Az BKR Judge Issues Preliminary Injunction Without Bond

McCaffery DEUTSCH- Court Order re preliminary injunction hearing

Filed under: foreclosure

Strategic Defaults Scaring the Securitizers

This is what scares the hell out of the pretender lenders. The reason? Because it transfers POWER from them to the borrower. They have embarked on numerous “ventures” in PR, rumors and even attempts at criminal investigations to scare off people from dumping their sour investments.

The people who have shared their stories with me basically all say the same thing. They say that they are so far underwater in their homes that it does not make sense for them to stay in an investment where the only likely prospect is a continuing drain on their resources. As for the hit on their credit score, they regard that as a small price to pay in order to relieve themselves of the debt that they probably won’t be able to pay any time in this lifetime.

In all cases, they report that they are able to either rent or buy comparable housing, sometimes with seller financing, reducing their monthly payment substantially and eliminating the huge debt that exceeds the value of their prior home. In states that use nonjudicial sale,  the option of pursuing a deficiency judgment is usually limited or nonexistent. In states that permit the “lender” to pursue a deficiency judgment, the party filing suit against the former borrower must actually prove that they lost money. Thus most, if not all, of the defenses that are present in a foreclosure action would most likely apply in a case where a “lender” sued for the alleged loss (the difference between the auction sale price and the amount due on the mortgage according to whoever files suit).

With millions of people the target of foreclosure, and where many of them had high credit scores but for the foreclosure, some lenders are starting to treat the foreclosure hit as less significant than had been true prior to this foreclosure mess. Therefore the people who are electing a strategic default say a have found an effective vehicle to end the nightmare while at the same time recovering a portion of their loss on the loan product that was sold to them merely through nonpayment. Some people have reported to me that they have been able to defer the auction sale and eviction long enough to save enough money to buy another home.

In my opinion there are probably large numbers of current homeowners who are underwater for whom the strategic default (voluntary nonpayment) is a viable option. And it would seem from the article below that even for people who have substantial resources apart from the home the strategic default is considered by them to be viable and even mandatory when they look at their investment in the home as strictly an investment that went bad.

Biggest Defaulters on Mortgages Are the Rich

By DAVID STREITFELD

LOS ALTOS, Calif. — No need for tears, but the well-off are losing their master suites and saying goodbye to their wine cellars.

The housing bust that began among the working class in remote subdivisions and quickly progressed to the suburban middle class is striking the upper class in privileged enclaves like this one in Silicon Valley.

Whether it is their residence, a second home or a house bought as an investment, the rich have stopped paying the mortgage at a rate that greatly exceeds the rest of the population.

More than one in seven homeowners with loans in excess of a million dollars are seriously delinquent, according to data compiled for The New York Times by the real estate analytics firm CoreLogic.

By contrast, homeowners with less lavish housing are much more likely to keep writing checks to their lender. About one in 12 mortgages below the million-dollar mark is delinquent.

Though it is hard to prove, the CoreLogic data suggest that many of the well-to-do are purposely dumping their financially draining properties, just as they would any sour investment.

“The rich are different: they are more ruthless,” said Sam Khater, CoreLogic’s senior economist.

Five properties here in Los Altos were scheduled for foreclosure auctions in a recent issue of The Los Altos Town Crier, the weekly newspaper where local legal notices are posted. Four have unpaid mortgage debt of more than $1 million, with the highest amount $2.8 million.

Not so long ago, said Chris Redden, the paper’s advertising services director, “it was a surprise if we had one foreclosure a month.”

The sheriff in Cook County, Ill., is increasingly in demand to evict foreclosed owners in the upscale suburbs to the north and west of Chicago — like Wilmette, La Grange and Glencoe. The occupants are always gone by the time a deputy gets there, a spokesman said, but just barely.

In Las Vegas, Ken Lowman, a longtime agent for luxury properties, said four of the 11 sales he brokered in June were distressed properties.

“I’ve never seen the wealthy hit like this before,” Mr. Lowman said. “They made their plans based on the best of all possible scenarios — that their incomes would continue to grow, that real estate would never drop. Not many had a plan B.”

The defaulting owners, he said, often remain as long as they can. “They’re in denial,” he said.

Here in Los Altos, where the median home price of $1.5 million makes it one of the most exclusive towns in the country, several houses scheduled for auction were still occupied this week. The people who answered the door were reluctant to explain their circumstances in any detail.

At one house, where the lender was owed $1.3 million, there was a couch out front wrapped in plastic. A woman said she and her husband had lost their jobs and were moving in with relatives. At another house, the family said they were renters. A third family, whose mortgage is $1.6 million, said they would be moving this weekend.

At a vacant house with a pool, where the lender was seeking $1.27 million, a raft and a water gun lay abandoned on the entryway floor.

Lenders are fearful that many of the 11 million or so homeowners who owe more than their house is worth will walk away from them, especially if the real estate market begins to weaken again. The so-called strategic defaults have become a matter of intense debate in recent months.

Fannie Mae and Freddie Mac, the two quasi-governmental mortgage finance companies that own most of the mortgages in America with a value of less than $500,000, are alternately pleading with distressed homeowners not to be bad citizens and brandishing a stick at them.

In a recent column on Freddie Mac’s Web site, the company’s executive vice president, Don Bisenius, acknowledged that walking away “might well be a good decision for certain borrowers” but argues that those who do it are trashing their communities.

The CoreLogic data suggest that the rich do not seem to have concerns about the civic good uppermost in their mind, especially when it comes to investment and second homes. Nor do they appear to be particularly worried about being sued by their lender or frozen out of future loans by Fannie Mae, possible consequences of default.

The delinquency rate on investment homes where the original mortgage was more than $1 million is now 23 percent. For cheaper investment homes, it is about 10 percent.

With second homes, the delinquency rate for both types of owners was rising in concert until the stock market crashed in September 2008. That sent the percentage of troubled million-dollar loans spiraling up much faster than the smaller loans.

“Those with high net worth have other resources to lean on if they get in trouble,” said Mr. Khater, the analyst. “If they’re going delinquent faster than anyone else, that tells me they are doing so willingly.”

Willingly, but not necessarily publicly. The rapper Chamillionaire is a plain-talking exception. He recently walked away from a $2 million house he bought in Houston in 2006.

“I just decided to let it go, give it back to the bank,” he told the celebrity gossip TV show “TMZ.” “I just didn’t feel like it was a good investment.”

The rich and successful often come naturally to this sort of attitude, said Brent T. White, a law professor at the University of Arizona who has studied strategic defaults.

“They may be less susceptible to the shame and fear-mongering used by the government and the mortgage banking industry to keep underwater homeowners from acting in their financial best interest,” Mr. White said.

The CoreLogic data measures serious delinquencies, which means the borrower has missed at least three payments in a row. At that point, lenders traditionally file a notice of default and the house enters the official foreclosure process.

In the current environment, however, notices of default are down for all types of loans as lenders work with owners in various modification programs. Even so, owners in some of the more expensive neighborhoods in and around San Francisco are beginning to head for the exit, according to data compiled by MDA DataQuick.

In Los Altos, Los Altos Hills and the most expensive neighborhood in adjoining Mountain View, defaults in the first five months of this year edged up to 16, from 15 in the same period in 2009 and four in 2008.

The East Bay suburb of Orinda had eight notices of default for million-dollar properties, up from five in the same period last year. On Nob Hill in San Francisco, there were four, up from one. The Marina neighborhood had four, up from two.

The vast majority of owners in these upscale communities are still paying the mortgage, of course. But they appear to be cutting back in other ways. The once-thriving Los Altos downtown is pocked with more than a dozen empty storefronts in a six-block stretch.

But this is still Silicon Valley, where failure can always be considered a prelude to success.

In the middle of a workday, one troubled homeowner here leaned over his laptop at the kitchen table, trying to maneuver his way out from under his debt and figure out the next big thing.

His five-bedroom house, drained of hundreds of thousands of dollars of equity over the last 13 years, is scheduled for auction July 20. Nine months ago, after his latest business (he has had several) failed in what he called “the global meltdown,” the man, a technology entrepreneur, said he quit making his $9,000 monthly payments.

“I’m going to be downsizing,” he said.

The man spoke on the condition of anonymity because, he said, he did not want his current problems to interfere with his coming reinvention. “I’m a businessman,” he explained. “I have to be upbeat.”

Filed under: foreclosure

Notes on Hearings I Attended

NOTES ON HEARINGS

W. David Merrill was sworn. He said that he worked for American Home Mortgage Servicing as a senior loan consultant working in mitigation, mediation, and litigation. Hence, the witness only entered the picture long after the loan was declared in default, a notice of default was served, and a notice of sale was served. By definition, his personal knowledge was limited to that point in time when the case was handed over to him for mitigation, mediation, or litigation. More likely, his first brush with the case occurred shortly before the hearing in the afternoon of June 23, 2010 before Judge Hollowell.

Debtor’s attorney raised an objection based upon lack of personal knowledge. The judge overruled the objection. Debtor’s attorney further objected to the copy of the document that was allegedly signed as requiring foundation. The lack of foundation derives from the lack of competence of the witness.

The witness stated that AHMS was the service or for Deutsche Bank. By a written agreement, which was not produced, the witness stated that AHMS was the successor to America West. All objections were overruled.

The witness stated that he was the records custodian for AHMS. However, no foundation for that statement was offered, nor could the witness adequately answer questions on cross examination that were directed at the so-called business records and directed at the witnesses claim that he was in fact the records custodian. Anyone with familiarity of securitized loans knows very well that the servicer is not the records custodian. The attempt by Debtor’s attorney to raise this issue was overruled. In fact, earlier that morning in another case, the judge threatened Debtor’s with contempt of court.

The judge in both cases declared that she was using the doctrine of a colorable claim as she understood it to apply to a motion to lift stay.

The so-called business records were admitted in evidence over objection. The pooling and servicing agreement was admitted as Exhibit 6, but the terms of the pooling and servicing agreement were ignored. Based upon the naked assertion by AHMS, it was presumed that the substitute service or was properly authorized, and that issues raised by the expert  (me) were irrelevant to the preceding and that a very low threshold was required for the movant to obtain relief from stay.

Adding to the confusion, the judge herself stated on the record that the witness was not competent.

The judge was clearly viewing the claims raised by the debtor as a mere stalling tactic.

The concepts repeatedly introduced by Ryan in his pleadings and by myself as an expert witness were completely ignored. The judge refused to seriously consider the possibility that the multiplicity of parties who were in plain sight within the pooling and servicing agreement could present a problem of standing, real party in interest, whether the MOVANT was a creditor,  whether a proper accounting had been rendered, and us whether the balance due as claimed in the notice of the fault was correct or had material deficiencies, to wit:  (1) the identity of the beneficiary, trustee, and servicer was not properly stated and (2) the amount claimed to be in default was  fictitious.

The moving party presented a witness who attempted to justify the filing of three promissory notes as evidence of the obligation, each of which was different. The last and final promissory note was first shown to the expert witness for the  first time on the day of the hearing. This last note showed endorsements which were not apparent on previous “original” notes filed with the court. The Court expressed concern about this.

The testimony and the evidence both pointed to the same practice in both hearings.  For reasons relating to the securitization practices on Wall Street including but not limited to the repackaging of loan portfolios, mortgage-backed bonds, and the creation of collateralized debt obligations which in turn were sold as mortgage-backed bonds, the securitizations of the loans required that no actual formal assignment, endorsement,  or delivery be executed until the instructions were received from the lawyer for the investment banker that was the underwriter of the original series of mortgage-backed bonds. This was the testimony of the witness for the Movant.

Thus,  the legal owner of the loan remains the original party identified as the lender on the deed of trust (or the mortgage) until those instructions are received. Evidence from the industry including but not limited to the statistical probability that a particular loan or bond will be in litigation, strongly suggests that at least 97% of all securitized loans have never been the subject of a legal transfer of the obligation, note and mortgage as required under applicable state law regarding the transfer and recording of interests in real property, and the assignment and endorsement of the note.

In fact, the securitization parties were merely trading in an “expectation” of receivables generated through several channels, each of which depended upon the existence or stated existence of a performing loan. In actual practice, therefore, it may be fairly stated that in nearly all cases involving securitized loans, only the revenue streams arising from all parties and co-obligors were the subject of any trading or transfer activity.

Thus  the status of nearly all securitized loan could be fairly described as legally owned by the originating lender, who in all cases was not left with a receivable upon the closing of the loan transaction. The public records in which property interests are recorded clearly corroborate the conclusions stated herein. The only party that shows on those public records as having an “interest” in the loan is the originating lender. Since the originating lender has been paid in full –an uncontroverted fact– the obligation from the borrower to the originating lender was both created and satisfied at the time of closing.

Since the actual source of the funds that were borrowed by the debtor or borrower came from a remote source (a group of investors) who received a bond from a third party rather than receiving the note executed by the borrower, it is difficult to justify the position that third-party payments are irrelevant. It is equally difficult to construct a scenario under which anyone other than the originating lender had a legal claim under the original loan documents. However, there appears to be an equitable claim by the remote source of funds (the group of investors) for recovery of all payments made and received from all parties in the securitization chain. As to parties other than the borrower in the securitization chain, it appears that the remote source of funds (the group of investors) probably also have legal claims against the various parties in the securitization chain that created, sold and managed debits and credits attributable or allocable to the investor and to the loan accounts of the borrowers.

In the hearings I attended, many documents were offered in evidence that are not normally found in any type of foreclosure proceeding, nor would they be accepted in a judicial foreclosure proceeding without expensive foundation an explanation for their use. Limited powers of attorney, designation as limited signing officer, ratification of prior acts that don’t appear to have ever occurred, certificates of limited authority for certain named individuals to act as officers (obviously raising the question as to whether or not these individuals were ever officers of the entity in any other respectful), substitutions of trustee, endorsements from nonexistent entities, and other documents executed by parties outside of the chain of title, together with the use and confusion between assignments, endorsements, allonges.

Before the era of securitization of mortgage loans it was extremely rare to find any such documentation clouding the chain of title in a foreclosure proceeding. In this case ALL of those documents are present, as they are in millions of other foreclosure proceedings. Judges who have scrutinized these documents have universally arrived at the conclusion that the documents invariably suggest fabrication, forgery, unauthorized signatures, breaks in the chain of title, and frequently all of the above.

In this case, as in all cases where I have been an observer, no person or witness has been willing to testify that they know where these documents came from, when they were created, by whom they were created, or that they know the individuals who executed said documents. In my opinion, this corroborates my conclusion that no such documentation exists in nearly all cases. And further court corroborates my conclusion that any such documentation offered in support of a foreclosure was prepared after the declaration of the fault, after the notice of default, and after the notice of sale.

/s/ NEIL F GARFIELD

Filed under: bubble, CASES, CDO, CORRUPTION, Eviction, evidence, expert witness, foreclosure mill, GTC | Honor, HERS, investment banking, Investor, MODIFICATION, Mortgage, Motions, Pleading, securities fraud, Servicer, STATUTES, trustee

NEW JERSEY TRIAL COURT JUDGE ISSUES 53-PAGE OPINION DISMISING FORECLOSURE COMPLAINT OF BANK OF NEW YORK AS SECURITIZED TRUSTEE: OPINION COULD PAVE THE WAY FOR AMENDMENTS TO NEW JERSEY RULES OF PROCEDURE REQUIRING FORECLOSURE COMPLAINTS TO BE CERTIFIED AND FOR FORECLOSING PARTIES TO PRODUCE SECURITIZATION DISCOVERY IN ORDER TO BE ABLE TO PURSUE FORECLOSURE

Cleveland Fed Researchers Examine Derivatives, Systemic Risk – 2009 Annual Report Essay: Putting Systemic Risk on the Radar Screen

Cleveland Fed Researchers Examine Derivatives, Systemic Risk

As Congress works on finalizing financial reform legislation, there is widespread agreement about the need for better management of systemic risk. But in order to manage systemic risk, you need to be able to define and measure it, says researcher Joseph Haubrich, writing in the Federal Reserve Bank of Cleveland’s 2009 Annual Report.

(Vocus/PRWEB ) July 7, 2010 — As Congress works on finalizing financial reform legislation, there is widespread agreement about the need for better management of systemic risk. But in order to manage systemic risk, you need to be able to define and measure it, says researcher Joseph Haubrich, writing in the Federal Reserve Bank of Cleveland’s 2009 Annual Report. Haubrich and other Cleveland Fed economists advocate using the “four C’s” to define systemic risk: contagion, concentration, correlation, and context.

As the recent financial crisis demonstrated, the derivatives market can pose a substantial threat to financial stability in times of systemic turmoil. The lack of transparent reporting of trades and exposures can leave regulators and investors in the dark about where risks are concentrated. In a recent Economic Commentary, Federal Reserve Bank of Cleveland researchers Kent Cherny and Ben Craig discuss some of the benefits of moving the settlement or trading of derivative instruments onto exchanges or clearinghouses, similar to those currently being used for stocks and options.

Source: http://www.clevelandfed.org/About_Us/annual_report/2009/2009_essay.cfm

2009 Annual Report Essay: Putting Systemic Risk on the Radar Screen

• Table of Contents
• Sections
  • Introduction
  • What is Systemic Risk and How Should We Measure It?
  • Measuring Systemic Risk
  • Making Measures Work
  • Data Needs and Beyond
  • A New Information Infrastructure?
  • The Changing Face of Supervision
  • A Call for Transparency and Dialogue
  • Notes
  • References
• Sidebars
  • Financial Decoupling
  • Can a Stock Option Predict Financial System Chaos?
  • Bridges and Hedge Funds: Endogenous Risk

Introduction

As the nation ponders its response to the greatest financial crisis in generations, plans for regulatory reform are everywhere. Proposals to break up big financial companies, create a new agency for consumer protection, and lay out additional rules for derivatives, insurance companies, and hedge funds—they’re all on the table.

Many proposals call for enhanced supervision and regulation to combat systemic risk. Some proposals would tie leverage restrictions, capital requirements, or deposit insurance to systemic risk. Federal Reserve Bank of Cleveland President Sandra Pianalto has outlined three tiers of supervision with various levels and types of systemic significance.¹ Regardless of the outcome of current regulatory reform deliberations, systemic risk and systemic risk supervision seem destined to be a part of our new financial order.

But what exactly does systemic risk mean? Without a clear and comprehensive definition of systemic risk, and some way to measure it, no proposal can be fully implemented. In this essay, we argue that policymakers must begin in earnest to define and measure systemic risk. Without proper measures, one regulates, or governs, by anecdote rather than by facts.² Even reforms about which there is little controversy—such as the need to supervise and regulate systemically important financial institutions differently—will be limited or possibly counterproductive unless systemic risk is measured accurately. Although quantifying systemic risk may sound esoteric and technical, we suggest that it is easy enough to know where to begin and absolutely critical that we do so.

What Is Systemic Risk and How Should We Measure It?

Let’s accept, from the outset, that there are several plausible definitions of systemic risk, but any definition must capture the idea that a significant fraction of a financial market will be disrupted. Think about the classic banking panic, where depositors rush to convert their bank accounts into cash. In fact, scholars often emphasize the significant-fraction aspect by distinguishing between a run on a single bank and a panic, which involves many banks.³ Today, the significant-fraction idea means recognizing disruptions both inside and outside the banking system, including disturbances at nonbank financial institutions and within financial markets more broadly.

A second concept that a systemic risk definition should embrace is that of contagion: Problems at one financial institution may spread to others, just as a fire might spread through a crowded tenement. The contagion may arise because one bank’s failure makes people nervous about the safety of other banks, or because financial connections at one bank lead directly to a second bank’s failure. In the recent crisis, the panic quite obviously spread beyond banks. On September 16, 2008, the Reserve Primary Fund, a money market fund that held Lehman Brothers’ commercial paper, “broke the buck,” meaning it could no longer keep its net asset value at the standard one dollar. This alarming news started a run on other money market mutual funds, leading to a near shutdown in the commercial paper market, a major source of funding for nonfinancial businesses.⁴

The twin ideas of significant fraction and contagion can help make our definition of systemic risk more concrete. The Commodity Futures Trading Commission defines systemic risk as follows: “The risk that a default by one market participant will have repercussions on other participants due to the interlocking nature of financial markets. For example, Customer A’s default in X market may affect Intermediary B’s ability to fulfill its obligations in markets X, Y, and Z.”⁵ Alternatively, here is a definition offered by several professors at New York University: “Systemic risk can be thought of as a widespread failure of financial institutions or freezing up of capital markets that can substantially reduce the supply of capital to the real economy” (emphasis ours in both definitions).⁶

These definitions suggest that we recognize two dimensions of systemic risk—one looking at the risk lodged in a specific institution or market segment, and the other looking at the overall risk in the financial system. At the economy-wide level, unacceptable systemic risk is the risk that the financial system cannot perform its major functions, especially those that support production, consumption, and employment. We can also see in these definitions the beginning of the process of identifying systemically important firms—those whose problems could, in certain circumstances, lead to widespread financial and economic disruption.

Measuring Systemic Risk

Let’s say that we are satisfied, for now, that we know what we are looking for. How will we detect systemic risk? The first step is to recognize that it will likely have several defining characteristics, making it impossible to measure on a single scale. Think of an airline cockpit with its intricate display of outputs and dials. An experienced pilot watches several indicators of weather, location, and flight status as well as the plane’s fuel gauge and oil pressure. Similarly, we expect that a systemic risk supervisor would consider a broad set of indicators, some giving a market-wide view and others assessing particular firms.

Legislation defines the mission of most current financial supervisors in terms of the legal entities they supervise: banks, broker-dealers, or insurance companies. The recent financial crisis revealed several gaps. Even within the most comprehensively supervised banking organizations—financial holding companies—it was difficult to assemble a comprehensive risk profile, let alone an adequate appreciation of the potential risks they might pose to the financial system.⁷ But the crisis revealed that financial supervisors have to look even more broadly at the companies they supervise—they have to look at the various ways in which the firms are connected to one another and to how the financial markets themselves are functioning.

In the recent financial crisis, commercial banks as well as mortgage companies, broker-dealers, and insurance companies all fell prey to the panic. Fundamentally, the crisis revealed the instability of the “shadow banking” sector, where borrowing and lending took place outside commercial banks through financial conduits, structured investment vehicles, and financial product divisions of supposedly solid firms. And, as we learned all too painfully, the shadow banking system was quite fragile and was connected to the mainstream banking system in ways that were not fully understood. So as we seek measures of systemic risk, we will have to cast a wide net.

The Federal Reserve Bank of Cleveland has stressed four factors—the four C’s—that we believe are important for understanding systemic risk and for gauging its extent: contagion, concentration, correlation, and context.⁸ Eventually, we will have to find ways to quantify the first three and to contend with the fourth.

Contagion is a defining feature of systemic risk. How are different markets connected? How can a shock in one market be transmitted to another? The recent financial panic, for example, progressed quickly through the subprime mortgage market, money market mutual funds, and on to the commercial paper market.

Concentration. Seasoned travelers know that bad weather at JFK or O’Hare—major airline hubs—causes more delays than snow at airports in less-traveled cities like Akron or Topeka. In the financial sphere, this means that the more business that is concentrated in a few firms, the greater the systemic risk. Thus, problems at only a few major firms can destabilize the entire industry.

Correlation puts too many eggs in one basket. When firms take on the same risk, they can end up hobbled by the same shock. The problems of subprime mortgages infected many financial institutions and investors who held large amounts of mortgage-backed securities and collateralized debt obligations. Through the intricacies of structured finance, even the AAA-rated tranches of securities became “economic catastrophe bonds” when loans across the country began to sour and housing prices fell.⁹ A more subtle correlation emerged as investors lost confidence in the ratings, making their “investment-grade” bonds hard to sell. Once confidence in the ratings methodology for securitized assets eroded, investors became wary of familiar products far removed from subprime mortgages, such as student and auto loans. Thanks to correlation, the panic spread.

Context. When something happens is often as important as what happens. For example, the hedge fund Amaranth Advisors LLC collapsed in September 2006 after a deep loss in its derivatives investments, yet its failure did not have a systemic impact. In contrast, the hedge fund Long-Term Capital Management, with losses only half as large, suffered large capital losses and liquidity problems in fall 1998, right on the heels of the Asian crisis and the Russian default, and its difficulties had a significant effect on broader markets.¹⁰ Similarly, the treatment of Drexel Burnham Lambert in 1990 was much different from the assisted merger of Bear Stearns into JPMorgan Chase in early 2008, when the economic crisis was unfolding.

The four C’s describe broad characteristics of firms and markets that should matter to a systemic supervisor. Ultimately, having good metrics for the first three C’s—contagion, concentration, and correlation—will prove quite helpful to financial supervisors. But even now, with these guideposts, we can move to a more operational level for defining and measuring systemic risk.

Professor Andrew Lo of MIT’s Sloan School of Management has suggested that systemic supervisors should consider looking at leverage, liquidity, sensitivities, and implicit guarantees associated with specific financial organizations. All of these are subject to measurement, to varying degrees of precision.¹¹

The four C’s—contagion, concentration, correlation, and context—describe broad characteristics of firms and markets that should matter to a systemic supervisor.

Leverage describes how much a firm borrows based on its size. Leverage is commonly defined as the value of a firm’s assets divided by its shareholders’ equity. The portion of assets not financed with equity must be financed with debt. More leverage allows higher profits, but leverage also means that a huge loss becomes more likely to bankrupt the firm, since capital may be depleted and the debts must be repaid. The subtle ways leverage can affect a firm might best be illustrated by AIG: The firm’s AAA rating allowed it to be quite highly leveraged. But when AIG lost that rating, it had to put up more collateral for its derivative positions—collateral it did not have—causing the crisis that led to its bailout.¹² Leverage may seem easy to measure, but it becomes complicated in practice. Even when measured reasonably well, there is always the question: How much leverage is too much? And should the nature of a firm’s assets and liabilities figure into the setting of a leverage limit?

Liquidity measures how easily an asset can be sold or how much its price drops if the asset is sold quickly. If a firm needs cash, the safest asset in the world will be useless if no one will buy it. At the firm level, a distinction is often made between insolvency and illiquidity. For an insolvent firm, the value of its liabilities exceeds the value of its assets. An illiquid firm, even though it may be solvent, cannot meet its short-term obligations with valuable but hard-to-sell assets. Illiquidity can also create contagion. A desperate firm sells assets at fire-sale prices, which reduces the market value of similar assets at other firms, undermining market confidence in these firms. If the firms are forced to sell assets because of that loss of confidence, the problem spirals out of control. As is the case with leverage, financial analysts have put forward several liquidity measures. Supervisors will have to determine which one is the best benchmark and how much liquidity to require in various financial environments.

Sensitivities, which option traders call “the Greeks” (because they are usually denoted by Greek letters in the textbooks), measure how asset values change with interest rates and market conditions. This set of gauges is intended to describe how exposed and vulnerable the firm is to different shocks or scenarios that may plausibly arise. Supervisors would find it difficult to compute these measures based on regulatory reports, but sophisticated firms should already be tracking these measures. Obviously, the more volatile a firm’s asset valuation, the more quickly its leverage and liquidity ratios are likely to change.

Implicit guarantees are a less obvious source of risk, but they make it difficult for both firms and their supervisors to accurately gauge exposures. Both the firms themselves and the government offer these guarantees, which further complicates matters. The poster children for implicit firm guarantees were the structured investment vehicle and the related asset-backed commercial paper vehicle. Structured investment vehicles were legally structured as a way to remove assets from bank balance sheets, so had only limited guarantees from the sponsoring bank. Nonetheless, after the crisis hit, many banks provided recourse. On the government side, the recent crisis also provides examples, most notably Fannie Mae and Freddie Mac.

Making Measures Work

Integrating these concepts into something that financial supervisors can use requires another level of detail and, in some cases, extra care. Supervisors who want an early signal that markets are getting dangerous should follow a broad set of measures (and develop a healthy skepticism about their use). Supervisors seeking measures that signal actionable steps against individual firms will have to exercise greater caution, however. Waiting for near-certainty could be costly to market stability, but acting prematurely could needlessly harm the firm in question.

Several promising steps are being taken already to gauge both market risk and firm risk. One direction is to construct an early warning system for systemic problems at the broad market level.¹³ Sometimes this takes the form of a financial stress index such as the Bloomberg Financial Conditions Index, which looks at a variety of interest rates and prices (see figure 1).¹⁴ Other versions look at both prices and quantities, issuing a warning when asset prices shoot up at the same time as total credit (see figure 2).¹⁵ Yet another approach treats the entire economy as one big portfolio and looks at the “distance to default,” or roughly how large a shock it takes to destabilize the system.¹⁶

Some proposed reforms—particularly those that would classify some firms as being systemically important and subject them to enhanced supervision—require a set of institution-specific systemic risk measures.

Some proposed reforms, however—particularly those that would classify some firms as being systemically important and subject them to enhanced supervision—require a set of institution-specific systemic risk measures. Going down this path means looking more closely at individual firms, assessing which ones are either highly vulnerable or highly dangerous. The vulnerable firms are those with a high chance of failing when the system gets a shock.¹⁷ One way to identify these is to look for firms whose stock price plummets when the overall market drops. Knowing a firm is sensitive to systemic risk is not the same as knowing it is a likely source of contagion, however. To identify dangerous firms, we can turn the question around and ask which firms will bring down the market.¹⁸ In the data, this means looking at how much the market falls when the firm has a bad day.

Getting the details right is tricky and important: Nobody wants to close a bank, cap its leverage, or lend it billions of dollars based on a bad measure of systemic risk. For instance, what counts as a “big drop” in the market, and do you use stock prices, bond yields, or derivatives? Not only can each give different results, but as market-based measures, each reflects the market’s view of risk, which may not be grounded in reality.

Furthermore, using data from quiet times to infer behavior in crisis situations has its perils. The space shuttle Challenger’s O-rings performed acceptably in cool conditions, but failed dramatically in freezing temperatures.¹⁹ Long-Term Capital Management had a sophisticated risk control system that indicated a well-hedged portfolio: Market shifts would have offsetting effects on different assets, keeping the firm balanced. But when the crisis came, the offsets didn’t work, all prices moved together, and the firm needed a rescue. Clearly, it will take time to implement the systemic risk tools, to calibrate them in different ways, and to learn how successful they can be over time. The work is certain to be frustrating and contentious—and yet, it must be done.

Data Needs and Beyond

Knowing a firm’s stock price in real time is straightforward. It is quite another matter to observe a firm’s leverage, liquidity, sensitivity, and counterparty exposures on a nearly constant basis. This information will be among the most important data the systemic supervisor will collect, particularly in times of crisis, when the supervisor must quickly make tactical decisions about which firms to save, recapitalize, or close. But many, if not most, firms consider details about their portfolios and investment strategies as proprietary information, so supervisors should anticipate that firms may look for ways to avoid disclosing it.

A start would be to collect basic aggregate information about the firm: assets under management, leverage, portfolio holdings, counterparties, and investors. For commercial banks, much of this information is already collected, but for firms in less-regulated areas, such as hedge funds, it is not. According to Andrew J. Donohue, director of the Securities and Exchange Commission’s Division of Investment Management, “It is not uncommon that our first contact with a manager of a significant amount of assets is during an investigation by our Enforcement Division.”²⁰ Indeed, the exposures generated by AIG’s credit default swap contracts went unappreciated, even though the company was regulated as both an insurance company and a thrift holding company.

Just as airline safety requires more than assessing the metal fatigue on jetliners—crew rotation schedules, maintenance reviews, and air traffic patterns all matter as well—financial market safety requires many coordinated pieces of information. Data about individual firms build on knowledge of market structure and performance, such as clearing and settlement practices, market volume, patterns of counterparty relationships, and market liquidity. Clearly, supervisors will need to acquire some combination of firm—and market-level data to assess the overall state of the system.

A New Information Infastructure?

Several proposals have been advanced to create a new “information infrastructure” for the financial system. Federal Reserve Board Governor Daniel K. Tarullo recently provided a rationale for, and a set of principles to guide, an enhanced data collection regime.²¹ As Tarullo notes, data collection can be costly, and data overload can create problems for supervisors, so it pays to think carefully in advance about what information needs to be collected.

The academics behind the Squam Lake proposal are primarily worried about counterparty risk and fire-sale risk.²² They would have large financial institutions report quarterly on their asset positions and risk, and regulators would aggregate and release the data with a delay (to allay confidentiality concerns). Regulators would “standardize the process used to measure values and risk exposure” to allow for easier comparison across firms and greater information sharing among different regulators. Whatever the advantages of the fragmented U.S. financial regulatory system, it does mean that sharing information among agencies takes a concerted effort, particularly among regulators of different industries, such as state insurance commissions, the Federal Reserve, the Securities and Exchange Commission, and the Commodity Futures Trading Commission.

Tarullo and others note that data requirements are likely to be substantial. Some have called for the creation of a new agency, such as a National Institute of Finance, to gather, prepare, and house the required data.²³ Federal Reserve Bank of Philadelphia economist Leonard Nakamura proposes a U.S. financial regulatory database that would register every direct claim against firms, households, or other legal entities and would include derivatives contracts such as futures, options, and swaps.²⁴ In his proposal, institutions that buy, sell, or hold a registered asset would report their holdings and activities quarterly. Note that this requirement is not restricted to large, or even financial, firms. Some have called for even more frequent reporting—for instance, having financial institutions submit same-day details of all transactions to a highly secure non-public database accessible to regulators.²⁵

Reporting all of this information could be onerous, so it would probably make sense to pilot the system on a smaller scale before expanding it, to compare costs and benefits. Regular and timely reporting of a firm’s aggregate exposure to different counterparties, with full details available by close of business in case of an authentic emergency, would give a more manageable set of information for supervisors without imposing a burden that would send firms scurrying to an offshore tax haven.

The Changing Face of Supervision

A world in which systemic risk is measured and managed will require new skill sets and processes for regulators and, quite possibly, new forms of supervision. Analyzing the new information, searching for trends and vulnerabilities, and developing and refining better measures of systemic risk will take teams of analysts drawn from various fields. Few people will have the necessary expertise in network theory, risk analysis, and statistics, to say nothing of the legal background, to process all of the information.

Although regulatory reform legislation has not yet been enacted as of this writing, it is quite clear that supervision must change. Systemic risk will be monitored in some fashion, and the information collected will be incorporated into supervisory practices. Indeed, the Federal Reserve has already made a number of changes in its practices and is contemplating additional ones. In response to the financial crisis, the Federal Reserve has found it useful to create cross-functional teams of examiners, economists, and market and legal experts. These teams were involved with the Supervisory Capital Assessment Program (SCAP)—also known as the stress test—for the nation’s largest banks. The SCAP, announced in February 2009, when confidence in the banking system was still very shaky, has been widely regarded as successful in bolstering public confidence and in quelling the turmoil in financial markets.²⁶ The program has also had a profound effect on how Federal Reserve officials are thinking about systemic risk supervision going forward.²⁷

The SCAP demonstrated the value of conducting cross-firm, horizontal reviews of all activities within holding companies that can create risk for the firm and the financial system. The Federal Reserve will be combining firm-specific data analysis and market-based indicators to identify situations that may affect multiple firms. By using scenario analysis, the Federal Reserve would be able to gauge the effect of possible market developments on the capital, liquidity, and leverage positions of systemically important financial institutions. Eventually, more sophisticated modeling would attempt to link traditional and enhanced supervisory information about a collection of financial institutions with market-based stress indicators to build a more comprehensive picture of emerging systemic problems. Although supervisors will always use judgment in interpreting the results obtained from such models, the modeling itself will require measures that quantify possible sources of systemic risk.

A Call for Transparency and Dialogue

The recent financial crisis should serve as a powerful reminder that financial markets are dynamic and will adapt to changes in supervision and regulation. We should anticipate that some market participants will look for ways to minimize the restrictions placed on their activities by developing new financial instruments and legal structures, and by expanding the use of implicit guarantees. Financial supervisors will need all the help they can get to stay current with evolving conditions. For its part, the public will want its own assurances that the supervisors are keeping a watchful eye.

In monetary policy, the public has many opportunities to observe the Federal Reserve’s progress in achieving its dual mandate to promote stable prices and maximum sustainable economic growth. The Federal Reserve’s monetary policy body, the Federal Open Market Committee (FOMC), meets regularly and immediately publishes its policy decisions and rationale. More information follows in meeting minutes, speeches by Fed officials, and Congressional testimony, providing the public with a good understanding of how inflation and unemployment can affect the Federal Reserve’s actions. Many highly sophisticated “Fed watchers” frequently comment on the FOMC’s strategy and actions, a situation that enables the FOMC to recognize when its own views might differ markedly from those of others. Over time, the FOMC has come to appreciate that a thoughtful communication strategy is a useful component of the policymaking process itself, and that its dialogue with the public leads to better policymaking.

Likewise, we think that supervisory efforts to limit systemic risk could benefit from the credibility and accountability that would arise from an expanded public dialogue. Wall Street gurus and others can criticize the measures of risk—or feel free to propose their own. Pundits can bemoan the supervisors’ slow response to rising levels of risk—or their overreaction to noisy data. Public discourse about supervisory strategy and actions could help market participants understand how supervisors are identifying and mitigating systemic risk, and ultimately sharpen the tools and refine the gauges in the supervisors’ toolboxes.

More research, data collection, analysis, and practical experience are likely to considerably improve supervisors’ ability to tie specific measures of systemic risk to requirements for deposit insurance premiums, capital, liquidity, and leverage. In a very real sense, the supervision of systemic risk stands at the early stages of an evolution that prudential supervision has been undergoing for decades. Even as late as the 1970s, different federal supervisors (primarily the Federal Reserve and the Comptroller’s Office of the Treasury) had very different approaches to bank supervision. Attempts to provide a more standardized approach began in the Johnson administration, but progress was slow.²⁸ In 1978, Congress formalized the convergence, creating the Federal Financial Institutions Examination Council, which introduced the CAMEL system (for Capital, Assets, Management, Earnings, and Liquidity).²⁹ The system continued to evolve: Concerns that banks held too little capital prompted supervisors to add a risk-based approach in 1988. That approach did not account for market risk, so in 1997 supervisors added an S for Sensitivity to market risk. As banks used securitization to further reduce capital, other changes were implemented.³⁰ The next step in that evolution could well be a similar system for macrostability ratings, such as the recent proposal by Gary Stern and Ron Feldman.³¹

In this essay, we have explained why we think it is important to learn more about systemic risk measurement. We have shared some of our thinking about the topic and summarized the thinking of others. But this one-way communication does not constitute dialogue. What do you think about designing ways to measure systemic risk and a platform to manage it? Take this as a request for public comment: Send your ideas to us at SystemicRisk@clev.frb.org.

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Notes

1. Pianalto (2009). [Return]
2. Stigler (1975). [Return]
3. Gorton (1985). See also Warsh (2009). [Return]
4. Dwyer and Tkac (2009). [Return]
5. Commodity Futures Trading Commission (2010). [Return]
6. Acharya. Philippon, Richardson, and Roubini (2009). [Return]
7. This difficulty could be overcome by clarifying the Federal Reserve’s role as the consolidated supervisor of financial holding companies. A consolidated supervisor has the authority to collect information from all affiliates within a holding company and to take supervisory actions that enable it to manage the consolidated risk of the entire enterprise. [Return]
8. Thomson (2009) and Haubrich and Thomson (2009). [Return]
9. Coval, Jurek, and Stafford (2009). [Return]
10. Greenspan (1998). [Return]
11. Lo (2009). [Return]
12. Sjostrom (2009). [Return]
13. For example, De Nicolo and Lucchetta (2010). The Federal Reserve Bank of Cleveland has also been working on developing and piloting a model. [Return]
14. Bloomberg (2010). The Federal Reserve Bank of Kansas City also puts out a Financial Stress Index. [Return]
15. Borio and Drehman (2009). [Return]
16. Gray, Merton, and Bodie (2007). [Return]
17. Acharya, Pedersen, Philippon, and Richardson (2009). [Return]
18. Adrian and Brunnermeier (2009). [Return]
19. An extended discussion is in Tufte (1997). [Return]
20. Donohue (2009). [Return]
21. Tarullo (2010a). [Return]
22. Squam Lake Working Group on Financial Regulation (2009). [Return]
23. Mendelowitz and Liechty (2010). [Return]
24. Nakamura (2010). [Return]
25. Rowe (2009). [Return]
26. Similar teams have been formed to assess the effects of incentive compensation on financial firms. See Alvarez (2010). [Return]
27. Tarullo (2010b). [Return]
28. Robertson (1995). [Return]
29. Tarullo (2008). [Return]
30. Tarullo (2008). [Return]
31. Stern and Feldman (2009). [Return]

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References

• Acharya, Viral V., Lasse H. Pedersen, Thomas Philippon, and Matthew Richardson. 2009. “Regulating Systemic Risk.” In Viral V. Acharya and Matthew Richardson, eds., Restoring Financial Stability: How to Repair a Failed System. Hoboken, N.J.: Wiley.
• Acharya, Viral V., Thomas Philippon, Matthew Richardson, and Nouriel Roubini. 2009. “A Bird’s-Eye View: The Financial Crisis of 2007-2009.” In Viral V. Acharya and Matthew Richardson, op. cit.
• Adrian, Tobias, and Markus Brunnermeier. 2009. “CoVar.” Staff Report No. 348. Federal Reserve Bank of New York (August).
• Alvarez, Scott G. 2010. “Incentive Compensation.” Testimony before the House Committee on Financial Services (February 25).
• Bloomberg Financial Conditions Index. 2010. www.bloomberg.com/apps/quote?ticker=BFCIUS%3AIND
• Borio, Claudio, and Matthias Drehman. 2009. “Assessing the Risk of Banking Crises—Revisited.” Quarterly Review, Bank for International Settlements (March), 29-46.
• Commodity Futures Trading Commission. 2010. “A Guide to the Language of the Futures Industry.” www.cftc.gov/ConsumerProtection/EducationCenter/CFTCGlossary/index.htm
• Coval, Joshua, Jakub Jurek, and Erik Stafford. 2009. “The Economics of Structured Finance.” Journal of Economic Perspectives 23(1): 3-25.
• De Nicolo, Gianni, and Marcella Lucchetta. 2010. “Systemic Risks and the Macroeconomy.” IMF Working Paper 10/29, International Monetary Fund (February), 1-40.
• Donohue, Andrew J. 2009. “Regulating Hedge Funds and Other Private Investment Pools.” Testimony before the Subcommittee on Securities, Insurance, and Investment of the U.S. Senate Committee on Banking, Housing, and Urban Affairs (July 15).
• Dwyer, Gerald P., and Paula Tkac. 2009. “The Financial Crisis of 2008 in Fixed Income Markets.” Working Paper 2009-20. Federal Reserve Bank of Atlanta (August).
• Gorton, Gary. 1985. “Bank Suspension of Convertibility.” Journal of Monetary Economics 15(2): 177-93.
• Gray, Dale F., Robert C. Merton, and Zvi Bodie. 2007. “Contingent Claims Approach to Measuring and Managing Sovereign Credit Risk.” Journal of Investment Management 5(4): 5-28.
• Greenspan, Alan. 1998. Testimony before the House Committee on Banking and Financial Services at the Hearing on Hedge Fund Operations (October 1).
• Haubrich, Joseph G., and James B. Thomson. 2009. “Too Big to Fail and the Definition of Systemic Significance.” Lombard Street Journal 1 (15): 24-30.
• Hu, Henry C. 2009. “Empty Creditors and the Crisis.” Wall Street Journal (April 10).
• Hu, Henry C., and Bernard S. Black. 2008. “Equity and Debt Decoupling and Empty Voting II: Importance and Extension.” University of Pennsylvania Law Review 156: 625-739.
• Leland, Hayne, and Mark Rubinstein. 1988. “Comments on the Market Crash: Six Months After.” Journal of Economic Perspectives 2(3): 45-50.
• Lo, Andrew W. 2008. “What Happened to the Quants in August 2007?” In Hedge Funds: An Analytic Perspective. Princeton, N.J.: Princeton University Press.
• Lo, Andrew W. 2009. “The Feasibility of Systemic Risk Measurement.” Testimony written for the House Committee on Financial Services (October 19).
• Mendelowitz, Allan I., and John Liechty. 2010. “The National Institute of Finance: Providing Financial Regulators with the Data and Tools Needed to Safeguard our Financial System.” Testimony before the Senate Subcommittee on Security, International Trade, and Finance, Committee on Banking, Housing, and Urban Affairs (February 10).
• Nakamura, Leonard. 2010. “Durable Financial Regulation: Monitoring Financial Instruments as a Counterpart to Regulating Financial Institutions.” White Paper. Federal Reserve Bank of Philadelphia (January 4).
• Pianalto, Sandra. 2009. “Steps toward a New Financial Regulatory Architecture.” Remarks, Ohio Bankers’ Day, April 1. www.clevelandfed.org/For_the_Public/News_and_Media/Speeches/2009/Pianalto_20090401.cfm
• Robertson, Ross M. 1995. The Comptroller and Bank Supervision: A Historical Appraisal. Washington DC: Office of the Comptroller of the Currency, 213.
• Rowe, David. 2009. “Twenty-first-century Supervision.” Risk (December): 93.
• Shiller, Robert J. 2005. Irrational Exuberance. Princeton, N.J.: Princeton University Press, second edition.
• Sjostrom, William K. 2009. “The AIG Bailout.” Washington and Lee Law Review 66(3): 943-94.
• Squam Lake Working Group on Financial Regulation. 2009. “A New Information Infrastructure for Financial Markets.” Council on Foreign Relations, Center for Geo-economic Studies, Working Paper (February).
• Stern, Gary H., and Ron Feldman. 2009. “Macrostability Ratings: A Preliminary Proposal.” The Region. Federal Reserve Bank of Minneapolis, 12-17.
• Stigler, George J. 1975. “The Economist and the State,” in The Citizen and the State: Essays on Regulation. Chicago: University of Chicago Press, 50.
• Strogatz, Steven H., Daniel M. Abrams, Allan McRobie, Bruno Eckhardt, and Edward Ott. 2005. “Theoretical Mechanics: Crowd Synchrony on the Millennium Bridge.” Nature 438 (November), 43-44.
• Tarullo, Daniel K. 2008. “Banking on Basel: The Future of International Financial Regulation.” Washington DC: Peterson Institute, 30-31.
• Tarullo, Daniel K. 2010a. “Equipping Financial Regulators with the Tools Necessary to Monitor Systemic Risk.” Testimony before the Senate Subcommittee on Security, International Trade, and Finance, Committee on Banking, Housing, and Urban Affairs (February 12).
• Tarullo, Daniel K. 2010b. “Lessons from the Crisis Stress Tests.” Remarks at the Federal Reserve Board International Research Forum on Monetary Policy. Washington DC (March 26).
• Thal Larsen, Peter. 2008. “Goldman Pays the Price of Being Big.” Financial Times (August 13).
• Thomson, James B. 2009. “On Systemically Important Financial Institutions and Progressive Systemic Mitigation.” Policy Discussion Paper No. 27. Federal Reserve Bank of Cleveland (August).
• Tufte, Edward R. 1997. Visual Explanations. Cheshire, Conn.: Graphics Press.
• Warsh, Kevin. 2009. “The Panic of 2008.” Remarks, Council of Institutional Investors, 2009 Spring Meeting, Washington DC, April 6. www.federalreserve.gov/newsevents/speech/warsh20090406a.htm
• Zuckerman, Gregory. 2007. “Concentration Proves Winner at Hedge Fund.” Wall Street Journal (May 14).

Source: http://www.clevelandfed.org/About_Us/annual_report/2009/2009_essay.cfm

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4closureFraud.org

Nobody Likes Appraisal Fraud

I’ve been getting some “hate mail” from people who obviously have a vested interest in getting a message out that the appraisers did nothing wrong. This is the equivalent of saying the rating agencies did nothing wrong rating securities AAA when they were worthless.

The simple facts are that the “lender” had no skin in the game so there was no actual underwriting and no risk. SO the usual appraisal verification was skipped. AND the appraisal process was flipped on its head. Instead of using the lowest appraisal possible so as to decrease their risk of non-payment, they pushed the appraiser to come up with the “right” number so they could close the deal which meant overvaluing the property.

This behavior increased the risk but resulted in the same fees to the “lender” for impersonating a Lender. The incentive was to close the deal without regard to repayment through borrower performance or selling the property.

Filed under: foreclosure

SEC Knocking Down the Door at JP Morgan Chase

JPM’s Jamie Dimon likes to brag and bully people with who he knows and talks to. Well now is his big chance. He gets to talk to the SEC who are investigating the truth about the liabilities and repurchase obligations connected with the mortgage mess. Eventually, the SEC is going to figure out that Dimon’s bravado and arrogance stemmed from the fact that he thought he got away with the biggest heist in history. Not so. Don’t do the crime if you can’t do the time.

When all is said and one it will become apparent that the winners and losers are easily accounted for — on one side there are the winners who committed the largest act of fraud in human history — and on the other side there are the losers who lost their money and homes to satisfy the rapacious lust for money and power. The losers were investors, pensioners, homeowners and taxpayers. The losers included people who depend upon various social services — you know little things like police, fire, rescue, education, medical emergencies, medical care for the young and the list goes on and on.

When all is said and one it will be clear that trillions in federal “aid” was taken by Dimon and his fellow future cell mates under false pretenses. The only losses these investment banks ever faced was a loss of excess profits. Lehman and Bear Stearns may have been different because they were even more clueless than the rest about the toxicity of the crap they were dealing out. But then they didn’t get any of that Federal money did they? (Not that they should have).

The SEC Just Demanded More Information On JPMorgan Repurchase Liabilities

(This guest post was published at SubprimeShakeout.com.)

The Securities and Exchange Commission (SEC) recently took a much needed step towards improving the transparency of bank balance sheets, particularly when it comes to the adequacy of reserves for mortgage repurchase obligations stemming from banks’ violations of representations and warranties.

Due to findings of mortgage fraud and underwriting deficiencies in the mortgage origination process and  misrepresentation in the packaging of mortgages, banks have been experiencing a drastic increase in the number of repurchase demands they are receiving, including from Government-Sponsored Entities (“GSE”), monoline and mortgage insurers and other end purchasers of RMBS securitizations, such as the Federal Home Loan Banks.  Banks have responded by taking on additional reserves, which have had the effect of reducing mortgage income in the corresponding period.  Now, however, in a letter dated January 29, 2010, the SEC has asked JP Morgan to clarify its reserving methodology for mortgage put-backs—a process that has historically been opaque and difficult for outsiders to evaluate.

As an investor, I have long been concerned with whether the banks’ levels of reserves represent accurate reflections of their true liability.  Just to get a sense of the magnitude of this issue, in SEC v. Angelo Mozilo, the SEC alleges that Countrywide originated over $450 billion of mortgages annually during the boom years.  What percentage of those Countrywide mortgages were fraudulently originated?  What percentage are getting sent back for repurchase? Even a modest percentage could lead to substantial losses for Bank of America (“BofA”), Countrywide’s parent and potential successor in liability (see Subprime Shakeout post on recent ruling in MBIA v. Countrywide).

Additionally, there is some alarming evidence that BofA actually did assume the liabilities of Countrywide, and is thus on the hook for the liabilities of its subsidiary.  At the time of Bank of America’s purchase of Countrywide, Scott Silvestri, a Bank of America spokesperson is quoted as saying, “[w]e bought the company and all of its assets and liabilities.  We are aware of the claims and potential claims against the company and factored these into the purchase”  (emphasis added).  This led Florida Attorney General Bill McCollum, in announcing his intention to negotiate a settlement with Countrywide regarding predatory lending practices, to say, “there is technically a deep pocket.  They’ve [BofA] acquired them [Countrywide], they assume their liabilities.”

The SEC’s actions are very important in this debate over mortgage buybacks.  The SEC has asked JP Morgan to clarify its reserving methodology in the following five areas:

a)  The specific methodology employed to estimate the allowance related to various representations and warranties, including any differences that may result depending on the type of counterparty to the contract.

b)  Discuss the level of allowances established related to these repurchase requests and how and where they are classified in the financial statements.

c)  Discuss the level and type of repurchase requests you are receiving, and any trends that have been identified, including your success rates in avoiding settling the claim.

d)  Discuss your methods of settling the claims under the agreements. Specifically, tell us whether you repurchase the loans outright from the counterparty or just make a settlement payment to them. If the former, discuss any effects or trends on your nonperforming loan statistics. If the latter, discuss any trends in terms of the average settlement amount by loan type.

e)  Discuss the typical length of time of your repurchase obligation and any trends you are seeing by loan vintage.

The monoline insurers have constantly complained that banks have continued to be amenable to processing repurchase requests and repurchasing loans associated with Fannie and Freddie due to the necessity of continuing a business relationship with the GSEs.  They claim that for similar violations of rep & warranties, however, the mortgage originators have denied their repurchase requests.  This requirement from the SEC asking for clarification on discriminating between repurchase requests from the GSEs versus the monolines/other investors should have interesting consequences.  As Jay Brown, the CEO of MBIA, recently stated in the company’s Q1 2010 conference call, “we have discussed the process that Fannie and Freddie use with their folks to see how it compares to the process that we use both from examining the loans and also in terms of the accounting, and both approaches are consistent with our own.”

The SEC’s requirement to provide clarity on the counterparties to repurchase requests should lead to more fair treatment for the insurers.  The requirement to provide increased disclosure on mortgage putbacks from the insurers could also ratchet up the pressure on the banks to settle repurchase requests.  If they honor repurchase requests from Fannie and Freddie for very similar violations of reps & warranties but refuse to honor them for the insurers, continuing to litigate could lead to large damage claims for adverse rulings in court.

For investors who may not be aware of how significant of an issue this is for the banks, it is imperative to read the testimony of Richard Bowen in front of the Financial Crisis Inquiry Commission.  Dick Bowen was the Senior Vice President and Chief Underwriter for Correspondent Acquisitions for Citigroup Mortgage.  In early 2006, he was promoted to Business Chief Underwriter for Correspondent Lending in the Consumer Lending Group.  The numbers he cites in his testimony are astounding.  I will allow his testimony to speak for itself:

The delegated flow channel purchased approximately $50 billion of prime mortgages annually… In mid-2006 I discovered that over 60% of these mortgages purchased and sold were defective. Because Citi had given reps and warrants to the investors that the mortgages were not defective, the investors could force Citi to repurchase many billions of dollars of these defective assets. This situation represented a large potential risk to the shareholders of Citigroup…I started issuing warnings in June of 2006 and attempted to get management to address these critical risk issues. These warnings continued through 2007 and went to all levels of the Consumer Lending Group…We continued to purchase and sell to investors even larger volumes of mortgages through 2007. And defective mortgages increased during 2007 to over 80% of production. (emphasis added)

Digging through Citi’s public financials, it is unclear what reserves have been set aside to reflect the possibility of these noncompliant mortgages travelling back to Citi’s balance sheet.  The SEC’s recent letter to JP Morgan should provide increased disclosure for these types of liabilities lurking on bank balance sheets.

David Grais’s lawsuits on behalf of the Federal Home Loan Banks (“FHLB”) against investment banks involved in the packaging of RMBS securitizations that were bought by the FHLB also provide for interesting reading.  The Federal Home Loan Banks bought $23 billion of RMBS securitizations from a number of investment banks.  These structured products contained representations regarding maximum LTV ratios on the underlying mortgages.  In these lawsuits, the FHLBs of San Francisco (complaint available here) and Seattle (complaint available here) contend that widespread appraisal fraud led to incorrect LTV reps on the pools of mortgages purchased by the FHLBs.  They are suing to recover losses stemming from their purchases of these mortgage securities.  David Grais was a roommate of Supreme Court Justice Samuel Alito for three years while they were undergraduates at Princeton University.  His legal credentials and ability to undertake complex litigation should not be underestimated.

As Gretchen Morgenson writes in the New York Times, though disputes over losses from mortgage-backed securities are hard to litigate because investors must persuade factfinders that their losses were not simply the result of a market crash,

[r]ecent filings by two Federal Home Loan Banks — in San Francisco and Seattle — offer an intriguing way to clear this high hurdle. Lawyers representing the banks, which bought mortgage securities, combed through the loan pools looking for discrepancies between actual loan characteristics and how they were pitched to investors.

You may not be shocked to learn that the analysis found significant differences between what the Home Loan Banks were told about these securities and what they were sold.

The rate of discrepancies in these pools is surprising. The lawsuits contend that half the loans were inaccurately described in disclosure materials filed with the Securities and Exchange Commission.

These findings are compelling because they involve some 525,000 mortgage loans in 156 pools sold by 10 investment banks from 2005 through 2007. And because the research was conducted using a valuation model devised by CoreLogic, an information analytics company that is a trusted source for mortgage loan data, the conclusions are even more credible . . .

The model concluded that roughly one-third of the loans were for amounts that were 105 percent or more of the underlying property’s value. Roughly 5.5 percent of the loans in the pools had appraisals that were lower than they should have been.  That means inflated appraisals were involved in six times as many loans as were understated appraisals . . .

It is unclear, of course, how these court cases will turn out.  But it certainly is true that the more investors dig, the more they learn how freewheeling the Wall Street mortgage machine was back in the day.

Investors should take a hard look at bank balance sheets to understand the adequacy of reserves for this huge contingent liability.  It is not surprising that banks have stonewalled any attempt to get clarity on this issue – hopefully the SEC’s explicit demands from JP Morgan to increase their disclosure will have a knock-on effect for the others.

Menal Mehta is a Principal at Branch Hill Capital, which invests in Special Situations.

Tags: Wall Street, SEC, Banks, JP Morgan, Regulation
Read more: http://www.businessinsider.com/sec-jpmorgan-reserves-liabilities-2010-6#ixzz0suq6ckLn

Filed under: foreclosure

DEUTSCHE DISCLAIMS ANY ECONOMIC INTEREST IN THE LOANS

COMMENT FROM READER:  I received a printed copy from the Deutsche Bank, in reply to a complaint I filed against Deutsche Bank to Federal Reserve Bank New York. Title of the Page is “ROLE OF THE TRUSTEE IN THE US MORTGAGE MARKET”

Under the TRUSTEE; It says ” Performs a variety of functions, among them acting as TRUSTEE for the Securitization Trust and sometimes CUSTODIAN FOR THE MORTGAGE DOCUMENTS. A corporate trustee for the mortgage backed securities (MBS) only serves an administrative role, but  has no ownership stake nor beneficial interest in the underlying loans of the securitization.

ROLE OF TRUSTEE IN A FORECLOSURE
Deutsche Bank in its capacity as trustee holds certain mortgage loans for MBS transactions. The BENEFICIAL OWNERS of these loans are INVESTORS in MBS, typically large institutions such as pension funds, mutual funds and insurance companies. Although the trustee of MBS is legal owner of record of mortgage loans. THE TRUSTEE DOES NOT ITSELF HAVE AN ECONOMIC INTEREST IN THE LOANS. Moreover the trustee is only NOMINALLY involved in the foreclosure process.

RESPONSE: I thank the reader for bringing this to my attention and would like copies of the documents sent to ngarfield@msn.com. Here the largest (by far) originator of foreclosure process in the country who is now doing so in its own name is, in writing,. disclaiming any interest, ownership or rights to the loans, much the same as MERS.

This is in direct contradiction to actual testimony and proffers by counsel in the courtroom. I’ve been there and I’ve heard it. It’s a lie. The ONLY real parties in interest are the investors and really IS that simple. The only parties that advanced money to fund this scheme are the investors. THEY created a pool of money first that was then replaced with a complex web of collateralized debt obligations, synthetic CDOs etc.

The ONLY other parties that LEGALLY received any benefit of the money in that pool of money were the homeowners who put their house up as collateral — collateral that overstated, just as the value of the mortgage backed securities was over-stated.  Until we all get on the same page about this we can’t fix it. Both the investors and the borrowers were cheated and defrauded through outright lies, deception and hundreds of pages of documents with conflicting provisions. The only provisions in use wer ethose that benfited the itnermediaries to the detriment of both the borrowers and the ivnestors.

The page we need to be on is that there was single transaction between the investor and the borrower. everyone else was an intermediary agent, fiduciary or intervenor unwanted by either the investor or the borrower.

The only people who actually lost money were the real parties in interest — the investor and the borrower. Deutsche Bank and others like it are doing their best to keep the borrowers and investors as far apart as possible just like they did when they did the loan. If the borrowers and investors ever get together and compare notes, they will BOTH file suit against ALL the intermediaries for fraud, breach of contract and breach of fiduciary duties. At that point Deutsche Bank will have no place to hide because they cannot say they are the real party in interest when the real party in interest is standing right there in court.

When we are all on that page, the mortgage mess will unravel along with the death grip that Wall Street has on our economy and millions and homeowners. Investors will recover far more money than they have been offered or paid and borrowers will get to keep their homes with a new mortgage that reflects the realities of the history of their transaction and the true fair market value.

Filed under: bubble, CDO, CORRUPTION, Eviction, evidence, expert witness, foreclosure, foreclosure mill, GTC | Honor, HERS, Mortgage, securities fraud, STATUTES, trustee Tagged: DEUTSCHE BANK

OUTRAGEOUS – Law Office of David J. Stern Files Fraudulent Foreclosure on Family Including Federal Tax Lien of Another Man with Different SSN

This comes in from Bill Warner WBI Inc. Private Detective Agency

Excerpts from the post…

I received a confidential report from a Florida Family that the Law Office of David J. Stern in Plantation Fl had mistakenly filed a Foreclosure on this family and for some unknown reason (to seek leverage) had included a Federal Tax Lien of another man with the same name but this man had a different Social Security Number (SSN), a different middle name and a different Date of Birth (DOB) and never lived at the address of the supposed Foreclosed property.

The Law Office of David J. Stern in their rush to foreclose then Served a Complaint on the United States of America (USA) as a co-defendant in the Foreclosure as they held the Federal Tax Lien on the”other” man.

The Law Office of David J. Stern then also served the Foreclosure Complaint papers on the US Attorney’s Office and so indicated that the subject of their Federal Tax Lien was the owner of the property in the Foreclosure Complaint, which was incorrect.

If these allegations are true, this enterprise has hit a new level of deception…

You can see the entire post here;

LAW OFFICE OF DAVID J. STERN MISTAKENLY FILES FORECLOSURE ON FLORIDA FAMILY, INCLUDES FEDERAL TAX LIEN OF ANOTHER MAN WITH A DIFFERENT SOCIAL SECURITY NUMBER & SERVES US ATTORNEY, HOW STUPID

AGAIN, HOW CAN THE COURTS OF THIS STATE GRANT SUMMARY JUDGMENT TO ANY OF THESE FIRMS KNOWING THEY ARE COMMITING MASSIVE FRAUD ACROSS THE STATE???

WHERE IS THE OUTRAGE PEOPLE???

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4closureFraud.org

Foreclosure Fraud to be Discussed on Nationally Syndicated Radio Show The Power Hour

JOIN US TOMORROW MORNING FOR HOURS OF RADIO TIME ON THE NATIONALLY SYNDICATED RADIO SHOW THE POWER HOUR.

The show can be heard here Listen Live

THURSDAY – JULY 8 – SPECIAL “Foreclosed Upon” FEATURE:

Florida foreclosure activist and former guest on TPH LISA EPSTEIN (Foreclosure Hamlet) provides updates to the major headway, and the difficulties, when fighting back to defend your home. Plus, the latest information as to what the State of Florida intends to do with all the “hidden pre-foreclosures” that banks have been secretly keeping off the official record.
Joining Lisa will be:
ANDY from Massachusetts as a person challenging “Denial of the Debt” in it’s validity;

RANDY from Florida will dispel the notion that homeowners facing foreclosure are predominately folks that “bit off more than they could chew”.
ALLISON from Texas about The Courts legislating from the bench and how this is severely impairing the homeowner’s consumer protection rights.
Websites for more information and continual updates: http://www.ForeclosureHamlet.org and http://www.4closurefraud.org

A Message from The Power Hour:
Other foreclosed upon homeowners’ stories – that time does not allow for us to interview live – as examples to further dispel the notion that homeowners facing foreclosure “deserve it”. [ sending over to Wanda and Kathryn to post below]
*  Ann in Ohio’s story
*  Kim in Maine’s story (Will be in today’s E-Mail Blast)
*  Lela in Florida’s story (Will be in today’s E-Mail Blast)
*  Tim in Texas’s story: Please visit TimMiller.com and see his YouTubeVideo at: http://www.youtube.com/watch?v=Hm_W445bidA

If time allows: OPEN LINES for those that are being foreclosed upon: Toll-free: 1 800 259 9231

Florida Foreclosure Defense lawyer MATT WEIDNER truly “gets it” and will share with us the incredible depth of this ever-growing problem, from “hidden foreclosures” to the Separation of Powers (how the legal system dealing with foreclosures is completely out-of-control and the rule of law is being seriously ignored in favor of the banking/loan industry); What he sees on the horizon, the good (lawyers are waking up) and the bad (foreclosures are about to get a whole lot worse in numbers).
“The greatest transfer of wealth ever perpetuated in history is taking place right now.”

Please be sure and read Matt’s articles on foreclosure fraud and the rule of law in foreclosure cases [Separation of Powers] at: http://mattweidnerlaw.com/blog

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4closureFraud.org

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