COMING BACK: COVERED MORTGAGE BONDS WITHOUT THE FRAUD

  • EDITOR’S NOTE: There are those who say that all derivatives are bad. They say that the securitization of mortgages could only result in fraud. They say that the securitization of mortgages could only result in widespread title defects having a negative impact on all commerce for decades or even centuries. I do not agree. The securitization of mortgages is based on the premise of spreading risk so that more investors would make more money available for loans. The securitization of mortgages  has the same validity as the securitization of ownership in corporations (stocks and options).
  • All of the above criticisms are valid in terms of the US experience and the impact on world economy over the last 10 years. But there is a difference between bad or fraudulent practice and a bad idea. Had Wall Street stayed within the bounds of formal and informal rules that had guided the evolution of the finance industry for centuries, there would be no foreclosure crisis because the criteria and assumptions for underwriting loans would have remained unchanged. In fact, this is exactly what was represented in the prospectus to the hapless investors in mortgage bonds. There would be no mortgage meltdown because the disclosure documents to prospective borrowers would clearly  reveal the viability of the loan, the reliability of the presumed value of the property, and the likelihood that this transaction would succeed.
  • There is actually a model for the securitization of credit that exists and has existed for centuries. The investment bankers and brokers made plenty of money as fees justifiably earned in the creation and selling of the securities resulting from a regulated infrastructure that was mostly transparent to everyone involved. They were called covered bonds. They are still called covered bonds. The only reason Wall Street did not use this model is that it was transparent and they would not be able to oversell the market, bet against the securities they were underwriting, or secretly siphon exorbitant fees out of the system. With full disclosure there was no doubt as to the identity of the creditor, the identity of the borrower, the existence of any co-obligors, the existence of any insurance and whether any loss mitigation payments had been made in the event of default.
  • The article below points out that although Bank of America and Washington Mutual have both issued covered bonds, the industry did not follow this model because of regulatory and risk factors. I disagree. Neither regulatory nor risk factors impeded the use of this model. The only reason it was not used was because of the desire to obscure the real action and the real parties and the real money and to deceive those who advanced the money and those who borrowed it.
  • I offer this to you as a reference point by which you can explain to a court the way things could have looked had there been honest intent on the part of the participants in the securitization chain. It is by reference to models like this that I have designed the analyses of securitization and title chains in the COMBO package that we offer.
November 2, 2010

An Effort to Adapt a European-Style Tool to U.S. Mortgages

By JULIE SATOW

Covered bonds, a financing tool that has been popular in Europe since the 18th century, are winning converts here as a new way to finance residential and commercial mortgages.

A covered bond is a securitized debt instrument backed by a pool of high-quality assets, usually mortgages. But unlike the assets in a securitized mortgage bond, the assets in a covered bond, known as a cover pool, are kept on the issuer’s balance sheet. This may provide an extra measure of safety, as the issuer will be less likely to underwrite risky loans, experts say.

There is no established market for the bonds in the United States, though they are a $3 trillion business overseas and lately have been attracting American institutional investors. This year, Representative Scott Garrett, Republican of New Jersey, introduced a bill that would establish a covered bond framework here.

The House Financial Services Committee passed the bill in July, and it narrowly missed being included in the Dodd-Frank financial overhaul law. Experts predict that covered bond legislation could pass both houses next year.

A covered bond has several characteristics that protect the bondholder: The assets in the cover pool are subjected to monthly monitoring by an independent third party, and should one of the loans become nonperforming, the issuer is obligated to remove it and replace it with a performing loan.

It is also typical that the cover pools are fenced off from the bank’s other assets in case of a default, and are overcollateralized, so that the market value is in excess of the face value of the bonds that it backs. Bondholders also have dual recourse to both the assets in the cover pool and the issuer in case of a bankruptcy.

Because of the safety features, most covered bonds are rated triple-A. In the history of the European covered bond market, which began in 1769 when Prussia issued them to finance agricultural projects, there has not been a single default, according to Anna T. Pinedo, a partner at the law firm Morrison & Foerster and the author of a legal work on covered bonds.

“We have seen the difficulties wrought by the complexity of securitizations,” said Bert Ely, a financial and monetary policy consultant based in Alexandria, Va. “Covered bonds, on the other hand, are a very clean and simple tool. A bank makes a loan, keeps the loan on its books and issues a covered bond. There is no sale and resale of mortgages.”

Despite their safety, covered bonds have not been popular here in part because government-sponsored enterprises like Fannie Mae and Freddie Mac have made it affordable for banks to finance the bulk of their mortgages by tapping the securitization market. That market has been largely frozen in the wake of the housing bust.

“Banks need alternative methods for financing mortgages,” said Jerry R. Marlatt, senior of counsel in the capital markets group at Morrison & Foerster. “The time is going to come when the housing market is going to recover, and now is the time to get new forms of financing in place.”

Washington Mutual and Bank of America are the only domestic banks to have issued covered bonds (Washington Mutual in 2006 and Bank of America in 2007). But without legislation providing a framework for how the bonds would behave in case of bankruptcy, the banks were forced to create costly contracts that made further issuance too expensive and complicated.

While Mr. Garrett has proposed legislation to facilitate bond issuance here, there is some conflict with the Federal Deposit Insurance Corporation. The regulator, which takes over failed banks, has several concerns, chief among them the fate of the cover pools.

The pools are overcollateralized, sometimes by as much as three times the face value of the bonds, and the F.D.I.C. wants access to these overcollateralized assets after a bankruptcy. Otherwise, if the cover pools shield the bulk of the bank’s assets from being claimed, it puts the depositors at undue risk, the regulator argues.

“We support covered bond legislation, but not at the expense of our obligation to protect the deposit insurance fund,” said Michael H. Krimminger, deputy to the F.D.I.C. chairwoman.

Market players say that if the F.D.I.C. were given control over the cover pool, it would put bondholders at too much risk.

“The F.D.I.C. is basically saying ‘trust me,’ ” said Paul Hinton, vice president of NERA Economic Consulting. “But administrations change, policies change, and this makes it risky for bondholders.”

Without legislation, American banks are hamstrung, and in their stead, foreign banks have begun to move in on the domestic market. This year, a record $28 billion worth of dollar-denominated covered bonds have been issued to American institutional investors, according to Dealogic. The bulk of the bonds were issued by Canadian banks, with French, Norwegian and British institutions also participating.

Unlike when Washington Mutual and Bank of America originally tried to start an American market for this debt, “in the last six to eight months, there has been a confluence of events that have brought covered bonds to the attention of U.S. investors,” said Sean Davy, the managing director of the corporate credit markets division of the Securities Industry and Financial Markets Association, a Wall Street trade group.

Institutional investors are hungry for high-quality bonds in which to invest, since traditional sources for such debt dried up after the housing bust, Mr. Davy said. European and Canadian banks are looking to diversify their investor base, and several factors have made it economical for them to issue dollar-denominated debt, he added.

As a result, more institutional investors, like insurance companies and pension funds, are buying up covered bonds from foreign banks. In other words, American investors are helping to finance the mortgage markets abroad, Mr. Marlatt said. “The playing field is not equal. Foreign banks are financing European mortgage loans with U.S. money,” he added. “Why shouldn’t American banks be empowered to help investors fund the mortgage market here?”

Mr. Garrett said covered bonds were a needed salve for the financial crisis. “This bill is good for the issuer,” he said, “because it will provide another financing tool for the bank; it’s good for the investor because it is a new, secure place to invest for the long term; and it’s good for the consumer because it will provide new lines of credit and simplify the issues now plaguing mortgage modifications.”

5 Responses

  1. I live in MN. and need a foreclosure atty. rather soon, I need someone that understands the scam. Any help getting me touch with the right atty. would be deeply appreciated. Please e-mail.
    Thanks
    Virg.

  2. I’m sorry, I have agreed with everything until just about now. I don’t think it’s a good idea. If they are going to make money off of me, more than once, I should have a say in it, no matter how thin the risk is for the money makers. I have lived here and only have a bit of extra payment (used to be equity) for many years, don’t tell me they have not made money. Too much. The gain for them in selling so many times is what has got me stuck in my student loans for example. No one will refinance my rate because they refinanced their rate and paid my loan. I don’t like that, at all. My owner contract with my previous home is where it should be. he was able to retire after selling me his home and his payments were like retirement the government is shorting out on now. Companies are on going entities, people and their homes are not.

  3. FASB 166 and 167 have mandated that the off-balance sheet conduits be brought back onto bank’s balance sheet. This is where they now sit. No more hiding. Problem is – they did this too late.

  4. MERS LEGAL SERVICE ADDRESS

    http://www.scribd.com/doc/41564028/Mortgage-Electronic-Registration-System-Inc-Mers-Address-for-Legal-Process-Serving

    MERS AS A THIRD PARTY SUPONEA OF RECORDS IN BK. USEFUL TOOL. THEY WILL NOT PRODUCE ANYTHING IN STATE COURT. FEDERAL IS DIFFERENT.

    http://www.scribd.com/doc/41562775/MORTGAGE-ELECTRONIC-REGISTRATION-SYSTEMS-INC-THIRD-PARTY-SUPONEA-Mers-Suponea-11-8-10-Final

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