The Mortgage Fraud Investigation – Shouldn't It Be Regarded As A Really Big Deal?
Last week, president Obama mumbled something about a mortgage fraud task force during his State of the Union ramble. Later on in the week, US Attorney General Holder provided more details, which was followed by the issue of subpoenas to 11 financial institutions. The focus is on residential MBS (mortgage backed securities, ed). This is one version of the news:
Housing Wire: (this link leads to the Google cache version, as apparently the original article has been removed for reasons unknown)
The market, especially the stocks of the banks involved, took the news in stride. However, shouldn't this be a really big deal?
We know to the extent to which the robo-signing error has thrown the entire foreclosure process into a state of mass confusion. While it may be technically labeled as fraud, it is in reality basically very sloppy processing by servicers who were (and are) overwhelmed by the volume of defaults. No one was intentionally trying to foreclose on widows and orphans to cheat them out of their homes.
The State Attorney Generals have been trying to extort obscene amounts from the banks for this error. Personally I think the big bad banks are evil and should be punished, but in this case they are being punished for the wrong deed.
This newest investigation into the RMBS market should open a Pandora's box.
The whole chain started with the so-called "liar loans". There is no way around the fact that thousands, probably hundreds of thousands, applicants falsified income and asset information on the loan application in order to defraud a lender into giving them a loan. Instead of rejecting these loans, the big bad banks funded the loans, packaged them and sold them to lazy investors who relied on rating agencies paid by the issuers instead of doing their own due diligence.
In my opinion, the only way that the banks are not on the hook for this is if they included a disclosure statement in their representations and warranties that said something like this:
The issuer did not check for the accuracy of the loan applications. The issuer did not verify income, asset or any other financial information provided by applicants. In fact, the issuer simply made some of these numbers up for the applicants. Buyers of these securities should be aware that they are buying pure garbage and must rely upon their own stupidity in making this purchase….
There are numerous ongoing lawsuits filed by investors against MBS issuers. If the attorneys general are able to prove fraud, could the banks be liable for a lot more than what is currently deemed to be at stake?
Furthermore, what happens to all the derivatives such as the CDS written on MBS? Can the AIG's of this world ask for the claims to be paid back since the losses were ultimately due to fraud and not a normal credit default?
There have been talks about a settlement for the robo-signing scandal in the immediate future. I wonder how can the banks accept any deals that are only limited to the robo-signing issue.
I do not have the answer and have not yet seen a good legal opinion, but this new investigation looks like a potentially explosive issue.
Addendum by Pater Tenebrarum:
A Potential Game Changer and The Socionomic View
It should be added to the above that US banks still have mortgage related assets amounting to nearly $ 3 trillion on their books. The value of these assets is a perennial moving target (we have therefore dubbed this the 'moving target problem'). At any given point in time, a bank balance sheet is merely a snapshot of the particular period it depicts. In the meantime, collateral values continue to decline and due to the vast 'shadow inventory' pipeline this seems set to continue for some time.
The potential liabilities banks will face from investors trying to get restitution for various types of MBS the banks have sold to them during the bubble have long been known to represent a large, but difficult to quantify additional headache for the banks. The collapse of Bank of America's stock price last year was largely tied to the fact that stock market investors were unable to gauge how big this liability would become.
The one thing the banks always had going in their favor on this issue was that the great bulk of MBS investors were themselves 'sophisticated' professional investors. They should have been capable of doing a modicum of due diligence of their own.
Instead they relied on dubious credit ratings and the 'insurance' provided by CDS written by credit insurance firms (of which AIG tuned out to be the most egregiously exposed). However, anyone in possession of an abacus and an ounce of common sense could have worked out on the back of an envelope that this insurance wasn't going to be worth anything if it should ever come to be called in. The writers of such CDS simply couldn't survive a general downturn in the market. They could perhaps deal with the occasional blow-up, but not a widespread one that engulfed a large percentage of mortgage loans.
Alas, if the mortgage fraud task force manages to prove that many of these MBS were in fact fraudulent deals, then we are looking at a game changer with regards to the liabilities the banks could face.
Once it has been determined that certain deals were fraudulent, the civil suits will presumably breeze through with great ease. Investors suing for restitution will be able to point at the criminal judgments and say that it has already been proven that they were in fact defrauded. The potential liabilities of the banks would undoubtedly balloon as a result.
Note that the outcome of the investigation and any law suits that might flow from it, as well as the outcome of civil litigation, are highly dependent on the state of the social mood. It is in fact the souring social mood that is the driving force behind the launching of such investigations. No-one worried about potential fraud during the bubble, although the facts were not different then from what they are today. The only difference was that no-one had as of yet suffered losses, but if the MBS deals were fraudulent, they were just as fraudulent when they were still making money.
Bubbles always create numerous opportunities for fraud. As a rule, the longer a bubble expands, the more fraudulent activity there will be. However, it usually only comes to light after the bubble has burst. Only then comes society's urge to exact retribution for the perceived crimes to the fore.
Should the social mood improve, then the banks will probably get away with out-of-court settlements. They are likely to involve large amounts, but not as large as to create an existential problem for the banks involved.
However, in the event of a further deterioration of the social mood – which will be reflected in the stock market's primary trend – the outcome could in fact turn out to be life-threatening for some banks.
As an aside, the SEC is now also probing Deutsche Bank's 'Crap Subprime CDO's'. The context is familiar from a similar investigation Goldman Sachs faced a while ago:
“The Securities and Exchange Commission investigates a Wall Street behemoth over claims that it assembled and sold a package of subprime mortgage-backed securities at the behest of hedge fund king John Paulson without telling other investors that Paulson planned to short it.”
John Paulson's highly successful short trade of mortgage-backed securities continues to haunt the banks that helped him put together the baskets of securities he wanted to short. As they didn't want to be the counterparties to his shorts, they sold the underlying securities to other investors – and of course had to present the securities concerned in the best possible light to such investors, in spite of the fact that they knew that Paulson had picked them for the great likelihood of eventual default. In our opinion these investors didn't do the due diligence they should have done, but once again, the investigation is symptomatic for the deterioration in social mood. The fact that Paulson profited greatly from correctly anticipating the collapse is of course anathema to many people as well.
US attorney general Eric Holder – going after the MBS deals sold during the housing bubble
(Photo via: the Web/unknown source)
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
6 Responses to “A Really Big Deal”
Most read in the last 20 days:
- A Striking Chart
The Economy and the Stock Market As long time readers know, we are always paying close attention to the manufacturing sector, which is far more important to the US economy than is generally believed. In terms of gross output it is the largest sector of the economy, and it should of course be obvious that saving, investment and production are the only ways to create wealth. What's left of the Brooklyn Domino Sugar Refinery. Photo credit: Paul Raphaelson Contrary...
- Trump and Putin Narrowly Escape Assassination Attempt
The Gloves are Coming Off First a little bit of recent history. Readers are probably aware that some questions about the occasionally malfunctioning Deep State android... no, wait, we'll start again. Questions have recently been raised about the health of presidential candidate Hillary Clinton by various “alt-right” tinfoil hat-wearing conspiracy theorists, such as this one. The monsters are normally hiding under Hillary's bed, but lately they have come out into the open...
- US Economy - Curious Pattern in ISM Readings
Head Fake Theory Confirmed? This is a brief update on our last overview of economic data. Although we briefly discussed employment as well, the overview was as usual mainly focused on manufacturing, which is the largest sector of the economy by gross output. Pepsi factory in Baltimore, 1956 Photo via pinterest.com Readers may recall that we have pointed out for some time that there was quite a large gap between the data reported in regional Fed manufacturing...
- Why the Fed Destroyed the Market Economy
What Have You Done for Me Lately? Swing voters are a fickle bunch. One election they vote Democrat. The next they vote Republican. For they have no particular ideology or political philosophy to base their judgment upon. The primacy of the wallet. They don’t give a rip about questions of small government or big government. Nor do they have any druthers about the welfare or warfare state. In effect, they really don’t care. What’s important to the...
- How is Real Wealth Created?
An Abrupt Drop Let’s turn back to our regular beat: the U.S. economy and its capital markets. We’ve been warning that the Fed would never make any substantial increase to interest rates. Not willingly, at least. Groping in the dark, Yellen-style Each time Fed chief Janet Yellen opens her mouth, out comes a hint that more rate hikes might be coming. But each time, it turns out that the economy is not as robust as she had believed... and that a rate hike isn’t...
- Janet Yellen’s Shame
Playing Politics In honest capitalism, you do what you can to get other people to voluntarily give you money. This usually involves providing goods or services they think are worth the price. You may get a little wild and crazy from time to time, but you are always called to order by your customers. In the market economy, consumers reign supreme. There is no such thing as a “lost” vote in the marketplace; every penny spent affects production. Mises noted: “Consumers...
- Get Ready for a New Crisis – in Corporate Debt
Imposter Dollar OUZILLY, France – We’re going back to basics here at the Diary. We’re getting everyone on the same page... learning together... connecting the dots... trying to figure out what is going on. The new three dollar bill issued by the Apprehensive States of America. We made a breakthrough when we identified the source of so many of today’s bizarre and grotesque trends. It’s the money – the new post-1971 dollar. This new dollar is green. You...
- The Economy, the Stock Market and the Fed
John Hussman on Recent Developments We always look forward to John Hussman's weekly missive on the markets. Some people say that he is a “permabear”, but we don't think that is a fair characterization. He is rightly wary of the stock market's historically extremely high valuation and the loose monetary policy driving the surge in asset prices. The S&P 500 Index and the NYSE advance-decline line. Most market internals weakened steadily until early February 2016, but...
- Hanjin Marooning in San Pedro Bay
Global Trade Reversal Expansions and contractions in global trade have played out over long secular trends for thousands of years. The Silk Road, for example, was established by the Han Dynasty of China in 130 BC, and allowed for continuous trade between East and West for nearly 1,600 years. In addition to economic trade, the Silk Road was also a conduit for culture and knowledge among its network of civilizations. A map of the main ancient Silk Road - click to...
- Donald’s Electoral Struggle
Wicked and Terrible After touting her pro-labor union record, the Wicked Witch of Chappaqua rhetorically asked, “why am I not 50 points ahead?” Her chief rival bluntly responded: “because you’re terrible.”* No truer words have been uttered by any of the candidates about one of their opponents since the start of this extraordinary presidential campaign! Electoral map (note that the coloration may no longer be applicable...) That Hillary Clinton is...
- Great Causes, a Sea of Debt and the 2017 Recession
Great Cause NORMANDY, FRANCE – We continue our work with the bomb squad. Myth disposal is dangerous work: People love their myths more than they love life itself. They may kill for money. But they die for their religions, their governments, their clans... and their ideas. Famous French hippie and author Voltaire. He wears the same sardonic grin in every painting, whether he's depicted at a young or an old age, doesn't matter. His real name was François-Marie Arouet; he...
- The Donald Versus Killary: War or Peace?
War: A Warning from the Past Although history does not exactly repeat itself, it does provide parallels and sometimes quite ominous ones. Such is the case with the current U.S. Presidential election and the one which occurred one hundred years earlier. The Donald probably has the better slogan... The dominating question which hung over the 1916 campaign was whether the country would remain neutral in regard to the horrific slaughter which was taking place on the...