The elephant in the living room: What is the Federal Government Buying?

The article below by Andrew Rosenfield is an excellent summary of the problems and contradictions facing the Obama administration. But it misses the same point that everyone has failed to ask about. If the intent was to sell the loans to investors and Wall Street took money for that sale, then we must assume that the investors own the mortgages and/or notes and/or obligations — unless they have been paid by insurance, Federal bailout, cross collateralization, overcollateralization, credit default swaps or simply sold to another investor.
AIG insured what may turn out to be trillions of debt probably without any rights of subrogation. They were basically writing bad checks and there was nothing to stop them. They didn’t have the assets to issue the insurance but so what, they were getting paid fees every time the issued a policy. Same with credit default swaps which now total double the amount of the value of all equities (stocks) in the world. So whether it is one of the new Maiden Lane entities, or direct deal with the Federal Reserve, or a direct deal with the U.S. Department of the treasury, who owns what?
The mortgage has been extinguished by negotiation of a non-negotiable isntrument. The note was paid at closing, so the borrower certainly doesn’t owe anything to the originating lender. And the obligation might still exist, perhaps to the Federal Government, but it was taxpayer dollars that paid for the bailouts. Do the borrowers get credit for their share of the bailout they paid for in taxes? Is the federal government the owner of these mortgages and notes and obligations? If so, why have they not recorded anything in the property records of each applicable state?
And the biggest question of all: exactly what was the content of any written instrument between the Federal government and AIG, the banks etc. with respect to these loans? Was it an assignment? How could that be valid when the assignor didn’t own the instrument? Was it a loan? How was the collateral described?
There is now no doubt whatsoever that the title chain on the mortgages, notes and obligations is hopelessly broken and lost.
This underscores the inability of anyone to enforce any mortgage, note or obligation of any kind that was securitized — without (a) acting in a judicial forum with all necessary and indispensable parties present possessed of legal standing for jurisdiction (b) alleging a cause of action for affirmative relief (c) attaching appropriate documentation in accordance withe the rules of civil procedure and (d) proving their allegations with the testimony of competent witnesses (Oath, Personal Perception, Memory and ability to Communicate) to provide appropriate foundation for introduction of the core enabling documentation, the ledgers and records of ALL the players in the securitization chain, and all agreements (Pooling and Service, Assignment and Assumption etc.) and all insurance (AIG, AMBAC credit default swaps) and all cross collateralization (Pooling and tranching) that would enable a judge or jury to KNOW with reasonable certainty that the mortgage, note and/or obligation are enforceable and by whom and in what amount after third party co-obligor payments!
NY Times April 6, 2009
Op-Ed Contributor

How to Clean a Dirty Bank


COMMERCIAL banks in the United States are not subject to the bankruptcy statute — when they become insolvent they are simply acquired by the government. This is what banks sign on for in return for a charter, deposit insurance and direct access to the Federal Reserve lending window, which generally allow banks to prosper as long as they control risk.

Now Treasury Secretary Timothy Geithner wants to apply this same swift acquisition process to large insolvent “shadow banks” that risk doing damage to the financial system — big hedge funds, investment banks, insurance holding companies and the like — because bankruptcy proceedings move too slowly to allow these institutions to be quickly refinanced or restructured.

Secretary Geithner says the lack of a good mechanism to restructure Lehman Brothers contributed to that firm’s failure last fall. And it is why the Bush administration’s ill-designed overnight infusion of capital into American International Group turned out to be such a mess. The company avoided bankruptcy, but could not be properly restructured.

Mr. Geithner is right to want a rapid seizure system for shadow banks. What’s odd is that at the same time that he is proposing one, the government is failing to use powers it already has to restructure insolvent commercial banks. Instead, Mr. Geithner continues to suggest a variety of other actions that seem unlikely to solve the banks’ central problem — a lack of equity capital. Perhaps he fears what would happen if large bank holding companies were to default on their bonds, which are held by insurance companies and other institutional investors. But that is a problem that needs to be tackled head-on, not by propping up failing banks.

Consider what happens when the government acquires an insolvent bank. The shareholders and the debt holders of the bank’s holding company may be essentially wiped out — even as the bank itself is merged into another institution. That is what happened, for example, when JPMorgan Chase “acquired” Washington Mutual bank; its holding company promptly went bankrupt. This approach allows the market to properly discipline banks. The fear of loss gives investors the critical incentive to deny capital to those that take excessive risks. Also, when the price of a bank holding company’s stock and debt plummets, it is an early warning of trouble.

Treasury’s new plan, the Public-Private Investment Program, reduces that incentive by preserving shareholder and debt holder ownership of insolvent banks. It also injects capital into those banks in a roundabout, unproductive way. Under the program, the government will help private investors buy at auction the banks’ toxic assets (what Treasury now calls “legacy assets”). Private firms will use government funds, along with some money of their own, to buy the assets at prices above current market value.

The government will bear almost all the exposure to losses from these transactions, but earn only a small fraction of any profits. Another problem is that if the buyers of these assets harvest significant gains, they will have to worry that Congress might seek to recapture the money in the future, as it has threatened to in the recent bonus turmoil at A.I.G. This fear will lower the bids and therefore the amount paid for the toxic assets.

Even if it is successful, the program will add very little new capital to the banks — roughly only the amount paid for toxic assets that is over and above their current value.

There is a simpler, sounder and fairer way to recapitalize an insolvent bank. The government should seize it, as it is already authorized — indeed, compelled — to do. Then it could inject cash (in the form of Treasury notes) as equity in the bank and, at the same time, remove the toxic assets the bank holds. Bank regulators might perhaps swap Treasury securities for toxic assets “at par” — that is, in an amount equal to the original purchase price of the assets removed. This would be a fair transaction, and it would cost nothing, because the government would own both the bank and the bonds. The toxic assets could then be placed in the basement of the Treasury building while we wait to see what they turn out to be worth.

The government could then quickly — say within a month — auction off the bank. Speed would be critical: If Treasury were to hold a large bank for a long time, it would be difficult to retain the most talented employees, and it is the people, along with a clean balance sheet, that make a bank valuable.

If markets work at all (and if they don’t, Treasury’s new plan is doomed to fail), such an auction would produce a new privately owned “clean” bank, with ample capital to lend. It would also generate proceeds from the sale that would be at least as great as the value of the securities injected into the bank as equity — and likely greater.

If the recapitalized bank could not be sold at a price that amounts to (at least) the new cash injected, then the bank would be worthless, but not because of the toxic asset problem. It would be because the bank has been mismanaged or has other bad loans unrelated to the mortgage crisis, and such a bank should be allowed to fail.

If the sale succeeds, however, the government would have created a fully financed private bank at essentially no incremental cost to taxpayers, and Treasury would still hold the toxic assets on its books — to be sold whenever it becomes economical to do so.

This is a simple and fair plan. And unlike the Public-Private Investment Program, it would not reward bank investors for their folly or inject too little capital when more is needed.

Andrew M. Rosenfield is a senior lecturer at the University of Chicago Law School and the chief executive of an investment advisory firm.

4 Responses

  1. Banks Sitting on Rising Pile of Foreclosures

    A vast “shadow inventory” of foreclosed homes that banks are holding off the market could wreak havoc with the already battered real estate sector, industry observers say.

    Lenders nationwide are sitting on hundreds of thousands of foreclosed homes that they have not resold or listed for sale, according to numerous data sources. And foreclosures, which banks unload at fire-sale prices, are a major factor driving home values down.

    Dan Edstrom

  2. Thank you for the very detailed explanation. I have an Attorney who gets it here in Minnesota. His name is John Neve and his number is (952) 929-3232 and his email is you should add him to the list!! Thanks again

  3. Drew: This is difficult to get without a few years of law school. The law favors free flow of commerce. We are a nation of laws (supposedly) and not people. So our laws and judicial procedures uphold and enforce contracts, promises, commitments, terms, conditions and covenants. In reliance upon that people act knowing that such contracts etc. will be enforced. So if they act on it, they know that whatever is coming to them, they will get or a judgment will be entered against the other party for failing to abide by the contract. The promissory note in a mortgage loan closing is a contract. It is an unconditional promise to pay money from the borrower to the payee of the note — according to the terms of the note. And the Payee agrees to apply your payments against what you promised to pay. So if your monthly payment is $1250 and you pay $1250, the Payee is bound by contract to apply your payment to the amount due for that month. Thus for the moment, after you make the only payment due, you owe nothing because you have satisfied your promise to make a payment for that month. Now suppose your aunt made the $1250 payment for you. You made the promise but someone else (your aunt) made the payment. As long as your aunt made it clear that she was making the payment on your promissory note, you personally no longer have an obligation to make the monthly payment. Why? because it was paid. Whether your aunt made the payment by mistake (put the wrong account number on it because she had the same lender), or she she did it as a gift or she did it as a loan to you makes no difference. The payment is made and the payee (lender) doesn’t care what her reasons were. All they know is that they have an an agreement with you (promissory note), you agreed to pay $1250 and they got the $1250. End of story. If the payee sues you to collect on that payment, you win because the best and most formidable defense to a suit to collect a debt is PAYMENT. And payment is what they got. At this point in our story, the payee is the mortgagee on your mortgage or the beneficiary under a deed of trust (same thing). The security for the promise (note) is your house and the security agreement (mortgage) is that if the promise is not fulfilled, they can take the house, sell it, apply it to what you owe them, give you back any excess and in many states they can get what is called a deficiency judgment for any shortfall between the amount they got on sale of the house and the amount they were owed under the agreement (note). And they usually add all kins of fees, costs, attorneys fees, default interest and other things that may or may not be proper since they can only charger what the terms and conditions or the mortgage and note agreements specifically state. But they often make up fees and slip them in because at that point people have usually given up and they are not looking for discrepancies between the charges that should be there and the charges that should not be there.

    Now let’s up the ante, as they say in poker. Suppose your aunt paid the entire principal amount of the note plus interest, plus fees to the payee and the payee understood that this was a payment on your note agreement. By law, the note is satisfied. By law a mortgage can only secure an unsatisfied note. So in the absence of any other facts or events, the note is satisfied which means the mortgage is extinguished and you could enforce that in court. Why? because the note and mortgage SAYS when the note is paid, your obligation is over and you are entitled to satisfaction of the mortgage in recordable form (or release and reconveyance in non-judicial states).

    However, if the payee assigned the note to your aunt it would be as though she loaned the money to you and you would owe all the same payments to her. And under the laws of most states the mere fact that your aunt is now the payee under the note is sufficient to create the presumption that she is also secured by the mortgage. So in this scenario nothing changes. You just owe your payments to someone new.

    Now assume that your aunt “sold” your note along with a bunch of others to someone we will call a mortgage aggregator (collector). And further suppose that the aggregator creates a trust out of the pool of assets that your aunt sold to him. And suppose that the trust pool provides that a total income of at least $7,000 per month will be received by a buyer of the trust. At that point, (I am oversimplifying here) your note lost its identity and became part of something larger, which was NOT contemplated in your mortgage security agreement. There are many reasons, but each of the reasons is compounded by the fact that besides pooling, there were other co-obligors, cross collateralization, over collateralization, insurance and credit default swaps, each of which added a CONDITION to your original promise to pay. In simple terms your unconditional promise to pay the payee has been converted in a new contract between the buyer and seller of the trusts, pools and mortgage backed securities. Those new contracts contained both conditions and terms and provisions providing protection from liability. None of those terms were in your loan agreement with the original payee. So your original unconditional promise to pay the payee has been replaced by (a) the original payee getting paid and (b) conditional promises to pay and “co-obligors” added after you signed YOUR note.

    When the payee simply assigned your note, it was the assignment of what is called a negotiable isntrument. A negotiable instrument is an unconditional promise to pay without reference to third party transactions who are not referenced in the original promise (note). When your aunt grouped your note and that of other borrowers together as a unit, the character of the transaction changed from a promise to pay by you to the promise to pay a total amount of several people. If one of them didn’t pay, then the promise was breached, even if you were up to date in your payments. When they added all the other terms and conditions, insurance and now the Federal bailouts, your unconditional promise to pay evolved into a conditional promise by OTHERS to pay. Your note was no longer negotiable but they were pretending it was. WHY? because in a nation of laws you can’t write in additional terms to a contract after it was signed unless the original signatories agree. Did you know about all that was happening behind the curtain of securitization? No. Did you even know they was anything happening behind that curtain? No. Did you even know the curtain was there? No. If you had known that your obligation was being bundled with others and that your payment could be used to cover the payment of another borrower, would you have signed the note? No. If you knew there was insurance and other guarantees that would cover the payments or principal if you failed to pay, would you have wanted to make clear that you received the benefit of that? You bet!

    So your unconditional promise to pay has been satisfied by payment from a third party (your aunt) and then converted into a new contract between your aunt and a dozen other people in the securitization chain. Since your promise was satisfied (even though it was your aunt who made the payment) your note is satisfied, and the mortgage is extinguished. Again this is an oversimplification and you should check with local counsel before acting on this in your own case.

  4. Neil could you explain this to the viewers, The mortgage has been extinguished by negotiation of a non-negotiable instrument. Thank you I am devoted to spreading the word.

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