How Wall Street Perverted the 4 Cs of Mortgage Underwriting

MOST POPULAR ARTICLES

COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary CLICK HERE TO GET COMBO TITLE AND SECURITIZATION REPORT

CUSTOMER SERVICE 520-405-1688

Editor’s Comment: 

For thousands of years since the dawn of money credit has been an integral part of the equation.  Anytime a person, company or institution takes your money or valuables in exchange for a promise that it will return your money or property or pay it to someone else (like in a check) credit is involved.  Most bank customers do not realize that they are creditors of the bank in which they deposit their money.  But all of them recognize that on some level they need to know or believe that the bank will be able to make good on its promise to honor the check or pay the money as instructed. 

Most people who use banks to hold their money do so in the belief that the bank has a history of being financially stable and always honoring withdrawals.  Some depositors may look a little further to see what the balance sheet of the bank looks like.   Of course the first thing they look at is the amount of cash shown on the balance sheet so that a perspective depositor can make an intelligent decision about the liquidity or availability of the funds they deposit. 

So the depositor is in essence lending money to the bank upon the assumption of repayment based upon the operating history of the bank, the cash in the bank and any other collateral (like FDIC guarantees).

As it turns out these are the 4 Cs of loan underwriting which has been followed since the first person was given money to hold and issued a paper certificate in exchange. The paper certificate was intended to be used as either a negotiable instrument for payment in a far away land or for withdrawal when directly presented to the person who took the money and issued the promise on paper to return it.

Eventually some people developed good reputations for safe keeping the money.  Those that developed good reputations were allowed by the depositors to keep the money for longer and longer periods.  After a while, the persons holding the money (now called banks) realized that in addition to charging a fee to the depositor they could use the depositor’s money to lend out to other people.  The good banks correctly calculated the probable amount of time for the original depositor to ask for his money back and adjusted loan terms to third parties that would be due before the depositor demanded his money.

The banks adopted the exact same strategy as the depositors.  The 4 Cs of underwriting a loan—Capacity, Credit, Cash and Collateral—are the keystones of conventional loan underwriting. 

The capacity of a borrower is determined by their ability to repay the debt without reference to any other source or collateral.  For the most part, banks successfully followed this model until the late 1990s when they discovered that losing money could be more profitable than making money.  In order to lose money they obviously had to invert the ratios they used to determine the capacity of the borrower to repay the money.  To accomplish this, they needed to trick or deceive the borrower into believing that he was getting a loan that he could repay, when in fact the bank knew that he could not repay it.  To create maximum confusion for borrowers the number of home loan products grew from a total of 5 different types of loans in 1974 to a total of 456 types of loans in 2006.  Thus the bank was assured that a loss could be claimed on the loan and that the borrower would be too confused to understand how the loss had occurred.  As it turned out the regulators had the same problem as the borrowers and completely missed the obscure way in which the banks sought to declare losses on residential loans.

Like the depositor who is trusting the bank based upon its operating history, the bank normally places its trust in the borrower to repay the loan based upon the borrowers operating history which is commonly referred to as their credit worthiness, credit score or credit history.  Like the capacity of the borrower this model was used effectively until the late 1990s when it too was inverted.  The banks discovered that a higher risk of non-payment was directly related to the “reasonableness” of charging a much higher interest rate than prevailing rates.  This created profits, fees and premiums of previously unimaginable proportions.  The bank’s depositors were expecting a very low rate of interest in exchange for what appeared as a very low risk of nonpayment from the bank.  By lending the depositor’s money to high risk borrowers whose interest rate was often expressed in multiples of the rate paid to depositors, the banks realized they could loan much less in principal than the amount given to them by the depositor leaving an enormous profit for the bank.  The only way the bank could lose money under this scenario would be if the loan was actually repaid.  Since some loans would be repaid, the banks instituted a power in the master servicer to declare a pool of loans to be in default even if many of the individual loans were not in default.  This declaration of default was passed along to investors (depositors) and borrowers alike where eventually both would in many, if not most cases, perceive the investment as a total loss without any knowledge that the banks had succeeded in grabbing “profits” that were illegal and improper regardless if one referred to common law or statutory law.

Capacity and credit are usually intertwined with the actual or stated income of the borrower.  Most borrowers and unfortunately most attorneys are under the mistaken belief that an inflated income shown on the application for the loan, subjects the borrower to potential liability for fraud.  In fact, the reverse is true.  Because of the complexity of real estate transactions, a history of common law dating back hundreds of years together with modern statutory law, requires the lender to perform due diligence in verifying the ability of the borrower to repay the loan and in assessing the viability of the loan.  Some loans had a teaser rate of a few hundred dollars per month.  The bank had full knowledge that the amount of the monthly payment would change to an amount exceeding the gross income of the borrower.   In actuality the loan had a lifespan that could only be computed by reference to the date of closing and the date that payments reset.  The illusion of a 30-year loan along with empty promises of refinancing in a market that would always increase in value, led borrowers to accept prices that were at times a multiple of the value of the property or the value of the loan.  Banks have at their fingertips numerous websites in which they can confirm the likelihood of a perspective borrower to repay the loan simply by knowing the borrower’s occupation and geographical location.  Instead, they allowed mortgage brokers to insert absurd income amounts in occupations which never generate those levels of income.  In fact, we have seen acceptance and funding of loans based upon projected income from investments that had not yet occurred where the perspective investment was part of a scam in which the mortgage broker was intimately involved.  See Merendon Mining scandal.

The Cash component of the 4 Cs.  Either you have cash or you don’t have cash.  If you don’t have cash, it’s highly unlikely that anyone would consider a substantial loan much less a deposit into a bank that was obviously about to go out of business.   This rule again was followed for centuries until the 1990s when the banks replaced the requirement of cash from the borrower with a second loan or even a third loan in order to “seal the deal”.  In short, the cash requirement was similarily inverted from past practices.  The parties involved at the closing table were all strawmen performing fees for service.  The borrower believed that a loan underwriting was taking place wherein a party was named on the note as the lender and also named in the security instrument as the secured party. The borrower believed that the closing could never have occurred but for the finding by the “underwriting lender” that the loan was proper and viable.  The people at the closing table other than the borrower, all knew that the loan was neither proper nor viable.  In many cases the borrower had just enough cash to move into a new house and perhaps purchase some window treatments.  Since the same credit game was being played at furniture stores and on credit cards, more money was given to the borrower to create fictitious transactions in which furniture, appliances, and home improvements were made at the encouragement of retailers and loan brokers.  Hence the cash requirement was also inverted from a positive to a negative with full knowledge by the alleged bank who didn’t bother to pass this knowledge on to its “depositors” (actually, investors in bogus mortgage bonds). 

Collateral is the last of the 4 Cs in conventional loan underwriting.  Collateral is used in the event that the party responsible for repayment fails to make the repayment and is unable to cure it or work out the difference with the bank.  In the case of depositors, the collateral is often viewed as the full faith and credit of the United States government as expressed by the bank’s membership in the Federal Deposit Insurance Corporation (FDIC).  For borrowers collateral refers to property which they pledge can be used or sold to satisfy obligation to repay the loan.  Normally banks send one or even two or three appraisers to visit real estate which is intended to be used as collateral.  The standard practice lenders used was to apply the lower appraisals as the basis for the maximum amount that they would lend.  The banks understood that the higher appraisals represented a higher risk that they would lose money in the event that the borrower failed to repay the loan and property values declined.  This principal was also used for hundreds of years until the 1990s when the banks, operating under the new business model described above, started to run out of people who could serve as borrowers.  Since the deposits (purchases of mortgage bonds) were pouring in, the banks either had to return the deposits or use a portion of the deposits to fund mortgages regardless of the quality of the mortgage, the cash, the collateral, the capacity or any other indicator that a normal reasonable business person would use.  The solution was to inflate the appraisals of the real estate by presenting appraisers with “an offer they couldn’t refuse”.  Either the appraiser came in with an appraisal of the real property at least $20,000 above the price being used in the contract or the appraiser would never work again.  By inflating the appraisals the banks were able to move more money and of course “earn” more fees and profits. 

The appraisals were the weakest link in the false scheme of securitization launched by the banks and still barely understood by regulators.  As the number of potential borrowers dwindled and even with the help of developers raising their prices by as much as 20% per month the appearance of a rising market collapsed in the absence of any more buyers.

Since all the banks involved were holding an Ace High Straight Flush, they were able to place bets using insurance, credit default swaps and other credit enhancements wherein a movement of as little as 8% in the value of a pool would result in the collapse of the entire pool.  This created the appearance of losses to the banks which they falsely presented to the U.S. government as a threat to the financial system and the financial security of the United States.  Having succeeded in terrorizing the executive and legislative branches and the Federal Reserve system, the banks realized that they still had a new revenue generator.  By manufacturing additional losses the government or the Federal Reserve would fund those losses under the mistaken belief that the losses were real and that the country’s future was at stake.  In fact, the country’s future is now at stake because of the perversion of the basic rules of commerce and lending stated above.  The assumption that the economy or the housing market can recover without undoing the fraud perpetrated by the banks is dangerous and false.  It is dangerous because more than 17 trillion dollars in “relief” to the banks has been provided to cover mortgage defaults which are at most estimated at 2.6 trillion.  The advantage given to the megabanks who accepted this surplus “aid” has made it difficult for community banks and credit unions to operate or compete.   The assumption is false because there is literally not enough money in the world to accomplish the dual objectives of allowing the banks to keep their ill gotten gains and providing the necessary stimulus and rebuilding of our physical and educational infrastructure.  

The simple solution that is growing more and more complex is the only way that the U.S. can recover.  With the same effort that it took in 1941 to convert an isolationist largely unarmed United States to the most formidable military power on the planet, the banks who perpetrated this fraud should be treated as terrorists with nothing less than unconditional surrender as the outcome.  The remaining 7,000 community banks and credit unions together with the existing infrastructure for electronic funds transfer will easily allow the rest of the banking community to resume normal activity and provide the capital needed for a starving economy. 

See article:  www.kcmblog.com/2012/04/05/the-4-cs-of-mortgage-underwriting-2

BAC assigned a note in 2010 that they sold in 2003

Editor’s Note: Recontrust appears to be wholly owned by Bank of America. This particular deal looks like a “reconstituted” mortgage backed security comprised of new securities which are “backed” by old mortgage backed securities which in turn are backed by a list of “loans” which may or may not exist, and which certainly have at least in part been paid in whole or in part through insurance, credit default swaps and federal bailout.

From the comment Section of the Blog:

ReconTrust filed a NOD on behalf of BAC “servicer” for GRS Mort. Trust 2003-9, seven days later filed an assignment to GSR Mort. Trust of the deed of trust and note dated 8-13-03. I had no notice of GRS or Recontrust until seven years later. It looks like BAC assigned a note in 2010 that they sold in 2003. It also appears a pattern of fraud is occuring with all of us as their victims. If anyone knows what GSR Mortgage stands for please inform. I any one is interested in exposing the pattern let me know. I have 40 days before the notice of sale. I’m also pursuing this pro se.

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.

SCANDAL BIGGER THAN BERNIE: NY POST

THANK YOU PAUL FROM ATLANTA: YOU DEFINITELY HAVE YOUR EYE ON THE RIGHT BALL.

And then there is this one which described the scale of the Wall Street schemes that brought all of us to this point. People are just starting to realize that they are all citizens of the same country and that if financial firms put the fix on 20 million people its effect will be felt by all 300 million citizens. This isn’t about personal responsibility — it’s about criminal responsibility. This isn’t about ideology — it’s about morality. This isn’t about collecting a legal debt — it’s about stealing money and property. The Madoff scheme is a tiny fraction of one percent of the scale of the Wall Street derivative scheme. Compare $5 to $10,000 if you want to look at numbers you can comprehend. The real numbers are $50 billion (Madoff) and $500+ trillion (Wall Street).

SCANDAL BIGGER THAN BERNIE

Last Updated: 7:42 PM, August 13, 2009

Posted: 7:42 PM, August 13, 2009

HARRY Markopolos — the whistleblower on Bernie Madoff who proved to be much smarter than the SEC — says there are evildoers out there who will make the Ponzi scum “look like small-time.” Markopolos gave a speech to 400 of the faithful at the Greek Orthodox Church in Southampton and predicted major scandals will soon be revealed about the unregulated, $600 trillion, credit-default swap market. “To put it in simple terms, it is like buying fire insurance policies from five different insurance companies on your neighbor’s house and then burning down the house,” he said. After his lecture, Hampton Sheet publisher Joan Jedell reports Markopolos was feted at a dinner at Nello Summertimes hosted by John Catsimatidis and his wife, Margo, who were joined by Al D’Amato and Greek shipping magnates Nicholas Zoullas and Spiros Milonas.

%d bloggers like this: