APPRAISERS AND CREDIT RATING COMPANIES ARE GETTING AWAY WITH IT TOO

Posted on March 8, 2011 by Neil Garfield

COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary COMBO TITLE AND SECURITIZATION SEARCH, REPORT, ANALYSIS ON LUMINAQ

EDITOR’S NOTE: In 1983 the nominal value of credit derivatives was zero. Today it is over $600 TRILLION. None of this would have been possible without the active complicity of credit rating companies who as quasi public agencies “assured” the quality of securities sold to both sophisticated and unsophisticated investors. People forget that in most cases behind every “sophisticated” investor are millions of unsophisticated investors who entrusted their money to these venerable institutions to manage their savings and pensions.

A full 1/4 of the $600 TRILLION in derivatives is related in some exotic way to the housing market. When appraisal companies put profit before their reputations, you would have thought that the world would have come crashing down around them. When appraisers of real property were given instructions on what value they had to come back with to make the deal work (or else they would never be hired again), you would have thought that licensing boards would have revoked their licenses and criminal investigations would have led to prosecutions.

The whole grand hallucination referred to as securitization of debt instruments, was achieved by deceit, cheating and outright theft. But the guards at the gate not only let the barbarians in, they are letting them out too. I’m probably too old to see the eventual outcome of having a country governed by banks. But our children and grandchildren will see it in living color, and as food prices and other commodities start to rise and as the value of money falls, they will feel the pain of our folly and our failure to correct a situation that still is correctable. The founding fathers of our country gave us the right the and the means to do it.

If you like what you see, and you think that things are all going in the right direction, then you don’t need to do anything. You are probably a banker or financier with tens of millions of even tens of billions of wealth stashed away, with provisions for every eventuality. The rest of us don’t have that luxury. We were steered into an economy of excess by people who made sure that we had the money in our hands to spend — but only if we spent it, leaving ourselves and our economy and our future in tatters. If you don’t like that picture and the picture painted by hundreds of economists around the world, with our noble experiment becoming a banana republic, then maybe you should do something about it.

Innovation has been the hallmark of American success. Innovation is what it will take to bring about the changes that are necessary to have a country that is governed, with consent of the governed, by people who value human rights for all more than intense concentrations of wealth for a few. Millions of Americans have fought and died and been injured or maimed fighting for our rights as set forth in the constitutions. We treat our returning vets as expendable, and we treat their predecessors as part of some dry historical landscape without meaning.  If we are truly patriotic, then we will end the tyranny of wealth, and return to a society where wealth is possible, where hope springs eternal and where our expectations are virtually guaranteed, that our children will live better than we did.

Think back and remember. IF you can’t remember then research. We did it before. Let’s do it again.

Hey, S.E.C., That Escape Hatch Is Still Open

By GRETCHEN MORGENSON

IT’S hard to say what’s more exasperating: the woeful performance of the credit ratings agencies during the recent mortgage securities boom or the failure to hold them accountable in the bust that followed.

Not that Congress hasn’t tried, mind you. The Dodd-Frank financial reform law, enacted last year, imposed the same legal liabilities on Moody’s, Standard & Poor’s and other credit raters that have long applied to legal and accounting firms that attest to statements made in securities prospectuses. Investors cheered the legislation, which subjected the ratings agencies to what is known as expert liability under the securities laws.

But since Dodd-Frank passed, Congress’s noble attempt to protect investors from misconduct by ratings agencies has been thwarted by, of all things, the Securities & Exchange Commission. The S.E.C., which calls itself “the investor’s advocate,” is quietly allowing the raters to escape this accountability.

When Dodd-Frank became law last July, it required that ratings agencies assigning grades to asset-backed securities be subject to expert liability from that moment on. This opened the agencies to lawsuits from investors, a policing mechanism that law firms and accountants have contended with for years. The agencies responded by refusing to allow their ratings to be disclosed in asset-backed securities deals. As a result, the market for these instruments froze on July 22.

The S.E.C. quickly issued a “no action” letter, indicating that it would not bring enforcement actions against issuers that did not disclose ratings in prospectuses. This removed the expert-liability threat for the ratings agencies, and the market began operating again.

At the time, the S.E.C. said its action was intended to give issuers time to adapt to the Dodd-Frank rules and would stay in place for only six months. But on Jan. 24, the S.E.C. extended its nonenforcement stance indefinitely. Issuers are selling asset-backed securities without the ratings disclosures required under S.E.C. rules, and rating agencies are not subject to expert liability.

MARTHA COAKLEY, the attorney general of Massachusetts, has brought significant mortgage securities cases against Wall Street firms — and she is disturbed by the S.E.C.’s position. Last week, she sent a letter to Mary Schapiro, the chairwoman of the S.E.C., asking why the commission was refusing to enforce its rules and was thereby defeating Congressional intent where ratings agencies’ liability is concerned.

“We wanted to make clear that we see this as a problem and important enough that we would like an answer,” Ms. Coakley said in an interview last week. “They are either going to enforce this or say why they are not. As a state regulator, we don’t enforce Dodd-Frank, but we certainly deal with the fallout when it is not enforced.”

An S.E.C. spokesman, John Nester, said that the agency would respond to Ms. Coakley.

Meredith Cross, director of the S.E.C.’s division of corporation finance, explained the agency’s decision to stand down on the issue: “If we didn’t provide the no-action relief to issuers, then they would do their transactions in the unregistered market,” she said. “You would impede investor protection. We thought, notwithstanding the grief we would take, that it would be better to have these securities done in the registered market.”

Unfortunately, the S.E.C.’s actions appear to continue the decades of special treatment bestowed upon the credit raters. Among the perquisites enjoyed by established credit raters is protection from competition, since regulators were required to approve new entrants to the business. Regulators have also sanctioned the agencies’ ratings by embedding them into the investment process: financial institutions post less capital against securities rated at or above a certain level, for example, and investment managers at insurance companies and mutual funds are allowed to buy only securities receiving certain grades.

This is a recipe for disaster. Given that ratings were required and the firms had limited competition, they had little incentive to assess securities aggressively or properly. Their assessments of mortgage securities were singularly off-base, causing hundreds of billions in losses among investors who had relied on ratings.

That the S.E.C.’s move strengthens the ratings agencies’ protection from investor lawsuits, which runs counter to the intention of Dodd-Frank, is also disturbing. Moody’s and Standard & Poor’s have argued successfully for years that their grades are opinions and subject to the same First Amendment protections that journalists receive. This position has made lawsuits against the raters exceedingly difficult to mount, a problem that Dodd-Frank was supposed to fix.

I asked Representative Barney Frank, the Massachusetts Democrat whose name is on the 2010 financial reform legislation, if he was concerned that the S.E.C.’s inaction was enabling ratings agencies to evade liability.

Mr. Frank said he believed the S.E.C.’s move was part of a longer-term strategy to eliminate investor reliance on ratings and remove, at long last, all references to credit ratings agencies in government statutes. Indeed, the S.E.C. proposed a new rule last week that would eliminate the requirement that money market funds buy only securities with high credit ratings. If the rule goes through, fund boards would have to make their own determinations that the instruments they buy are of superior credit quality.

Still, Mr. Frank said, the commission could do a better job of explaining that its nonenforcement stance is part of an effort to reduce reliance on ratings. “The message should not be lax enforcement by the S.E.C.; it should be a lack of confidence in the ratings,” he said.

The problem is that it could take years to rid the investment arena of all references to ratings. In the meantime, the S.E.C. is letting the ratings agencies escape accountability once again.

Moreover, investors are right to fear that the S.E.C. may be capitulating to threats by the ratings agencies to boycott the securitization market as long as they are subject to expert liability. After all, Moody’s and S.& P. have succeeded before in derailing attempts by legislators to bring accountability to asset-backed securities.

Back in 2003, for example, Georgia’s legislature enacted one of the toughest predatory-lending laws in the nation. Part of the law allowed issuers of and investors in mortgage pools to be held liable if the loans were found to be abusive. Shortly after that law went into effect, the ratings agencies refused to rate mortgage securities containing Georgia loans because of this potential liability. The law was soon rewritten to eliminate the liability, allowing predatory lending to flourish.

IT is certainly important that the S.E.C. work to eliminate references to ratings in the investment arena, and to reduce investor reliance on them. But Congress couldn’t have been clearer in its intent of holding the agencies accountable. That the S.E.C. is undermining that goal is absurd in the extreme.

Filed under: bubble, CDO, CORRUPTION, currency, Eviction, foreclosure, GTC | Honor, Investor, Mortgage, securities fraud | Tagged: , , , , , | 4 Comments »

Ratings Arbitrage a/k/a Fraud

Posted on May 13, 2010 by Neil Garfield

Investment banks bundled mortgage loans into securities and then often rebundled those securities one or two more times. Those securities were given high ratings and sold to investors, who have since lost billions of dollars on them.

Editor’s Note: The significance of this report cannot be overstated. Not only did the investment bankers LOOK for and CREATE loans guaranteed to fail, which they did, they sold them in increasingly complex packages more than once. So for example if the yield spread profit or premium was $100,000 on a given loan, that wasn’t enough for the investment bankers. Without loaning or investing any additional money they sold the same loans, or at least parts of those loans, to additional investors one, two three times or more. In the additional sales, there was no cost so whatever they received was entirely profit. I would call that a yield spread profit or premium, and certainly undisclosed. If the principal of the loan was $300,000 and they resold it three times, then the investment bank received $900,000 from those additional sales, in addition to the initial $100,000 yield spread profit on sale of the loan to the “trust” or special purpose vehicle.

So the investment bank kept $1 million dollars in fees, profits or compensation on a $300,000 loan. Anyone who has seen “The Producers” knows that if this “show” succeeds, i.e., if most of the loans perform as scheduled and borrowers are making their payments, then the investment bank has a problem — receiving a total of $1.3 million on a $300,000 loan. But if the loans fails, then nobody asks for an accounting. As long as it is in foreclosure, no accounting is required except for when the property is sold (see other blog posts on bid rigging at the courthouse steps documented by Charles Koppa).

If they modify the loan or approve the short sale then an accounting is required. That is a bad thing for the investment bank. But if they don’t modify any loans and don’t approve any short-sales, then questions are going to be asked which will be difficult to answer.

You make plans and then life happens, my wife says. All these brilliant schemes were fraudulent and probably criminal. All such schemes eventually get the spotlight on them. Now, with criminal investigations ongoing in a dozen states and the federal government, the accounting and the questions are coming anyway—despite the efforts of the titans of the universe to avoid that result.

All those Judges that sarcastically threw homeowners out of court questioning the veracity of accusations against pretender lenders, can get out the salt and pepper as they eat their words.

“Why are they not in jail if they did these things” asked practically everyone on both sides of the issue. The answer is simply that criminal investigations do not take place overnight, they move slowly and if the prosecutor has any intention of winning a conviction he must have sufficient evidence to prove criminal acts beyond a reasonable doubt.

But remember the threshold for most civil litigation is merely a preponderance of the evidence, which means if you think there is more than a 50-50  probability the party did something, the prima facie case is satisfied and damages or injunction are stated in a final judgment. Some causes of action, like fraud, frequently require clear and convincing evidence, which is more than 50-50 and less than beyond a reaonsable doubt.

From the NY Times: ————————

The New York attorney general has started an investigation of eight banks to determine whether they provided misleading information to rating agencies in order to inflate the grades of certain mortgage securities, according to two people with knowledge of the investigation.

by LOUISE STORY

Andrew Cuomo, the attorney general of New York, sent subpoenas to eight Wall Street banks late Wednesday.

The investigation parallels federal inquiries into the business practices of a broad range of financial companies in the years before the collapse of the housing market.

Where those investigations have focused on interactions between the banks and their clients who bought mortgage securities, this one expands the scope of scrutiny to the interplay between banks and the agencies that rate their securities.

The agencies themselves have been widely criticized for overstating the quality of many mortgage securities that ended up losing money once the housing market collapsed. The inquiry by the attorney general of New York, Andrew M. Cuomo, suggests that he thinks the agencies may have been duped by one or more of the targets of his investigation.

Those targets are Goldman Sachs, Morgan Stanley, UBS, Citigroup, Credit Suisse, Deutsche Bank, Crédit Agricole and Merrill Lynch, which is now owned by Bank of America.

The companies that rated the mortgage deals are Standard & Poor’s, Fitch Ratings and Moody’s Investors Service. Investors used their ratings to decide whether to buy mortgage securities.

Mr. Cuomo’s investigation follows an article in The New York Times that described some of the techniques bankers used to get more positive evaluations from the rating agencies.

Mr. Cuomo is also interested in the revolving door of employees of the rating agencies who were hired by bank mortgage desks to help create mortgage deals that got better ratings than they deserved, said the people with knowledge of the investigation, who were not authorized to discuss it publicly.

Contacted after subpoenas were issued by Mr. Cuomo’s office late Wednesday night notifying the banks of his investigation, spokespeople for Morgan Stanley, Credit Suisse and Deutsche Bank declined to comment. Other banks did not immediately respond to requests for comment.

In response to questions for the Times article in April, a Goldman Sachs spokesman, Samuel Robinson, said: “Any suggestion that Goldman Sachs improperly influenced rating agencies is without foundation. We relied on the independence of the ratings agencies’ processes and the ratings they assigned.”

Goldman, which is already under investigation by federal prosecutors, has been defending itself against civil fraud accusations made in a complaint last month by the Securities and Exchange Commission. The deal at the heart of that complaint — called Abacus 2007-AC1 — was devised in part by a former Fitch Ratings employee named Shin Yukawa, whom Goldman recruited in 2005.

At the height of the mortgage boom, companies like Goldman offered million-dollar pay packages to workers like Mr. Yukawa who had been working at much lower pay at the rating agencies, according to several former workers at the agencies.

Around the same time that Mr. Yukawa left Fitch, three other analysts in his unit also joined financial companies like Deutsche Bank.

In some cases, once these workers were at the banks, they had dealings with their former colleagues at the agencies. In the fall of 2007, when banks were hard-pressed to get mortgage deals done, the Fitch analyst on a Goldman deal was a friend of Mr. Yukawa, according to two people with knowledge of the situation.

Mr. Yukawa did not respond to requests for comment.

Wall Street played a crucial role in the mortgage market’s path to collapse. Investment banks bundled mortgage loans into securities and then often rebundled those securities one or two more times. Those securities were given high ratings and sold to investors, who have since lost billions of dollars on them.

Banks were put on notice last summer that investigators of all sorts were looking into their mortgage operations, when requests for information were sent out to all of the big Wall Street firms. The topics of interest included the way mortgage securities were created, marketed and rated and some banks’ own trading against the mortgage market.

The S.E.C.’s civil case against Goldman is the most prominent action so far. But other actions could be taken by the Justice Department, the F.B.I. or the Financial Crisis Inquiry Commission — all of which are looking into the financial crisis. Criminal cases carry a higher burden of proof than civil cases. Under a New York state law, Mr. Cuomo can bring a criminal or civil case.

His office scrutinized the rating agencies back in 2008, just as the financial crisis was beginning. In a settlement, the agencies agreed to demand more information on mortgage bonds from banks.

Mr. Cuomo was also concerned about the agencies’ fee arrangements, which allowed banks to shop their deals among the agencies for the best rating. To end that inquiry, the agencies agreed to change their models so they would be paid for any work they did for banks, even if those banks did not select them to rate a given deal.

Mr. Cuomo’s current focus is on information the investment banks provided to the rating agencies and whether the bankers knew the ratings were overly positive, the people who know of the investigation said.

A Senate subcommittee found last month that Wall Street workers had been intimately involved in the rating process. In one series of e-mail messages the committee released, for instance, a Goldman worker tried to persuade Standard & Poor’s to allow Goldman to handle a deal in a way that the analyst found questionable.

The S.& P. employee, Chris Meyer, expressed his frustration in an e-mail message to a colleague in which he wrote, “I can’t tell you how upset I have been in reviewing these trades.”

“They’ve done something like 15 of these trades, all without a hitch. You can understand why they’d be upset,” Mr. Meyer added, “to have me come along and say they will need to make fundamental adjustments to the program.”

At Goldman, there was even a phrase for the way bankers put together mortgage securities. The practice was known as “ratings arbitrage,” according to former workers. The idea was to find ways to put the very worst bonds into a deal for a given rating. The cheaper the bonds, the greater the profit to the bank.

The rating agencies may have facilitated the banks’ actions by publishing their rating models on their corporate Web sites. The agencies argued that being open about their models offered transparency to investors.

But several former agency workers said the practice put too much power in the bankers’ hands. “The models were posted for bankers who develop C.D.O.’s to be able to reverse engineer C.D.O.’s to a certain rating,” one former rating agency employee said in an interview, referring to collateralized debt obligations.

A central concern of investors in these securities was the diversification of the deals’ loans. If a C.D.O. was based on mostly similar bonds — like those holding mortgages from one region — investors would view it as riskier than an instrument made up of more diversified assets. Mr. Cuomo’s office plans to investigate whether the bankers accurately portrayed the diversification of the mortgage loans to the rating agencies.

Gretchen Morgenson contributed reporting

Filed under: bubble, CDO, CORRUPTION, Eviction, expert witness, Fannie MAe, foreclosure, foreclosure mill, Forensic Analysis Workshop, GTC | Honor, HERS, investment banking, Investor, MODIFICATION, Mortgage, Motion Practice and Discovery, politics, securities fraud, Securitization Survey, Servicer, STATUTES, trustee, workshop | Tagged: , , , , , , , , , , , , , , , , , , , , , , , , , , , | 11 Comments »

Discovery, Forensic Analysis and Motion Practice: The Prospectus

Posted on March 26, 2010 by Neil Garfield

USE THIS AS A GUIDE FOR DISCOVERY, FORENSIC ANALYSIS AND MOTION PRACTICE TO COMPEL DISCLOSURE

see for this example SHARPS%20CDO%20II_16.08.07_9347

Comments in Red: THIS IS A PARTIAL ANNOTATION OF THE PROSPECTUS. IF YOU WANT A FULL ANNOTATION OF THIS PROSPECTUS OR ANY OTHER YOU NEED AN EXPERT IN SECURITIZATION TO DO IT. THERE ARE THREE OBVIOUS JURISDICTIONS RECITED HERE: CAYMAN ISLANDS, UNITED STATES (DELAWARE), AND IRELAND WITH MANY OTHER JURISDICTIONS RECITED AS WELL FOR PURPOSES OF THE OFFERING, ALL INDICATING THAT THE INVESTORS (CREDITORS) ARE SPREAD OUT ACROSS THE WORLD.

Note that the issuance of the bonds/notes are “non-recourse” which further corroborates the fact that the issuer (SPV/REMIC) is NOT the debtor, it is the homeowners who were funded out of the pool of money solicited from the investors, part of which was used to fund mortgages and a large part of which was kept by the investment bankers as “profit.”There is no language indicative that anyone other than the investors own the notes from homeowner/borrowers/debtors. Thus the investors are the creditors and the homeowners are the debtors. Without the investors there would have been no loan. Without the borrowers, there would would have been no investment. Hence, a SINGLE TRANSACTION.

If you read carefully you will see that there is Deutsch Bank as “initial purchaser” so that the notes (bonds) can be sold to pension funds, sovereign wealth funds etc. at a profit. This profit is the second tier of yield spread premium that no TILA audit I have ever seen has caught.

The amount of the “LEVEL 2” yield spread premium I compute on average to be approximately 30%-35% of the total loan amount that was funded FOR THE SUBJECT LOAN on average, depending upon the method of computation used.Thus a $300,000 loan would on average spawn two yield spread premiums, “level 1” being perhaps 2% or $6,000 and “level 2” being 33% or $100,000, neither of which were disclosed to the borrower, a violation of TILA.

The amount of the yield spread premium is a complex number based upon detailed information about the what actually took place in the sale of all the bonds and what actually took place in the sale of all the loan products to homeowners and what actually took place in the alleged transfer or assignment of “loans” into a master pool and what actually took place in the alleged transfer or assignment of “loans” into specific SPV pools and the alleged transfer or assignment of “loans” into specific tranches or classes within the SPV operating structure.

Here is the beginning of the prospectus with some of the annotations that are applicable:

Sharps CDO II Ltd., (obviously a name that doesn’t show up at the closing with the homeowner when they sign the promissory note, mortgage (or Deed of Trust and other documents. You want to ask for the name and contact information for the entity that issued the prospectus which is not necessarily the same company that issued the securities to the investors) an exempted company (you might ask for the identification of any companies that are declared as “exempted company” and their contact information to the extent that they issued any document or security relating to the subject loan) incorporated with limited liability you probably want to find out what liabilities are limited) under the laws of the Cayman Islands (ask for the identity of any foreign jurisdiction in which enabling documents were created, or under which jurisdiction is claimed or referred in the enabling documentation) (the “Issuer”) (Note that this is the “issuer” you don’t see don’t find about unless you ask for it), and Sharps CDO II Corp., (it would be wise to check with Delaware and get as much information about the names and addresses of the incorporators) a Delaware corporation (the “Co-Issuer” and together with the Issuer, the “Co-Issuers”), pursuant to an indenture (don’t confuse the prospectus with the indenture. The indenture is the actual terms of the bond issued just like the “terms of Note” specify the terms of the promissory note executed by the borrower/homeowner at closing) (the “Indenture”), among the Co-Issuers and The Bank of New York, as trustee (Note that BONY is identified “as trustee” but the usual language of “under the terms of that certain trust dated….etc” are absent. This is because there usually is NO TRUST AGREEMENT designated as such and NOT TRUST. In fact, as stated here it is merely an agreement between the co-issuers and BONY, which it means that far from being a trust it is more like the operating agreement of an LLC) (the “Trustee”), will issue up to U.S.$600,000,000 Class A-1 Senior Secured Floating Rate Notes Due 2046 (the “Class A-1 Notes”), U.S.$100,000,000 Class A-2 Senior Secured Floating Rate Notes Due 2046 (the “Class A-2 Notes”), U.S.$60,000,000 Class A-3 Senior Secured Floating Rate
Notes Due 2046 (the “Class A-3 Notes” and, together with the Class A-1 Notes and the Class A-2 Notes, the “Class A Notes”), U.S.$82,000,000 Class B Senior Secured Floating Rate Notes Due 2046 (the “Class B Notes”), U.S.$52,000,000 Class C Secured Deferrable Interest Floating Rate Notes Due 2046 (the “Class C Notes”), U.S.$34,000,000 Class D-1 Secured Deferrable Interest Floating Rate Notes Due 2046 (the “Class D-1 Notes”) and U.S.$27,000,000 Class D-2 Secured Deferrable Interest Floating Rate Notes Due 2046 (the “Class D-2 Notes” and, together with the Class D-1 Notes, the “Class D Notes”). The Class A Notes, the Class B Notes, the Class C Notes and the Class D Notes are collectively referred to as the “Senior Notes.” The Class A-2 Notes, the Class A-3 Notes, the Class
B Notes, the Class C Notes and the Class D Notes and the Subordinated Notes (as defined below) are collectively referred to as the “Offered Notes.” Concurrently with the issuance of the Senior Notes, the Issuer will issue U.S.$27,000,000 Class D-2 Secured Deferrable Interest Floating Rate Notes Due 2046 (the “Class D-2 Notes” and, together with the Class D-1 Notes, the “Class D Notes pursuant to the Indenture and U.S.$45,000,000 Subordinated Notes due 2046 (the “Subordinated Notes”) pursuant to the Memorandum and Articles of Association of the Issuer (the “Issuer Charter”) and in accordance with a Deed of Covenant (“Deed of Covenant”) and a Fiscal Agency Agreement (the “Fiscal Agency Agreement”), among the Issuer, The Bank of New York, as Fiscal Agent (in such capacity, the “Fiscal Agent”) and the Trustee, as Note Registrar (in such capacity, the “Note Registrar”). The Senior Notes and the Subordinated Notes are collectively referred to as the “Notes.” Deutsche Bank Aktiengesellschaft (“Deutsche Bank”), New York Branch (“Deutsche Bank AG, New York Branch” and, in such capacity, the “TRS Counterparty”) will enter into a total return swap transaction (the “Total Return Swap”) with the Issuer pursuant to which it will be obligated to purchase (or cause to be purchased) the Class A-1 Notes issued from time to time by the Issuer under the circumstances described herein and therein. (cover continued on next page)

It is a condition to the issuance of the Notes on the Closing Date that the Class A-1 Notes be rated “Aaa” by Moody’s Investors Service, Inc. (“Moody’s”) and “AAA” by Standard & Poor’s Ratings Services, a division of The McGraw-Hill Companies, Inc. (“Standard & Poor’s,” and together with Moody’s, the “Rating Agencies”), that the Class A-2 Notes be rated “Aaa” by Moody’s and “AAA” by Standard & Poor’s, that the Class A-3 Notes be rated “Aaa” by Moody’s and “AAA” by Standard & Poor’s, that the Class B Notes be rated at least “Aa2” by Moody’s and at least “AA” by Standard & Poor’s, that the Class C Notes be rated at least “A2” by Moody’s and at least “A” by Standard & Poor’s, that the Class D-1 Notes be rated “Baa1” by Moody’s and “BBB+” by Standard & Poor’s, that the Class D-2 Notes be rated “Baa3” by Moody’s and “BBB-” by Standard & Poor’s.
This Offering Circular constitutes the Prospectus (the “Prospectus”) for the purposes of Directive 2003/71/EC (the “Prospectus Directive”). Application has been made to the Irish Financial Services Regulatory Authority (the “Financial Regulator”) (you could ask for the identification and contact information of any financial regulator referred to in the offering circular, prospectus or other documents relating to the securitization of the subject loan), as competent authority under the Prospectus Directive for the Prospectus to be approved. Approval by the Financial Regulator relates only to the Senior Notes that are to be admitted to trading on the regulated market of the Irish Stock Exchange or other regulated markets for the purposes of the Directive 93/22/EEC or which are to be offered to the public in any Member State of the European Economic Area. Any foreign language text that is included within this document is for convenience purposes only and does not form part of the Prospectus.
Application has been made to the Irish Stock Exchange for the Senior Notes to be admitted to the Official List and to trading on its regulated market.
APPROVAL OF THE FINANCIAL REGULATOR RELATES ONLY TO THE SENIOR NOTES WHICH ARE TO BE ADMITTED TO TRADING ON THE REGULATED MARKET OF THE IRISH STOCK EXCHANGE OR OTHER REGULATED MARKETS FOR THE PURPOSES OF DIRECTIVE 93/22/EEC OR WHICH ARE TO BE OFFERED TO THE PUBLIC IN ANY MEMBER STATE OF THE EUROPEAN ECONOMIC AREA.
SEE “RISK FACTORS” IN THIS OFFERING CIRCULAR FOR A DESCRIPTION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED IN CONNECTION
WITH AN INVESTMENT IN THE NOTES. THE SENIOR NOTES ARE NON-RECOURSE OBLIGATIONS OF THE CO-ISSUER AND THE NOTES ARE LIMITED
RECOURSE OBLIGATIONS OF THE ISSUER, PAYABLE SOLELY FROM THE COLLATERAL DESCRIBED HEREIN.
THE NOTES DO NOT REPRESENT AN INTEREST IN OR OBLIGATIONS OF, AND ARE NOT INSURED OR GUARANTEED BY, THE TRUSTEE, DEUTSCHE BANK SECURITIES INC., DEUTSCHE BANK OR ANY OF THEIR RESPECTIVE AFFILIATES. Note that you have more than one trustee without any specific description of where one trustee ends and the other begins. It is classic obfuscation and musical chairs. NOTE ALSO THAT TRUSTEE DISCLAIMS ANY INTEREST IN THE BONDS BEING ISSUED [REFERRED TO AS “NOTES” JUST TO MAKE THINGS MORE CONFUSING].

Filed under: bubble, CDO, CORRUPTION, currency, Eviction, foreclosure, GTC | Honor, HERS, Investor, Mortgage, securities fraud | Tagged: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | 14 Comments »

Self Dealing Part II: Investigations Started

Posted on December 25, 2009 by Neil Garfield

NY Times: “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

Mr. Lippmann made his pitch to select hedge fund clients, arguing they should short the mortgage market. He sometimes distributed a T-shirt that read “I’m Short Your House!!!” in black and red letters.

While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them,

Editor’s Note: It would be wise to pay careful attention to news reports and press releases from investigating agencies and to track the discovery in class action and other cases filed. A lot of your work might already be done, right down to the same lender you are  dealing with.

December 24, 2009

Banks Bundled Bad Debt, Bet Against It and Won

In late October 2007, as the financial markets were starting to come unglued, a Goldman Sachs trader, Jonathan M. Egol, received very good news. At 37, he was named a managing director at the firm.

Mr. Egol, a Princeton graduate, had risen to prominence inside the bank by creating mortgage-related securities, named Abacus, that were at first intended to protect Goldman from investment losses if the housing market collapsed. As the market soured, Goldman created even more of these securities, enabling it to pocket huge profits.

Goldman’s own clients who bought them, however, were less fortunate.

Pension funds and insurance companies lost billions of dollars on securities that they believed were solid investments, according to former Goldman employees with direct knowledge of the deals who asked not to be identified because they have confidentiality agreements with the firm.

Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, include Deutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.

How these disastrously performing securities were devised is now the subject of scrutiny by investigators in Congress, at the Securities and Exchange Commission and at the Financial Industry Regulatory Authority, Wall Street’s self-regulatory organization, according to people briefed on the investigations. Those involved with the inquiries declined to comment.

While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them, people briefed on the matter say.

One focus of the inquiry is whether the firms creating the securities purposely helped to select especially risky mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded.

Some securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created.

Goldman and other Wall Street firms maintain there is nothing improper about synthetic C.D.O.’s, saying that they typically employ many trading techniques to hedge investments and protect against losses. They add that many prudent investors often do the same. Goldman used these securities initially to offset any potential losses stemming from its positive bets on mortgage securities.

But Goldman and other firms eventually used the C.D.O.’s to place unusually large negative bets that were not mainly for hedging purposes, and investors and industry experts say that put the firms at odds with their own clients’ interests.

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”

Investment banks were not alone in reaping rich rewards by placing trades against synthetic C.D.O.’s. Some hedge funds also benefited, including Paulson & Company, according to former Goldman workers and people at other banks familiar with that firm’s trading.

Michael DuVally, a Goldman Sachs spokesman, declined to make Mr. Egol available for comment. But Mr. DuVally said many of the C.D.O.’s created by Wall Street were made to satisfy client demand for such products, which the clients thought would produce profits because they had an optimistic view of the housing market. In addition, he said that clients knew Goldman might be betting against mortgages linked to the securities, and that the buyers of synthetic mortgage C.D.O.’s were large, sophisticated investors, he said.

The creation and sale of synthetic C.D.O.’s helped make the financial crisis worse than it might otherwise have been, effectively multiplying losses by providing more securities to bet against. Some $8 billion in these securities remain on the books at American International Group, the giant insurer rescued by the government in September 2008.

From 2005 through 2007, at least $108 billion in these securities was issued, according to Dealogic, a financial data firm. And the actual volume was much higher because synthetic C.D.O.’s and other customized trades are unregulated and often not reported to any financial exchange or market.

Goldman Saw It Coming

Before the financial crisis, many investors — large American and European banks, pension funds, insurance companies and even some hedge funds — failed to recognize that overextended borrowers would default on their mortgages, and they kept increasing their investments in mortgage-related securities. As the mortgage market collapsed, they suffered steep losses.

A handful of investors and Wall Street traders, however, anticipated the crisis. In 2006, Wall Street had introduced a new index, called the ABX, that became a way to invest in the direction of mortgage securities. The index allowed traders to bet on or against pools of mortgages with different risk characteristics, just as stock indexes enable traders to bet on whether the overall stock market, or technology stocks or bank stocks, will go up or down.

Goldman, among others on Wall Street, has said since the collapse that it made big money by using the ABX to bet against the housing market. Worried about a housing bubble, top Goldman executives decided in December 2006 to change the firm’s overall stance on the mortgage market, from positive to negative, though it did not disclose that publicly.

Even before then, however, pockets of the investment bank had also started using C.D.O.’s to place bets against mortgage securities, in some cases to hedge the firm’s mortgage investments, as protection against a fall in housing prices and an increase in defaults.

Mr. Egol was a prime mover behind these securities. Beginning in 2004, with housing prices soaring and the mortgage mania in full swing, Mr. Egol began creating the deals known as Abacus. From 2004 to 2008, Goldman issued 25 Abacus deals, according to Bloomberg, with a total value of $10.9 billion.

Abacus allowed investors to bet for or against the mortgage securities that were linked to the deal. The C.D.O.’s didn’t contain actual mortgages. Instead, they consisted of credit-default swaps, a type of insurance that pays out when a borrower defaults. These swaps made it much easier to place large bets on mortgage failures.

Rather than persuading his customers to make negative bets on Abacus, Mr. Egol kept most of these wagers for his firm, said five former Goldman employees who spoke on the condition of anonymity. On occasion, he allowed some hedge funds to take some of the short trades.

Mr. Egol and Fabrice Tourre, a French trader at Goldman, were aggressive from the start in trying to make the assets in Abacus deals look better than they were, according to notes taken by a Wall Street investor during a phone call with Mr. Tourre and another Goldman employee in May 2005.

On the call, the two traders noted that they were trying to persuade analysts at Moody’s Investors Service, a credit rating agency, to assign a higher rating to one part of an Abacus C.D.O. but were having trouble, according to the investor’s notes, which were provided by a colleague who asked for anonymity because he was not authorized to release them. Goldman declined to discuss the selection of the assets in the C.D.O.’s, but a spokesman said investors could have rejected the C.D.O. if they did not like the assets.

Goldman’s bets against the performances of the Abacus C.D.O.’s were not worth much in 2005 and 2006, but they soared in value in 2007 and 2008 when the mortgage market collapsed. The trades gave Mr. Egol a higher profile at the bank, and he was among a group promoted to managing director on Oct. 24, 2007.

“Egol and Fabrice were way ahead of their time,” said one of the former Goldman workers. “They saw the writing on the wall in this market as early as 2005.” By creating the Abacus C.D.O.’s, they helped protect Goldman against losses that others would suffer.

As early as the summer of 2006, Goldman’s sales desk began marketing short bets using the ABX index to hedge funds like Paulson & Company, Magnetar and Soros Fund Management, which invests for the billionaire George Soros. John Paulson, the founder of Paulson & Company, also would later take some of the shorts from the Abacus deals, helping him profit when mortgage bonds collapsed. He declined to comment.

A Deal Gone Bad, for Some

The woeful performance of some C.D.O.’s issued by Goldman made them ideal for betting against. As of September 2007, for example, just five months after Goldman had sold a new Abacus C.D.O., the ratings on 84 percent of the mortgages underlying it had been downgraded, indicating growing concerns about borrowers’ ability to repay the loans, according to research from UBS, the big Swiss bank. Of more than 500 C.D.O.’s analyzed by UBS, only two were worse than the Abacus deal.

Goldman created other mortgage-linked C.D.O.’s that performed poorly, too. One, in October 2006, was a $800 million C.D.O. known as Hudson Mezzanine. It included credit insurance on mortgage and subprime mortgage bonds that were in the ABX index; Hudson buyers would make money if the housing market stayed healthy — but lose money if it collapsed. Goldman kept a significant amount of the financial bets against securities in Hudson, so it would profit if they failed, according to three of the former Goldman employees.

A Goldman salesman involved in Hudson said the deal was one of the earliest in which outside investors raised questions about Goldman’s incentives. “Here we are selling this, but we think the market is going the other way,” he said.

A hedge fund investor in Hudson, who spoke on the condition of anonymity, said that because Goldman was betting against the deal, he wondered whether the bank built Hudson with “bonds they really think are going to get into trouble.”

Indeed, Hudson investors suffered large losses. In March 2008, just 18 months after Goldman created that C.D.O., so many borrowers had defaulted that holders of the security paid out about $310 million to Goldman and others who had bet against it, according to correspondence sent to Hudson investors.

The Goldman salesman said that C.D.O. buyers were not misled because they were advised that Goldman was placing large bets against the securities. “We were very open with all the risks that we thought we sold. When you’re facing a tidal wave of people who want to invest, it’s hard to stop them,” he said. The salesman added that investors could have placed bets against Abacus and similar C.D.O.’s if they had wanted to.

A Goldman spokesman said the firm’s negative bets didn’t keep it from suffering losses on its mortgage assets, taking $1.7 billion in write-downs on them in 2008; but he would not say how much the bank had since earned on its short positions, which former Goldman workers say will be far more lucrative over time. For instance, Goldman profited to the tune of $1.5 billion from one series of mortgage-related trades by Mr. Egol with Wall Street rival Morgan Stanley, which had to book a steep loss, according to people at both firms.

Tetsuya Ishikawa, a salesman on several Abacus and Hudson deals, left Goldman and later published a novel, “How I Caused the Credit Crunch.” In it, he wrote that bankers deserted their clients who had bought mortgage bonds when that market collapsed: “We had moved on to hurting others in our quest for self-preservation.” Mr. Ishikawa, who now works for another financial firm in London, declined to comment on his work at Goldman.

Profits From a Collapse

Just as synthetic C.D.O.’s began growing rapidly, some Wall Street banks pushed for technical modifications governing how they worked in ways that made it possible for C.D.O.’s to expand even faster, and also tilted the playing field in favor of banks and hedge funds that bet against C.D.O.’s, according to investors.

In early 2005, a group of prominent traders met at Deutsche Bank’s office in New York and drew up a new system, called Pay as You Go. This meant the insurance for those betting against mortgages would pay out more quickly. The traders then went to the International Swaps and Derivatives Association, the group that governs trading in derivatives like C.D.O.’s. The new system was presented as a fait accompli, and adopted.

Other changes also increased the likelihood that investors would suffer losses if the mortgage market tanked. Previously, investors took losses only in certain dire “credit events,” as when the mortgages associated with the C.D.O. defaulted or their issuers went bankrupt.

But the new rules meant that C.D.O. holders would have to make payments to short sellers under less onerous outcomes, or “triggers,” like a ratings downgrade on a bond. This meant that anyone who bet against a C.D.O. could collect on the bet more easily.

“In the early deals you see none of these triggers,” said one investor who asked for anonymity to preserve relationships. “These things were built in to provide the dealers with a big payoff when something bad happened.”

Banks also set up ever more complex deals that favored those betting against C.D.O.’s. Morgan Stanley established a series of C.D.O.’s named after United States presidents (Buchanan and Jackson) with an unusual feature: short-sellers could lock in very cheap bets against mortgages, even beyond the life of the mortgage bonds. It was akin to allowing someone paying a low insurance premium for coverage on one automobile to pay the same on another one even if premiums over all had increased because of high accident rates.

At Goldman, Mr. Egol structured some Abacus deals in a way that enabled those betting on a mortgage-market collapse to multiply the value of their bets, to as much as six or seven times the face value of those C.D.O.’s. When the mortgage market tumbled, this meant bigger profits for Goldman and other short sellers — and bigger losses for other investors.

Selling Bad Debt

Other Wall Street firms also created risky mortgage-related securities that they bet against.

At Deutsche Bank, the point man on betting against the mortgage market was Greg Lippmann, a trader. Mr. Lippmann made his pitch to select hedge fund clients, arguing they should short the mortgage market. He sometimes distributed a T-shirt that read “I’m Short Your House!!!” in black and red letters.

Deutsche, which declined to comment, at the same time was selling synthetic C.D.O.’s to its clients, and those deals created more short-selling opportunities for traders like Mr. Lippmann.

Among the most aggressive C.D.O. creators was Tricadia, a management company that was a unit of Mariner Investment Group. Until he became a senior adviser to the Treasury secretary early this year, Lewis Sachs was Mariner’s vice chairman. Mr. Sachs oversaw about 20 portfolios there, including Tricadia, and its documents also show that Mr. Sachs sat atop the firm’s C.D.O. management committee.

From 2003 to 2007, Tricadia issued 14 mortgage-linked C.D.O.’s, which it called TABS. Even when the market was starting to implode, Tricadia continued to create TABS deals in early 2007 to sell to investors. The deal documents referring to conflicts of interest stated that affiliates and clients of Tricadia might place bets against the types of securities in the TABS deal.

Even so, the sales material also boasted that the mortgages linked to C.D.O.’s had historically low default rates, citing a “recently completed” study by Standard & Poor’s ratings agency — though fine print indicated that the date of the study was September 2002, almost five years earlier.

At a financial symposium in New York in September 2006, Michael Barnes, the co-head of Tricadia, described how a hedge fund could put on a negative mortgage bet by shorting assets to C.D.O. investors, according to his presentation, which was reviewed by The New York Times.

Mr. Barnes declined to comment. James E. McKee, general counsel at Tricadia, said, “Tricadia has never shorted assets into the TABS deals, and Tricadia has always acted in the best interests of its clients and investors.”

Mr. Sachs, through a spokesman at the Treasury Department, declined to comment.

Like investors in some of Goldman’s Abacus deals, buyers of some TABS experienced heavy losses. By the end of 2007, UBS research showed that two TABS deals were the eighth- and ninth-worst performing C.D.O.’s. Both had been downgraded on at least 75 percent of their associated assets within a year of being issued.

Tricadia’s hedge fund did far better, earning roughly a 50 percent return in 2007 and similar profits in 2008, in part from the short bets.

Filed under: bubble, CDO, CORRUPTION, currency, Eviction, foreclosure, GTC | Honor, Investor, Mortgage, securities fraud | Tagged: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , | 7 Comments »

Ohio Sues Rating Firms for Losses in Funds: Fraud Catching Up with Swindlers

Posted on November 21, 2009 by Neil Garfield
NOW AVAILABLE ON KINDLE/AMAZON
WHY THIS IS IMPORTANT TO FORECLOSURE DEFENSE AND OFFENSE: OK I know the last thing you want to hear is how complex this scheme was. But if you can get over the intimidation factor, you will see how the lawsuits filed by individual homeowners, attorney generals, and class actions are picking apart the whole scheme, coming up with the inconvenient answers that Wall Street is working to avoid and that many government officials are too lazy or paid off or whatever to get involved.
So here we focus on the rating agencies and you might be asking why do I care if I wasn’t an investor who bought those empty bonds that funded my loan? The reason is that others with far greater resources than you are doing your work for you.
The SINGLE transaction, starting with the sale of the bond to the investor and then to the sale of the financial loan product to the homeowner and then ending with the false foreclosures and unconscionable proceeds of credit default swaps could ONLY have been achieved with the active participation from the rating agencies.
By selling their reputation for objectivity to the highest bidder, by misusing their skill in assessing credit risk,  the rating agencies enabled those bonds to be sold under the pretense that they were AAA sound investments. But for that the mortgage meltdown would never have occurred. But for that, you would not be in the upside down position, or delinquency, default or foreclosure in which you find yourself.
But for the free flow of free money there would have been no pressure to get rid of it in order to make Wall Street’s unconscionable profits. And without that pressure, housing prices would have remained relatively stable instead of shooting up to unprecedented (by any measure) unsustainable levels that were not reflective of what the homeowner would get when Wall Street’s scheme was over.
Your home loan was rated by these rating agencies. They looked the other way and changed underwriting standards from common sense to common fraud. The ONLY way the bonds sold to investors could have been rated so high was by rating the underlying mortgages and notes. No REAL analysis would have done anything except raise red flags bringing the rating down to junk. Just starting with the appraisal” on the house which was also a form of rating, no reasonable person could possible look at the history of housing prices and believe that the 30% jump in 4 months was sustainable. Nobody using their own money would fund a deal based on that. It is only because the originating “lenders” (i.e, straw-men, conduits) were not using their own capital that these loans were made.
We were all duped by the appraisers and the rating agencies who sold their integrity to the highest bidder. And in the process of tragedy of astonishing severity is unfolding, getting worse and fooling the American public — until it reaches each and every one of us, which it will.
At some point the homeowners should be suing the rating agencies and appraisers for their part in all this. The counterclaim is both fraud in the inducement and fraud in the execution. Fraud in the execution because you thought you were just taking out a loan when in fact you were purchasing a financial loan product that was a security promising you passive returns whose value was intentionally misrepresented. Fraud in the inducement because had you known the true value of the property you would never have assumed that you could cover the loan terms, which were also illegal and predatory.
The game is on. If you reach the truth before Goldman et al are done, you can stop it, reverse it, and set the country back on the path of confidence in an economy that is based upon something other than $500 trillion in derivative vapor.
November 21, 2009

Ohio Sues Rating Firms for Losses in Funds

Already facing a spate of private lawsuits, the legal troubles of the country’s largest credit rating agencies deepened on Friday when the attorney general of Ohio sued Moody’s Investors Service, Standard & Poor’s and Fitch, claiming that they had cost state retirement and pension funds some $457 million by approving high-risk Wall Street securities that went bust in the financial collapse.

The case could test whether the agencies’ ratings are constitutionally protected as a form of free speech.

The lawsuit asserts that Moody’s, Standard & Poor’s and Fitch were in league with the banks and other issuers, helping to create an assortment of exotic financial instruments that led to a disastrous bubble in the housing market.

“We believe that the credit rating agencies, in exchange for fees, departed from their objective, neutral role as arbiters,” the attorney general, Richard Cordray, said at a news conference. “At minimum, they were aiding and abetting misconduct by issuers.”

He accused the companies of selling their integrity to the highest bidder.

Steven Weiss, a spokesman for McGraw-Hill, which owns S.& P., said that the lawsuit had no merit and that the company would vigorously defend itself.

“A recent Securities and Exchange Commission examination of our business practices found no evidence that decisions about rating methodologies or models were based on attracting market share,” he said.

Michael Adler, a spokesman for Moody’s, also disputed the claims. “It is unfortunate that the state attorney general, rather than engaging in an objective review and constructive dialogue regarding credit ratings, instead appears to be seeking new scapegoats for investment losses incurred during an unprecedented global market disruption,” he said.

A spokesman for Fitch said the company would not comment because it had not seen the lawsuit.

The litigation adds to a growing stack of lawsuits against the three largest credit rating agencies, which together command an 85 percent share of the market. Since the credit crisis began last year, dozens of investors have sought to recover billions of dollars from worthless or nearly worthless bonds on which the rating agencies had conferred their highest grades.

One of those groups is largest pension fund in the country, the California Public Employees Retirement System, which filed a lawsuit in state court in California in July, claiming that “wildly inaccurate ratings” had led to roughly $1 billion in losses.

And more litigation is likely. As part of a broader financial reform, Congress is considering provisions that make it easier for plaintiffs to sue rating agencies. And the Ohio attorney general’s action raises the possibility of similar filings from other states. California’s attorney general, Jerry Brown, said in September that his office was investigating the rating agencies, with an eye toward determining “how these agencies could get it so wrong and whether they violated California law in the process.”

As a group, the attorneys general have proved formidable opponents, most notably in the landmark litigation and multibillion-dollar settlement against tobacco makers in 1998.

To date, however, the rating agencies are undefeated in court, and aside from one modest settlement in a case 10 years ago, no one has forced them to hand over any money. Moody’s, S.& P. and Fitch have successfully argued that their ratings are essentially opinions about the future, and therefore subject to First Amendment protections identical to those of journalists.

But that was before billions of dollars in triple-A rated bonds went bad in the financial crisis that started last year, and before Congress extracted a number of internal e-mail messages from the companies, suggesting that employees were aware they were giving their blessing to bonds that were all but doomed. In one of those messages, an S.& P. analyst said that a deal “could be structured by cows and we’d rate it.”

Recent cases, like the suit filed Friday, are founded on the premise that the companies were aware that investments they said were sturdy were dangerously unsafe. And if analysts knew that they were overstating the quality of the products they rated, and did so because it was a path to profits, the ratings could forfeit First Amendment protections, legal experts say.

“If they hold themselves out to the marketplace as objective when in fact they are influenced by the fees they are receiving, then they are perpetrating a falsehood on the marketplace,” said Rodney A. Smolla, dean of the Washington and Lee University School of Law. “The First Amendment doesn’t extend to the deliberate manipulation of financial markets.”

The 73-page complaint, filed on behalf of Ohio Police and Fire Pension Fund, the Ohio Public Employees Retirement System and other groups, claims that in recent years the rating agencies abandoned their role as impartial referees as they began binging on fees from deals involving mortgage-backed securities.

At the root of the problem, according to the complaint, is the business model of rating agencies, which are paid by the issuers of the securities they are paid to appraise. The lawsuit, and many critics of the companies, have described that arrangement as a glaring conflict of interest.

“Given that the rating agencies did not receive their full fees for a deal unless the deal was completed and the requested rating was provided,” the attorney general’s suit maintains, “they had an acute financial incentive to relax their stated standards of ‘integrity’ and ‘objectivity’ to placate their clients.”

To complicate problems in the system of incentives, the lawsuit states, the methodologies used by the rating agencies were outdated and flawed. By the time those flaws were obvious, nearly half a billion dollars in pension and retirement funds had evaporated in Ohio, revealing the bonds to be “high-risk securities that both issuers and rating agencies knew to be little more than a house of cards,” the complaint states.

Filed under: bubble, CDO, CORRUPTION, currency, Eviction, foreclosure, GTC | Honor, Investor, Mortgage, securities fraud | Tagged: , , , , , , , , , , , , , , , , , , , | 7 Comments »

Foreclosure Defense and Offense: Rating Agencies and Appraisals

Posted on June 4, 2008 by Neil Garfield

Taking the entire Mortgage Meltdown process as a single transaction starting with the origination of the loan to the borrower and ending with the sale of an asset backed security to an investor, a pattern of deception and confusion emerges — providing the borrower with an arsenal of offensive and defensive strategies to avoid foreclosure, recover damages and even free their property from the mortgage altogether. In foreclosure defense and particularly offense for “lender” liability, keep in mind that there was a chain of entities who all knowingly conspired (under a cloak of what they deemed “plausible deniability”).

This chain was never disclosed to the borrower — thus the disclosure obligations set forth in TILA, state law, RICO, common law and other resources were never met and the right to rescission was blocked by lack of information, to wit: the borrower in most cases does not know who to send the rescission letter to because in all likelihood there are now multiple parties who have an interest in the security instrument, the note and the risk of loss, none of whom were disclosed to the borrower at or after closing. 

These participants are subject to liability for monetary damages and many are insured as well as having deep pockets of their own. They also de-linked several aspects of what had been a single event — the purchase of a home with a first mortgage on residential property using money in part loaned by a lender who took the risk of non-payment, followed underwriting guidelines set by the banking industry and regulators, and therefore had a direct stake in the outcome of the loan and a specific desire to avoid default on the loan. 

The de-linking of teht ransaction and overlapping with other parts of the entire single “mortgage meltdown” chain resulted in separation of the security interest from the the obligation to pay, adding obligors who had liability for payment, and adding receivers of income. Thus the classic and relatively simple foreclosure that involved non-payment by the borrower to the lender, was converted in a complex series of transactions leaving the investor who bought the asset backed security with the right to the income and some rights to the security interests, and others with the the right to the security interest but no right to payment, and still others who made payments to the investor or who were liable for non-payment to the investor who acquired the right to payment from the underlying mortgage and note from which his asset backed security derived its value.

The significance of this in foreclosure defense is that the party alleging non-payment by the borrower is NOT and CANNOT allege non-payment to the entity or person (investor) who is entitled to that payment. The usual person entering the foreclosure process is the trustee posting notice of sale or the originating lender filing foreclosure. But they do not know if the investment bank, an insurer or some other third party, including another borrower was contributing to the flow of payments that the investor received, nor do they know the allocation of those funds which the investor received.

Thus the party entitled to income from the borrower’s note may or may not have been paid by the borrower (through overcharges and other TILA violations in addition to regular monthly payments, or by third parties whose obligation derived in part from the note signed by the borrower and in part by hundreds or thousands of other notes in cross collateralization agreements or cross guarnatees, indemnifications, indentures and covneants between the lender, mortgage agregator, investment banker, seller of teh security and the investor who bought the security. 

You can therefore take the position that if the default alleged is non-payment, the entity or person making the allegation must prove the non-payment and that proving that the borrower did not make one or more payments does not prove that the party (investor) entitled to payment did not get paid in whole or in part. Thus no default has been alleged without alleging that no payment was received by the holder of the original note and mortgage and the party to whom payment was to be received as a result of the income stream from this mortgage combined with thousands of other mortgages.

Production of the original note and mortgage becomes critical and a condition precedent to any action, sale, motion for summary judgment, judgement of foreclosure, sale or rights of redemption. Equally important and perhaps more so is the production of the documents that assigned, sold or otherwise transferred the security interest, the income from the note or the risk of non-payment to one or more parties. You will find that in many cases, those are all different third parties with different interests and agendas.

Perhaps the most important, we are finding in Ohio and other states, that NOBODY can come up with documents that directly link a particular borrower with any of these third parties holding primary or secondary rights to the security instrument, the note, or the risk of loss. In those cases, we are seeing borrowers walk away with their home free and clear of any encumbrances and lawyers getting paid fat bonuses or contingency fees for eliminating the risk of foreclosure, and feeing the borrower from the entanglement in a complex transaction that was never disclosed to him/her/them.

The appraisers, who are usually insured by errors and omissions policies, state the fair market value of real property through supposedly independent analysis of comparable statistics and other factors. The standards are governed by the regulatory board in each state that licenses them, although there might still be some states who do not license appraisers. In states without licensing, they are governed by common law and other applicable law concerning deceptive business practices.

The rating agencies state the quality of a security that is used to determine the fair market value of the security. They too are supposedly using objective means, analysis and due diligence to issue their rating. In the world of the mortgage meltdown, rating agency objectivity broke down y virtue of two main factors: (a) the rating agencies were competing for customers and revenue and (b) in a related factor, the rating agency analysts were receiving gifts, pressure from clients (issuers) and pressure from management to “accommodate” the client (issuer). A Nationally Recognized Statistical Rating Organization (or “NRSRO”) is a credit rating agency which issues credit ratings that the U.S. Securities and Exchange Commission (SEC) permits other financial firms to use for certain regulatory purposes.

The nine organizations currently designated as NRSROs are:

Ratings by NRSRO are used for a variety of regulatory purposes in the United States. In addition to net capital requirements (described in more detail below), the SEC permits certain bond issuers to use a shorter prospectus form when issuing bonds if the issuer is older, has issued bonds before, and has a credit rating above a certain level. SEC regulations also require that money market funds (mutual funds that mimick the safety and liquidity of a bank savings deposit, but without FDIC insurance) comprise only securities with a very high rating from an NRSRO. Likewise, insurance regulators use credit ratings from NRSROs to ascertain the strength of the reserves held by insurance companies.

The following article described the efforts of the New York Attorney general to address the break down of objectivity caused by competition for fees.

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Bond-Rating 
Shifts Loom 
In Settlement

N.Y.’s Cuomo Plans 
Overhaul of How 
Firms Get Paid
By AARON LUCCHETTI
June 4, 2008; Page C1

The three major bond-rating firms are set to overhaul the way they collect fees as part of a settlement with New York state’s attorney general, Andrew Cuomo, that could be announced as soon as this week, people familiar with the matter said.

If a deal is reached, it could change the $5 billion-a-year bond-rating industry as fundamentally as Mr. Cuomo’s predecessor Eliot Spitzer did six years ago with his settlement with Wall Street firms over stock-research analysts whose recommendations were compromised by investment-banking ties.

[Andrew Cuomo]

Terms of Mr. Cuomo’s settlement with Moody’s Corp.’s Moody’s Investors Service; McGraw-Hill Cos.’ Standard & Poor’s unit; and Fimalac SA’s Fitch Ratings deal with what many critics claim has been a chronic problem with bond ratings: They are paid for by the entities being rated. That financial dependence has been blamed for the industry’s failure to predict that risky subprime mortgages would crumble, resulting in losses and shaken confidence.

The accord attempts to change the incentive structure for the ratings firms. Now, while more than one ratings firm reviews most deals, not all of them always rate the deal and get paid. That gives the firms an incentive to go easy on their rating in order to win the business.

Under the Cuomo settlement, which would cover the hardest-hit portions of the mortgage market, the firms would get paid for their review, even if they didn’t end up getting hired to rate the deal. This would mean the firms would get paid even if they were tough. The plan, which requires final agreement by Mr. Cuomo’s office and the rating firms, wouldn’t dictate the exact fees rating firms could charge. But the firms would be required to charge more than a nominal fee for their preliminary work.

The bond-rating firms also have tentatively agreed to disclose on a quarterly basis the fees they are paid for nonprime-mortgage-backed securities, which include subprime mortgages and so-called Alt-A mortgages that have less documentation or don’t conform with prime-mortgage standards.

Such disclosures are seen as a potential red flag to help investors detect instances where bond issuers or their bankers may have essentially pitted different rating firms against each other in order to get a higher rating.

In an interview late last year, Brian Clarkson, then the president and chief operating officer of Moody’s Investors Service, acknowledged that “there is a lot of rating shopping that goes on…What the market doesn’t know is who’s seen” certain transactions but wasn’t hired to rate those deals. Last month, Mr. Clarkson, who once ran the Moody’s group overseeing mortgages and other structured-finance products, stepped down, effective in July.

The settlement is unlikely to satisfy critics who have urged that bond-rating firms stop being paid altogether by bond issuers or that the firms be permitted to rate any deal they choose, regardless of whether the issuer cooperates. Following the settlement, bond issuers still would get a strong say over which firms published the final rating, as well as those invited to look over a pool of loans in the first place.

For Moody’s, S&P and Fitch, the agreement largely eliminates the possibility of a nasty showdown with Mr. Cuomo, whose office has been investigating the industry for about nine months, poring through thousands of pages in documents and emails and interviewing senior executives at each of the three big rating firms, people familiar with the matter said.

Mr. Cuomo has leverage over the bond-rating industry partly because Moody’s and S&P are based in New York. The attorney general also has one of the most powerful legal tools in the nation: the 1921 Martin Act, which spells out a broad definition of securities fraud without requiring that prosecutors prove intent to defraud.

In a statement, Deven Sharma, S&P’s president, said the firm “is pleased to work with New York Attorney General Andrew M. Cuomo and other rating agencies on these important measures, which we believe will help ensure our ratings process continues to be of the highest quality.”

Rating-company shares rose after The Wall Street Journal reported news of the settlement talks Tuesday afternoon. In 4 p.m. composite trading on the New York Stock Exchange, Moody’s was at $38.45, up $1.80, or 4.9%. McGraw-Hill was up 38 cents at $41.20.

As the probe proceeded, attorneys in Mr. Cuomo’s office concluded that rating firms could be more effective if Wall Street had less control over which ones were paid, these people said. As part of the deal, the firms would cooperate with Mr. Cuomo’s continuing investigation into investment banks and other financial firms that issued mortgage-backed securities later plagued by high levels of defaults. The New York attorney general is trying to determine if banks intentionally overlooked or hid flaws in loans that were securitized and sold to investors.

The decision not to seek fines from the three major bond-rating firms partly reflects Mr. Cuomo’s firm but less-confrontational style than that of Mr. Spitzer. The 50-year-old Mr. Cuomo, elected in 2006, has promised to aggressively pursue financial wrongdoing, and the likely pact shows he believes investor confidence can be shored up without an all-out attack on the bond-rating industry.

Mr. Cuomo’s settlement will likely be structured in a way that doesn’t contradict rules being proposed by the Securities and Exchange Commission. It will take up to six months to implement and may also need to address antitrust concerns at investment banks or among smaller rating firms. “Without knowing all the details, I’m concerned it would entrench the three large rating firms,” said David Schroeder, chief operating officer of DBRS, a Toronto rating firm not included in the settlement talks.

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