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“Borrowers beware: your assumption that you are in default is based upon the fact that YOU didn’t make a payment. But you can only be in default if that payment was due. The payment cannot be due if the creditor has been satisfied in whole or in part by the various means by which these Bankers diverted money from the investors into their own pockets. You should be very concerned about that — because that money sitting in the pockets of Bankers is actually money that should be applied against the balance due on your “loan.” After all you paid for it with your own money in the form of taxes, payments to the servicer and the value of your signature and identity without which the mortgage bonds could never have been sold to investors.” Neil Garfield http://www.livinglies.me
EDITOR’S NOTE: I picked this up from the comments. It’s very good and helps describe some of the inner workings of how this crisis manifested as a grueling indictment of Wall Street and government laissez-faire, while the system played with our money, our future and the quality of our lives.
The one thing that keeps bothering me about the Lehman Brothers situation is that Lehman is in Bankruptcy while Aurora is not. But Aurora is essentially an arm of Lehman, and it is a mere servicer that is asserting rights of ownership over loans in direct derogation of the rights of (1) investors who put up the money and (b) borrowers who are trying to modify or settle the claims relating to their loan or the title on their property. By what right is Aurora operating outside the scrutiny of the Bankruptcy Court in New York that is unraveling the Lehman puzzle?
I am aware of motions filed with respect to this issue but I am unaware of any resolution of those motions. It seems that the Bankruptcy Court is being used as yet another layer to keep investors from understanding or even knowing the facts about their investments. The goal is obviously to deplete the apparent equity in the homes down to zero, which is why housing prices are going down. It is no mystery. The lower the housing prices, the easier it is to eat up the equity with fees that are uncontrollable.
Thus the Banks have a vested interest in keeping the housing market in a downward spiral just as they had a vested interest in keeping it in an upward spiral when they were soliciting unsophisticated borrowers and investors to buy into this game. I might add that Alan Greenspan himself said in a television interview that he and a 100 other highly respected PhD economists looked at these financial products and were unable to decipher them.
Thus the effort by Wall Street to create asymmetry of information succeeded, which is all they needed to make the investors rely on the investment banks for the value of their investment and make the borrowers rely on them (through fraudulent inflated appraisals) for the value of their signature on paper that was in truth only part of the scheme of issuance of unregistered fraudulent securities. The fraud continues because the government regulators still don’t understand that the Banks are controlling the modification process, that they are producing scant modifications that fail anyway, just to pacify the government, and not to create an actual steady flow of modifications.
The Banks want the property, and then, using the valuation factors that were buried in the prospectus and pooling and services agreement, they are in the position of declaring a total loss for the investors, while the Banks diverted money and assets that were due to the investors. This is really very simple. If the Banks wanted to settle the claims on the mortgages and foreclosures, they would have done so. They have the power, the infrastructure and the money to do it. They are not doing it because they are creating the appearance of a total loss while they line their pockets with investors money — money that should be paid to or credited to the investor.
If the investor actually received the money or was the recipient of a credit for the money pocketed by the Banks, then the amount due to the creditor would be reduced. This is turn would reduce the obligation due to the investor — an obligation that supposedly derives in large part from borrowers who thought they were entering into conventional loans but were in fact issuing paper that was traded without regulation or accountability. Thus all or part of the money that went into the pockets of the Banks is actually a credit against the obligation due to the ivnestor, a fact well known to investors and which is causing them to sue, the SEC to bring enforcement actions and other administrative actions to take a variety of actions, all leading presumably to criminal prosecutions.
The fact that is getting lost in all this is that if the obligation is reduced, then the amount claimed as due from the borrower is correspondingly reduced. The borrowers’ obligations may have been reduced to zero but in virtually all cases, it has been substantially reduced IN FACT, but applied IN LAW — i.e., the Notice of Default is wrong in every case as is the the notice of sale, the judgments entered, and the bogus auction that takes place in which title goes not to the investors or for the benefit of the investors but to the Banks who were using the money of the investors and thus had no loss.
In many cases the balance, unknown to the homeowner, was reduced to zero long before they were even notified that action was taken being against them for failing to pay — but what they failed to pay was a payment that was not due. IN fact, the diverted funds sitting in the pockets of the Bankers, is equal to far more than any group of so-called defaulted loans — and it is looking like far more than any group of loans that were funded during this period. That being the case, it is easy to see why the economy is anemic — the bankers have sucked out all the blood and as the body tries to cover they keeping taking that too.
Borrowers beware: your assumption that you are in default is based upon the fact that YOU didn’t make a payment. But you can only be in default if that payment was due. The payment cannot be due if the creditor has been satisfied in whole or in part by the various means by which these Bankers diverted money from the investors into their own pockets. You should be very concerned about that — because that money sitting in the pockets of Bankers is actually money that should be applied against the balance due on your “loan.” After all you paid for it with your own money in the form of taxes, payments to the servicer and the value of your signature and identity without which the mortgage bonds could never have been sold to investors.
I was watchng Cnbc around 1AM: it was about the repackagind of CDO’s and the great export they are, also stated that the issue in the mortgage origination and Kyle Vance who note the historic crash we are undergoing now …. I guess there are transcripts, set the stage from beginning to where we are now on Wall Street
Also, following in researchng HSBC:
How maths killed Lehman Brothers
by Horatio Boedihardjo
Submitted by plusadmin on June 1, 2009
• credit crunch
• financial mathematics
• financial modelling
• Plus new writers award 2009
This article is the winner in the university category of the Plus new writers award 2009.
On a sunny morning in 2001, a piece of investment plan landed on the desk of Dick Fuld, the then Chief Executive of Lehman Brothers. The document, compiled by a team of maths and physics PhDs, included a calculation to show how the bank will always end up with a profit if they invest on the real estate markets. Fuld was impressed. The next five years saw the bank borrowing billions of dollars to invest in the housing market. It worked. The housing market boom had turned Lehman Brothers from a modest firm into the world’s fourth largest investment bank.
The Lehman Brothers headquarters, Rockefeller Center, New York, before the collapse. Image: David Shankbone.
But as the housing market started to shrink, the assumptions that the PhDs made began to break down one by one. The investment now became a mistake, resulting in a stunning loss of $613 billion. On September 15 2008 Lehman Brothers collapsed — “The largest bankruptcy in the US history,” as described by Wikipedia.
The money making model
Imagine that you are working for Lehman Brothers and one morning you receive a phone call from HSBC.
“Hi! A hundred customers have each borrowed $1 million from us for a year. We would like to buy an insurance from you which will cover us in the case of any of them defaulting. From their application forms we reckon they each have a 3% chance of default. How much will the insurance cost?”
You can in fact calculate it, easily. The 100 customers each have a 3% chance of defaulting, so you expect three customers to default next year. That is, you will need to pay $3 million next year. Assuming the interest rate is about 3% each year, next year’s $3 million would be worth 3/(3/100+1)=3/1.03=2.91 million now.
Therefore HSBC will have to pay you at least $2.91 million for the insurance. Obviously Lehman Brothers wasn’t a charity and so, to make money, they would double the price to $5.82 million and expect to make $2.91 million out of each of these deals on average. This kind of insurance is called a credit default swap (CDS).
The legendary CDO
After putting down the phone, you might be quite worried about what would happen if ten of the borrowers defaulted, because then you would have to pay $10 million back! In this case, consider this deal: how about paying me a certain premium, and if more than ten defaults occur, you will only need to pay for ten of them and I will pay for the rest. If less than ten defaults occur, you will have to pay for all the defaults and I won’t pay anything. The type of deal that I am offering is called the senior tranche of a collateralised debt obligation (CDO) contract, while the one you are getting is called the junior tranche of the CDO.
Looks like a safe investment? Better think twice!
The attractiveness of the senior tranche is that almost all of the time I don’t have to pay anything, just pocketing my premium. Imagine how unlikely it is to have more than ten borrowers defaulting together! Senior tranches were generally considered to be almost as safe as borrowing money from the government. Since the senior tranche offers a better return than, but seems to be just as safe as, putting the money in the bank, the investors just loved it. In 2004 there were only $157.4 billion of CDO being issued, but by 2007 the amount grew to $481.6 billion.
But don’t you find it a bit unfair that you can have something as safe as bank deposits, that offers a higher return?
Yes, it is unfair! In fact, CDO is a lot riskier than bank deposits, but Lehman Brothers, like many investors, didn’t seem to know that. Let’s go back to our original model. The first source of error is that we have assumed that each investor has a 3% chance of defaulting. How do we know that? It must be from historical data. The problem is, there hasn’t been a national drop of housing price since the great depression in the 1920s, so the chance that a borrower defaults was calculated on the basis of a good period when the housing prices surged. However, the housing market crashed in 2007. Many borrowers’ properties are now worth even less than the loan they have to pay in the future, so many of them refuse to pay. To worsen the situation, 22% of these borrowers are the so-called subprime borrowers — those who had little income and had little hope of returning money. Banks were not afraid of lending money to them because even if they defaulted, the insurance would pay them back. The participation of the subprime borrowers makes lending much riskier than before.
In fact, the default probability in the US has quadrupled from the 3% as assumed in the model to 12% since 2007, making it four times riskier. This means that investors like Lehman Brothers will be hit four times harder than they have anticipated.
Actually it is worse than that. The profitability, or lack of it, of financial products more complicated than CDS and CDO may depend on the square of the default probability, rather than the probability itself. Now as the default probability rises from 0.03 to 0.12, the square of the probability increased from 0.0009 to 0.0144 — that’s an increase by a factor of 16!
The Lehman Brothers headquarters on the night of September 15, 2008. Image: Robert Scoble.
There is also a second and more subtle source of error. Whether you can make money from selling the CDO insurance for the bank depends on whether the borrowers return the money, which in turns depends on the economy. So if the economy goes down, you are a lot more likely to lose money. If you are an active investor, then you probably have invested in the stock market as well. Now if the market crashes you lose both the money invested in the stock market and in the CDO. Suppose, on the other hand, that instead of spending the money on CDO, you bet on whether Manchester United will win the European Champion League. This time in order to lose all your money you need both the market to go down and Manchester United to lose their match — this is less likely than just having the market go down. Therefore, investing on CDO is a riskier choice than betting for Manchester United. The error in our model is that we have not taken into account this extra risk due to its dependence of CDO on the market.
These two errors were sufficient to mask the risk in CDO. In fact, the errors are so serious that 27 out of 30 of the CDOs issued by Merril Lynch were downgraded from AAA (the safest investment) to “junk” when the errors were spotted.
The fall of Lehman Brothers
Lehman Brothers, unaware of the hidden risks, decided to invest big on CDO. It even had a 35 to 1 debt to equity ratio, that is, it only owned $1 out of every $36 in its bank account — the other $35 were borrowed from somewhere. This meant that a loss of just 3% of the money on its balance sheet, would have meant the loss of all the money it owned. After suffering heavy losses (more than 3% of the money in its balance) from CDO, borrowers began to lose confidence and called back the loans. As Lehman had always relied on short-term loans, its lenders were able to pull their cash back quickly. Now the bank was in trouble. It borrowed much more than it was able to return and soon found itself unable to pay back.
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