Accounting for Damages: Madoff Ruling May Affect Homeowner Claims

Editor’s Note: Looking further down the road, when the Ponzi aspect of the Mortgage Meltdown is fully revealed, it will become obvious that both yield spread premiums and the proceeds of credit default swaps, insurance and federal bailout are subject to claims by homeowners. The Trustee’s conclusion as affirmed by the Judge’s ruling in the Madoff case will undoubtedly come up as a resource or support for persuasive argument about how those proceeds should be allocated.
The Judge’s conclusion was obvious even if it was controversial. The Trustee appointed to do the accounting decided that the Madoff assets should be apportioned on the basis of the actual dollar loss instead of what was shown on the Madoff statements to investors. Since the entire scheme was fraudulent, the statements sent out to investors were a lie and it would be inappropriate to allow any distribution to any investor for more than what they had invested.
Similarly, the proceeds from payments on credit default swaps, yield spread premiums (both at the borrower and investor levels), insurance and bailout money will need to be allocated to each individual loan to credit the homeowner debtor against the original obligation as evidenced by the note.
This allocation will not be as simple as the Madoff case for several reasons. But the Madoff allocation underscores that you can’t get a court to award you “damages” if you suffered no actual monetary damage.It is the same thing as the standing argument. Virtually all foreclosures for the past several years have been brought by non-creditors who produced either fabricated or irrelevant paperwork.
So the parties who purchased credit default swaps using money (profit) obtained from the yield spread premium gained from lying to the investor and the homeowner about the true intrinsic yield value of the transaction should not be allowed any allocation unless the money for the CDS came from a source other than these Ponzi transactions.
Additional factors in the allocation might include subjective issues if a court determines that risk of loss should be apportioned amongst all participants instead of just between the investors and the participants in the securitization chain. And there is that nagging problem of two Federal claims, one from TILA and the other from the SEC regulations, which appear to create a claim on the same pool of  proceeds by both the homeowner debtor and investor creditor.
March 2, 2010

Madoff Judge Endorses Trustee’s Rule on Losses

A federal bankruptcy judge in Manhattan has approved the fiercely disputed method used by the court-appointed trustee to calculate victim losses in Bernard L. Madoff’s enormous Ponzi scheme.

In a decision filed on Monday, Federal Bankruptcy Judge Burton R. Lifland ruled that losses should be defined as the difference between the cash paid into a Madoff account and the amount withdrawn before the fraud collapsed in mid-December 2008.

Judge Lifland rejected emotional arguments by hundreds of defrauded investors seeking to have their claims based on the balances shown on their final account statements, sent out just weeks before Mr. Madoff was arrested. He pleaded guilty last March and is serving a 150-year prison term.

The ruling is a setback for investors like Adele Fox of Tamarac, Fla., an 87-year-old retired school secretary who was widowed in 1986. Mrs. Fox withdrew more than her original capital for living expenses, but still had nearly $3 million on her account statement when the fraud was discovered.

Under Judge Lifland’s ruling, she is not eligible for cash from the Securities Investors Protection Corporation, the industry-financed organization that provides limited protection for customers of failed Wall Street firms.

“My health has been a mess,” Mrs. Fox said on Monday. “I can manage, more or less, but if I have to go into a facility, what would I do? All my life savings, it all went into Madoff and it is all gone.”

She added, “I don’t want to seem like a pig — I just want this insurance that I think I’m entitled to.”

If losses were based on the final account statements, Mrs. Fox and almost every Madoff investor would be eligible for up to $500,000 from SIPC — not as insurance, Judge Lifland noted, but as a cash advance against their fair share of any recovered assets.

The total of those account balances — the wealth investors believed they had saved — was nearly $65 billion, by far the largest financial fraud loss in history.

But those statements “were bogus and reflected Madoff’s fantasy world of trading activity,” Judge Lifland wrote in his opinion.

As such, they cannot reflect legitimate “securities positions” on which claims can be based, he said.

Instead, Judge Lifland endorsed the approach of the Madoff trustee, Irving H. Picard. The differences between how much investors put into their accounts and the amount they took out are “the only verifiable amounts” reflected in the Madoff firm’s records, Judge Lifland said of that method.

That ruling gives hope to investors like Simon P. Jacobs, a businessman in New York who wrote the judge to support Mr. Picard’s approach. Mr. Jacobs said that he “would be thrilled to get 25 percent of my cash back — while these opponents have gotten 100 percent back, at least.”

Those who withdrew all their initial investment before the collapse “still feel they have lost money,” he said. “But in truth, they did not lose any money. When the dust settled, they had gotten all their money back” while investors like him did not, he said.

He added: “Critics say that Mr. Picard is not representing them — well, he’s representing me to the hilt.”

Mr. Picard has said that the out-of-pocket cash losses for people like Mr. Jacobs total slightly more than $20 billion — still a record amount, but a bit closer to the multibillion-dollar amount Mr. Picard hopes to collect in the Madoff liquidation process.

Investors who did not retrieve all or, in many cases, any of their initial capital from Mr. Madoff, argue that they should have first claim on whatever assets Mr. Picard collects — since it was their money that Mr. Madoff used to cover the withdrawals and fictional profits he paid to others.

And Judge Lifland agreed.

While many Ponzi schemes have been resolved in the courts through the “cash in, cash out” method, it is rare for a Ponzi scheme to occur inside a SIPC-protected brokerage firm. Judge Lifland acknowledged that “the complex and unique facts of Madoff’s massive Ponzi scheme” defied any simple analysis.

Indeed, he added, “the parties have advanced compelling arguments in support of both positions,” sometimes using the same court cases and statutory language to support their opposing claims.

But after “a thorough and comprehensive analysis of the plain meaning and legislative history of the statute, controlling Second Circuit precedent, and considerations of equity and practicality,” he endorsed the trustee’s approach.

“It would be simply absurd to credit the fraud and legitimize the phantom world created by Madoff” when determining victim losses, he said.

The ruling was promptly criticized by Helen Davis Chaitman, a lawyer for several hundred Madoff victims and a victim herself.

“Unless and until this decision is reversed, no American who invests in the stock market with the hope of retiring on his savings, has any protection against a dishonest broker,” Ms. Chaitman said in a statement released by a coalition of Madoff victims.

She added: “If we learned anything in the last two years, it was that Wall Street will manipulate the law to enrich itself at the expense of every honest, hard-working American taxpayer. Now we know that no American can rely on SIPC insurance.”

But Stephen P. Harbeck, the president of SIPC, said the court recognized that Mr. Picard’s approach “does the greatest good for the greatest number of people, consistent with the law.”

David J. Sheehan, a lawyer for Mr. Picard, said he and the trustee expected an appeal and “hope it will be dealt with in an expedited way.”

Its normal path would be through the United States District Court to the Second Circuit Court of Appeals, both in Manhattan. But if the appeal is allowed to bypass the district court, it could speed up the resolution of the dispute.

6 Responses

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  3. Nye
    I think that the “double jeopardy” defense theory of the borrowers “debt owed to who” is a strong claim & probable liability of the borrower to further the accounting necessity .

  4. How long do you think this back and forth will continue? So much fake “value” – everyone is trying to lay claim to their piece that they are “owed” in one way or another but what they don’t seem to grasp is that the money was never real in the first place.

    It’s ALL one big Ponzi. Madoff is nothing compared to the grand global delusion that the “money” of the last 10 years getting pumped in was real and will somehow return.

  5. Proof that loans are being paid by someone elses money!

    Moody’s warns on GMAC mortgage bond servicing
    Thu Mar 4, 2010 3:07pm EST
    Related News

    * Moody’s upgrades GMAC on US Tsy capital infusion
    Fri, Feb 5 2010

    NEW YORK, March 4 (Reuters) – Moody’s Investors Service on Thursday said it may downgrade portions of 125 residential mortgage bonds based on unusual “cash management arrangements” of GMAC Mortgage LLC, which services loans in the securities.

    Bonds | Funds News | ETFs News

    The rating company said GMAC commingled cash flows from multiple bonds in a single custodial account, Moody’s said in a statement. This allowed GMAC to use cash from loans in one bond for principal and interest payments on another, it said.

    By allowing the commingling, it “increases the likelihood that some RMBS deals may not be able to recover the amounts ‘borrowed’ by the servicer to fund advances or another RMBS deal if a servicer bankruptcy were to occur,” Moody’s said.

    This could give rise to competing claims in a bankruptcy proceeding, the rater said.

    Downgrades based on mortgage servicing, rather than credit, may add to concerns of bond investors who have been long accustomed to harsh rating cuts as delinquencies and foreclosures increase losses.

    GMAC Mortgage is a unit of Residential Capital LLC. Residential Capital is owned by GMAC Inc.

    For some commentary see this link:
    http://market-ticker.denninger.net/

  6. I totally agree with this ruling. If it walks like a turkey, gobbles like a duck, and its DNA turns out to be a turkey, then its a turkey, no matter if you’re told it is a duck. You should have known better. BUYER/BORROWER BEWARE!

    But now like Neal says, the shoes on the other foot. if there are no damages to the “Plaintiff” or foreclosing entity (and you don’t know till you get ALL accounting records), then there are no damages. You are not entitled to “double recovery” of damages in any state I know of without an award of punitive, special or treble damages and if there are other parties that paid and got paid that were the true holders, then you don’t have a duck, you have a turkey.

    If someone says we traded the duck for the turkey, then let them come forward, prove the “exchange” and deal and prove up their damages. If not, say, hey, my loan is here, just not my lien. I’ll take declaratory judgment that the note is obligated to the REAL LENDER (not pretender), but the mortgage/deed must be released and they have no security interest.

    The REAL lender can sue me then come get a judgment if they can prove and try to take the property then!

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