COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary

EDITOR’S NOTE: The action that needs watching is how the banks are maneuvering to settle for pennies on the dollar. They have the offset of the bailout and other payments to work with on both sides of the insurance contract so it isn’t as simple as it looks. But in addition to the carrot they are wielding the stick with as much force as they can muster. Here the banks are trying to get MBIA declared insolvent which means receivership and probably the end of MBIA’s claims against the banks for fraud in the sale of the mortgage backed securities and the misleading reporting of the content of those securities to procure an MBS insurance contract on which MBIA paid.

The question for investors to ask is where’s the money? That is a simple demand for an accounting. There you have the biggest stick of all.


MBIA Fights Banks for Its Life


MBIA, an insurance company whose very existence is imperiled because it underestimated the risks involved in mortgage lending, says the banks owe it billions because they lied about the mortgages backing securities that MBIA insured. The insurer’s financial statements show it is solvent in large part because that money will be coming in.

The banks disagree. Their financial statements reflect no such obligation.

Just who is right will be determined over time, by courts and by negotiations. It is unlikely that much more will be known before annual reports come out this spring, but pressure is building on both sides to provide more complete disclosure of possible outcomes, and of how they reached their conclusions.

In the meantime, many of the same banks being sued by MBIA are trying to persuade a judge that the company is now and has been insolvent for a couple of years. That case was supposed to come to trial this month, but it has been delayed in part by the refusal of the New York State Insurance Department, MBIA’s regulator, to let a judge see e-mails between department officials when the department was approving a plan that reorganized MBIA in ways that left some MBIA-insured policyholders — notably banks — less likely to be paid if there are defaults.

In the last couple of weeks, two seemingly contradictory verdicts were rendered on MBIA’s health. First, Standard & Poor’s downgraded MBIA’s bond rating to the lower regions of junk, warning that the company’s “capital adequacy is very weak,” although it did have enough assets to meet all claims for at least a few years. Then the stock leaped 35 percent over five trading days.

The apparent cause for the increase was the disclosure that three banks — JPMorgan Chase, Barclays and Royal Bank of Canada — had withdrawn from the suit challenging the insurance department approval of the MBIA reorganization. It seems unlikely that that in itself would be very important, since the other banks seem committed to pursuing the case. The banks are not seeking damages, just a reversal of the reorganization, so the number of plaintiffs is important only in determining who shares the costs of the case.

But there also is speculation that MBIA and the banks that withdrew from the suit reached other deals that could bolster MBIA’s position. Did the banks agree to pay some of the money MBIA says it is owed? If so, that could go a long way toward validating MBIA’s decision to book $2.2 billion in payments from the banks, even though up until now it has reached only one settlement, and that for an amount so small that the company deemed it immaterial.

Alternatively, did one or more of the banks reach an agreement on policy commutations? In such a deal, the beneficiary of insurance — in this case the banks as owners of securities insured by MBIA — agree to accept a payment now in return for canceling the insurance. That could provide evidence that MBIA’s eventual exposure will not be as great as S.& P. feared when it cut the bond rating of MBIA Inc., the parent company, to B-minus.

The stock market reaction would seem to indicate that whatever happened may have been material, but neither the banks nor MBIA will say if any other agreements were reached, but MBIA disclosed this week that it had dropped a lawsuit claiming it was defrauded by Royal Bank. MBIA says it will have something to say on March 1, when it releases its annual financial statements.

All of this stems from the run-up to the financial crisis, when no one took steps that could have halted irresponsible lending before it rose to crisis proportions. Instead, everyone involved thought it profitable to assume that all was well and to book immediate profits. The banks making the bad loans sold them off in securitizations. The rating agencies gave AAA ratings to securities without actually looking at the loans. MBIA and its competitors insured the securities without bothering to look at the loans. Now MBIA claims that the banks defrauded it because many of the loans did not meet the stated underwriting criteria. Institutional investors — among them banks themselves — bought the securities without doing much homework either.

One disclosure in MBIA’s third-quarter filing with the Securities and Exchange Commission provides an insight into just how fictional those ratings were on the most exotic securities, what are known as multisector collateralized debt obligations, or C.D.O.’s. and C.D.O.-squareds. A C.D.O. is backed by securities that are backed by actual loans. A C.D.O.-squared is backed by securities that are backed by securities that are backed by actual loans.

MBIA said that 99 percent of such securities that it insured were rated AAA at issuance, with the remainder rated AA, also a very high rating. Now 1 percent are rated AAA and another 7 percent have lesser investment grade ratings. The remaining 92 percent have junk bond ratings. MBIA insured $18 billion in such securities, and now expects to pay $2.3 billion in claims, an amount it says “could increase materially.”

The outlook seems to have been getting worse, but that has not been reflected in MBIA’s balance sheet. In the third quarter of last year, the company concluded that it would have to pay out $107 million more than it had expected on insured securities backed by residential mortgages. But its expected loss on such securities fell. How could that be? It was simple: the company increased the amount it expected to get from the banks.

The differing views of what will be paid have raised eyebrows both at the S.E.C. and at the Public Company Accounting Oversight Board, which regulates auditors. The S.E.C., in letters to financial institutions, warned in October that an accounting rule “requires you to establish accruals for litigation and other contingencies when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated.” Even if those criteria are not met, “disclosure of the contingency is required to be made when there is at least a reasonable possibility that a loss or an additional loss has been incurred,” the S.E.C. added.

Last month the accounting board followed up with a message to auditors warning that there was a “risk of material misstatement” in financial statements, in part because of litigation over mortgage securitizations.

Warnings to accountants cannot produce certainty when there is none, even if they can produce better disclosures regarding the range of possibilities. Much hinges on just how big the losses from bad mortgages are going to be. MBIA thinks S.& P.’s fears regarding its capital are based on assumptions that the losses could be much larger than they actually will be. Given how badly S.& P. once underestimated the risks, it is certainly possible that it is now overestimating them. But the opposite is also possible.

MBIA’s hopes of going back into the business of writing new policies are based on its reorganization — or transformation, as the company calls it — which split its existing policies into two groups. One, covering municipal bonds issued by American state and local government agencies, still has the support of all of MBIA’s assets. The other, covering foreign bonds and all structured finance transactions, is backed by only some of the assets.

The New York State Insurance Department concluded that both parts would be solvent, and authorized the complex arrangement. The fact the company had made a detailed proposal was not disclosed to the public until after it was approved in early 2009.

In reaching its decision, the department made clear that it was trying to keep muni bond insurance available. The case pending in New York State court challenges the department approval, claiming it was arbitrary and capricious.

The judge hearing the case ordered the department to turn over to a hearing officer all e-mail regarding the deal sent by five department officials to each other in the two months before the transaction was approved. The hearing officer is supposed to look for evidence of bias and, if he finds any, turn those e-mails over to the banks. This week the New York attorney general’s office, which is representing the department, notified the court it wanted to appeal that order and keep the documents secret. It said such disclosures would be unprecedented and could harm the department’s ability to have frank internal discussions in future cases.

Officials from the insurance department and the state attorney general’s office refused to discuss the issue this week, but Robert J. Giuffra Jr., a partner in Sullivan & Cromwell who is representing the banks, was happy to do so. “They seem to be fighting hammer and tong to avoid any public disclosure of the internal basis of their decision,” he said, adding that the banks believed they could prove that MBIA was insolvent and that the regulator’s “so-called thorough review was window dressing.”

MBIA will not be able to write new muni bond insurance unless and until the reorganization survives legal challenge. The company had hoped to have a ruling by now, but further delays seem inevitable. This week the judge hearing the case, James A. Yates, announced he was leaving the bench to become counsel to the speaker of the New York Assembly, Sheldon Silver. It will take time for a new judge to understand the facts in the case. At MBIA, the tone is upbeat. Last spring, when the stock price was under pressure, the company resumed its stock repurchases, and through October had spent $28 million buying back shares. That is not a lot of money for a company with billions in assets, but MBIA is also a company whose most recent balance sheet would have shown no net worth had it not been able to book the expected payments from the banks and deferred tax assets whose value will be realized only after the company returns to profitability and is able to avoid paying taxes on those profits.

“Our continued solvency and payment of all claims and obligations since our transformation confirms that the New York State Insurance Department was correct in concluding that the transformation was fair and equitable to all policyholders and fully consistent with New York insurance law,” Jay Brown, the company’s chief executive, said in a statement.

Floyd Norris comments on finance and economics in his blog at nytimes.com/norris.

34 Responses

    The Class A-2 Certificates will have
    the benefit of a financial guaranty insurance policy issued by MBIA Insurance

    This insurance policy will, in general, guarantee accrued and
    unpaid interest on the Class A-2 Certificates on each distribution date and the
    principal amount then owing on the Class A-2 Certificates on the distribution
    date in September 2030. However, this insurance policy will not cover any
    prepayment interest shortfalls and will not cover certain other interest
    shortfalls with respect to the Class A-2 Certificates and will not provide
    credit enhancement for any class of certificates other than the Class A-2

    11/3/2000 DJL Capital Investors Inc, 11 Madison Ave NY (Domestic Entity Other)
    3/09/2001Renamed Credit Suisse First Boston Private Equity Inc.
    8/31/2007Renamed Credit Suisse Private Equity Inc.
    1/01/2011 Renamed credit Suisse Private Equity LLC

    #1 bCS Holdings (1647970) 12/31/1996
    Credit Suisse First Boston Futures Inc (1667428)
    Credit Suisse First Boston Inc 1574834 to #1
    Credit Suisse First Boston Management Corp (1667615) Securities Broker Dealer
    Collateralized Mortgage Securities Corp (1667633) Securities Broker Dealer
    Asset Backed Securities Corp 1667624 Securities Broker Dealer flows to

    Credit Suisse (Usa) Inc [ formerly Credit Suisse First Boston USA Inc ] — 3/25/09 U.S. SEC # 29646






    o Represent ownership interests in a trust, whose assets are primarily a
    pool of fixed and adjustable rate, first lien residential mortgage loans
    that were generally originated in accordance with underwriting guidelines
    that are not as strict as Fannie Mae and Freddie Mac guidelines.

    Credit enhancement for all of the classes of offered certificates will be
    provided by excess interest to create overcollateralization and subordination.

    Delivery of the offered certificates, other than the Class R Certificates,
    will be made in book-entry form through the facilities of The Depository Trust
    Company, Clearstream, Luxembourg and the Euroclear System on or after November
    30, 2000.


    o DLJ Mortgage Acceptance Corp. The depositor maintains its principal office
    at 11 Madison Avenue, 4th Floor, New York, New York 10010. Its telephone
    number is (212) 325-2000.


    o Wells Fargo Home Mortgage, Inc. (sometimes referred to in this prospectus
    supplement as Wells Fargo).


    o Wells Fargo Home Mortgage, Inc. will service the mortgage loans.


    o General Electric Mortgage Insurance Corporation.

    The Depositor has acquired for the benefit of the trust fund a loan-level
    primary mortgage insurance policy to be issued by GEMICO with respect to those
    mortgage loans with original loan-to-value ratios in excess of 60% at


    o The Chase Manhattan Bank.


    o November 1, 2000.


    • November 30, 2000.
    Distribution Date December 26, 2000

  2. Barry in Tacoma,

    Maybe. Witnessing “events” that show courts are just beginning to contemplate what is going on.

    For those that have been front runners in this — but no success in courts — it is some consolidation that courts are now questioning past decisions. This will continue.

  3. barry–just look at the affirmative defenses pled by the defendants–ofuscation. Its the same in any case. If its my case and I don’t get securitization how will I explain it. I went to a ton of American Trial Association trial classes. Here’s the thing–you have to talk to the jury in 8th grade education terms. You have ten minutes to make yoru point with any witness. You have to sell the judge on a case during summary judgment BEFORE IT EVER GETS TO THE JURY OR YOU WON’T GET TO the JURY. The average judge who gets these cases hears the following cases : red light green light car accidents, divorces, murders, brech of contract busienss cases, med malpractice, personal injury–DO YOU SEE FORECLOSURE DEFENSE CASES? No. It is basic contract, negligence, fraud. The experts are doctors of some type. Traffic analysts. Not wall street security analysts. Folks, no judge likes looking stupid, they rather deny a claim than look stupid.

  4. Gwen,

    K.I.S.S. – Right on Gwen. Obfuscation is the primary tool of the enemy. I believe their backup weapon is diversion by social and political issues in media.

    Even though the argument against securitization is technically right, it doesn’t matter if the judge doesn’t get it. And the judge is never going to spend hundreds of hours getting it.

    Debating securitization and accounting against the Trustee and Servicer validates their agency by arguing against them !!!

    Homeowner: Your honor, the note was paid, and the psa says this, and wall street did this, and …

    Trustee: Your honor, they didn’t pay their mortage, they’re conspiracy theorists.

    How would you decide if you were a busy judge?

    K.I.S.S. – start with the blatant slanders in your courthouse as prima facie evidence and go from there. Keep it in local court. The slanders on title are so much more concrete.

    Everybody – get and comprehend Dave Krieger’s book at Cloudedtitles.com.

  5. Barry, I agree. I have 30 plus years of trial exp in complex litigation (antitrust, construction litigation, and mostly complex civil rights actions against everyone from the FBI to the Catholic Church to GM and every gov agency and every city within 100 mi of kc). I ws one of the first lawyers to use a pyschiatrist/pyschologist/social worker team in sexual harassment cases. I took some of the developers of the MMPI and regularly deposed experts. I spent 1800 hrs this year working on understanding this stuff–the securities stuff is unintellible and remains unintelligible and I have a brotherinlaw and cousin who are high end wall street people who have been helping me–they even scratch their heads at some of the stuff floated on this website and some others. I was before a judge last friday who I have known 35 years. She said, Gwen, you are really smart in simplifying things but this stuff is really difficult for us judges to “get”. Explain. I spent two hours “explaining” and she said she was still in “preschool”. She’s not stupid. That is why I urge people to go the quiet title, declaratory judgment route with some common law claims for fraud, neg and breach of contract or trust. Even some of the theories under TILA, RESPA, sec, rico, sherman antitrust when applying to the foreclosure crisis leave these jduges head’s spinning. In my opinion part of the reason we are loosing is because we are not KISS. We have not met head on the “get a house free argument” (I do have some theories on how to approach that and made progress in that). But when I ask people on this blog what is going on–I get zilch. There is no common sense discovery, no common sense response to motions to dismiss. The bankrtupcy court is doing better because the trustees are opposing the lift the stay motions on the common sense “lack of standing” argument. The one thing my judge got last friday (I won by the way the motion of the day) was “the note issues”. She asked the trustee–do you have it, have you ever had it, have you seen it, has anyone seen it, did boa tell you they had it, did you ahve it when you attempted to foreclose–the answer to all the questions was no. i won the motion a few moments later. Again KISS. I agree, you and I are not stupid–I have written briefs in three fed circuits of appeal for years and the USSCT. I have tried 4 to 6 week trials. But the so called experts here are clueless how to present–and no trial lawyer would ever think of putting them on the stand. I know I wouldn’t. My expert is the Chicago Title guy who found my title broken–I told the judge that, and she nodded affirmatively. Stupid simple. Broekn chain of title and all else flows from that as IBANEZ says. If I can do shrinks, social workers etc and can’t do a title case, there is something seriously wrong with me as a litigator.

  6. M. Soliman, Expert Witness,

    Regarding your title, I can believe the “Expert” part as far as your knowledge of securitization accounting.

    I cannot believe the “Witness” part of your title. If you speak like you write, I do not believe you could effectively “witness” in any legal setting before common people or a judge. Maybe — if you were coached by a very sharp attorney. My guess is that’s where your success has been. I print copies of most of what you say here and go back and read them from time to time and I still don’t get it. Hate to tell you it’s not me. I once reverse-engineered a communication protocol using an oscilloscope, Logic Analyzer, and a spreadsheet. I’ve even de-compiled a little assembly language. One of my favorite classes in grad school was “Theory of Computation” which inevitably ends up in “language theory” because if a problem cannot be written in language, it cannot be compiled into ones and zeros and solved by a machine. Though I believe (because of a few acknowledgements by ANONYMOUS and usedkarguy) your motive to help us is sincere, you would be far more helpful to us all if you could have somebody else edit your knowledge into plain language. Nevertheless I cannot decode you.

    You could do well with a patient editor. You need to verbally explain to the editor and let him/her write the substance, with you checking for accuracy. Repeat this in a feedback loop until both you are satisfied with the content, and the editor is happy with the readability. You could probably sell a book and do very well, as well as help your fellow man.

    I do believe what you have to say may be very very important, and value your knowledge, just not your writing.

    I mean this as constructive criticism and respect you.

  7. to Gwen: never mind! thanks i got it.

  8. TO GWEN: you are a big contributor in this “Leprechaun’s” world..:)
    whats the name of the book someone mentioned below and who is the author please?
    Ps: is it “clouded titles”?

  9. richard, dave’s book talks about lp. I don’t practice anymore so I can’t draft pleadings for you. I can send you what I am doing in my own case. write me at gwencaranchini@sbcglobal.net and i will send you my current template I am using to amend my case, the lis pendens and the notice of lp I filed. To answer your question, qt/dc/lp should stop foreclosuore but BOA/BAC is claimig you still need a TRO. See the tro as part of the qt/dc/action. a lp makes it impossible to sell the property at sale because the title is “clouded” further by the lp giving notice of the qt action so that a title company will not pass title on the property–that is the best explanation I can give of a lp. Generally, a judge will grant a tro if you file the qt/dc/lp action but you have to be prepared to go do that.

  10. Gwen, in an earlier posting you noted filing a lis pendens with a quiet title action to hold off a foreclosure. I am in the dark on a property owner filing a lis pendens . I am a 1/3 of the way through “clouded titles”. Just beginning my research in law library for Kings County (Brooklyn). Thanks

  11. anonymous–no I haven’t but I had a good hearing last week in my state case againt the trustee–my state court judge is going to let me add back in the qt/dc action that got removed to fed ct so that the trustee is part of it–that’s good news because she asks QUESTIONS–I raised the Kemp decision with her and she was very interested in it–her issue in my case is where’s the note and what’s the value if any–the prelimin title report shows my title broken but she is waiting for BOA to again be before her–so yes I think Kemp will be a big issue for her. I’ll keep you all posted

  12. ANONYMOUS-perhaps this is a good time to revisit the 2009 Federal Reserve TILA amendment wherein it was stated that “….the lender is that person who can account for the loan on its’ balance sheet”. This affects “modifications”, standing, etc. And we know that trusts have no balance sheet, that they are pass-throughs. So if the trusts never were assigned the loans(BOA v.Kemp), then have any lawsuits further addressed this? Haven’t heard much more about this one way or the other.

  13. To soliman (and anonymous). Anonymous is right. I just got off the phone with another securities lawyer who now does this work and he said there is absolutely no validity to this opinion and should be ignored. If you ahve some authoriy for this “opinion” please send to me and I will check it out with my seucrity lawyers who are doing foreclosure. gwencaranchini@sbcglobal.net

  14. Gwen -Agree with you.

    M.Solimon — you are making the mistake of focusing on securization structures that are backed by assets that still have receivables. Foreclose, in the terminology of the Safe Harbor rules you discuss, is directed to securities that are current (not in terms of real property foreclosure – but in terms of the performing MBS securities). Non-performing loans are removed from current receivable pass-through trusts. This is also an error that courts make — that is, courts are told that once an asset is transferred to a QSPE — it stays there. Not only are assets not properly transferred from the onset (which the FDIC has not figured out yet) but non-performing assets collection rights are swapped out.

    In addition, FDIC — whatever it’s involvement, is going to find many more burdens it will not be able to address. This includes loans supposedly paid off- that were not paid off- falsely placing borrower in default — before new loan is even executed, multiple pledges of loans to multiple vehicles, completely invalid accounting, — and the same missing documents, fraudulent documents, etc — that borrowers are finding.

    Problem with government agencies — and from the onset of the crisis — is that they wrongly assumed all was on the up and up. It was/is not. And, FDIC has just not yet caught up to this information. They will — FDIC, like other government agencies, are just a little slow.

  15. To M Soliman: with alldue respect, I think you are wrong. I have had this traced thru the securities trail, and I am not in foreclosure–i filed suit to stop them coming forward and trust me the judge I have will not let it go forward. The theor you have I have not seen and I have done 1800 hrs of research and talked to securities lawyers as well as high end wall street people. If you wish t explain write me at gwencarnchini@sbcglobal.net

  16. GWEN – The fed quiet title and declaratory judgment will soon to be added to the state court action given the willingness of the judge to…

    know who is foreclosing on you. its the fdic .hold co and a receiver….the debt collector typically has a judgement already in hand before he gets to court. The foreclosure proceeding is to release the asset under a writ. Receivership. Stop.stop guessing people. . . . your info is off base trust me. The rain has started and Noah left the dock. Swim now Its FDIC avoidance powers that can strike any complaint for declaratory releif and injunctive remedies. It can stay any court decision …except…

    your in the stone age if you think your going against a lender and dec relief is waiting for you …..stone age. Even is you win they bring it back – 20 times and they brought it back and won. I too was stuborn at first …but in 2008 …this is 2011.

    you need to be samrt here and strike back under a different approach.


    with The FDIC “Safe Harbor Rule”?.

    Submitted by M.Soliman

    On September 27, 2010, the Board of Directors of the Federal DepositInsurance Corporation (the “*FDIC*”) approved a final rule, codified as 12
    C.F.R. § 360.6, entitled “Treatment of financial assets in connection with asecuritization or participation” (the “*Safe Harbor Rule*”). The Safe HarborRule establishes new conditions for the FDIC’s assurance that it will not,
    in its capacity as conservator or receiver for a failed insured depository
    institution (“*IDI*”), assert its repudiation power with respect to
    contracts of the IDI so as to avoid transfers of financial assets in
    connection with qualifying securitizations or participations originated by
    that IDI. Adoption of the rule follows an Advance Notice of Proposed
    Rulemaking by the FDIC of December 15, 2009,1 and a Notice of Proposed
    Rulemaking of May 11, 2010.2 The FDIC’s memorandum describing the final Safe
    Harbor Rule (the “*FDIC Rule Memorandum*”), including the text of the final
    rule, is available athttp://edocket.access.gpo.gov/2010/pdf/2010-24595.pdf

    The Safe Harbor Rule takes effect on December 31, 2010.

    The Safe Harbor Rule has important implications for disclosure and risk
    retention requirements for asset backed securities (“*ABS*”) and other
    securitizations involving IDIs. This memorandum briefly described the
    background to the FDIC’s repudiation power as it relates to the Safe Harbor
    Rule, summarizes the principal provisions of the Rule, and assesses the
    impact of the Safe Harbor Rule in light of related regulatory developments.

    *I. Background to the FDIC’s Repudiation Power and the 2000 Safe Harbor*

    The Federal Deposit Insurance Act (the “*FDIA*”) grants the FDIC the power
    in its capacity as conservator or receiver for a failed IDI to repudiate
    unperformed contracts of the IDI where the FDIC determines such contracts to
    be burdensome.3 This power has been cons*true*d by the FDIC to allow the
    FDIC to “repudiate” a secured financing of an IDI by repaying the financing
    amount and recovering the relevant collateral. The economic characteristics
    of a securitization – in which an IDI transfers loans or other financial
    assets to a special purpose entity (“*SPE*”) and the SPE issues securities
    backed by these financial assets, with the IDI typically retaining some
    portion of the residual or equity securities of the SPE – are economically
    similar to a limited recourse secured financing by the IDI. A securitization
    transaction therefore raises the prospect of being recharacterized as
    secured debt.

    Outside the FDIC context, such recharacterization concerns are addressed by
    structuring the relevant transaction such that under applicable state law,
    the securitization SPE will be considered separate from the originator in a
    bankruptcy and the*sale* of assets to the SPE will be considered a “*true* *
    sale*”. Securitization structures involving IDIs must address the possible
    recharacterization of the transaction by the FDIC as secured debt, with the
    result that the FDIC might apply the repudiation power to reclaim assets
    transferred to the securitization SPE. Since 2000, a prior FDIC safe harbor
    rule has specified that securitizations meeting certain basic conditions
    would not be avoided by means of the repudiation power.4

    One factor relevant to whether a securitization might be recharacterized is
    the accounting treatment of the transaction. A securitization may result in
    the securitized assets being accounted for as off balance sheet, having been
    sold by the originator to the SPE; or the assets may remain on the balance
    sheet of the originator, with the originator accounting for the
    securitization as a secured financing. The FDIC’s discussion of the
    rationale for the Safe Harbor Rule highlights that the FDIC places
    considerable importance on this feature in the context of the repudiation
    power. The FDIC referred to its “longstanding evaluation of the assets
    potentially subject to receivership powers” as having been “based on the
    treatment of those assets as on or off balance sheet.”5 The FDIC further
    emphasized that “it is appropriate for the FDIC to rely on the books and
    records of a failed IDI in administering a conservatorship or receivership
    and consider how to apply a safe harbor for assets that are deemed part of
    the IDI’s balance sheet under GAAP.”6

    The FDIC’s focus on the importance of the accounting treatment of a
    securitization is prompted by recent changes to accounting standards. Prior
    to the changes effected by Statement of Financial Accounting Standards 166
    and 167,7 the prevailing model for securitization was that of off-balance
    sheet financing. SPEs were established to qualify as “qualified special
    purpose entities” which were not subject to accounting consolidation by
    their parent originator. Previous *FAS* *140*standards required “legal
    isolation” assurances to the effect that the relevant transfer of assets
    would be treated as a “*true**sale*” and not clawed back in the insolvency
    of the originator or its affiliates, in order to treat a transfer to the SPE
    as a *sale*for accounting purposes. The 2000 Safe Harbor Rule facilitated
    such off-balance sheet treatment by confirming that the FDIC would not use
    the repudiation power to challenge a *sale* of financial assets to an SPE
    which otherwise met the requirement for isolation of the relevant assets
    under *FAS* *140*.

    With the changes to *FAS* *140* wrought by *FAS* 166 and *FAS* 167, it has
    become much less likely for securitizations to be treated as off-balance
    sheet. Through a combination of new standards for *sale* accounting under *
    FAS* 166, and new standards for consolidation of SPEs and similar entities
    (“variable interest entities” or “VIEs”) under *FAS* 167, securitizations
    that have the same legal and economic characteristics as transactions
    previously treated as off balance sheet by an IDI will now be treated as
    secured financings. Responding to this change, the FDIC has refused to
    maintain the 2000 Safe Harbor Rule. Separately, in reaction to the perceived
    role of past securitization practices in contributing to the credit crisis,
    the FDIC has also sought to add a substantive regulatory element to the safe
    harbor rule. The new conditions to the safe harbor, summarized below, go
    well beyond the factors that would be relevant to the FDIC’s assessment of
    whether respecting a securitization as a *true* *sale* would disadvantage an
    IDI in receivership. Instead, by imposing substantial conditions on safe
    harbor treatment, the FDIC seeks to impose new standards on the
    securitization market.

    *II. The Operation of the Safe Harbor*

    A. Key Definitions; GSE Exclusion

    A “securitization” for purposes of the Safe Harbor Rule is defined as the
    “issuance by an issuing entity of obligations for which the investors are
    relying on the cash flow or market value characteristics and the credit
    quality of transferred financial assets” to service the relevant
    obligations.8 An “issuing entity” is broadly defined as an “entity that owns
    a financial asset or financial assets transferred by the sponsor and issues
    obligations supported by such asset or assets.”9 A “sponsor” is “a person or
    entity that organizes and initiates a securitization by transferring
    financial assets, either directly or indirectly, including through an
    affiliate, to an issuing entity.”10 The notion of a securitization is thus
    not limited to transfers of assets that occur in connection with primary
    credit origination: repackagings or transfers by banks of assets acquired in
    the secondary market could also be included as “securitizations.” Even a
    transfer of a single asset, without tranching a credit risk, to an “issuing
    entity” may be a “securitization” under the Safe Harbor Rule.

    The definition of “issuing entity” embeds within it an exclusion for
    transactions involving the Federal National Mortgage Association, Federal
    Home Loan Mortgage Corporation, Government National Mortgage Association or
    similar government sponsored enterprises (each a “GSE”) from the ambit of
    the Safe Harbor Rule. Under the definition of “issuing entity,” a “Specified
    GSE or an entity established or guaranteed by a Specified GSE shall not
    constitute an issuing entity.”11 Due to the nature of the rule as a safe
    harbor, the effect of this exclusion is unclear. The intent of this
    exclusion may have been to relieve GSE transactions from the conditions of
    the Safe Harbor Rule, but the operation of the exclusion would instead
    appear to deny safe harbor treatment, whether or not the GSE transaction
    complies with the conditions of the rule. Since under *FAS* 167 standard
    GSE-guaranteed transactions do not leave the underlying mortgage loans on
    the balance sheet of the originating IDI, however, the Safe Harbor Rule may
    have been thought unnecessary.

    A significant portion of the conditions of the Safe Harbor Rule are
    described below as being applicable only to residential mortgage backed
    securities (“*RMBS*”) transactions. However, it should be noted that the
    Safe Harbor Rule defines this class of transactions by reference to
    “securitizations in which the financial assets include *any *residential
    mortgage loans.”12 Even a very low concentration of residential mortgage
    assets would thus appear to trigger the more stringent conditions of the
    Safe Harbor Rule that apply to RMBS.

    B. Conditions to the Safe Harbor

    *1. Risk Retention and RMBS Reserve*

    The Safe Harbor Rule provides that the securitization documents for a safe
    harbored transaction must require a 5 percent retention of credit risk on
    the transferred assets.13 The credit risk retained “may be either in the
    form of an interest of not less than five (5) percent in each of the credit
    tranches sold” or “in a representative sample of the securitized financial
    assets equal to not less than five (5) percent of the principal amount of
    the financial assets at transfer.” In allowing risk retention with respect
    to the assets, rather than the securitization tranches themselves, the FDIC
    was responding to concerns that the risk retention requirement “could cause
    securitizations that might otherwise qualify for *sale* accounting
    treatment” under *FAS* 166 and 167 “to not qualify for that treatment.”14
    The retained interest may not be “sold or pledged, or hedged . . . except
    for the hedging of interest rate or currency risk” while the securitization
    is outstanding.15

    The foregoing risk retention provisions will take effect prior to the more
    detailed interagency risk retention rules implementing Section 941(b) of the
    Dodd-Frank Act. However, the Safe Harbor Rule provides that when the
    Dodd-Frank rules become effective, “such final regulations shall exclusively
    govern” the risk retention requirement under the safe harbor.16

    For RMBS transactions, the Safe Harbor Rule further provides that the
    documents must require “the establishment of a reserve fund equal to at
    least five (5) percent of the cash proceeds of the securitization” to cover
    repurchases of financial assets “for breach of representations and
    warranties.”17 The unused balance of the fund shall be released to the
    sponsor after 1 year from issuance. This reserve fund requirement is a
    separate requirement from the risk retention provisions and will not be
    superseded by the Dodd-Frank risk retention rules.

    *2. Disclosure*

    The Safe Harbor Rule provides generally that the documents for a
    securitization must require that “information about the obligations and the
    securitized financial assets shall be disclosed to all potential investors
    at the financial asset or pool level, as appropriate for the financial
    assets, and security level to enable evaluation and analysis of the credit
    risk and performance of the obligations and financial assets.”18 The
    disclosure requirement applies both for the initial *sale* “on or prior to
    issuance of obligations” and on an ongoing basis “at the time of delivery of
    any periodic distribution report and, in any event at least once per
    quarter.”19 The required information must “at a minimum” comply with the
    requirements of Regulation AB under the Securities Act “even if the
    obligations are issued in a private placement or are not otherwise required
    to be registered.”20 This reference to Regulation AB is particularly
    important in light of the extensive asset-level reporting and disclosure
    requirements currently proposed as amendments to Regulation AB and related
    rules under the Securities Act (so-called “*Reg AB II*”).21

    In addition to several general references to the type of initial disclosure
    and reporting information that is required, the Safe Harbor Rule expressly
    provides that the securitization documents require that “the nature and
    amount of compensation paid to the originator, sponsor, rating agency or
    third-party advisor, any mortgage or other broker, and the servicer(s)” be
    disclosed, as well as “the extent to which any risk of loss on the
    underlying assets is retained by any of them for such securitization.”22 The
    securitization documents must also require disclosure of changes to this
    information on an ongoing basis.

    For RMBS transactions, the Safe Harbor Rule additionally requires (i)
    disclosure of specified loan level information, (ii) that a representation
    and warranty address, and that the sponsor confirm, compliance with
    applicable regulatory standards and guidances for mortgage loans, (iii)
    disclosure of a third party diligence report on compliance with such
    standards and representations and warranties on the relevant financial
    assets and (iv) disclosure of any “ownership interest by the servicer or an
    affiliate of the servicer” in other whole loans secured by the same real

    An important general qualification to the disclosure requirements is that
    “[i]nformation that is unknown or not available to the sponsor or the issuer
    after reasonable investigation may be omitted,”24 if the issuer expressly
    discloses that such information is unavailable.

    *3. Transaction Structure*

    Similarly to the condition applicable to securitizations under Regulation
    AB, a securitization qualifying under the Safe Harbor Rule “must be
    primarily based on the performance of financial assets that are transferred
    to the issuing entity and, except for interest rate or currency mismatches
    between the financial assets and the obligations, shall not be contingent on
    market or credit events that are independent of such financial assets.”25
    Products such as synthetic securitizations, credit-linked notes or similar
    structured products are thus outside the scope of the Safe Harbor Rule.

    In the case of RMBS, additional structural restrictions apply:

    * a. RMBS capital structure*. The capital structure
    of the securitization is limited to six tranches. However, the rule provides
    an exception for prepayment allocations within the most senior class, and
    contemplates that a tranche may be further repackaged or securitized into
    additional tranches.

    b. *No RMBS external credit enhancement*. The
    obligations “cannot be enhanced at the issuing entity or pool level through
    external credit support or guarantees.”26 There are exceptions for
    loan-level mortgage insurance and GSE guarantees, as well as for support for
    the “temporary payment of principal and/or interest” by liquidity
    facilities. However, ABS financial guaranty policies such as those
    previously issued by monoline insurance companies would be disqualified.

    c. *RMBS servicer standards*. Servicers must have
    specified authorities and responsibilities to take actions, including
    modifying assets “to address reasonably foreseeable default,” and to
    maximize the value and minimize losses on the securitized assets. The
    securitization documents must require “industry best practices” for
    servicers and that servicers must “act for the benefit of all investors, and
    not for the benefit of any particular class of investors.”27 Requirements
    that a servicer make advances for delinquent payments of principal and
    interest must be limited to three payment periods unless qualifying
    reimbursement facilities are available.

    d. *RMBS compensation provisions*. Compensation to
    rating agencies or “similar third-party evaluation companies” is required to
    be payable under the securitization documents in part over the five-year
    period after issuance of the obligations “based on the performance of
    surveillance services and the performance of the financial assets,” with no
    more than 60 percent of such compensation being payable at closing.28
    Documents must also provide for compensation incentives for servicers for
    loss mitigation and other specified activities.

    *4. Resecuritizations*

    A resecuritization which includes underlying ABS does not qualify under the
    Safe Harbor Rule unless the disclosures that would be required by the Safe
    Harbor Rule for the assets underlying those Resecuritized ABS are made
    available to the investors in the resecuritization. A complete “drill down”
    of information on the underlying ABS asset pool would appear to be required,
    irrespective of the relevant asset concentration.

    *5. Affiliate/Insider Sale Restriction*

    The securitization documents must require that obligations issued in the
    securitization “shall not be predominantly sold to an affiliate (other than
    a wholly-owned subsidiary consolidated for accounting and capital purposes
    with the sponsor)” or to an “insider” of the sponsor.29

    *6. Other Requirements*

    Certain other basic documentation and structuring requirements apply, such
    as the requirement for the transaction to be an “arms length, bona fide
    securitization,” for the securitization agreements to be in writing and
    reflected in the IDI’s official records, for the securitization to be in the
    ordinary course of business and not in contemplation of insolvency, for
    adequate consideration, for transfers to be properly perfected, for the
    roles of servicer and sponsor to be documented separately, for securitized
    assets to be properly identified and cash proceeds not to be commingled, and
    certain other requirements. These are largely requirements retained from the
    2000 Safe Harbor Rule.

    C. Effect of the Safe Harbor Rule on Securitizations Treated as *Sale*s

    Where a securitization satisfies the conditions for *sale* accounting under
    GAAP (except for the “legal isolation” requirement itself), the Safe Harbor
    Rule confirms that the FDIC “shall not, in the exercise of its statutory
    authority to disaffirm or repudiate contracts, reclaim, recover, or
    recharacterize as property of the institution or the receivership” the
    relevant transferred financial assets.30

    D. Effect of the Safe Harbor Rule on Securitizations Treated as Financings

    For a securitization accounted for as a secured financing, the Safe Harbor
    Rule does not actually prevent the repudiation power from being applied.
    Instead, the rule constrains the manner in which the repudiation power would
    be exercised. For a qualifying securitization, the Safe Harbor Rule provides
    for two alternatives in this respect.

    *First*, if the FDIC as conservator or receiver “is in monetary default
    under a securitization due to its failure to pay or apply collections from
    the financial assets received by it in accordance with the securitization
    documents,” and such default continues for 10 business days following a
    notice to the FDIC, the FDIC is deemed to consent “to the exercise of
    contractual rights” in accordance with the documents governing the
    securitization, including secured creditor remedies.31 The exact
    circumstances that give rise to a “monetary default” are not clear. The Safe
    Harbor Rule could be read to state that monetary default and the resulting
    consent would arise independently from *either *a “failure to pay” – i.e. a
    default in the sense of a shortfall in scheduled distributions of principal
    or interest – or in the alternative due to a default arising from the FDIC’s
    “failure to apply collections” per the securitization documents. The better
    reading, however, appears to be that monetary default requires both
    circumstances: *i.e.* that a default must have arisen “due to” a failure to
    pay the amounts actually collected. To the extent that creditors’ remedies
    arise under contractual securitization documents following a shortfall in
    payment, even where available funds have been appropriately paid or applied,
    it is unclear whether such remedies would be covered by the Safe Harbor

    Second, if the FDIC provides a written notice of repudiation of the
    securitization agreement, and the FDIC fails to pay specified damages in
    connection with such repudiation, the FDIC is similarly deemed to consent to
    the exercise of contractual remedies by the creditors in respect of the
    securitization. The required damages are specified as an amount equal to (i)
    the “par value of the obligations outstanding on the date of the appointment
    of the conservator or receiver” (less any interim payments of principal)
    plus (ii) “accrued interest through the date of repudiation in accordance
    with the contract documents to the extent actually received” from proceeds
    of the financial assets.32 The “to the extent actually received” language –
    effectively making the required payment limited recourse to proceeds of the
    securitized assets — appears to modify only the required payment of
    interest. The required payment of “par value” does not appear to be subject
    to a similar limitation of recourse. Thus, it is unclear what “par value”
    would be in the case of obligations that have experienced a writedown
    following realized losses in respect of principal in the asset pool.
    Similarly, the “par value” of securities that are in the form of residual or
    equity instruments is uncertain. Finally, the requirement for payment of
    “par value” plus “accrued interest” does not appear to include any makewhole
    payments or redemption premiums.

    In either of the alternatives above, the deemed consent of the FDIC is
    subject to the proviso that “no involvement of the receiver or conservator
    is required” other than consents, waivers or transfers “in the ordinary
    course of business.”33 Also, the Safe Harbor Rule further provides that
    prior to a repudiation described above, or prior to the effectiveness of a
    consent following a monetary default, the FDIC (i) consents to the servicer
    making (or as servicer shall make) payments to the extent actually received
    on the financial assets in accordance with the securitization documents and
    (ii) consents to the servicer conducting its servicing activity (or as
    servicer shall perform such activity) in accordance with the transaction

    E. Loan Participations

    The Safe Harbor Rule distinguishes “securitizations” from “participations”
    for purposes of the provisions of the rule. Thus, with respect to “transfers
    of financial assets made in connection with participations,” the disclosure,
    risk retention, servicing standards, and other of the principal conditions
    to the Safe Harbor Rule are not applicable. The only condition imposed by
    Section 360.6(d)(1) of the Safe Harbor Rule on participations is that “such
    transfer satisfies the conditions for*sale* accounting treatment” under
    GAAP. This favorable treatment for participations is expressly extended to
    “last-in, first-out” participations, provided that “the transfer of a
    portion of the financial asset” – as opposed to the entire participation
    interest – satisfies the conditions for *sale* accounting treatment.34

    *III. The Implications of the New Safe Harbor*

    The Safe Harbor Rule has important implications for securitization
    transactions effected after December 31, 2010. While the primary
    requirements of the rule – additional disclosure and risk retention
    requirements – overlap with parallel new requirements under Reg AB II and
    under the Dodd-Frank Act, respectively, the Safe Harbor Rule has significant
    incremental effects in these two areas. In the area of risk retention, the
    effect is primarily one of timing. The Safe Harbor Rule conditions become
    effective on December 31, 2010, whereas the Dodd-Frank implementing
    regulations will become effective one year after publication (for
    residential mortgage backed securities) and two years after publication (for
    other ABS), respectively, of the relevant implementing rules. As a result of
    the Safe Harbor Rule, therefore, the economic consequences of the 5 percent
    risk retention requirement will be felt before the implementation period
    envisioned by the Dodd-Frank Act.

    In the case of the additional disclosure conditions, the Safe Harbor Rule
    requirements extend to circumstances beyond those contemplated by Reg AB II.
    While proposed amendments to Rule 144A, Rule 144 and Regulation D under the
    Securities Act in connection with Reg AB II may also compel privately placed
    ABS transactions to meet the disclosure and reporting requirements similar
    to those applicable to registered transactions, these amendments as proposed
    would only require such disclosure and reporting upon the request of
    investors. No such “upon request” condition is present in the Safe Harbor
    Rule. Moreover, the Safe Harbor Rule’s conditions would apply even in
    circumstances not reached by Reg AB II, such as in transactions that are
    exempt under Section 3 of the Securities Act, Section 4(2) private
    placements and related “Section 4(1 ½)” secondary transfers, and
    transactions exempt under Regulation S.

    The Safe Harbor Rule may also create investor uncertainty and impair
    investor expectations for securitizations that are accounted for as secured
    financings (generally by consolidation of the issuing entity under *FAS* 167),
    due to the absence of complete relief from the repudiation power. First,
    while as noted it is unclear what the “par value” would be of a
    securitization interest not in the form of debt, the provisions of the Safe
    Harbor Rule seem to leave open the ability of the FDIC to reclaim the equity
    or residual value of securitized assets – *i.e.* the value of the
    securitized assets over and above the “par value” of the obligations issued
    in the securitization — in the event of an IDI insolvency. Equity interests
    that are not held by the IDI itself may thus lose the benefit of any gain in
    a receivership of the IDI. Similarly, no adjustment is made in the Safe
    Harbor Rule for obligations that may be trading at a premium or a discount –
    due to interest rate characteristics, currency features, maturity
    characteristics and so on. As noted above, payment at “par value” does not
    appear to include makewholes or other adjustments that might ordinarily be
    payable to address such characteristics. The allocation of prepayment risks
    associated with a mortgage pool among different classes of RMBS – a core
    feature of RMBS structures — would appear to be subject to being upset in
    the event of a repudiation of an RMBS transaction accounted for as a
    financing. The adverse effects on investor expectations would be
    particularly substantial in the case of “interest-only” or “principal-only”

    The Safe Harbor Rule also creates uncertainty as to the effect of changes in
    accounting consolidation treatment that may take place after the initial
    securitization. *FAS* 167 provides for the possibility of reconsideration
    events resulting from changes in the ownership of interests in a VIE and a
    reassessment of what entity is the primary beneficiary that should
    consolidate a VIE. It is thus quite possible that a securitization initially
    accounted for as a *sale* could subsequently be brought on balance sheet by
    an IDI. The Safe Harbor Rule does not address what would happen in such a
    circumstance. Indeed, because the Safe Harbor Rule distinguishes
    securitizations not based on how they are actually accounted for, but on
    whether the *conditions *for *sale* accounting are met, the rule raises the
    prospect that a securitization erroneously accounted for as a *sale* might
    lose the protections of the Safe Harbor Rule after the fact.

    Finally, the Safe Harbor Rule poses problems for “re-REMICs” and other
    re-securitizations of outstanding ABS. As noted above, existing ABS may be
    resecuritized only where the IDI complies with the new disclosure
    requirements as to such ABS on a “drill down” basis. However, agreements for
    existing assets would not give holders the right to obtain all of the
    information required under the Safe Harbor Rule, and no “grandfathering” or
    similar provision applies. This may prove a significant impediment to an IDI
    wishing to use resecuritization techniques to address existing inventories
    of ABS assets. This concern may, however, be mitigated by the carveout
    mentioned above for disclosure for information that is “unknown or not
    available to the sponsor or the issuer after reasonable investigation.”

    *IV. Transactions Outside the Scope of the Safe Harbor Rule*

    It should be remembered that the conditions of the Safe Harbor Rule are not
    regulatory prescriptions. If an IDI does not need to avail itself of the
    safe harbor, it need not comply with the rule. In this respect, the primary
    motivation for compliance with the 2000 Safe Harbor Rule – accounting
    treatment – will no longer apply in most cases to the new Safe Harbor Rule.
    Because many securitizations can no longer be accounted for as off balance
    sheet, even with the benefit of the Safe Harbor Rule, IDIs that formerly
    complied with the safe harbor in order to assure themselves of off balance
    sheet treatment for a securitization have no reason to do so. The practical
    importance of the Safe Harbor Rule largely rests with the requirements of
    rated transactions. Rating agencies have not indicated definitively what
    comfort they might require regarding compliance with the Safe Harbor Rule in
    order to rate securitization interests of an IDI separately from the credit
    risk of the IDI.

    Even in unrated transactions, securitization investors seeking a higher
    degree of certainty as to the results of a possible future FDIC receivership
    may of course also be concerned that an IDI comply with the Safe Harbor
    Rule. Nevertheless, outside the rating agency context, the importance of the
    Safe Harbor Rule is more uncertain. The FDIC has noted that the Safe Harbor
    Rule “is not exclusive, and it does not address any transactions that fall
    outside the scope of the safe harbor or that fail to comply with one or more
    safe harbor conditions.”35 And in the Safe Harbor Rule and accompanying
    memorandum, the FDIC has not asserted that its repudiation power will
    necessarily be applied to a securitization if the safe harbor conditions are
    not satisfied. The FDIC further notes that the repudiation power is not a
    power to avoid asset transfers or recover assets that are sold.36
    Accordingly, many purchases of assets from IDIs in connection with a
    securitization – for example, where the relevant IDI sells assets but is not
    a primary sponsor of the securitization — can and should occur without the
    need for compliance with the safe harbor conditions.

    The FDIC has also not asserted that the repudiation power is any more likely
    to apply to asset pledges or transfers that do not involve securitizations
    and do not comply with the conditions of Safe Harbor Rule. Thus, ordinary
    secured lending, covered bond transactions or other transactions not falling
    within the scope of a defined “securitization”—though they may be subject to
    repudiation—should not suffer any additional consequences for failure to
    comply with the rule. Moreover, while the Safe Harbor Rule seems necessarily
    to raise the prospect of “repudiation” of transactions entered into by
    certain subsidiaries of an IDI – i.e. issuing entities for securitizations
    — as opposed to the IDI itself, the FDIC has not questioned basic legal
    standards of corporate separateness. The FDIC has long had criteria for
    recognizing the legal separation of a corporate subsidiary from an IDI, 37
    and nothing in the materials accompanying the Safe Harbor Rule purports to
    revoke or overturn this guidance.

    Even so, while the Safe Harbor Rule is cast as a non-exclusive safe harbor,
    the FDIC plainly intends the rule to have a prescriptive effect. Whether
    driven by rating agency concerns, a desire for greater investor certainty or
    otherwise, market participants face significant new burdens in complying
    with the conditions of the rule.

  18. OK, this is a long, long read and post, and not about court cases…but about how we find ourselves here in this predicament, and what we should do about it. This guy is way smart…Hernando de Sota….long live de Sota….


    The Obama administration must tackle a problem that has bedeviled the emerging markets for years.

    Wall Street harshly judged U.S. Treasury Secretary Timothy Geithner’s proposals for saving the nation’s banks. His televised remarks in mid-February were supposed to reassure watchers by outlining the Obama administration’s plan for fixing the financial markets, but the market plunged as he spoke. Yet Wall Street was wrong. The lack of details in Geithner’s presentation doesn’t really matter right now. More important is the fact that the administration has finally focused the U.S. on the primary cause of the current economic crisis: the trillions of dollars of “toxic paper” on the balance sheets of financial institutions. This poisonous paper is scaring off potential creditors and investors who lack the legal means to understand what this paper signifies, how much there is, who has it and who might be a bad risk. Finally, policymakers in the White House seem to be coming to grips with the real enemy: the debasement of the legal financial documents that represent value, allow it to be transferred and signal risk.

    Look around: everything of economic value that you own—house and car titles, mortgages, checking accounts, stocks, contracts, patents, other people’s debts (including derivatives)—is documented on paper. You are able to hold, transfer, assess and certify the value of such assets only through documents that have been legally authenticated by a global system of rules, procedures and standards. Ensuring that the relationship between those documents and each of the independent assets they represent is never debased requires a formidable system of legal property rights. That system produces the trust that allows credit and capital to flow and markets to work.

    It is through paper that we connect and know the global economy. It is impossible to do business on a national level—never mind in a globalized marketplace—without reliable legal documentation. Yet this worldwide web of trust is now crashing down. In recent years, governments have debased paper by carelessly allowing into the market a biblical flood of financial instruments derived from bad mortgages nominally valued at some $600 trillion or more—twice as much as all the rest of the world’s legal paper, whether it represents cash, traditional financial assets, or property, tangible or intangible.

    The astonishing quantity of these documents, and the fact that they’re so tangled up and poorly recorded, is making it difficult to determine how much there is, what it’s worth or who holds it. Given that the volume of these derivatives dwarfs all other paper, the mess is also undermining one of the greatest achievements of property law: the power to identify and isolate with precision every asset and every particular interest on that asset. Thus a meager 7 percent default on subprime mortgages that were funded or insured by derivatives—maybe only a few hundred billion dollars worth of toxic paper—is debasing the rest of the economic paper and contaminating the entire economy. Because this toxic paper refers to credit and capital, it affects all economic activity; the loss of trust spares no one, spreading out in all directions and beyond local bubbles, whether subprime housing or dotcom. And then staring you in the face may be the worst recession in modern history.

    U.S. and European authorities find it difficult to believe that the fundamental cause of a recession could be a poorly paperized legal system. But in emerging markets, like the one I come from, the importance of paper is pretty obvious. Most of our people are poor and live in the anarchy of the shadow economy, where their assets and contracts are covered by paper that is endemically toxic: not recorded, not standardized, difficult to identify, hard to locate and with a real value so opaque that ordinary people cannot build trust in each other or be trusted in global markets. In the shadow economies of the developing world, credit paralysis is a chronic condition. So when I look at the recession that has started in the West—triggered by toxic paper—I feel right at home.

    The main challenge for Obama and Geithner is to restore trust in the prime vehicle of credit—not money, which we know how to control, but paper, which we clearly don’t. The overwhelming amount of available credit is made up of proprietary paper, such as mortgages, bonds and derivatives, all of which is not money per se but has some of the financial attributes of money—what economists used to call “moneyness.” To prevent the debasement of paper and adequately infer its value, the Obama administration must turn to well-tested rules ensuring paper’s credibility.

    Among those rules: The derivatives scattered helter-skelter all over thousands of idiosyncratic types of opaque documents must be clarified, categorized, standardized and recorded in publicly accessible registries, like all other property documents. The law must take into account externalities—how all financial transactions affect outside, interested parties (the age-old legal principle of erga omnes, “toward all,” historically developed under property law to protect third parties from the negative consequences of secret deals carried out by aristocracies unaccountable to no one but themselves).

    Moreover, every financial deal must be tethered to the real performance of the originating asset, ensuring that the amount of debt secured on the basis of assets does not become dangerously “out of scale” with those assets underlying the debt—the most prominent cause of a recession, according to the economist John Kenneth Galbraith. And assets can continue to be leveraged and repackaged—but only to improve the value of the original asset. Finally, it must be recognized that clarity and precision are indispensable for creating credit and capital through paper.

    These are the criteria for sorting out toxic assets and preventing any future contagion from causing another recession. The Obama team will also have to educate those who still cling to the hope that the existing market will eventually sort things out—that all that is required is recapitalizing banks, stricter oversight and injecting money into the economy. That won’t be enough. Modern legal markets only work if paper is reliable and people have access to credit and explicit information. “Let the market do its work” now means, in effect, “let the shadow economy do its work.” Yet the main beneficiaries in a shadow economy are vulture capitalists and loan sharks, who devour producers with good credit scores but no credit.

    Still another challenge to Obama is that many of those involved in resolving the crisis now claim that it is virtually impossible to identify and value all the toxic paper now on the financial institutions’ books. Yet in the past U.S. and European lawyers and bureaucrats have proved brilliant at sorting out toxic paper whether it referred to bad debt, confusing claims or opaque legislation. In doing so, they have untangled claims after the California gold rush, picked up the pieces of Europe’s crumbling precapitalist order, converted Japan’s feudal enclaves into a market economy after World War II and reunified Germany after the fall of the Berlin Wall. That’s the process of capitalism: continuous detoxification. And we’re hard at it today, too, in developing countries, searching for toxic paper in our shadow econ-omies—informal titles, licenses, contracts, laundered money and identity documents —in an effort to bring their people into the mainstream.

    The Obama rescue plan must also recognize that governments can no longer delegate the solution exclusively to financial specialists who operate within the narrow context of the derivatives market. As it now stands, the law that governs derivatives lacks the standards required to keep paper tethered to reality, the indicators to size up the damage and the tools to sort out the growing conflicts of interest between the holders of derivative paper and the rest of society. Nor does the financial community have the inclination, the incentives or the economic interest for such a down-and-dirty job.

    It has always been government’s role to establish standards, set and enforce weights and measures, keep records and bring every shadow economy under the rule of law. Escaping this recession requires restoring order, precision and trust to financial paper. That will be a daunting legal and political challenge. But the hard decisions about locating, valuing, and isolating the toxic paper, and figuring out who will foot the bill for the losses—taxpayers, banks or vulture capitalists— will be easier to make the sooner politicians realize that the alternative could be the collapse of the very system that has generated the most prosperity in history—and all hell breaking loose.

    Whole deal here:


  19. To those who thank me, you are more than welcome. I used Ibanez friday in court and defeated a Motion to dismiss by the trustee and the judge loved I had the case (only two hours old). That’s because of people like you who put these things on line that we can use. So thank you. I have a trial date in Oct. A judge who is willing to be educated and listens. Hopefully the case will proceed apace now. The fed quiet title and declaratory judgment will soon to be added to the state court action given the willingness of the judge to listen. However, detailed pleading with common sense approaches that judges understand is what wins these judges. again thanks to each of you

  20. gwen caranchini, thanks from me too as your case and approach very much resemble my situation, and I’m currently reading Clouded Titles as well. Great book BTW.

    Thanks for your contributions.

  21. ok, what clouded titles Dave Krieger and I are doing is that we outline all the deficiencies in the recordings that have been made at the courthouse. We take that delineation of deficiences and write a letter to the title company and say (which you must do if you are seeking a title policy) this is what we believe is deficient and that cloudes the title. Will you issue a policy with or without exceptions or a declination. The title company then sends a letter noting the exceptions which exceptions make a title policy unavailable. The quiet title sets forth the deficiencies in the recordings. We then ask that a court find that the title is clouded irretrieveably and as evidence thereof provide the preliminary title report. We ask that the court publish as well for the statutory time period and we ask for a jury trial on any fact issues. We also ask under the declaratory judgment action availble with a quiet title action under state law that the court find the title is so broken it needs to be lodged solely in my name. That would leave an unsecured note but for the declaratory judgment action which asks that it be found that the note has no value or is null and void because it was split from the dot and/or the purported holders (if they come forward) cannot show value in the note. By publishing on these grounds you are asking the true holder to come forward and prove they are in fact the holder under bsically UCC law that says there must be a holder with proper signatories in a proper chain of title. These two actions once decided (probably on summary judgment) then give rise to the common law causes of action: slander of title, collecting money by an entity having no right to do so, deceptive collection practices, fraud, actions agaisnt the trustee for breach of fiduciary duty, against the servicer for breach of duty, against the pretender lender for breach of duty etc. etc. This is what I have done but note the common law would all come from the clouded title and declaratory judgment action. O and by teh way put a tro in the case so if they attempt to foreclose you are stop them dead and file a lis pendens at the recorder’s office and file a notice attaching a copy of the recorded lis pendens in your lawsuit like I did.

    This is based upon mo law and what I have done. I don’t purport to give legal advice and say this will work for you because I don’t review docs. This works for me because of my own docs on file and not on file. It is based upon personal legal research.

  22. To Jeff, If a homeowner would file suit for TILA violations before default the Federal judge only needs to hear that the plaintiff can CURRENTLY tender after rescission is granted. Homeowners should not “go broke” before legal action.

  23. @ Gwen Caranchini:

    For clarification, is it that you’ve demonstrated to the judge via a preliminary title report that the trustee, who is foreclosing via trustee sale, is the entity that has no standing and is not in the chain of title as a holder of the note, and that fact is illustrated in the preliminary report?

    Or, is it the servicer of the loan that is not in your preliminary title report, and does not hold the note?

    And, which one are you challenging to produce the note, the servicer, the trustee or both?

    I just purchased CloudedTitles, so I’m getting clearer by the minute.

    Thank you for your contributing comments, and knock ’em out!

  24. excuse me if I don’t kno your juris terms–tender??? demurrer is generally a motion to dismiss and why these caess are getting dismissed is beyond me. Reasonable pleading of quiet title with lis pendens should keep any one of these from being dismissed. what grounds are dismissals on–I am shocked given the lack ofownership of the titles and lack of tender of original docs that I am hearing about–in my on case yesterday, in a m/dismiss denied by the trial ct filed by the trustee the judge pointedly asked: do you have the note, have you seen the original note, do you now where it is, has boa said they have it–to which the trustee said “no” and she shook her head. My case is set for trial in oct and she is letting me amend to add iback in a quiet title action removed to fed court because the fed judge will not remand which he agres is a in rem ation which requires the trustee to be parrt of it and the judge won’t do it in fed court. So, I will soon have my entire case again in state court and she has ordered mandatory mediation. Her views ae rather clear in my opinion that I have been getting the run around. With a preliminary title report from chicago title showing my title broken, she agrees that sj is unavailable to them, but may be available t me. So why are people loosing motions to dismiss? Under what theory?

  25. The tender issue is chopping homeowners at the knees, or they are getting defeated at the demurrer stage.

  26. So jeff are they settled for reduced principle low inter loan mods? Or are they foreclosed upon and go away–i just don’t hear about what is happening to those who do sue–but not getting any discovery at all and settling is just well–stupid and unheard of in my somewhat ext. experience.

  27. Gwen, I don’t think most even make it to discovery but I like the K.I.S.S. principle









  31. great comment jan–email me I have something I just learned today taht I will share. I am sure you have my email but I can’t find yours

  32. […] This post was mentioned on Twitter by Eric Chase. Eric Chase said: MBIA IN FIGHT FOR LIFE, SETTLING ON THE SIDE « Livinglies's Weblog: … with the Securities and Exchange Commiss… http://bit.ly/h2TdZq […]

  33. To see succinctly how this has clobbered smaller insurers, I invite you all to view the 10-K reports of Radian Insurance group, of Philadelphia. Radian was a player in MBS insurance, and has now hired Digital Risk Advisors, of Florida, to do forensic reviews of claims. To no surprise, fraud in origination, by brokers, is being found, and Radian is refusing claims.

    If the insurer is finding origination fraud and refusing claims, finding that the loan was fraudulent ab initio, then why should the Obligor pay anything on the same Note?

  34. what I want to know is whether anyone out there–ANYONE AT ALL–has asked for in discovery of the banks who allegedly claim to own their loan, whether their loan was insured in any way and gotten the paperwork on the insurance, when it may have kicked in and whether it paid off the loan–simple discovery requests–HAS ANYONE DONE THAT??? HAS ANYONE ASKED WHETHER A BANK GOT GOV MONEY IN TARP OR STIMULUS OR ANYTHING ELSE AND APPLIED IT TO DEFAULTED LOANS IN OR OUT OF POOLS? WHAT WAS THE RESUULTS?
    its part of my discovery requests but there has been a stay on discovery that is about to be lifted in my case and itis question no. 1–if the note was paid off in whole or in part, WELL END SO MANY DISCUSSIONS–SUMMARY JUDGMENT HERE WE COME

Contribute to the discussion!

%d bloggers like this: