Livinglies's Weblog

We keep seeing bits and pieces in the media instead of the entire picture. Let’s trace the average mortgage meltdown event:

1. It is 2003. Builder Stan Plans Construction project, goes to 1st National Lender and is surprised to learn that the lender is very flexible. It turns out that the bigger the loan, the more the Lender makes and the lower the risk to the builder who is table to take down money from the loans that largely replenish his investment in the property. This is because Wall Street in its ever increasing creativity is experimenting with moving risk now and not just money through the use of derivatives.
2. Builder submits projections that are very rosy. In many cases, he gets the message to make the picture rosier.  This by the way is called fraud and collusion. The Lender tells him to beef up his projections because the Lender wants to increase the loan to include operating expenses and any other expenses that could reasonably pass the giggle test as being associated with building a project. 
3. The Lender, knowing that it has pre-sold the loan risk or has a ready buyer for the loan risk, doesn’t care anymore about the success of the project. This is the overall dangerous movement away from J Pierpont Morgan’s admonition that risk is a matter of character. Risk has now been converted to abstract numbers unrelated to any particular project and based upon averages that include figures from other real estate projects that bear little similarity to the one at hand. 
4. The Lender is the intermediator between the ultimate source of the amount loaned and the borrower. The Lender is in substance a fee-based operation in which lenders while appearing to loan their own money are in fact merely acting as a conduit. 
5. This is very much like the traditional role of banks — taking deposits from those who want their money protected in a bank and then lending it out in some proportion that allows the bank to keep enough money on hand to meet expected demands for cash. Except that here the Lender is not taking any deposits. But then again it isn’t left with the risk of the loan either so its depositors or capital holders are not at risk, at least for very long — unless it is found that the Lender was a willing, knowing participant, in the creation of fraudulent data for the express purposes of making the figures look appealing (i.e., less appearance of risk than actual risk) to prospective buyers.
6. The reason for this little conspiracy is a conspiracy not unlike the junk bond scandal, but at least they were then called junk bonds which more or less put everyone on notice that they could be worthless  or at the very least were risky. 
7. Investment Banking arms of major brokerage and depository financial institutions put together packages of derivatives called collateralized debt obligations (CDOs) which is an obscure way of saying you are purchasing a note or a bond that is “backed” by a mortgage on land and improved property. Sounds fairly secure, until you go back to the beginning of the story where the value of the land, the projected income, the value of the end product were all grossly overstated with the complete knowledge of everyone but you. 
8. Then the Investment Banking houses obtained ratings for these obligations and even had a class of CDOs that were rated Aaa. Partly in order to convince other institutions to buy these high-rated debt securities with a risk assessment of practically zero, and partly because they were sucking on their own own exhaust, the investment banking houses actually retained portions of these “investments” in their portfolios giving the appearance of a growing amount of portfolio investments that the investment banking house had itself created. This is sort of like printing your own currency. IN fact it IS the creation of money, free money, that made everyone crazy. 
9. Despite the actual high risk of the investment which is known to al everyone, and because they were able to buy investment ratings on these CDOs the managers of mutual funds, pension funds, retail brokerage and other financial institutions around the world were convinced to take on these “investments” to make their portfolios (and thus the manager’s performance rating) LOOK good, even though the disparity between the high rate of return and the “low” risk was apparent and put it simple terms, didn’t make sense — like the adage, if it looks to good to be true, it is.
10. The average Joe Investor who has money in mutual funds, pension funds, retirements accounts, and other holdings, is for the most part not even dimly aware that these transactions have taken place. He has only to look at the newspaper and glowing reports from his fund managers to “know” that his money is safe and growing, just the way it was supposed to be. 
11. Joe Investor is driving along the road, and as it happens, he sees a sign for anew development of residential and commercial buildings exactly where his wife said she wanted to live. It turns out that the builder is none other than the builder who started this ball rolling, and who is in debt up to his eye-balls despite the appearance of being a solid long standing member of the development community and having his shares traded on a national stock exchange.
12. Joe and his wife find just the right house and then are presented with the final price of the house with all the extra’s, options, non-standard options, and custom features they have ordered. What started out as a $275,000 house is not $575,000, when you include the Lot premium for the fantastic view of hawks flying over manmade waters with mountains in the background. 
13. Joe knows he can’t afford the house just like the builder knows that if the project doesn’t sell out quickly, he and any buyer who gave him a deposit will be screwed. Of course the builder won’t be completely screwed because even without the first sale, he will have taken down loan money for general and administrative overhead including his own salary.
14. The salesman refers Joe and his Wife to either an on-site mortgage broker or someone else with whom the builder has a “relationship.” Joe is assured that through flexible financing, if he qualifies, he will be able to afford the house.
15. Joe and his wife are presented by the mortgage broker with a variety of alternatives and they choose the easiest one that will enable them to buy this house. They put no money down or a very small down payment, get a monthly payment that is even lower than what they are now paying on a house that has apparently increased in value (because of “market” conditions), and they figure they are actually coming out ahead because they are getting more equity out of their old house than anything they thought they could get, and they get a brand new house just where they want it. 
16. Because Joe’s actual income is lower than what is needed to justify the loan, the wife is told to say she in self-employed and making enough money to pick up the difference. This is also fraud, but since everyone knows about it doesn’t really seem like fraud. The lender and builder claim plausible deniability, knowing full well that Joe might very well not pay his mortgage payment a few months or years down the line because the mortgage terms will change in ways that were explained but not understood by Joe and his wife. 
17. 17. It turns out, in this case, that Joe and Mary, his wife have signed papers for a $575,000 mortgage, when you include the home equity second mortgage, and that the terms are very easy on Joe and Mary — at first. They start out with only a $1450 monthly payment which is accomplished by starting the loans out at a very low mortgage rate, partial payment of the interest which is added to the mortgage loan,  and an increase in the rate and the payment starting in 2 years. And it increases quickly after that because first, the interest rate must come up to what is normal and second, the “lender” is not going to lend them money to pay the interest forever. 
18. Joe and Mary move in and using their savings and credit cards and the equity of their prior home, they manage to complete the house which came with bare bones fixtures, no window treatments, no landscaping etc. They are now maxed out on credit card debt, acquiring more credit cards, and their savings are depleted to zero. 
19. They don’t have to worry though because prices are going up so fast that they have $300,000 in equity in the new house, or so it appears. They know they can get a larger home equity line if they need it or sell the house at a tidy profit. 
20. Suddenly 2 years have passed and the payment starts rising sharply, particularly on the home equity line of credit that was essential for closing. They are now being presented with a payment of $4,000 per month, which exceeds the actual income of Joe and Mary. 
21. Joe and Mary default on mortgage and the house is sold to the Lender at auction. All the investment they made in additions to the house after closing are lost. 
22. The Lender has assigned the servicing of the mortgage to another company and is now completely out of the picture for intents and purposes. The house sits there unoccupied, perhaps vandalized and declining in value to a point far below the total mortgage. The home equity line was wiped out by the foreclosure of the first mortgage. The actual loss of that goes back through the pipeline to the investment banks, retail brokerage, managed funds and direct investments by individuals. As it turns out Joe’s retirement account was invested heavily in CDOs and is now virtually worthless — zero as to the mortgages that were home equity lines that have now been wiped out and down some 30% on the first mortgage line that was granted.
23. At the moment, Joe has not fully absorbed the fact that his retirement is in jeopardy but he is getting an uneasy feeling.
24. What has happened is that that all of Joe’s hard earned savings, investment and retirement accounts have been wiped out by converting them from investments to fees to middlemen. Joe has lent money to himself without knowing it and crated a feeding frenzy where his safety and well-being were dead last on everyone’s list. 

Filed under: Uncategorized | Tagged: foreclosure, fraud, investment banking, lender, Mortgage, pension |