Why Are the Banks Abandoning Homes? Hundreds of Thousands of Homes Bulldozed After Foreclosure

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No reasonable person would abandon this many homes after taking the trouble to foreclose on them. There is an obvious preference for foreclosure over workouts, modifications, short sales, resales, and other tools. This shows clearly that loss mitigation is not one of the factors in the minds of those who say they represent investors or REMIC trusts.

So they must have a reason to force the sale of a home other than loss mitigation. The people initiating these foreclosures and subsequent abandonment are acting against the interest of the investors who actually put up the money for the “securitization fail” that I identified and Adam Levitin named.

Thus it must be concluded that those who control the foreclosure process at the big investment banks benefit in some way other than loss mitigation. That can only mean one of two things:

  • The people making the decision make more money foreclosing than in pursuing workouts, modifications, or other settlements and/or
  • The people making the decision are using the foreclosing process to institutionalize “securitization fail” and thus avoid trillions of dollars in liability owed to the investors, insurers, guarantors, counterparties on hedge products, the borrowers and local, state and federal government.

This can only mean that the purpose of the foreclosure is not to mitigate damages to the actual lender or creditor. They don’t want performing loans even if it means that the homeowner is paying off the entire balance of the loan. And they make it difficult if not impossible to get a correct figure for a payoff.

So if the money is not the issue, and the house is not really in issue why do they pursue foreclosures, fabricate documents to do it and use robo-signers and robo witnesses to force through foreclosures on homes they will only abandon at the end of the process?

Should we not be asking whether good faith and clean hands have been established to justify the equitable remedy of forfeiture of the home?

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In South Florida news this morning, local Sheriffs are banding together to board up more than 1,000 homes in Lake Worth. In each case the home was foreclosed. In most cases, the homeowner applied for a modification and was told they could not apply until they were 90 days in arrears. In most cases, all efforts at modification were turned down under the guise that the investors refused to modify or workout the loan. That was most probably a lie. Neither the servicer nor the Trustee or other “enforcer” ever went to the investors with a single workout plan.

Continuous allegations of fraudulent foreclosures on predatory and fraudulent loans have been “settled” but not with the effected homeowners nor with local governments and homeowner associations who are deeply effected by this tragic fraud on the courts, the borrowers, the governments, and the society at large — as millions of jobs were lost and hundreds of thousands of businesses closed down as their customers were displaced from their homes (around 16 Million people directly displaced by fraudulent foreclosures thus far).

As foreclosures continue to increase in number (despite news reports to the contrary) more homeowners are being forced out of their homes, including many that were in the family for generations. The houses, now empty, lay dormant sometimes for 6 years or more before the actual “auction” sale takes place. During that time, miscreants move in creating meth labs, crack houses, safe houses for gangs etc. In the end the property is abandoned, and it leads to more foreclosures and more abandonment. Eventually entire neighborhoods are converted to ghost towns reducing the property values to zero — perfect for an intermediary who wants to cheat investors. The foreclosure sale and abandonment show the recovery at zero. Investors are even told that they should be happy that they didn’t incur further liability than their investment in the property.

In most states, effort to reclaim the homes have failed because they were stripped of the vital mechanical systems and even building materials — a new industry resulting from this process of foreclosure and abandonment. The local property taxes are unpaid for years — leading to forever where the homes are completely abandoned and demolished. But the local government is stuck with the bill because with the new construction from the false boom created by the banks they expanded infrastructure and social services (police, fire, medical etc.).

Meanwhile the same local government is being told that their investment in mortgage bonds have produced losses. So they are stuck with the double whammy of non-payment of property and other taxes plus a direct loss incurred from the “securitization fail” scheme. I believe that attorneys ought to take cases on contingency where local government files suit against the banks. The allegation should be made that not only did the banks NOT act in good faith, they acted in BAD faith because they had no right to foreclose on false papers created at the closing of a loan wherein the borrower and investors were unaware of the true nature of the transaction.

EMINENT DOMAIN IS NOW IN PLAY: MORTGAGES BEING SEIZED

One of the interesting things about the news media and its relationship with the Wall Street banks is that the real events happening out in the marketplace are completely disregarded by virtually everyone if the event would encourage similar efforts to challenge or replace the toxic mortgages that litter the landscape of the financial marketplace. One such series of events includes eminent domain. When it was first proposed it was quite a bit of publicity about it and if you relied upon the mainstream media reporting financial information you would have assumed that it was an idea that simply came and went.

Not so fast. Eminent domain has been  in use for at least one year as municipalities condemned the mortgage, and seize it for its real value. In some cases the banks are working to have the value declared as what the Federal Reserve is paying: 100%. In most cases the value is pegged lower and the savings are passed on to homeowner who now no longer need to leave their homestead and can pay a newly reconstituted mortgage that reflects economic reality, giving them the roof over their heads and the possibility of building equity again.

It will really get interesting when eminent domain results in questioning the ownership and the money trail establishing the value of the mortgage. It seems that at least one entity, Mortgage Resolution Partners LLC , has realized that there is value in this business plan as we have previously discussed on this blog several times.  The real value of the mortgages is probably zero or close to that amount. In fact it may well be that the value of the mortgages is actually negative as I have previously discussed in other articles on this blog.

That presents an unparalleled profit opportunity for intermediaries who create or promote a situation in which the old toxic mortgage gets “paid off” and a new mortgage is essentially created out of the old one but does not possess any of the toxic qualities of the securitized mortgages. The interesting part of this of course is that the new mortgages will probably be sold into the secondary market and securitized. Perhaps this time they will do it right. If this catches on in a big way despite bank efforts to hush it up, then the foreclosure crisis will be over.

Steven Gluckstern, who’s spent more than a year pushing local governments to seize mortgages from bond trusts to cut balances and help homeowners, is renewing attempts with backing from cities in California and Nevada.

To read the entire article, go to http://www.bloomberg.com/news/2013-07-17/eminent-domain-plan-decried-by-doubleline-sees-new-life.html

Local Governments Weigh Eminent Domain to Stop Foreclosures

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Editor’s Comment:  

Picking up on a thought from Schiller, San Bernardino County is taking a long hard look at invoking the government’s power of eminent domain to seize mortgages, sell them to investors at market value and provide a basis for the homeowners to stay in the home based upon the reality of the marketplace without the corruption of data created by the Wall Street banks.

I did a little research on this idea and while it is a bit of a stretch it does not appear to be excluded from the power of eminent domain to claim the right to purchase the loans at fair market value and resell them to investors. Many properties have been seized by local government only to allow private developers to build highrise luxury towers on the same property.

All this does is force the issue of an open fair free market system and take away the power of the banks to manipulate the market for mortgages and housing. As it stands, these mortgages are blighting hundreds of neighborhoods in hundreds of cities. The basis of invoking the power is classic and permissible. Whether it can be or will be allowed by the courts is another matter.

One way of looking at it is to presume to know the defense: that eminent domain is not used for mortgages and then split hairs as to whether a mortgage is an interest in property that could be subject to eminent domain. That fails because nearly all properties taken by eminent domain have mortgages on them and the mortgages get paid in the same way — fair market value. What happens to the rest of the mortgage balance claimed by the lender? Well that remains to be seen.

If many local governments start invoking this power, it will gain momentum.

San Bernardino County Weighs Eminent Domain to Fight Foreclosures

The county, along with Ontario and Fontana, wants to use eminent domain to seize underwater mortgages from investors and restructure them to help borrowers keep the homes.

By Alejandro Lazo

A plan by San Bernardino County to seize mortgages and restructure them for underwater homeowners using eminent domain is perhaps the most aggressive example of how local governments are seeking new ways to combat foreclosure.

The cities of Ontario and Fontana are partnering with the county to create a Homeownership Protection Program that would use private funds to acquire underwater mortgages from investors. The county and the two cities have created a joint authority to explore and possibly enact the plan, and the first public meeting of that authority will be held next week.

David Wert, a spokesman for the county, said the program is worth exploring because it could offer a solution to one of the region’s most entrenched problems: the vast number of loans that are stuck underwater, with more money owed than the property is worth. If the program were to go countywide, it could benefit 20,000 to 30,000 homeowners, he said.

“The only thing we are doing at this point is conducting a conversation,” Wert said. “But the reason the county is interested in talking about this is because this is a proposal that could — if everything checks out — address the problem on a fairly large scale.”

Although still in its initial stages, the aggressive proposal has attracted controversy. A number of banking, financial and business groups oppose it, contending that seizing mortgages would raise constitutional issues and could increase lending costs in those cities.

The California Mortgage Bankers Assn., the American Bankers Assn. and the American Securitziation Forum, along with several other financial groups, sent a letter of opposition to the county and the two cities.

“We believe that the contemplated use of eminent domain raises very serious legal and constitutional issues,” the letter read. “It would also be immensely destructive to U.S. mortgage markets by undermining the sanctity of the contractual relationship between a borrower and creditor, and similarly undermining existing securitization transactions.”

Dustin Hobbs, a spokesman for the California Mortgage Bankers Assn., said the program also could hurt the local housing market.

“It could be devastating,” Hobbs said. “If investors are unsure as to the disposition of mortgages in San Bernardino County and in Fontana and Ontario, it could really curtail lending in the area, and if not curtail, certainly increase costs for new loans.”

San Bernardino County’s plan is the latest of several measures by local governments to fight foreclosures and the problems often associated with resulting neglect: crime and blight.

Chicago passed an ordinance last year that requires banks and other financial institutions to maintain vacant properties that have been foreclosed upon.

Oakland has instituted a blight program that would require banks to register, inspect and maintain homes that are in foreclosure. Cleveland has been using a land bank program to tear down foreclosed homes.

Legal experts said the San Bernardino County proposal was one of the first initiatives to try to strike at the problem before a home is in the foreclosure process.

At this point in the planning, only homeowners who are current on their mortgage payments would be allowed to participate in the program, which would target mortgages that have been securitized and sold to private investors. That would exclude loans owned or backed by mortgage titans Fannie Mae and Freddie Mac. The acquired loans would be restructured, lowering the amount owed, with the intent of helping the owner keep the home.

The plan was first proposed to the county by a San Francisco firm named Mortgage Resolution Partners. The firm has employed investment banks Evercore Partners and Westwood Capital to raise money for the initiative from private investors.

Kurt Eggert, a professor of law at Chapman University, said a sticking point could be whether the investors are able to make a profit on the transactions. He said he liked that the plan, unlike efforts elsewhere, was an attempt to get ahead of the problem.

“The alternatives too often are just cities cleaning up afterward, and getting stuck with the mess, and getting stuck with the foreclosures and the abandoned buildings,” he said. “It is good to see cities trying to do something proactive.”

Cornell Law Professor Robert C. Hockett advised Mortgage Resolution Partners on the design of the proposal. The initiative should pass muster in courts because they have had a long tradition of upholding cities’ eminent domain powers as long as the valuation methods used to acquire properties are sound, Hockett said.

It particularly makes sense to use eminent domain to seize underwater mortgages that have been securitized, he said, because often those mortgages can’t be sold at market value for legal reasons. Often, those loans must be sold at face value — a higher price — because of the contracts governing them, he said.

“The fact they can’t be marketed is the reason we are using eminent domain,” Hockett said. “This is actually a pro-market solution.”


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We now have a growing group of unlikely bedfellows — investors, homeowners and local governments who were all duped and whose claims are being treated as though each one was unique when in fact the entire plan was a highly organized crime. Add the Federal government to that group who has also demanded “buy-back” of fake mortgages and fake mortgage bonds, although it is highly probable that the government was complicit, certainly in the BUSH administration when the Government and the Fed started all these bailout programs whose total seems to exceed the total of ALL credit that was extended in the original transactions!?!

MY QUESTION IS WHETHER DIMON IS RIGHT: DOES HE LIVE IN A COMPLETELY RISK-FREE ENVIRONMENT OR ARE WE GOING TO APPLY THE LAW TO HIM? GOD HELP US IF HIS ASSUMPTION IS CORRECT.

THE MORE IMPORTANT QUESTION IS WHETHER WE ARE FINALLY GOING TO MAKE THE OBVIOUS CORRECTION OF AN OBVIOUS LIE ABOUT THE VALUE OF THE PROPERTIES AND THE ELABORATELY CONSTRUCTED ILLUSION OF “GROWTH” ? IT ISN’T “PRINCIPAL REDUCTION” TO CUT IT DOWN TO THE REAL FIGURE THAT SHOULD HAVE BEEN USED — IT’S PRINCIPAL CORRECTION.

STATES, COUNTIES, CITIES, TOWNS, INVESTORS AND HOMEOWNERS CAN ONLY GET OUT FROM UNDER THE ILLUSION OF DEBT BY ACKNOWLEDGING THE OBVIOUS — IT ISN’T REALLY THERE IF YOU APPLY THE LAW. IT’S ONLY THERE IF YOU APPLY UNBOUNDED POWER.

EDITOR’S COMMENT: Time for local government to start seeking debt relief and doing those securitization reports and research. Whether they received money from the banks or not, officials in local government are being forced to face the reality that they are presiding over the collapse of our social system for lack of money.

They are in debt — and the amount of debt so vastly exceeds their ability to pay or any prospect to pay that defaults are inevitable — including strategic defaults and bankruptcies where the debt is modified downward. In other words, they are in the same boat as the homeowners.

Actually they are worse off because Wall Street had the nerve to sell local governments triple-A rated mortgage bonds that were worthless, putting them both in the same boat as homeowners and the same boat as other investors.

And if you dig deeper you will connect the dots — the appraisal fraud and other misleading information led these municipalities, towns and counties into planning and for phenomenal growth in demand for services over wider geographical areas, each local government believing that their revenue stream and population would grow at a rate that was both unprecedented and unsupported by any economic fundamentals. They are now stuck with debt to pay for services, they won’t deliver, roads they won’t build, and buildings that are being abandoned or sold.

In plain language, the argument that the crisis grew from greedy homeowners must also be extended to greedy politicians who intentionally bankrupted their cities and towns in the misguided attempt to make a fast buck. Few people will argue whether people are greedy, whether they are homeowners or politicians, but the argument that they would intentionally put themselves in a position of drowning in debt is absurd. There is only one reason this all happened — Wall Street sales machine went to work selling people on “concept” and funding it with other people’s money to create a vast illusion for which we are all paying whether we  participated or not.

The astonishing reversal of fortune for virtually all Americans (except a select few who continue to lie about what they did and when they knew what they were doing) and all their societal structures, governments and government services (police, fore, medical, education etc) is in stark contrast to the massive profits and bonuses that continue to be reported and paid on Wall Street. The entire country has been tilted past the tipping point, so that everything of value went from the the nation as a whole to Wall Street.

In a NY Times Magazine article on Jamie Dimon he continues the BIG LIE strategy that Moynihan over at BofA is using: we had didn’t realize the extent of the lying on stated income loans. He’s staying on message because it is working. As a group, most of us still want to believe and do believe that our system will not break down, but it IS breaking down. The process is already underway. Dimon’s current lie is intended to distract us from considering that the lie was created by him and his officers and employees. The lie works because you must take the time away from your job-hunting and ask yourself how all those applications were filled with bad information without anyone knowing about it. “Due diligence,” a term coined on Wall Street for inspecting the chicken before you buy it, is NEVER overlooked.

Countrywide, Chase, Citi, Goldman and others lied about the quality of the loans and the values of the real property and the documentation of the loans, notes and mortgages because they could. They controlled the entire apparatus. The sheer size made it look “institutionalinstead of organized crime. Of course they knew, but they were acting in a totally risk-free environment because they were using other people’s money — investors to whom they lied with the same lies that were told to borrowers — we have reviewed the application, verified the data, verified the value of the property, and the loan meets with underwriting standards. The loan is approved. Or in the case of local government, the bond is approved, the underwriting and selling of it shall begin.

We now have a growing group of unlikely bedfellows — investors, homeowners and local governments who were all duped and whose claims are being treated as though each one was unique when in fact the entire plan was a highly organized crime. Add the Federal government to that group who has also demanded “buy-back” of fake mortgages and fake mortgage bonds, although it is highly probable that the government was complicit, certainly in the BUSH administration when the Government and the Fed started all these bailout programs whose total seems to exceed the total of ALL credit that was extended in the original transactions!?!

MY QUESTION IS WHETHER DIMON IS RIGHT: DOES HE LIVE IN A COMPLETELY RISK-FREE ENVIRONMENT OR ARE WE GOING TO APPLY THE LAW TO HIM? GOD HELP US IF HIS ASSUMPTION IS CORRECT.

THE MORE IMPORTANT QUESTION IS WHETHER WE ARE FINALLY GOING TO MAKE THE OBVIOUS CORRECTION OF AN OBVIOUS LIE ABOUT THE VALUE OF THE PROPERTIES AND THE ELABORATELY CONSTRUCTED ILLUSION OF “GROWTH” ? IT ISN’T PRINCIPAL REDUCTION TO CUT IT DOWN TO THE REAL FIGURE THAT SHOULD HAVE BEEN USED — IT’S PRINCIPAL CORRECTION.

STATES, COUNTIES, CITIES, TOWNS, INVESTORS AND HOMEOWNERS CAN ONLY GET OUT FROM UNDER THE ILLUSION OF DEBT BY ACKNOWLEDGING THE OBVIOUS — IT ISN’T REALLY THERE IF YOU APPLY THE LAW. IT’S ONLY THERE IF YOU APPLY UNBOUNDED POWER.

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Mounting State Debts Stoke Fears of a Looming Crisis

By MICHAEL COOPER and MARY WILLIAMS WALSH

The State of Illinois is still paying off billions in bills that it got from schools and social service providers last year. Arizona recently stopped paying for certain organ transplants for people in its Medicaid program. States are releasing prisoners early, more to cut expenses than to reward good behavior. And in Newark, the city laid off 13 percent of its police officers last week.

While next year could be even worse, there are bigger, longer-term risks, financial analysts say. Their fear is that even when the economy recovers, the shortfalls will not disappear, because many state and local governments have so much debt — several trillion dollars’ worth, with much of it off the books and largely hidden from view — that it could overwhelm them in the next few years.

“It seems to me that crying wolf is probably a good thing to do at this point,” said Felix Rohatyn, the financier who helped save New York City from bankruptcy in the 1970s.

Some of the same people who warned of the looming subprime crisis two years ago are ringing alarm bells again. Their message: Not just small towns or dying Rust Belt cities, but also large states like Illinois and California are increasingly at risk.

Municipal bankruptcies or defaults have been extremely rare — no state has defaulted since the Great Depression, and only a handful of cities have declared bankruptcy or are considering doing so.

But the finances of some state and local governments are so distressed that some analysts say they are reminded of the run-up to the subprime mortgage meltdown or of the debt crisis hitting nations in Europe.

Analysts fear that at some point — no one knows when — investors could balk at lending to the weakest states, setting off a crisis that could spread to the stronger ones, much as the turmoil in Europe has spread from country to country.

Mr. Rohatyn warned that while municipal bankruptcies were rare, they appeared increasingly possible. And the imbalances are so large in some places that the federal government will probably have to step in at some point, he said, even if that seems unlikely in the current political climate.

“I don’t like to play the scared rabbit, but I just don’t see where the end of this is,” he added.

Resorting to Fiscal Tricks

As the downturn has ground on, some of the worst-hit cities and states have resorted to fiscal sleight of hand to stay afloat, helping them close yawning budget gaps each year, but often at great future cost.

Few workers with neglected 401(k) retirement accounts would risk taking out second mortgages to invest in stocks, gambling that the investment gains would be enough to build bigger nest eggs and repay the loans.

But that is just what Illinois, which has been failing to make the required annual payments to its pension funds for years, is doing. It borrowed $10 billion in 2003 and used the money to invest in its pension funds. The recession sent their investment returns below their target, but the state must repay the bonds, with interest. The solution? Illinois sold an additional $3.5 billion worth of pension bonds this year and is planning to borrow $3.7 billion more for its pension funds.

It is the long-term problems of a handful of states, including California, Illinois, New Jersey and New York, that financial analysts worry about most, fearing that their problems might precipitate a crisis that could hurt other states by driving up their borrowing costs.

But it is the short-term budget woes that nearly all states are facing that are preoccupying elected officials.

Illinois is not the only state behind on its bills. Many states, including New York, have delayed payments to vendors and local governments because they had too little cash on hand to make them. California paid vendors with i.o.u.’s last year. A handful of other states, worried about their cash flow, delayed paying tax refunds last spring.

Now, just as the downturn has driven up demand for state assistance, many states are cutting back.

The demand for food stamps has been rising significantly in Idaho, but tight budgets led the state to close nearly a third of the field offices of the state’s Department of Health and Welfare, which take applications for them. As states have cut aid to cities, many have resorted to previously unthinkable cuts, laying off police officers and closing firehouses.

Those cuts in aid to cities and counties, which are expected to continue, are one reason some analysts say cities are at greater risk of bankruptcy or are being placed under outside oversight.

Next year is unlikely to bring better news. States and cities typically face their biggest deficits after recessions officially end, as rainy-day funds are depleted and easy measures are exhausted.

This time is expected to be no different. The federal stimulus money increased the federal share of state budgets to over a third last year, from just over a quarter in 2008, according to a report issued last week by the National Governors Association and the National Association of State Budget Officers. That money is set to run out next summer. Tax collections, meanwhile, are not expected to return to their pre-recession levels for another year or two, given that the housing market and broader economy remain weak and that unemployment remains high.

Scott D. Pattison, the budget association’s director, said that for states, next year could be “the worst year of this four- or five-year downturn period.”

And few expect the federal government to offer more direct aid to states, at least in the short term. Many members of the new Republican majority in the House campaigned against the stimulus, and Washington is debating the recommendations of a debt-reduction commission.

So some states are essentially borrowing to pay their operating costs, adding new debts that are not always clearly disclosed.

Arizona, hobbled by the bursting housing bubble, turned to a real estate deal for relief, essentially selling off several state buildings — including the tower where the governor has her office — for a $735 million upfront payment. But leasing back the buildings over the next 20 years will ultimately cost taxpayers an extra $400 million in interest.

Many governments are delaying payments to their pension funds, which will eventually need to be made, along with the high interest — usually around 8 percent — that the funds are expected to earn each year.

New York balanced its budget this year by shortchanging its pension fund. And in New Jersey, Gov. Chris Christie deferred paying the $3.1 billion that was due to the pension funds this year.

It is these growing hidden debts that make many analysts nervous. States and municipalities currently have around $2.8 trillion worth of outstanding bonds, but that number is dwarfed by the debts that many are carrying off their books.

State and local pensions — another form of promised debt, guaranteed in some states by their constitutions — face hidden shortfalls of as much as $3.5 trillion by some calculations. And the health benefits that state and large local governments have promised their retirees going forward could cost more than $530 billion, according to the Government Accountability Office.

“Most financial crises happen in unpredictable ways, and they hit you when you’re not looking,” said Jerome H. Powell, a visiting scholar at the Bipartisan Policy Center who was an under secretary of the Treasury for finance during the bailout of the savings and loan industry in the early 1990s. “This one isn’t like that. You can see it coming. It would be sinful not to do something about this while there’s a chance.”

So far, investors have bought states’ bonds eagerly, on the widespread understanding that states and cities almost never default. But in recent weeks the demand has diminished sharply. Last month, mutual funds that invest in municipal bonds reported a big sell-off — a bigger one-week sell-off, in fact, than they had when the financial markets melted down in 2008. And hedge funds are already seeking out ways to place bets against the debts of some states, with the help of their investment banks.

Of course, not all states are in as dire straits as Illinois or California. And the credit-rating agencies say that the risk of default is small. States and cities typically make a priority of repaying their bond holders, even before paying for essential services. Standard & Poor’s issued a report this month saying that the crises that states and municipalities were facing were “more about tough decisions than potential defaults.”

Change in Ratings

The credit ratings of a number of local governments have improved this year, not because their finances have strengthened somewhat, but because the ratings agencies have changed the way they analyze governments.

The new higher ratings, which lower the cost of borrowing, emphasize the fact that municipal defaults have been much rarer than corporate defaults.

This October, Moody’s issued a report explaining why it now rates all 50 states, even Illinois, as better credit risks than a vast majority of American non-financial companies.

One reason: the belief that the federal government is more likely to bail out a teetering state than a bankrupt company.

“The federal government has broadly channeled cash to all state governments during recent recessions and provided support to individual states following natural disasters,” Moody’s explained, adding that there was no way of being sure how Washington would respond to a bond default by a state, since it had not happened since the 1930s.

But some analysts fear the ratings are too sanguine, recalling that the ratings agencies also dismissed the possibility that a subprime crisis was brewing. While most agree that defaults are unlikely, they fear that as states struggle with their growing debts, investors could decide not to buy the debt of the weakest state or local governments.

That would force a crisis, since states cannot operate if they cannot borrow. Such a crisis could then spread to healthier states, making it more expensive for them to borrow, if Europe is an example.

Meredith Whitney, a bank analyst who was among the first to warn of the impact the subprime mortgage meltdown would have on banks, is warning that she sees similar problems with state and local government finances.

“The state situation reminded me so much of the banks, pre-crisis,” she said this fall on CNBC.

There are eerie similarities between the subprime debt crisis and the looming municipal debt woes. Among them:

¶Just as housing was once considered a sure bet — prices would never fall all across the country at the same time, conventional wisdom suggested — municipal bonds have long been considered an investment safe enough for grandmothers, because states could always raise taxes to pay their bondholders. Now that proposition is being tested. Harrisburg, the capital of Pennsylvania, considered bankruptcy this year because it faced $68 million in debt payments related to a failed incinerator, which is more than the city’s entire annual budget. But officials there have resisted raising taxes.

¶Much of the debt of states and cities is hidden, since it is off the books, just as the amount of mortgage-related debt turned out to be underestimated. States and municipalities often understate their pension liabilities, in part by using accounting methods that would not be allowed in the private sector. Joshua D. Rauh, an associate professor of finance at Northwestern University, and Robert Novy-Marx, an assistant professor of finance at the University of Rochester, calculated that the true unfunded liability for state and local pension plans is roughly $3.5 trillion.

¶The states and many cities still carry good ratings, and those issuing warnings are dismissed as alarmists, reminding some analysts of the lead up to the subprime crisis.

Now states are bracing for more painful cuts, more layoffs, more tax increases, more battles with public employee unions, more requests to bail out cities. And in the long term, as cities and states try to keep up on their debts, the very nature of government could change as they have less money left over to pay for the services they have long provided.

Richard Ravitch, the lieutenant governor of New York, is among those warning that states are on an unsustainable path, and that their disclosures of pension and health care obligations are often misleading. And he worries how long it can last.

“They didn’t do it with bad motives,” he said. “Ninety-five percent of them didn’t understand what they were doing. They did it because it was easier than taxing people or cutting benefits. We’re getting closer and closer to the point where we can’t do that anymore. I don’t know where that is, but I know we’re close.”

Swaps as Breach of Fiduciary Duties

“That’s right. Issuers are essentially paying twice for flawed deals that bestowed great riches on the bankers and advisers who sold them. Taxpayers should be outraged, but to be angry you have to be informed — and few taxpayers may even know that the complicated arrangements exist.”

Editor’s Note: At some point, it will become obvious and axiomatic that Wall Street works for itself and their pattern of selling is devoted to making money whether the investment sold goes up, down or sideways. As long as money moves Wall Street makes money. One of the crazier aspects of their hold on Government is that while they make all this money, they don’t get taxes, because they usually pick and choose when they report the income even as it is sitting safely in off-shore havens or buried in holding or contingency accounts. Much of the federal and State deficits would be partially or completely offset if they just enforced their tax laws — collecting taxes owed to them by Wall Street players.
Meanwhile, back at the ranch, everyone and everything is dying, drained of all lifeblood in what is left of our “free market” economy. The current case in point, deftly pointed out and explained by Gretchen Morgenstern of the New York Times, is local government officials who were misled into buying into a credit default swap program without knowing the risks. They thought they were increasing income and decreasing risk. Instead they were , like the borrowers on teaser rates, drawn into complicated instruments, relying upon the advice of the people who sold it to them. These isntruments gave them the initial appearance of something beneficial while in the end it wrecked them.
Sound familiar? Whether it is simply outright fraud, or breach of fiduciary duty there is no doubt that the public officers who bought into this plan thought that it would be good for them politically because it would be haled as a smart move.
They bought into this program because the investment bankers who sold it to them had knowledge so far superior to the public officials that there was no choice but to rely on the investment banker on the issues of value and risk. Most authorities claim that when that situation arises, a fiduciary relationship arises whether it was intended or not. And when a party has knowledge and skills far superior to the counter-party in a transaction, they have a duty to use those skills and inform the customer accordingly.
The same holds true in mortgage financing. In the last 10 years, underwriters tell me that the number of loan products grew from 4 to 400. The huge array of potential loan products alone made the choice out of the reach of knowledge and experience of most borrowers. Add the complexity of securitization and we were all sitting ducks, relying on the mortgage broker, appraiser, the party originating the loan (who often was confused as being a bank or acting as bank when they were acting as a broker or conduit), the closing agent, the real estate broker, developer, insurance companies (title and property) to assess the value and risks of each transaction. In truth no underwriting was being done because no bank would have approved the loan in most cases.
Investment bankers created a chain of participants to create layers and plausible deniability, in the process, millions of homeowners are losing their homes to companies they never knew existed and thousands of municipalities and local government projects are going broke.
March 5, 2010 NY Times

The Swaps That Swallowed Your Town

By GRETCHEN MORGENSON

AS more details surface about how derivatives helped Greece and perhaps other countries mask their debt loads, let’s not forget that the wonders of these complex products aren’t on display only overseas. Across our very own country, municipalities, school districts, sewer systems and other tax-exempt debt issuers are ensnared in the derivatives mess.

Like the credit default swaps that hid Greece’s obligations, the instruments weighing on our municipalities were brought to us by the creative minds of Wall Street. The rocket scientists crafting the products got backup from swap advisers, a group of conflicted promoters who consulted municipalities and other issuers. Both of these camps peddled swaps as a way for tax-exempt debt issuers to reduce their financing costs.

Now, however, the promised benefits of these swaps have mutated into enormous, and sometimes smothering, expenses. Making matters worse, issuers who want out of the arrangements — swap contracts typically run for 30 years — must pay up in order to escape.

That’s right. Issuers are essentially paying twice for flawed deals that bestowed great riches on the bankers and advisers who sold them. Taxpayers should be outraged, but to be angry you have to be informed — and few taxpayers may even know that the complicated arrangements exist.

Here’s how municipal swaps worked (in theory): Say an issuer needed to raise money and prevailing rates for fixed-rate debt were 5 percent. A swap allowed issuers to reduce the interest rate they paid on their debt to, say, 4.5 percent, while still paying what was effectively a fixed rate.

Nothing wrong with that, right?

Sales presentations for these instruments, no surprise, accentuated the positives in them. “Derivative products are unique in the history of financial innovation,” gushed a pitch from Citigroup in November 2007 about a deal entered into by the Florida Keys Aqueduct Authority. Another selling point: “Swaps have become widely accepted by the rating agencies as an appropriate financial tool.” And, the presentation said, they can be easily unwound (for a fee, of course).

But these arrangements were riddled with risks, as issuers are finding out. The swaps were structured to generate a stream of income to the issuer — like your hometown — that was tethered to a variable interest rate. Variable rates can rise or fall wildly if economic circumstances change. Banks that executed the swaps received fixed payments from the issuers.

The contracts, however, assumed that economic and financial circumstances would be relatively stable and that interest rates used in the deals would stay in a narrow range. The exact opposite occurred: the financial system went into a tailspin two years ago, and rates plummeted. The auction-rate securities market, used by issuers to set their interest payments to bondholders, froze up. As a result, these rates rose.

For municipalities, that meant they were stuck with contracts that forced them to pay out a much higher interest rate than they were receiving in return. Sure, the rate plunge was unforeseen, but it was not an impossibility. And the impact of such a possible decline was rarely highlighted in sales presentations, municipal experts say.

Another aspect to these swaps’ designs made them especially ill-suited for municipal issuers. Almost all tax-exempt debt is structured so that after 10 years, it can be called or retired by the city, school district or highway authority that floated it. But by locking in the swap for 30 years, the municipality or school district is essentially giving up the option to call its debt and issue lower-cost bonds, without penalty, if interest rates have declined.

Imagine a homeowner who has a mortgage allowing her to refinance without a penalty if interest rates drop, as many do. Then she inexplicably agrees to give up that opportunity and not be compensated for doing so. Well, some towns did exactly that when they signed derivatives contracts that locked them in for 30 years.

Then there are the counterparty risks associated with municipal swaps. If the banks in the midst of these deals falter, the municipality is at peril, because getting out of a contract with a failed bank is also costly. For example, closing out swaps in which Lehman Brothers was the counterparty cost various New York State debt issuers $12 million, according to state filings.

Termination fees also kick in when a municipal issuer wants out of its swap agreement. They can be significant.

New York State provides a good example. An Oct. 30, 2009, filing describing its swaps shows that for the most recent fiscal year, April 2008 to March 2009, the state paid $103 million to terminate roughly $2 billion worth of swaps — more than a quarter of which resulted from the Lehman bankruptcy in September 2008.

(You can find this report online at bit.ly/cS8ZFV.)

As of Nov. 30, 2009, New York had $3.74 billion worth of swaps outstanding. Even so, New York doesn’t have as much of a problem with swaps as other jurisdictions. Still, New York could have spent that $103 million on many other things that the state needs.

The prime example, of course, of a swap-imperiled issuer is Jefferson County, Ala. Its swaps were supposed to lower the county’s costs, but instead they wound up increasing its indebtedness. Groaning under a $3 billion debt load, the county is facing the possibility of bankruptcy.

Critics of swaps hope that increased taxpayer awareness of these souring deals will force municipalities to think twice. “When municipalities enter into these swaps they end up paying more and receiving much less,” said Andy Kalotay, an expert in fixed income.

Why is that? One reason, Mr. Kalotay said, is the use of swap advisers.

“The basic problem is the swap adviser gets paid only if there is a transaction — an unbelievable conflict of interest,” he said. “It’s the adviser who is supposed to protect you, but the swap adviser has a vested interest in seeing something happen.”

WHAT is especially maddening to many in the municipal securities market is that issuers are now relying on the same investment banks that put them into swaps-embedded debt to restructure their obligations. According to those who travel this world, issuers are afraid to upset their relationships with their bankers and are not holding them accountable for placing them in these costly trades.

“We need transparency where Wall Street discloses not only the risks but also calculates the potential costs associated with those risks,” said Joseph Fichera, chief executive at Saber Partners, an advisory firm. “If you just ask issuers to disclose, even in a footnote, the maximum possible loss or gain from the swap they probably wouldn’t do it. And if they did that, then investors and taxpayers would know what the risks are, in plain English.”

Mr. Fichera is right. At this intersection of two huge and extremely opaque arenas — the municipal debt market and derivatives trading — sunlight is sorely needed.

Mortgage Meltdown: Local Government Meltdown and Benefits

 

How to Benefit from the Mortgage Meltdown:

Tax assessments are heading south along with home valuations — at the moment. Price declines from lower demand and oversupply will continue in many places for years to come. 

If the experts are right, the first thing we can already see happening is that revenues from taxes based upon real estate valuation are declining and will decline by at least 15% by end of 2008, joined by decreasing revenue from issuing permits for new construction and all the administrative fees that go along with new construction, old construction, filing fees for deeds and mortgages etc.  

One ray of sunshine is that inflation has begun its launch into the twilight zone. As the value of each dollar goes down, that means it will take more dollars to buy something than it did yesterday. That means the absolute dollars in price and valuation will start to increase. If you know the dollars are worth less than yesterday, you will ask for more today when you sell your labor or even your couch at a yard sale.

So we have two opposite forces at work on prices here. One is a loss of demand and continuing oversupply causing what would ordinarily be a net loss of valuation and a net loss of tax revenues, and the other being inflation which will cause the price and valuations of things to buy or sell to go up in absolute dollars. Those dollars are becoming worth less and less as time goes on, so people are demanding more and more of them as payment for goods, services and taxes. 

Cities and Counties who assess real estate taxes expressed as a percentage of valuation will most likely see some relief. Hyper-inflation, expected by mid-2008, will result in much higher “prices” (expressed in dollars of declining value). 

While contracts and employment compensation will eventually be tied to some inflation index that people trust (not the CPI or PCE),  the lag time between the increased valuations and revenues resulting from inflation and the payment of contracts and compensation based upon older fixed dollars will produce a net gain for local government — and individuals. It could amount to a “windfall.” 

Consumers and borrowers can take a hint from all this. The price everything is going to increase exponentially while we take the hit from hyper-inflation caused by the largest case of economic fraud in world history. 

But your mortgage, consumer loans, lease and other contracts are expressed in old dollars: these are dollars that were worth far more then than they are now and dollars that will be worth far less in another year or two. 

It behooves you to take advantage of this bounce by going after compensation based upon fixed dollars adjusted monthly for inflation (resulting in receiving more dollars that are worth less) and paying old debts and payables in their original fixed amounts which have been devalued along with the dollar.  

Yes, it is complicated. But we all have an opportunity to game the system and get back part of what we will be losing as a result of the criminals who created this mess.  

 

 

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