through clearinghouses. Critics contend that the bankers will try to keep many types of derivatives away from the clearinghouses, since clearinghouses represent a step towards broad electronic trading that could decimate profits.

The banks already have a head start. Even a newly proposed rule to limit the banks’ influence over clearing allows them to retain majorities on risk committees. It remains unclear whether regulators creating the new rules — on topics like transparency and possible electronic trading — will drastically change derivatives trading, or leave the bankers with great control.

One former regulator warned against deferring to the banks. Theo Lubke, who until this fall oversaw the derivatives reforms at the Federal Reserve Bank of New York, said banks do not always think of the market as a whole as they help write rules.

“Fundamentally, the banks are not good at self-regulation,” Mr. Lubke said in a panel last March at Columbia University. “That’s not their expertise, that’s not their primary interest.”

A Fellow You might Want to talk With About Morgan Stanley Credit Default Swaps

Morgan Stanley’s head of European leveraged credit trading has resigned. Robert Lepone, who oversaw various teams, including high yield bonds, leveraged loans, credit default swaps and distressed debt, left Morgan Stanley’s London office for personal reasons, a spokesman said. His replacement will be announced in the coming weeks, the spokesman said, declining to comment further. Lepone’s departure comes less than two weeks after Joseph McManus, a vice president with Morgan Stanley’s investment-grade credit products group, left to join CastleOak Securities’ fixed-income sales team.

Goldman and JPM Still Playing with Other People’s Money

The five biggest U.S. commercial banks in the derivatives market — JPMorgan, Goldman Sachs, Bank of America Corp., Citigroup and Wells Fargo & Co. — account for 97 percent of the notional value of derivatives held in the banking industry [$605 trillion], according to the Office of the Comptroller of the Currency.

Goldman Sachs Demands Collateral It Won’t Dish Out

By Michael J. Moore and Christine Harper

March 15 (Bloomberg) — Goldman Sachs Group Inc. and JPMorgan Chase & Co., two of the biggest traders of over-the- counter derivatives, are exploiting their growing clout in that market to secure cheap funding in addition to billions in revenue from the business.

Both New York-based banks are demanding unequal arrangements with hedge-fund firms, forcing them to post more cash collateral to offset risks on trades while putting up less on their own wagers. At the end of December this imbalance furnished Goldman Sachs with $110 billion, according to a filing. That’s money it can reinvest in higher-yielding assets.

“If you’re seen as a major player and you have a product that people can’t get elsewhere, you have the negotiating power,” said Richard Lindsey, a former director of market regulation at the U.S. Securities and Exchange Commission who ran the prime brokerage unit at Bear Stearns Cos. from 1999 to 2006. “Goldman and a handful of other banks are the places where people can get over-the-counter products today.”

The collapse of American International Group Inc. in 2008 was hastened by the insurer’s inability to meet $20 billion in collateral demands after its credit-default swaps lost value and its credit rating was lowered, Treasury Secretary Timothy F. Geithner, president of the Federal Reserve Bank of New York at the time of the bailout, testified on Jan. 27. Goldman Sachs was among AIG’s biggest counterparties.

AIG Protection

Goldman Sachs Chief Financial Officer David Viniar has said that his firm’s stringent collateral agreements would have helped protect the firm against a default by AIG. Instead, a $182.3 billion taxpayer bailout of AIG ensured that Goldman Sachs and others were repaid in full.

Over the last three years, Goldman Sachs has extracted more collateral from counterparties in the $605 trillion over-the- counter derivatives markets, according to filings with the SEC.

The firm led by Chief Executive Officer Lloyd C. Blankfein collected cash collateral that represented 57 percent of outstanding over-the-counter derivatives assets as of December 2009, while it posted just 16 percent on liabilities, the firm said in a filing this month. That gap has widened from rates of 45 percent versus 18 percent in 2008 and 32 percent versus 19 percent in 2007, company filings show.

“That’s classic collateral arbitrage,” said Brad Hintz, an analyst at Sanford C. Bernstein & Co. in New York who previously worked as treasurer at Morgan Stanley and chief financial officer at Lehman Brothers Holdings Inc. “You always want to enter into something where you’re getting more collateral in than what you’re putting out.”

Using the Cash

The banks get to use the cash collateral, said Robert Claassen, a Palo Alto, California-based partner in the corporate and capital markets practice at law firm Paul, Hastings, Janofsky & Walker LLP.

“They do have to pay interest on it, usually at the fed funds rate, but that’s a low rate,” Claassen said.

Goldman Sachs’s $110 billion net collateral balance in December was almost three times the amount it had attracted from depositors at its regulated bank subsidiaries. The collateral could earn the bank an annual return of $439 million, assuming it’s financed at the current fed funds effective rate of 0.15 percent and that half is reinvested at the same rate and half in two-year Treasury notes yielding 0.948 percent.

“We manage our collateral arrangements as part of our overall risk-management discipline and not as a driver of profits,” said Michael DuVally, a spokesman for Goldman Sachs. He said that Bloomberg’s estimates of the firm’s potential returns on collateral were “flawed” and declined to provide further explanation.

JPMorgan, Citigroup

JPMorgan received cash collateral equal to 57 percent of the fair value of its derivatives receivables after accounting for offsetting positions, according to data contained in the firm’s most recent annual filing. It posted collateral equal to 45 percent of the comparable payables, leaving it with a $37 billion net cash collateral balance, the filing shows.

In 2008 the cash collateral received by JPMorgan made up 47 percent of derivative assets, while the amount posted was 37 percent of liabilities. The percentages were 47 percent and 26 percent in 2007, according to data in company filings.

“JPMorgan now requires more collateral from its counterparties” on derivatives, David Trone, an analyst at Macquarie Group Ltd., wrote in a note to investors following a meeting with Jes Staley, chief executive officer of JPMorgan’s investment bank.

Citigroup Collateral

By contrast, New York-based Citigroup Inc., a bank that’s 27 percent owned by the U.S. government, paid out $11 billion more in collateral on over-the-counter derivatives than it collected at the end of 2009, a company filing shows.

Brian Marchiony, a spokesman for JPMorgan, and Alexander Samuelson, a spokesman for Citigroup, both declined to comment.

The five biggest U.S. commercial banks in the derivatives market — JPMorgan, Goldman Sachs, Bank of America Corp., Citigroup and Wells Fargo & Co. — account for 97 percent of the notional value of derivatives held in the banking industry, according to the Office of the Comptroller of the Currency.

In credit-default swaps, the world’s five biggest dealers are JPMorgan, Goldman Sachs, Morgan Stanley, Frankfurt-based Deutsche Bank AG and London-based Barclays Plc, according to a report by Deutsche Bank Research that cited the European Central Bank and filings with the SEC.

Goldman Sachs

Goldman Sachs and JPMorgan had combined revenue of $29.1 billion from trading derivatives and cash securities in the first nine months of 2009, according to Federal Reserve reports.

The U.S. Congress is considering bills that would require more derivatives deals be processed through clearinghouses, privately owned third parties that guarantee transactions and keep track of collateral and margin. A clearinghouse that includes both banks and hedge funds would erode the banks’ collateral balances, said Kevin McPartland, a senior analyst at research firm Tabb Group in New York.

When contracts are negotiated between two parties, collateral arrangements are determined by the relative credit ratings of the two companies and other factors in the relationship, such as how much trading a fund does with a bank, McPartland said. When trades are cleared, the requirements have “nothing to do with credit so much as the mark-to-market value of your current net position.”

“Once you’re able to use a clearinghouse, presumably everyone’s on a level playing field,” he said.

Dimon, Blankfein

Still, banks may maintain their advantage in parts of the market that aren’t standardized or liquid enough for clearing, McPartland said. JPMorgan CEO Jamie Dimon and Goldman Sachs’s Blankfein both told the Financial Crisis Inquiry Commission in January that they support central clearing for all standardized over-the-counter derivatives.

“The percentage of products that are suitable for central clearing is relatively small in comparison to the entire OTC derivatives market,” McPartland said.

A report this month by the New York-based International Swaps & Derivatives Association found that 84 percent of collateral agreements are bilateral, meaning collateral is exchanged in two directions.

Banks have an advantage in dealing with asset managers because they can require collateral when initiating a trade, sometimes amounting to as much as 20 percent of the notional value, said Craig Stein, a partner at law firm Schulte Roth & Zabel LLP in New York who represents hedge-fund clients.

JPMorgan Collateral

JPMorgan’s filing shows that these initiation amounts provided the firm with about $11 billion of its $37.4 billion net collateral balance at the end of December, down from about $22 billion a year earlier and $17 billion at the end of 2007. Goldman Sachs doesn’t break out that category.

A bank’s net collateral balance doesn’t get included in its capital calculations and has to be held in liquid products because it can change quickly, according to an executive at one of the biggest U.S. banks who declined to be identified because he wasn’t authorized to speak publicly.

Counterparties demanding collateral helped speed the collapse of Bear Stearns and Lehman Brothers, according to a New York Fed report published in January. Those that had posted collateral with Lehman were often in the same position as unsecured creditors when they tried to recover funds from the bankrupt firm, the report said.

“When the collateral is posted to a derivatives dealer like Goldman or any of the others, those funds are not segregated, which means that the dealer bank gets to use them to finance itself,” said Darrell Duffie, a professor of finance at Stanford University in Palo Alto. “That’s all fine until a crisis comes along and counterparties pull back and the money that dealer banks thought they had disappears.”

‘Greater Push Back’

While some hedge-fund firms have pushed for banks to put up more cash after the collapse of Lehman Brothers, Goldman Sachs and other survivors of the credit crisis have benefited from the drop in competition.

“When the crisis started developing, I definitely thought it was going to be an opportunity for our fund clients to make some headway in negotiating, and actually the exact opposite has happened,” said Schulte Roth’s Stein. “Post-financial crisis, I’ve definitely seen a greater push back on their side.”

Hedge-fund firms that don’t have the negotiating power to strike two-way collateral agreements with banks have more to gain from a clearinghouse than those that do, said Stein.

Regulators should encourage banks to post more collateral to their counterparties to lower the impact of a single bank’s failure, according to the January New York Fed report. Pressure from regulators and a move to greater use of clearinghouses may mean the banks’ advantage has peaked.

“Before the financial crisis, collateral was very unevenly demanded and somewhat insufficiently demanded,” Stanford’s Duffie said. A clearinghouse “should reduce the asymmetry and raise the total amount of collateral.”

To contact the reporters on this story: Michael J. Moore in New York at mmoore55@bloomberg.net; Christine Harper in New York at charper@bloomberg.net.

Self Dealing Part II: Investigations Started

NY Times: “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

Mr. Lippmann made his pitch to select hedge fund clients, arguing they should short the mortgage market. He sometimes distributed a T-shirt that read “I’m Short Your House!!!” in black and red letters.

While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them,

Editor’s Note: It would be wise to pay careful attention to news reports and press releases from investigating agencies and to track the discovery in class action and other cases filed. A lot of your work might already be done, right down to the same lender you are  dealing with.

December 24, 2009

Banks Bundled Bad Debt, Bet Against It and Won

In late October 2007, as the financial markets were starting to come unglued, a Goldman Sachs trader, Jonathan M. Egol, received very good news. At 37, he was named a managing director at the firm.

Mr. Egol, a Princeton graduate, had risen to prominence inside the bank by creating mortgage-related securities, named Abacus, that were at first intended to protect Goldman from investment losses if the housing market collapsed. As the market soured, Goldman created even more of these securities, enabling it to pocket huge profits.

Goldman’s own clients who bought them, however, were less fortunate.

Pension funds and insurance companies lost billions of dollars on securities that they believed were solid investments, according to former Goldman employees with direct knowledge of the deals who asked not to be identified because they have confidentiality agreements with the firm.

Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.

How these disastrously performing securities were devised is now the subject of scrutiny by investigators in Congress, at the Securities and Exchange Commission and at the Financial Industry Regulatory Authority, Wall Street’s self-regulatory organization, according to people briefed on the investigations. Those involved with the inquiries declined to comment.

While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them, people briefed on the matter say.

One focus of the inquiry is whether the firms creating the securities purposely helped to select especially risky mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded.

Some securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created.

Goldman and other Wall Street firms maintain there is nothing improper about synthetic C.D.O.’s, saying that they typically employ many trading techniques to hedge investments and protect against losses. They add that many prudent investors often do the same. Goldman used these securities initially to offset any potential losses stemming from its positive bets on mortgage securities.

But Goldman and other firms eventually used the C.D.O.’s to place unusually large negative bets that were not mainly for hedging purposes, and investors and industry experts say that put the firms at odds with their own clients’ interests.

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

Investment banks were not alone in reaping rich rewards by placing trades against synthetic C.D.O.’s. Some hedge funds also benefited, including Paulson & Company, according to former Goldman workers and people at other banks familiar with that firm’s trading.

Michael DuVally, a Goldman Sachs spokesman, declined to make Mr. Egol available for comment. But Mr. DuVally said many of the C.D.O.’s created by Wall Street were made to satisfy client demand for such products, which the clients thought would produce profits because they had an optimistic view of the housing market. In addition, he said that clients knew Goldman might be betting against mortgages linked to the securities, and that the buyers of synthetic mortgage C.D.O.’s were large, sophisticated investors, he said.

The creation and sale of synthetic C.D.O.’s helped make the financial crisis worse than it might otherwise have been, effectively multiplying losses by providing more securities to bet against. Some $8 billion in these securities remain on the books at American International Group, the giant insurer rescued by the government in September 2008.

From 2005 through 2007, at least $108 billion in these securities was issued, according to Dealogic, a financial data firm. And the actual volume was much higher because synthetic C.D.O.’s and other customized trades are unregulated and often not reported to any financial exchange or market.

Goldman Saw It Coming

Before the financial crisis, many investors — large American and European banks, pension funds, insurance companies and even some hedge funds — failed to recognize that overextended borrowers would default on their mortgages, and they kept increasing their investments in mortgage-related securities. As the mortgage market collapsed, they suffered steep losses.

A handful of investors and Wall Street traders, however, anticipated the crisis. In 2006, Wall Street had introduced a new index, called the ABX, that became a way to invest in the direction of mortgage securities. The index allowed traders to bet on or against pools of mortgages with different risk characteristics, just as stock indexes enable traders to bet on whether the overall stock market, or technology stocks or bank stocks, will go up or down.

Goldman, among others on Wall Street, has said since the collapse that it made big money by using the ABX to bet against the housing market. Worried about a housing bubble, top Goldman executives decided in December 2006 to change the firm’s overall stance on the mortgage market, from positive to negative, though it did not disclose that publicly.

Even before then, however, pockets of the investment bank had also started using C.D.O.’s to place bets against mortgage securities, in some cases to hedge the firm’s mortgage investments, as protection against a fall in housing prices and an increase in defaults.

Mr. Egol was a prime mover behind these securities. Beginning in 2004, with housing prices soaring and the mortgage mania in full swing, Mr. Egol began creating the deals known as Abacus. From 2004 to 2008, Goldman issued 25 Abacus deals, according to Bloomberg, with a total value of $10.9 billion.

Abacus allowed investors to bet for or against the mortgage securities that were linked to the deal. The C.D.O.’s didn’t contain actual mortgages. Instead, they consisted of credit-default swaps, a type of insurance that pays out when a borrower defaults. These swaps made it much easier to place large bets on mortgage failures.

Rather than persuading his customers to make negative bets on Abacus, Mr. Egol kept most of these wagers for his firm, said five former Goldman employees who spoke on the condition of anonymity. On occasion, he allowed some hedge funds to take some of the short trades.

Mr. Egol and Fabrice Tourre, a French trader at Goldman, were aggressive from the start in trying to make the assets in Abacus deals look better than they were, according to notes taken by a Wall Street investor during a phone call with Mr. Tourre and another Goldman employee in May 2005.

On the call, the two traders noted that they were trying to persuade analysts at Moody’s Investors Service, a credit rating agency, to assign a higher rating to one part of an Abacus C.D.O. but were having trouble, according to the investor’s notes, which were provided by a colleague who asked for anonymity because he was not authorized to release them. Goldman declined to discuss the selection of the assets in the C.D.O.’s, but a spokesman said investors could have rejected the C.D.O. if they did not like the assets.

Goldman’s bets against the performances of the Abacus C.D.O.’s were not worth much in 2005 and 2006, but they soared in value in 2007 and 2008 when the mortgage market collapsed. The trades gave Mr. Egol a higher profile at the bank, and he was among a group promoted to managing director on Oct. 24, 2007.

“Egol and Fabrice were way ahead of their time,” said one of the former Goldman workers. “They saw the writing on the wall in this market as early as 2005.” By creating the Abacus C.D.O.’s, they helped protect Goldman against losses that others would suffer.

As early as the summer of 2006, Goldman’s sales desk began marketing short bets using the ABX index to hedge funds like Paulson & Company, Magnetar and Soros Fund Management, which invests for the billionaire George Soros. John Paulson, the founder of Paulson & Company, also would later take some of the shorts from the Abacus deals, helping him profit when mortgage bonds collapsed. He declined to comment.

A Deal Gone Bad, for Some

The woeful performance of some C.D.O.’s issued by Goldman made them ideal for betting against. As of September 2007, for example, just five months after Goldman had sold a new Abacus C.D.O., the ratings on 84 percent of the mortgages underlying it had been downgraded, indicating growing concerns about borrowers’ ability to repay the loans, according to research from UBS, the big Swiss bank. Of more than 500 C.D.O.’s analyzed by UBS, only two were worse than the Abacus deal.

Goldman created other mortgage-linked C.D.O.’s that performed poorly, too. One, in October 2006, was a $800 million C.D.O. known as Hudson Mezzanine. It included credit insurance on mortgage and subprime mortgage bonds that were in the ABX index; Hudson buyers would make money if the housing market stayed healthy — but lose money if it collapsed. Goldman kept a significant amount of the financial bets against securities in Hudson, so it would profit if they failed, according to three of the former Goldman employees.

A Goldman salesman involved in Hudson said the deal was one of the earliest in which outside investors raised questions about Goldman’s incentives. “Here we are selling this, but we think the market is going the other way,” he said.

A hedge fund investor in Hudson, who spoke on the condition of anonymity, said that because Goldman was betting against the deal, he wondered whether the bank built Hudson with “bonds they really think are going to get into trouble.”

Indeed, Hudson investors suffered large losses. In March 2008, just 18 months after Goldman created that C.D.O., so many borrowers had defaulted that holders of the security paid out about $310 million to Goldman and others who had bet against it, according to correspondence sent to Hudson investors.

The Goldman salesman said that C.D.O. buyers were not misled because they were advised that Goldman was placing large bets against the securities. “We were very open with all the risks that we thought we sold. When you’re facing a tidal wave of people who want to invest, it’s hard to stop them,” he said. The salesman added that investors could have placed bets against Abacus and similar C.D.O.’s if they had wanted to.

A Goldman spokesman said the firm’s negative bets didn’t keep it from suffering losses on its mortgage assets, taking $1.7 billion in write-downs on them in 2008; but he would not say how much the bank had since earned on its short positions, which former Goldman workers say will be far more lucrative over time. For instance, Goldman profited to the tune of $1.5 billion from one series of mortgage-related trades by Mr. Egol with Wall Street rival Morgan Stanley, which had to book a steep loss, according to people at both firms.

Tetsuya Ishikawa, a salesman on several Abacus and Hudson deals, left Goldman and later published a novel, “How I Caused the Credit Crunch.” In it, he wrote that bankers deserted their clients who had bought mortgage bonds when that market collapsed: “We had moved on to hurting others in our quest for self-preservation.” Mr. Ishikawa, who now works for another financial firm in London, declined to comment on his work at Goldman.

Profits From a Collapse

Just as synthetic C.D.O.’s began growing rapidly, some Wall Street banks pushed for technical modifications governing how they worked in ways that made it possible for C.D.O.’s to expand even faster, and also tilted the playing field in favor of banks and hedge funds that bet against C.D.O.’s, according to investors.

In early 2005, a group of prominent traders met at Deutsche Bank’s office in New York and drew up a new system, called Pay as You Go. This meant the insurance for those betting against mortgages would pay out more quickly. The traders then went to the International Swaps and Derivatives Association, the group that governs trading in derivatives like C.D.O.’s. The new system was presented as a fait accompli, and adopted.

Other changes also increased the likelihood that investors would suffer losses if the mortgage market tanked. Previously, investors took losses only in certain dire “credit events,” as when the mortgages associated with the C.D.O. defaulted or their issuers went bankrupt.

But the new rules meant that C.D.O. holders would have to make payments to short sellers under less onerous outcomes, or “triggers,” like a ratings downgrade on a bond. This meant that anyone who bet against a C.D.O. could collect on the bet more easily.

“In the early deals you see none of these triggers,” said one investor who asked for anonymity to preserve relationships. “These things were built in to provide the dealers with a big payoff when something bad happened.”

Banks also set up ever more complex deals that favored those betting against C.D.O.’s. Morgan Stanley established a series of C.D.O.’s named after United States presidents (Buchanan and Jackson) with an unusual feature: short-sellers could lock in very cheap bets against mortgages, even beyond the life of the mortgage bonds. It was akin to allowing someone paying a low insurance premium for coverage on one automobile to pay the same on another one even if premiums over all had increased because of high accident rates.

At Goldman, Mr. Egol structured some Abacus deals in a way that enabled those betting on a mortgage-market collapse to multiply the value of their bets, to as much as six or seven times the face value of those C.D.O.’s. When the mortgage market tumbled, this meant bigger profits for Goldman and other short sellers — and bigger losses for other investors.

Selling Bad Debt

Other Wall Street firms also created risky mortgage-related securities that they bet against.

At Deutsche Bank, the point man on betting against the mortgage market was Greg Lippmann, a trader. Mr. Lippmann made his pitch to select hedge fund clients, arguing they should short the mortgage market. He sometimes distributed a T-shirt that read “I’m Short Your House!!!” in black and red letters.

Deutsche, which declined to comment, at the same time was selling synthetic C.D.O.’s to its clients, and those deals created more short-selling opportunities for traders like Mr. Lippmann.

Among the most aggressive C.D.O. creators was Tricadia, a management company that was a unit of Mariner Investment Group. Until he became a senior adviser to the Treasury secretary early this year, Lewis Sachs was Mariner’s vice chairman. Mr. Sachs oversaw about 20 portfolios there, including Tricadia, and its documents also show that Mr. Sachs sat atop the firm’s C.D.O. management committee.

From 2003 to 2007, Tricadia issued 14 mortgage-linked C.D.O.’s, which it called TABS. Even when the market was starting to implode, Tricadia continued to create TABS deals in early 2007 to sell to investors. The deal documents referring to conflicts of interest stated that affiliates and clients of Tricadia might place bets against the types of securities in the TABS deal.

Even so, the sales material also boasted that the mortgages linked to C.D.O.’s had historically low default rates, citing a “recently completed” study by Standard & Poor’s ratings agency — though fine print indicated that the date of the study was September 2002, almost five years earlier.

At a financial symposium in New York in September 2006, Michael Barnes, the co-head of Tricadia, described how a hedge fund could put on a negative mortgage bet by shorting assets to C.D.O. investors, according to his presentation, which was reviewed by The New York Times.

Mr. Barnes declined to comment. James E. McKee, general counsel at Tricadia, said, “Tricadia has never shorted assets into the TABS deals, and Tricadia has always acted in the best interests of its clients and investors.”

Mr. Sachs, through a spokesman at the Treasury Department, declined to comment.

Like investors in some of Goldman’s Abacus deals, buyers of some TABS experienced heavy losses. By the end of 2007, UBS research showed that two TABS deals were the eighth- and ninth-worst performing C.D.O.’s. Both had been downgraded on at least 75 percent of their associated assets within a year of being issued.

Tricadia’s hedge fund did far better, earning roughly a 50 percent return in 2007 and similar profits in 2008, in part from the short bets.

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