The Beginning or the End for Loan Servicer Ocwen?

By William Hudson
Ocwen Financial, one of the largest subprime mortgage servicers in America, has big problems. Analysts predict that Ocwen will be forced to file bankruptcy as the SEC opens up two more investigations into the loan servicers business practices while the stock goes into free-fall.

A further hurdle will befall homeowners if Ocwen files for bankruptcy protection because another shield is placed between the homeowners and the banks who are the culprits- but just happen to control all of the “loan” information. As Neil Garfield would say, “They have plenty of bodies to throw under the bus.” To date, homeowners and their attorneys in litigation have been frustrated by attempts to discover who the true creditor is especially when the servicer hides behind bankruptcy, mergers and receivership (Fannie and Freddie).

Ocwen reported a $247 million annual loss while revenues tumbled 17.5% last week at the same time the SEC is continuing to scrutinize their shoddy and abusive servicing practices. Despite the fact that Ocwen previously settled with multiple government regulators upon findings of fraudulent servicing practices, apparently it is business as usual for Ocwen as authorities continue to investigate their business practices- without administering any penalty with teeth or consequences.

Only a month ago, Ocwen settled with the SEC for misstating their 2013 and 2014 financial results and were fined a paltry $2 million dollar fine for poor internal controls and failing to disclose the financial conflicts of their former CEO Bill Erby. In 2014 alone, Ocwen would pay a $100 million civil monetary penalty to the New York Department of Financial Services for violations and non-compliance with a prior consent order with a regulator. Last year they paid an additional $2.5 million fine to the California Department of Business Oversight on their servicing practices that ultimately led to Ocwen being barred from acquiring new Mortgage Servicing Rights in the state of California. Predictably, although the Department of Business Oversight had threatened to revoke their mortgage license- and should have- they failed to do so.

On the upside for Ocwen, is that they will remain in the business of servicing Ginnie Mae loans and will also continue to originate and service new Fannie and Freddie loans. My advice would be to steer clear of GSE loans like Fannie Mae and Freddie Mac if at all possible since it presents one more ‘layer’ to navigate if at a future time you suspect fraud may have been involved in your loan. Both Fannie Mae and Freddie Mac are quasi-governmental institutions that are immune to Freedom of Information Requests and federal transparency, while still benefiting from being private corporations. The GSE’s have a cushy little deal where they appear to exist outside of both governmental and corporate regulations.

Last year Ocwen demonstrated that they couldn’t effectively service government guaranteed loans, and was forced to sell $45 billion in mortgage servicing rights (MSRs) on loans originated by Fannie Mae to JPMorgan Chase. Ocwen was also forced to sell a total of $34.8 billion in MSR’s on Fannie Mae and Freddie Mac loans to competitor Nationstar Mortgage in two separate deals to unwind servicing legacy agency loans. Although I could go on and on about the abusive servicing practices that have resulted in Ocwen being financially fined and forced to sell its servicing rights, let’s just say these issues are indicative of the regulatory and investor pressures the servicing giants are now facing- across the board. At present, bondholders have requested that Ocwen be removed from servicing 119 different residential mortgage backed securities trusts with more requesting removal weekly.

Last Monday Ocwen was notified that the SEC would launch a new SEC probe into its servicing operations. The SEC is investigating Ocwen’s use of collection agents by the company’s various mortgage loan servicers, a practice that Ocwen has argued is a standard practice across the servicing industry. President Ronald Faris commented that their practices and fees are considered standard and should be of no concern. Faris is correct in that Ocwen’s illegal practices of using forged and fraudulent documents presented to courts across the country in order to foreclose is standard practice among loan servicing agents. However, Faris is delusional if he believes these practices should be of no concern. To whom? The shareholder who has no idea the loans Ocwen services are owned by phantom entities with no standing to foreclose, or the homeowner who is subjected to predatory servicing and foreclosure tactics? If the government agencies would do their jobs- Ocwen would cease to exist tomorrow.

The SEC has opened an investigation into the fees and expenses the company charges in connection with its management of liquidating mortgage loans and real estate properties in different RMBS trusts. Unfortunately, Ocwen is not being investigating for violations against consumers, but only because investors have complained and when investors complain the regulators and government take notice. Groups of investors have a tendency to get better results when they go up against a large corporation and can retain the best representation that money can buy. A homeowner in a small town outside Des Moines with an attorney specializing in family law doesn’t pose much of a threat or incite the same action.

It is unusual for the SEC to investigate business practices. Typically the SEC will only investigate the integrity of financial statements. CEO Ronald Faris spoke on a conference call Monday evening and addressed the investigation. He said what all good CEO’s say to distance themselves from controversy, “I can’t really comment except to say that we feel confident that the fees that are part of the servicing business that are either assessed to borrowers or passed on to RMBS investors are – they’re monitored closely by master servicers and trustees and others. We’ve had various third parties look at them. We have a good sense as to what other servicers have done since we’ve acquired a lot of servicing portfolios and been able to see what industry practice has been. And we feel comfortable that our process is within industry practice. So, we can’t comment on what exactly a regulator may be looking for, but we do believe that our processes are appropriate.” Faris confirms that he is simply going along with industry “best practices”. Best practices that have been revealed to include falsifying affidavits and forging mortgage documents in order to create the illusion of having standing to foreclose.

In January, Ocwen announced that Phyillis R. Caldwell joined the Board of Directors. Caldwell previously served as Chief of the Homeownership Preservation Office at the U.S. Department of the Treasury where she was responsible for oversight of the U.S. housing market stabilization, economic recovery, and foreclosure prevention initiatives established through the Troubled Asset Relief Program (TARP). Since Caldwell did such an outstanding job with TARP what could go wrong? Under TARP millions of TPP modification agreements were extended and revoked for no reason while the homeowner was in compliance with the terms of the agreement.

Upon announcing Ocwen’s director, the company issued a press release stating, “Phyllis’ character, deep experience in the housing and mortgage markets, and commitment to borrowers and communities makes her the right choice to move Ocwen forward and emerge as a stronger company with the highest standards in our industry.” Unfortunately, we know what commitment to borrowers and communities’ means for homeowners under Ocwen. It means that investors will be able to come in, purchase properties for pennies on the dollar and displace families while Ocwen alters legal instruments to give the illusion of standing and forecloses on properties. Becoming a stronger company refers to cashing in a few favors she has coming her way so Ocwen can escape extinction. Caldwell’s appointment is disturbing and it is obvious what type of ‘help’ she will provide to Ocwen (cronyism and assistance covering their fraud scheme).

Remember, Ocwen was issued a consent order from the CFPB in every state but Oklahoma last year that illustrated the “continued, systemic abuse of the American homeowner.” Ocwen was accused of “violating consumer financial laws at every stage of the mortgage servicing process,” according to CFPB Director Richard Cordray. However, under that settlement, Ocwen executives faced no criminal charges, did not pay the majority of penalties themselves, and were not forced to admit wrongdoing in the case.
Ocwen, like JPMorgan Chase, Citicorp, Bank of America and other bank servicers settled cases of mortgage servicing abuse in the National Morgan Settlement back in 2012 for 25 billion dollars. The banks paid a nominal fine, and transferred or sold their servicing operations to non-bank servicers like Ocwen.

As a non-bank servicer, Ocwen doesn’t own any of the loans. They merely service loans, collecting monthly payments and dealing with loan modifications and foreclosures, for investors who purchased them as part of mortgage-backed securities.  Ocwen makes the erroneous assumption that the loans they are servicing actually made it into the trusts they claim to. Ocwen has no way to verify if the note is where it is supposed to be but makes false assertions that it is simply because the bank “says so”.
Although Ocwen is not a bank, they have engaged in the exact same servicing practices as the big banks. Eric Mains who is suing CitiMortgage likes to call this game of passing around servicing rights while also claiming creditor rights, “Whack-a-Mole.” The entire servicing industry, by design, is about keeping the homeowner in the dark until they can properly execute the foreclosure action. Servicers change, account numbers change, customer service representatives provide account disinformation and banks routinely fail to comply with any statute meant to protect the homeowner from this type of exploitation and predation.

“Too often trouble began as soon as a loan transferred to Ocwen,” said CFPB Director Cordray when he announced the enforcement action last year. Ocwen was accused of charging borrowers more than stipulated in the mortgage contract; forcing homeowners to buy unnecessary insurance policies; charging borrowers unauthorized fees; providing inaccurate information to borrowers when questioned about excessive and unauthorized fees; lying about loan modification options; misplacing documents and ignoring or losing loan modification applications, deliberately causing homeowners to slip into foreclosure; illegally denying eligible borrowers loan modifications, and then lying to cover up their crimes. These activities result in foreclosures and a windfall of profits to the loan servicer who will then reap a free house, insurance proceeds and other undisclosed rewards granted for successfully foreclosing on a home. I wouldn’t be surprised if Ocwen had a Pirate of the Week award that includes a parking spot upfront near the CEO.

Finally, if Ocwen goes into bankruptcy, homeowners who have loans serviced by Ocwen will face further hardships attempting to unravel who their creditor is, if the loan was legitimately transferred, while being subjected to some unsavory servicing practices that appear to be designed to ensure the appearance of homeowner non-compliance. It is time that Ocwen ADMIT wrongdoing so that their executives will not be protected from legal consequences. Ocwen also needs to be forced to pay any penalties with their own money, not the investors. To date, Ocwen has only faced trivial administrative fines while foreclosing on thousands of homeowners under false pretenses, with fraudulent documents, by predatory means. Until the government regulators take real action- this is business as usual for the loan servicers.

 

 

Banks Still Out Cheating Their Customers and Everyone Else

It is easy to think of the mortgage meltdown as a period of time in which the banks went wild. Unfortunately that period of time never ended. They are still doing it. The level of sophistication it takes to do the kinds of things that banks have been doing for the last 20 years is probably beyond the knowledge and experience of any of the regulators. In addition, it is beyond the knowledge and experience of most consumers, lawyers and judges; in fact as to non-regulators, bank behavior makes no sense. After having seen the results of what are euphemistically called subprime mortgages, Wells Fargo is plunging back in and obviously expecting to make a profit. Apparently the quasi governmental entities that issue guarantees on certain mortgages will allow these subprime mortgages. Wells Fargo says it now understands the parameters under which the guarantors (Fannie and Freddie) will approve those mortgages without a risk that Wells Fargo will be required to buy them back.

That is kind of a mouthful. We have thousands of transactions that are being conducted that directly affect the ownership and balance of various types of loans including mortgage loans. The picture presented in court is that the ownership and status of each loan is stable enough for representations to be made. But the truth is that the professional witnesses hired by the bank’s foreclosure actions only present a slice of the life of a loan. They neither know nor do they inquire about the rest of the information. For example, they come to court with a a report showing the borrower’s record of payments to the servicer but they do not show servicer’s record of payments to the creditor. By definition they are saying that they only know part of the financial record and that consists of a made for trial report on the borrower’s activities. It does not show what happened to the payments made by the borrower and does not show payments made by others —  like loss sharing with the FDIC, servicer advances, insurance, and other actual payments that were made.

These payments are not allocated to any specific loan account because that would reduce the amount claimed as due from the borrower to the creditor — as it should. And the intermediaries and conduits who are making claims against the borrower have no intention of paying the actual creditors (the investors) any more than they absolutely have to. So you have these intermediaries claiming to be real parties in interest or claiming to represent the real parties in interest when in fact they are representing themselves.

They cheat the investor by not disclosing payments received from insurance and FDIC loss sharing. They cheat the borrower by not disclosing those payments that reduce the count receivable and therefore the account payable. They cheat the borrower again when they fail to show “servicer advances” which are payments received by the alleged trust beneficiaries regardless of whether or not the borrower submits monthly payments.  (That is, there can’t be a default in payments to the “trust” because the pass through beneficiaries are getting paid. Thus if there is any liability of the borrower it would be to intermediaries who made those servicer payments by way of a new liability created with each such payment and which is NOT secured by any mortgage because the borrower never entered into any deal with the servicer or investment bank — the real source of servicer advances).

Then they cheat the investor again by forcing a case into a foreclosure sale when the borrower was perfectly prepared, willing and able to enter into a settlement agreement that would have paid the rest are far more than the proceeds of a foreclosure sale and final liquidation. Their object is to maximize the loss of the investor and maximize the loss of the borrower to the detriment of both and solely for the benefit of the intermediary or conduit that is pulling the strings and handling the money.  And they are still doing it.

The banks have become so brazen that they are manipulating currency markets in addition to the debt markets. While we haven’t seen any reports about activities in the equity markets, there is no reason to doubt that their illegal activities are not present in equity transactions. For the judicial system to assume that the Banks are telling the truth or presenting an accurate picture of the  transaction activity relating to a particular loan is just plain absurd now. The presumption in court should be what it used to be, at a minimum. Before the era of securitization, most judges scrutinized the documentation to make sure that everything was in order. Today most judges will say that everything is in order because they are pieces of paper in front of them, regardless of whether any of those pieces of paper represents an accurate rendition of the facts related to the loan in dispute. Most judges in most cases are rubber-stamping judgments for intermediaries and thus are vehicles for the intermediaries and conduits to continue cheating and stealing from investors and borrowers.

The latest example is the control exercised by the large banks over currency trading. Regulators are clueless.  The banks are no longer even concerned with the appearance of propriety. They are cheating the system, the society, the government and of course the people with impunity. They are continuing to pay or promote their stocks as healthy investment opportunities. Perhaps they are right. If they continue to be impervious to prosecution for violating every written and unwritten rule and law then their stock is bound to rise both in price and in price-to-earnings ratio. They now have enough money which they have diverted out of the economy of this country and other countries that they can create fictitious transactions showing proprietary trading profits for the next 20 years.

This is exactly what I predicted six years ago. They are feeding the money back into the system and laundering it through the appearance of proprietary trading. It is an old trick. But they have enough money now to make their earnings go up every year indefinitely. On the other hand, if the regulators and investigators actually study the activities of the banks and start to bring enforcement actions and prosecutions, maybe some of that money that was taken from our economy can be recovered, and the financial statements of those banks will be revealed and smoke and mirrors. Then maybe their stock won’t look so good. Right now everyone is betting that they will get away with it.

New forex lawsuit parses data to make case

Yesterday, 03:13 PM ET · JPM

  • There have been a number of suits against the global banks over claims of forex manipulation, but this latest by the City of Philadelphia Board of Pensions and Retirement is the first to include research highlighting unusual movements in major currencies.
  • Using data compiled by Fideres, the plaintiffs analyzed daily trading right around the 4 PM fix of currency prices … curiously, anomalous price movements became rarer and less pronounced after the initial reports of rigging surfaced last summer.
  • Morgan Stanley has spent some time looking at euro/dollar spikes at 4 PM and also concluded they were unrelated to economic events. Instead of collusion though, Morgan pins the blame on computerized trading programs.
  • The seven banks sued by Philadelphia which is seeking damages as high as $10B: Barclays (BCS), Citigroup (C), Deutsche Bank (DB), HSBC, JPMorgan (JPM), RBS, and UBS.

Read more at Seeking Alpha:
http://seekingalpha.com/currents/post/1565171?source=ipadportfolioapp_email

FANNIE AND FREDDIE BLOCK INFORMATION, PROTECTING BANKS AND FORECLOSURES

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Fannie and Freddie should be held accountable for (1) failing to check whether the loans were in fact viable, in conformity with GSE requirements and industry standards for underwriting (2) failing to check whether the loans were properly transferred by the actual owner of the obligation and (3) failing to provide easy access to the loan and trust information so that Banks, auditors, regulators and borrowers would be able to determine whether a particular loan was claimed as an asset of the pool (trust) was in fact present.” Neil Garfield, livinglies.me

FANNIE AND FREDDIE DIDN’T MAKE OR CALL FOR LOANS

EDITOR’S ANALYSIS: Fannie and Freddie were not responsible for the housing bubble, nor were they pressuring the Banks to issue more loans, subprime loans or any kind of loans. Contrary to ideological dogma these government sponsored entities didn’t make any loans. They were neither depository nor lending institutions. They merely served as conduits through which the Banks securitized the loans using Fannie and Freddie as a Master Trustee of pools that were supposed to be Trusts holding pools of loans.

As we have seen, the pools were largely empty because the documents of transfer referred to defective or even non-existent loans and the Assignor frequently didn’t own the loan it said it was transferring into these GSE trusts. But Fannie and Freddie should be held accountable for (1) failing to check whether the loans were in fact viable, in conformity with GSE requirements and industry standards for underwriting (2) failing to check whether the loans were properly transferred by the actual owner of the obligation and (3) failing to provide easy access to the loan and trust information so that Banks, auditors, regulators and borrowers would be able to determine whether a particular loan was claimed as an asset of the pool (trust) was in fact present.

This last item, information access should be a no-brainer, but the GSE’s are like a brick Wall when we do our securitization analysis causing much confusion and irritation amongst analysts and borrowers. This information should be totally transparent but it isn’t. When you get to Fannie or Freddie, you are met with an entry on their website that says nothing about any of the questions raised above and which will make the OCC Review process that much more difficult. Either they have the information or they don’t. If they don’t, the entry shouldn’t be made on their website because they don’t actually know anything about particular loan or loan transaction.

“Fannie owns it” is a statement that many are making when not even the agency itself knows if that is true. And in the effort to prove the location of the loan, Borrowers are repeatedly making the same mistake: proving their opponent’s case for them. The burden of proof after any serious question regarding title or loan ownership is raised, shifts to the would-be forecloser. Beau Biden, Delaware AG who just filed suit against MERS, says that at the very least, 25% of the time the Banks are getting it wrong just because of the use of MERS. Add in other reasons and the numbers go sharply up.

I would say to the lawyers who are litigating these issues: don’t get caught in the trap of assuming the burden of the other side. Proving that the loan IS in a pool defeats part of your case. Later you are going to present evidence that they didn’t execute transfer documents properly. How do you expect a Judge to take that seriously when you have already admitted that the loan is in the pool? SUBPOENA THE RECORDS.

Today in doing securitisation research a loan may be discovered on the Fannie and Freddie websites. but this provides little help to the auditor or analyst. The entry onto the website indicates that these now government nationalised entities might be involved and not that the loan documents or mortgage was perfected as a lien, not that a transfer of the loan ever occurred and not whether the GSE’s are or ever were creditors since at no point in time did their charters permit them to act as lenders. It is this Wall of Silence that keeps us from knowing what we really went on.

If Fannie and Freddie show the loan their website the most that can be said about it is that they accepted the filings of the Banks without checking the paperwork, they assisted in the securitisation of the loan but won’t tell the average researcher anything about the name of the trust into which the loan was supposedly placed and they MAY have a guarantee liability to buy or pay off the loans. They demand money to give you any information beyond the website and then they don’t give you enough information.

The entire Fannie and Freddie myth is a Bank spin on private sector loans. The real data shows that it was the private sector Banks who originated ALL the loans — and then those same Banks supplanted the function of then GSE’s by going directly to the secondary Market and no doubt mixing in the GSE trust pools with the private pools so they could claim to investors that their investment into bogus mortgage bonds was guaranteed by the Federal government — a classic sales trick to make the bonds more appealing by reducing the appearance of any risk of loss.

The MO (method operations) was then same one they used in the creation of MERS wherein they privatised the recording system present in all states. By replacing the public system with their own non-secure data they could play with the data and claims and force us into accepting the representations of counsel as to the status of the loan.

Despite the very active PR machine, the Banks have been shown to have co-opted the role of government in tracking and diminished the assurance from a title record that Buyers of anything are actually getting to legal title to whatever they bought — whether it is real or personal property. THE BANKS WANT TO FORCE THE BORROWERS INTO ACCEPTING THE LOSSES CREATED BY MASSIVE FRAUD AND SCREW-UPS BY THE BANKS. But the borrowers had the least information about the transactions they were tricked into signing and clearly have the least amount resources to pay for the crisis.So the creative spin machine managed to convince our government but not our citizenry that the people as taxpayers should pay if the people as borrowers could not pay on deals that nobody could pay.

If you want to do something, then send a barrage of letters to Fannie, Freddie, and your congressmen about opening up that information on Freddie and Fannie. If they have the information let them say so and then make it available like any other public records request. If they don’t have the information let them explain why they show the loan on their website.

McClatchy Washington Bureau

Private sector loans, not Fannie or Freddie, triggered crisis

David Goldstein and Kevin G. Hall | McClatchy Newspapers

WASHINGTON — As the economy worsens and Election Day approaches, a conservative campaign that blames the global financial crisis on a government push to make housing more affordable to lower-class Americans has taken off on talk radio and e-mail.

Commentators say that’s what triggered the stock market meltdown and the freeze on credit. They’ve specifically targeted the mortgage finance giants Fannie Mae and Freddie Mac, which the federal government seized on Sept. 6, contending that lending to poor and minority Americans caused Fannie’s and Freddie’s financial problems.

Federal housing data reveal that the charges aren’t true, and that the private sector, not the government or government-backed companies, was behind the soaring subprime lending at the core of the crisis.

Subprime lending offered high-cost loans to the weakest borrowers during the housing boom that lasted from 2001 to 2007. Subprime lending was at its height from 2004 to 2006.

Federal Reserve Board data show that:

  • More than 84 percent of the subprime mortgages in 2006 were issued by private lending institutions.
  • Private firms made nearly 83 percent of the subprime loans to low- and moderate-income borrowers that year.
  • Only one of the top 25 subprime lenders in 2006 was directly subject to the housing law that’s being lambasted by conservative critics.

The “turmoil in financial markets clearly was triggered by a dramatic weakening of underwriting standards for U.S. subprime mortgages, beginning in late 2004 and extending into 2007,” the President’s Working Group on Financial Markets reported Friday. [Editor’s note: A weakening standard caused by the fact that Wall Street wanted weak loans because the worse the loan the more money they made in the spread between what was advanced by the investor for funding mortgages and what the amount actually funded in loans to borrowers.]

Conservative critics claim that the Clinton administration pushed Fannie Mae and Freddie Mac to make home ownership more available to riskier borrowers with little concern for their ability to pay the mortgages.

“I don’t remember a clarion call that said Fannie and Freddie are a disaster. Loaning to minorities and risky folks is a disaster,” said Neil Cavuto of Fox News.

Fannie, the Federal National Mortgage Association, and Freddie, the Federal Home Loan Mortgage Corp., don’t lend money, to minorities or anyone else, however. They purchase loans from the private lenders who actually underwrite the loans.

It’s a process called securitization, and by passing on the loans, banks have more capital on hand so they can lend even more.

This much is true. In an effort to promote affordable home ownership for minorities and rural whites, the Department of Housing and Urban Development set targets for Fannie and Freddie in 1992 to purchase low-income loans for sale into the secondary market that eventually reached this number: 52 percent of loans given to low-to moderate-income families.

To be sure, encouraging lower-income Americans to become homeowners gave unsophisticated borrowers and unscrupulous lenders and mortgage brokers more chances to turn dreams of homeownership in nightmares.

But these loans, and those to low- and moderate-income families represent a small portion of overall lending. And at the height of the housing boom in 2005 and 2006, Republicans and their party’s standard bearer, President Bush, didn’t criticize any sort of lending, frequently boasting that they were presiding over the highest-ever rates of U.S. homeownership.

Between 2004 and 2006, when subprime lending was exploding, Fannie and Freddie went from holding a high of 48 percent of the subprime loans that were sold into the secondary market to holding about 24 percent, according to data from Inside Mortgage Finance, a specialty publication. One reason is that Fannie and Freddie were subject to tougher standards than many of the unregulated players in the private sector who weakened lending standards, most of whom have gone bankrupt or are now in deep trouble.

During those same explosive three years, private investment banks — not Fannie and Freddie — dominated the mortgage loans that were packaged and sold into the secondary mortgage market. In 2005 and 2006, the private sector securitized almost two thirds of all U.S. mortgages, supplanting Fannie and Freddie, according to a number of specialty publications that track this data.

In 1999, the year many critics charge that the Clinton administration pressured Fannie and Freddie, the private sector sold into the secondary market just 18 percent of all mortgages.

Fueled by low interest rates and cheap credit, home prices between 2001 and 2007 galloped beyond anything ever seen, and that fueled demand for mortgage-backed securities, the technical term for mortgages that are sold to a company, usually an investment bank, which then pools and sells them into the secondary mortgage market.

About 70 percent of all U.S. mortgages are in this secondary mortgage market, according to the Federal Reserve.

Conservative critics also blame the subprime lending mess on the Community Reinvestment Act, a 31-year-old law aimed at freeing credit for underserved neighborhoods.

Congress created the CRA in 1977 to reverse years of redlining and other restrictive banking practices that locked the poor, and especially minorities, out of homeownership and the tax breaks and wealth creation it affords. The CRA requires federally regulated and insured financial institutions to show that they’re lending and investing in their communities.

Conservative columnist Charles Krauthammer wrote recently that while the goal of the CRA was admirable, “it led to tremendous pressure on Fannie Mae and Freddie Mac — who in turn pressured banks and other lenders — to extend mortgages to people who were borrowing over their heads. That’s called subprime lending. It lies at the root of our current calamity.”

Fannie and Freddie, however, didn’t pressure lenders to sell them more loans; they struggled to keep pace with their private sector competitors. In fact, their regulator, the Office of Federal Housing Enterprise Oversight, imposed new restrictions in 2006 that led to Fannie and Freddie losing even more market share in the booming subprime market.

What’s more, only commercial banks and thrifts must follow CRA rules. The investment banks don’t, nor did the now-bankrupt non-bank lenders such as New Century Financial Corp. and Ameriquest that underwrote most of the subprime loans.

These private non-bank lenders enjoyed a regulatory gap, allowing them to be regulated by 50 different state banking supervisors instead of the federal government. And mortgage brokers, who also weren’t subject to federal regulation or the CRA, originated most of the subprime loans.

In a speech last March, Janet Yellen, the president of the Federal Reserve Bank of San Francisco, debunked the notion that the push for affordable housing created today’s problems.

“Most of the loans made by depository institutions examined under the CRA have not been higher-priced loans,” she said. “The CRA has increased the volume of responsible lending to low- and moderate-income households.”

In a book on the sub-prime lending collapse published in June 2007, the late Federal Reserve Governor Ed Gramlich wrote that only one-third of all CRA loans had interest rates high enough to be considered sub-prime and that to the pleasant surprise of commercial banks there were low default rates. Banks that participated in CRA lending had found, he wrote, “that this new lending is good business.”

FDIC SUES LPS AND CORELOGIC ON APPRAISAL FRAUD

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LINK BETWEEN APPRAISAL FRAUD AND HIDDEN 2D TIER YIELD SPREAD PREMIUM

EDITOR’S NOTE: Now the FDIC gets it too. THE WORSE THE LOAN THE MORE MONEY THEY MADE. In the convoluted logic of the mortgage mess the investment banks profits skyrocketed as they increased the likelihood that the the loan would fail. Going into the subprime market was only one way it was done. The same facts apply across the board. A loan destined to fail was far more likely to carry an inflated nominal rate of interest, albeit knowing that the payments would not be made at earliest time possible. Since these loans could not be closed with borrowers unless the initial payment (teaser etc.) was low enough that the borrower could be convinced they could afford it, and the borrowers were relying on the mortgage broker and the fact that a lender would not take the risk unless there was merit to the deal, they relied upon the lender’s appraisal and apparent confirmation of appraisal of the property. By increasing the “value”of the property they were able to close larger loans. By closing larger loans, they were able to move more money faster.

The higher nominal rate of interest was something everyone except the borrower and investor knew would never be paid. The principal was also skewed based upon a higher rate of principal payments based upon an unsustainable appraisal (which of course also increased the size of the loan and therefore the principal and interest payments). The life of the loan and the effect on the actual rate of interest moved many loans into usury territory. And before you tell me that banks are exempt in many states from usury laws, let me say that in many states they are not and even if they banks ARE exempt the originators of nearly all securitized loans either were not banks at all or were banks acting as mortgage brokers — i.e., not actually underwriting the loan nor funding it.

The net effect of this, from a TILA standpoint, is that the APR was misstated in the Good Faith Estimate (GFE) given to each borrower which did not reflect the reality of the actual loan life (obviously ending when the payments reset to a level that exceeded the borrower’s income), the inflated appraisal and the actual terms of compensation being received by intermediaries who were not disclosed to the borrower or the investors. RESCISSION is therefore most probably an available remedy even in old loans as a result of this. ANd the amount that would be required for tender back to the “Lender” (originator) would be reduced by the amount of the appraisal fraud and other causes of action attendant to this fraud.

The plot thickens: by using crappy loans and getting what on paper looked like high interest rates (nominal rates), the banks were able to create the illusion that the DOLLAR amount of return that the investor was expecting was satisfied by the loans “in the portfolio” which we now know never made into the “portfolio” or “pool.” Thus by jacking up at least part of the portfolio nominal rates the banks were able to REDUCE THE PRINCIPAL of the so-called “loan,” which we now know was a sham. This reduction in the amount of principal actually funded produced a spread between the amount of money advanced by the investors and the amount of money actually funded, which the investors knew nothing about.

This spread was caused by the difference between the rates that the investors were expecting (yield) and the rates that the borrowers were supposed to pay (yield), which is why I identified a second yield spread premium (YSP2) years ago. This premium taken by the banks was in the form of profit on sale of loans that were neither sold nor even transferred but nobody knew that back then, although I suspected it based upon the inability of the banks to produce documentation on any performing loan. The only time they came up with documentation was when the loan was in foreclosure and it was in litigation and it was close a hearing in which they had to either putup or shut up. Many simply shut up and moved on to more low hanging fruit. 

FDIC Sues LPS and CoreLogic Over Appraisal Fraud; Shows Investors Leaving Money on the Table

Posted By igradman On May 30, 2011 (10:43 pm)

In another sign that the Federal Government is turning its focus towards prosecuting the securitization players who may have contributed to the Mortgage Crisis, the FDIC filed separate lawsuits against LSI Appraisal (available here) and CoreLogic (available here) earlier this month.  In the suits, both filed in the Central District of California, the FDIC, as Receiver for Washington Mutual Bank (“WAMU”), accuses vendors with whom WAMU contracted to provide appraisal services with gross negligence, breach of reps and warranties, and other breaches of contract for providing defective and/or inflated appraisals.  The FDIC seeks at least $154 million from LSI (and its parent companies, including Lender Processing Services and Fidelity, based on alter ego liability) and at least $129 million from CoreLogic (and its parent companies, including First American Financial, based on alter ego liability).

As we’ve been discussing on The Subprime Shakeout this past month, the U.S. Government has stepped up its efforts to pursue claims against originators, underwriters and other participants in mortgage securitization over irresponsible lending and underwriting practices that led to the largest financial crisis since the Great Depression.  This has included the DOJ suing Deutsche Bank over reckless lending and submitting improper loans to the FHA and the SEC subpoenaing records from Credit Suisse and JPMorgan Chase over so-called “double dipping” schemes.  The FDIC’s lawsuit is just the latest sign that much more litigation is on the horizon, as it focuses on yet another aspect of the Crisis that is ripe for investigation–appraisal fraud.

Granted, those familiar with the loan repurchase or putback process have long recognized that inflated or otherwise improper appraisals are a major category of rep and warranty violations that are found in subprime and Alt-A loans originated between 2005 and 2007.  In fact, David Grais, in his lawsuits on behalf of the Federal Home Loan Banks of San Francisco and Seattle, focused the majority of his allegations against mortgage securitizers on inflated appraisals (ironically, the data Grais used in his complaints was compiled by CoreLogic, which is now one of the subjects of the FDIC’s suits).

Grais likely zeroed in on appraisals in those cases because he was able to evaluate their propriety after the fact using publicly available data, as he had not yet acquired access to the underlying loan files that would have provided more concrete evidence of underwriting deficiences.  But, appraisals have been historically a bit squishy and subjective–even using retroactive appraisal tools–and absent evidence of a scheme to inflate a series of comparable properties, it can be difficult to convince a judge or jury that an appraisal that’s, say, 10% higher than you would expect was actually a negligent or defective assessment of value.

The reason that the FDIC/WAMU is likely focusing on this aspect of the underwriting process is because it’s one of the few avenues available to WAMU to recover its losses.  Namely, the FDIC is suing over losses associated with loans that it holds on its books, not loans that it sold into securitization.  Though the latter would be a much larger set of loans, WAMU no longer holds any ownership interest in those loans, and would not suffer losses on that pool unless and until it (or its new owner, JPMorgan) were forced to repurchase a significant portion of those loans (read: a basis for more lawsuits down the road).

Which brings me to the most interesting aspect of these cases.  As I mentioned, the FDIC is only suing these appraisal vendors over the limited number of loans that WAMU still holds on its books.  In the case against LSI, the FDIC only reviewed 292 appraisals and is seeking damages with respect to 220 of those (75.3%), for which it claims it found “multiple egregious violations of USPAP and applicable industry standards” (LSI Complaint p. 12).   Only 10 out of 292 (3.4%) were found to be fully compliant.  Yet, the FDIC notes earlier in that complaint that LSI “provided or approved more than 386,000 appraisals for residential loans that WaMu originated or purchased” (LSI Complaint p. 11).

In the case against CoreLogic, the FDIC says that it reviewed 259 appraisals out of the more than 260,000 that had been provided (CoreLogic Complaint pp. 11-12).  Out of those, it found only seven that were fully compliant (2.7%), while 194 (74.9%) contained multiple egregious violations (CoreLogic Complaint p. 12).  And it was the 194 egregiously defective appraisals that the FDIC alleges caused over $129 million in damages.

Can you see where I’m going with this?  If you assume that the rest of the appraisals looked very similar to those sampled by the FDIC, there’s a ton of potential liability left on the table.

Just for fun, let’s just do some rough, back-of-the-envelope calculations to provide a framework for estimating that potential liability.  I will warn you that these numbers are going to be eye-popping, but before you get too excited or jump down my throat, please recognize that, as statisticians will no doubt tell you, there are many reasons why the samples cited in the FDIC’s complaints may not be representative of the overall population.  For example, the FDIC may have taken an adverse sample or the average size of the loans WAMU held on its balance sheet may have been significantly greater than the average size of the loans WAMU securitized, meaning they produced higher than average loss severities (and were also more prone to material appraisal inflation). Thus, do not take these numbers as gospel, but merely as an indication of the ballpark size of this potential problem.

With that proviso, let’s project out some of the numbers in the complaints.  In the LSI/LPS case, the FDIC alleges that 75% of the appraisals it sampled contained multiple egregious violations of appraisal standards.  If we project that number to the total population of 386,000 loans for which LSI/LPS provided appraisal services, that’s 289,500 faulty appraisals.  The FDIC also claims it suffered $154 million in losses on the 220 loans with egregiously deficient appraisals, for an average loss severity of $700,000.  Multiply 289,500 faulty appraisals by $700,000 in losses per loan and you get a potential liability to LSI/LPS (on just the loans it handled for WAMU) of $202 billion.  Even if we cut the percentage of deficient appraisals in half to account for the FDIC’s potential adverse sampling and cut the loss severity in half to account for the fact that the average loss severity was likely much smaller (WAMU may have retained the biggest loans that it could not sell into securitizations), that’s still an outstanding liability of over $50 billion for LSI/LPS.

Do the same math for the CoreLogic case and you get similar results.  The FDIC found 74.9% of the loans sampled had egregious appraisal violations, meaning that at least 194,740 of the loans that CoreLogic handled for WAMU may contain similar violations.  Since the 194 egregious loans accounted for $129 million in losses according to the Complaint, that’s an average loss severity of $664,948.  Using these numbers, CoreLogic thus faces potential liabilities of $129 billion.  Even using our very conservative discounting methodology, that’s still over $32 billion in potential liability.

This means that somewhere out there, there are pension funds, mutual funds, insurance funds and other institutional investors who collectively have claims of anywhere from $82 billion to $331 billion against these two vendors of appraisal services with respect to WAMU-originated or securitized loans.  For how many other banks did LSI and CoreLogic provide similar services?  And how many other appraisal service vendors provided similar services during this time and likely conformed to what appear to have been industry practices of inflating appraisals?  The potential liability floating out there on just this appraisal issue alone is astounding, if the FDIC’s numbers are to be believed.

The point of this exercise is not to say that the FDIC necessarily got its numbers right, or even to say that WAMU wasn’t complicit in the industry practice of inflating appraisals.  My point is that these suits reveal additional evidence that investors are sitting on massive amounts of potential claims, about which they’re doing next to nothing.  Where are the men and women of action amongst institutional money managers (and for that matter, who is John Galt?)?  Are they simply passive by nature, and too afraid of getting sued to even peek out from behind the rock? Maybe this is why investors don’t want to reveal their holdings in MBS – they’re afraid that if unions or other organized groups of pensioners realized that their institutional money managers held WAMU MBS and were doing nothing about it, they would sue these managers and/or never run their money through them again.

The better choice, of course, would be to join the Investor Syndicate or one of the other bondholder groups that are primed for action, and then actually support their efforts to go after the participants in the largest Ponzi scheme in history (an upcoming article on TSS will focus on the challenges that these groups have faced in getting their members actually motivated to do something).  It seems that these managers should be focused on trying to recover the funds their investments lost for their constituents, rather than just acting to protect their own anonymity and their jobs.  If suits like those brought by the FDIC don’t cause institutional money managers to sit up and take notice, we have no other choice but to believe these individuals are highly conflicted and incapable of acting as the fiduciaries they’re supposed to be.  Of all the conflicts of interest that have been revealed in the fallout of the Mortgage Crisis, this last conflict would be the most devastating, because it would mean that the securitization participants who were instrumental in causing this crisis, and who were themselves wildly conflicted, will largely be let off the hook by those they harmed the most.

Article taken from The Subprime Shakeout – http://www.subprimeshakeout.com
URL to article: http://www.subprimeshakeout.com/2011/05/fdic-sues-lps-and-corelogic-over-appraisal-fraud-shows-investors-leaving-money-on-the-table.html


Jake Naumer
Resolution Advisors
3187 Morgan Ford
St Louis Missouri 63116
314 961 7600
Fax Voice Mail 314 754 9086

“KING” DEUTSCH CITED FOR DESTRUCTION OF CITIES

The article below was purloined from www.foreclosureblues.wordpress.com — the comments are mine. Neil Garfield

“According to the Federal Deposit Insurance Corporation (FDIC), Deutsche Bank now holds loans for American single-family and multi-family houses worth about $3.7 billion (€3.1 billion). The bank, however, claims that much of this debt consists of loans to wealthy private customers. (EDITOR’S NOTE: THUS ALL THE OTHER LOANS IT CLAIMS TO OWN, IT DOESN’T OWN)

The bank did not issue the mortgages for the many properties it now manages, and yet it accepted, on behalf of investors, the fiduciary function for its own and third-party CDOs. In past years, says mortgage expert Steve Dibert, real estate loans were “traded like football cards” in the United States. (Editor’s Note: This is why we say that the loan never makes it into the pool until litigation starts AND even if it was ever in the pool there is no guarantee it remained in the pool for more than a nanosecond). Sworn testimony from Deutsch employees corroborate that no assignments are done until “needed,” which means that in the mean time they are still legally owned by the loan originator. The loan originator therefore created an obligation that was satisfied simultaneously with the closing on the loan. The note is therefore evidence of an obligation that does not legally exist. Thus there are possible equitable theories under which investors could assert claims against the borrower, but the note and deed of trust or mortgage are only PART of the evidence and ONLY the investor has standing to bring that claim. Recent cases have rejected claims of “equitable transfer.”)

How many houses was he responsible for, Co was asked? “Two thousand,” he replied. But then he corrected himself, saying that 2,000 wasn’t the number of individual properties, but the number of securities packages being managed by Deutsche Bank. Each package contains hundreds of mortgages. So how many houses are there, all told, he was asked again? Co could only guess. “Millions,” he said.

The exotic financial vehicles are sometimes managed by an equally exotic firm: Deutsche Bank (Cayman) Limited, Boundary Hall, Cricket Square, Grand Cayman. In an e-mail dated Feb. 26, 2010, a Deutsche Bank employee from the Cayman Islands lists 84 CDOs and similar products, for which she identifies herself as the relevant contact person.

However, C-BASS didn’t just manage abstract securities. It also had a subsidiary to bring in all the loans that were subsequently securitized. By the end of 2005 the subsidiary, Litton Loan, had processed 313,938 loans, most of them low-value mortgages, for a total value of $43 billion.

EDITOR’S NOTE: Whether it is Milwaukee which is going the the way of Cleveland or thousands of other towns and cities, Deutsch Bank as a central player in more than 2,000 Special Purpose Vehicles, involving thousands more pools and sub-pools, is far and away the largest protagonist in the foreclosure crisis. This article, originally written in German, details just how deep they are into this mess, while at the same time disclaiming any part in it. It corroborates the article I wrote about the Deutsch Bank executive who said ON TAPE, which I have, that even though Deutsch is named as Trustee it knows nothing and does nothing.

SPIEGEL ONLINE
06/10/2010 07:42 AM
‘America’s Foreclosure King’
How the United States Became a PR Disaster for Deutsche Bank
By Christoph Pauly and Thomas Schulz

Deutsche Bank is deeply involved in the American real estate crisis. After initially profiting from subprime mortgages, it is now arranging to have many of these homes sold at foreclosure auctions. The damage to the bank’s image in the United States is growing.

The small city of New Haven, on the Atlantic coast and home to elite Yale University, is only two hours northeast of New York City. It is a particularly beautiful place in the fall, during the warm days of Indian summer.

But this idyllic image has turned cloudy of late, with a growing number of houses in New Haven looking like the one at 130 Peck Street: vacant for months, the doors nailed shut, the yard derelict and overgrown and the last residents ejected after having lost the house in a foreclosure auction. And like 130 Peck Street, many of these homes are owned by Germany’s Deutsche Bank.

“In the last few years, Deutsche Bank has been responsible for far and away the most foreclosures here,” says Eva Heintzelman. She is the director of the ROOF Project, which addresses the consequences of the foreclosure crisis in New Haven in collaboration with the city administration. According to Heintzelman, Frankfurt-based Deutsche Bank plays such a significant role in New Haven that the city’s mayor requested a meeting with bank officials last spring.

The bank complied with his request, to some degree, when, in April 2009, a Deutsche Bank executive flew to New Haven for a question-and-answer session with politicians and aid organizations. But the executive, David Co, came from California, not from Germany. Co manages the Frankfurt bank’s US real estate business at a relatively unknown branch of a relatively unknown subsidiary in Santa Ana.

How many houses was he responsible for, Co was asked? “Two thousand,” he replied. But then he corrected himself, saying that 2,000 wasn’t the number of individual properties, but the number of securities packages being managed by Deutsche Bank. Each package contains hundreds of mortgages. So how many houses are there, all told, he was asked again? Co could only guess. “Millions,” he said.

Deutsche Bank Is Considered ‘America’s Foreclosure King’

Deutsche Bank’s tracks lead through the entire American real estate market. In Chicago, the bank foreclosed upon close to 600 large apartment buildings in 2009, more than any other bank in the city. In Cleveland, almost 5,000 houses foreclosed upon by Deutsche Bank were reported to authorities between 2002 and 2006. In many US cities, the complaints are beginning to pile up from homeowners who lost their properties as a result of a foreclosure action filed by Deutsche Bank. The German bank is berated on the Internet as “America’s Foreclosure King.”

American homeowners are among the main casualties of the financial crisis that began with the collapse of the US real estate market. For years, banks issued mortgages to homebuyers without paying much attention to whether they could even afford the loans. Then they packaged the mortgage loans into complicated financial products, earning billions in the process — that is, until the bubble burst and the government had to bail out the banks.

Deutsche Bank has always acted as if it had had very little to do with the whole affair. It survived the crisis relatively unharmed and without government help. Its experts recognized early on that things could not continue as they had been going. This prompted the bank to get out of many deals in time, so that in the end it was not faced with nearly as much toxic debt as other lenders.

But it is now becoming clear just how deeply involved the institution is in the US real estate market and in the subprime mortgage business. It is quite possible that the bank will not suffer any significant financial losses, but the damage to its image is growing by the day.

‘Deutsche Bank Is Now in the Process of Destroying Milwaukee’

According to the Federal Deposit Insurance Corporation (FDIC), Deutsche Bank now holds loans for American single-family and multi-family houses worth about $3.7 billion (€3.1 billion). The bank, however, claims that much of this debt consists of loans to wealthy private customers.

More damaging to its image are the roughly 1 million US properties that the bank says it is managing as trustee. “Some 85 to 90 percent of all outstanding mortgages in the USA are ultimately controlled by four banks, either as trustees or owners of a trust company,” says real estate expert Steve Dibert, whose company conducts nationwide investigations into cases of mortgage fraud. “Deutsche Bank is one of the four.”

In addition, the bank put together more than 25 highly complex real estate securities deals, known as collateralized debt obligations, or CDOs, with a value of about $20 billion, most of which collapsed. These securities were partly responsible for triggering the crisis.

Last Thursday, Deutsche Bank CEO Josef Ackermann was publicly confronted with the turmoil in US cities. Speaking at the bank’s shareholders’ meeting, political science professor Susan Giaimo said that while Germans were mainly responsible for building the city of Milwaukee, Wisconsin, “Deutsche Bank is now in the process of destroying Milwaukee.”

As Soon as the Houses Are Vacant, They Quickly Become Derelict

Then Giaimo, a petite woman with dark curls who has German forefathers, got to the point. Not a single bank, she said, owns more real estate affected by foreclosure in Milwaukee, a city the size of Frankfurt. Many of the houses, she added, have been taken over by drug dealers, while others were burned down by arsonists after it became clear that no one was taking care of them.

Besides, said Giaimo, who represents the Common Ground action group, homeowners living in the neighborhoods of these properties are forced to accept substantial declines in the value of their property. “In addition, foreclosed houses are sold to speculators for substantially less than the market value of houses in the same neighborhood,” Giaimo said. The speculators, according to Giaimo, have no interest in the individual properties and are merely betting that prices will go up in the future.

Common Ground has posted photos of many foreclosed properties on the Internet, and some of the signs in front of these houses identify Deutsche Bank as the owner. As soon as the houses are vacant, they quickly become derelict.

A Victorian house on State Street, painted green with red trim, is now partially burned down. Because it can no longer be sold, Deutsche Bank has “donated” it to the City of Milwaukee, one of the Common Ground activists reports. As a result, the city incurs the costs of demolition, which amount to “at least $25,000.”

‘We Can’t Give Away Money that Isn’t Ours’

During a recent meeting with US Treasury Secretary Timothy Geithner, representatives of the City of Milwaukee complained about the problems that the more than 15,000 foreclosures have caused for the city since the crisis began. In a letter to the US Treasury Department, they wrote that Deutsche Bank is the only bank that has refused to meet with the city’s elected representatives.

Minneapolis-based US Bank and San Francisco-based Wells Fargo apparently took the complaints more seriously and met with the people from Common Ground. The activists’ demands sound plausible enough. They want Deutsche Bank to at least tear down those houses that can no longer be repaired at a reasonable cost. Besides, Giaimo said at the shareholders’ meeting, Deutsche Bank should contribute a portion of US government subsidies to a renovation fund. According to Giaimo, the bank collected $6 billion from the US government when it used taxpayer money to bail out credit insurer AIG.

“It’s painful to look at these houses,” Ackermann told the professor. Nevertheless, the CEO refused to accept any responsibility. Deutsche Bank, he said, is “merely a sort of depository for the mortgage documents, and our options to help out are limited.” According to Ackermann, the bank, as a trustee for other investors, is not even the actual owner of the properties, and therefore can do nothing. Besides, Ackermann said, his bank didn’t promote mortgage loans with terms that have now made the payments unaffordable for many families.

The activists from Wisconsin did, however, manage to take home a small victory. Ackermann instructed members of his staff to meet with Common Ground. He apparently envisions a relatively informal and noncommittal meeting. “We can’t give away money that isn’t ours,” he added.

Deutsche Bank’s Role in the High-Risk Loans Boom

Apparently Ackermann also has no intention to part with even a small portion of the profits the bank earned in the real estate business. Deutsche Bank didn’t just act as a trustee that — coincidentally, it seems — manages countless pieces of real estate on behalf of other investors. In the wild years between 2005 and 2007, the bank also played a central role in the profitable boom in high-risk mortgages that were marketed to people in ways that were downright negligent.

Of course, its bankers didn’t get their hands dirty by going door-to-door to convince people to apply for mortgages they couldn’t afford. But they did provide the distribution organizations with the necessary capital.

The Countrywide Financial Corporation, which approved risky mortgages for $97.2 billion from 2005 to 2007, was the biggest provider of these mortgages in the United States. According to the study by the Center for Public Integrity, a nonprofit investigative journalism organization, Deutsche Bank was one of Countrywide’s biggest financiers.

Ameriquest — which, with $80.7 billion in high-risk loans on its books in the three boom years before the crash, was the second-largest subprime specialist — also had strong ties to Deutsche Bank. The investment bankers placed the mortgages on the international capital market by bundling and structuring them into securities. This enabled them to distribute the risks around the entire globe, some of which ended up with Germany’s state-owned banks.

‘Deutsche Bank Has a Real PR Problem Here’

After the crisis erupted, there were so many mortgages in default in 25 CDOs that most of the investors could no longer be serviced. Some CDOs went bankrupt right away, while others were gradually liquidated, either in full or in part. The securities that had been placed on the market were underwritten by loans worth $20 billion.

At the end of 2006, for example, Deutsche Bank constructed a particularly complex security known as a hybrid CDO. It was named Barramundi, after the Indo-Pacific hermaphrodite fish that lives in muddy water. And the composition of the deal, which was worth $800 million, was muddy indeed. Many securities that were already arcane enough, like credit default swaps (CDSs) and CDOs, were packaged into an even more complex entity in Barramundi.

Deutsche Bank’s partner for the Barramundi deal was the New York investment firm C-BASS, which referred to itself as “a leader in purchasing and servicing residential mortgage loans primarily in the Subprime and Alt-A categories.” In plain language, C-BASS specialized in drumming up and marketing subprime mortgages for complex financial vehicles.

However, C-BASS didn’t just manage abstract securities. It also had a subsidiary to bring in all the loans that were subsequently securitized. By the end of 2005 the subsidiary, Litton Loan, had processed 313,938 loans, most of them low-value mortgages, for a total value of $43 billion.

One of the First Victims of the Financial Crisis

Barramundi was already the 19th CDO C-BASS had issued. But the investment firm faltered only a few months after the deal with Deutsche Bank, in the summer of 2007. C-BASS was one of the first casualties of the financial crisis.

Deutsche Bank’s CDO, Barramundi, suffered a similar fate. Originally given the highest possible rating by the rating agencies, the financial vehicle stuffed with subprime mortgages quickly fell apart. In the spring of 2008, Barramundi was first downgraded to “highly risky” and then, in December, to junk status. Finally, in March 2009, Barramundi failed and had to be liquidated. (EDITOR’S NOTE: WHAT HAPPENED TO THE LOANS?)

While many investors lost their money and many Americans their houses, Deutsche Bank and Litton Loan remained largely unscathed. Apparently, the Frankfurt bank still has a healthy business relationship with the subprime mortgage manager, because Deutsche Bank does not play a direct role in any of the countless pieces of real estate it holds in trust. Other service providers, including Litton Loan, handle tasks like collecting mortgage payments and evicting delinquent borrowers.

The exotic financial vehicles are sometimes managed by an equally exotic firm: Deutsche Bank (Cayman) Limited, Boundary Hall, Cricket Square, Grand Cayman. In an e-mail dated Feb. 26, 2010, a Deutsche Bank employee from the Cayman Islands lists 84 CDOs and similar products, for which she identifies herself as the relevant contact person.

Trouble with US Regulatory Authorities and Many Property Owners

The US Securities and Exchange Commission (SEC) is now investigating Deutsche Bank and a few other investment banks that constructed similar CDOs. The financial regulator is looking into whether investors in these obscure products were deceived. The SEC has been particularly critical of US investment bank Goldman Sachs, which is apparently willing to pay a record fine of $1 billion to avoid criminal prosecution.

Deutsche Bank has also run into problems with the many property owners. The bank did not issue the mortgages for the many properties it now manages, and yet it accepted, on behalf of investors, the fiduciary function for its own and third-party CDOs. In past years, says mortgage expert Steve Dibert, real estate loans were “traded like football cards” in the United States.

Amid all the deal-making, the deeds for the actual properties were often lost. In Cleveland and New Jersey, for example, judges invalidated foreclosures ordered by Deutsche Bank, because the bank was unable to come up with the relevant deeds.

Nevertheless, Deutsche Bank’s service providers repeatedly try to have houses vacated, even when they are already occupied by new owners who are paying their mortgages. This practice has led to nationwide lawsuits against the Frankfurt-based bank. On the Internet, angry Americans fighting to keep their houses have taken to using foul language to berate the German bank.

“Deutsche Bank now has a real PR problem here in the United States,” says Dibert. “They want to bury their head in the sand, but this is something they are going to have to deal with.”

Translated from the German by Christopher Sultan

SEC Charges Goldman Sachs With Fraud: Complaint Reveals Discovery Tips

see comp-pr2010-59 SEC Complaint V GS Fraud

“The Commission seeks injunctive relief, disgorgement of profits, prejudgment interest and civil penalties from both defendants.” Editor’s Note: Here is where the rubber meets the road. This same pool of illegal fraudulent profit is also subject to being defined as an undisclosed yield spread premium due to the borrowers. Some enterprising class action lawyer has some low hanging fruit here — the class is already defined for you by the SEC — all those homeowners subject to loan documents that were pledged or transferred into a pool which was received or incorporated by reference into this Abacus vehicle)

SECURITIES AND EXCHANGE COMMISSION

Litigation Release No. 21489 / April 16, 2010

Securities and Exchange Commission v. Goldman, Sachs & Co. and Fabrice Tourre, 10 Civ. 3229 (BJ) (S.D.N.Y. filed April 16, 2010)

The SEC Charges Goldman Sachs With Fraud In Connection With The Structuring And Marketing of A Synthetic CDO

The Securities and Exchange Commission today filed securities fraud charges against Goldman, Sachs & Co. (“GS&Co”) and a GS&Co employee, Fabrice Tourre (“Tourre”), for making material misstatements and omissions in connection with a synthetic collateralized debt obligation (“CDO”) GS&Co structured and marketed to investors. This synthetic CDO, ABACUS 2007-AC1, was tied to the performance of subprime residential mortgage-backed securities (“RMBS”) and was structured and marketed in early 2007 when the United States housing market and the securities referencing it were beginning to show signs of distress. Synthetic CDOs like ABACUS 2007-AC1 contributed to the recent financial crisis by magnifying losses associated with the downturn in the United States housing market.

According to the Commission’s complaint, the marketing materials for ABACUS 2007-AC1 — including the term sheet, flip book and offering memorandum for the CDO — all represented that the reference portfolio of RMBS underlying the CDO was selected by ACA Management LLC (“ACA”), a third party with expertise in analyzing credit risk in RMBS. Undisclosed in the marketing materials and unbeknownst to investors, a large hedge fund, Paulson & Co. Inc. (“Paulson”) [Editor’s Note: Brad Keiser in his forensic analyses has reported that Paulson may have been a principal in OneWest which took over Indymac and may have ties with former Secretary of Treasury Henry Paulson, former GS CEO], with economic interests directly adverse to investors in the ABACUS 2007-AC1 CDO played a significant role in the portfolio selection process. After participating in the selection of the reference portfolio, Paulson effectively shorted the RMBS portfolio it helped select by entering into credit default swaps (“CDS”) with GS&Co to buy protection on specific layers of the ABACUS 2007-AC1 capital structure. Given its financial short interest, Paulson had an economic incentive to choose RMBS that it expected to experience credit events in the near future. GS&Co did not disclose Paulson’s adverse economic interest or its role in the portfolio selection process in the term sheet, flip book, offering memorandum or other marketing materials.
The Commission alleges that Tourre was principally responsible for ABACUS 2007-AC1. According to the Commission’s complaint, Tourre devised the transaction, prepared the marketing materials and communicated directly with investors. Tourre is alleged to have known of Paulson’s undisclosed short interest and its role in the collateral selection process. He is also alleged to have misled ACA into believing that Paulson invested approximately $200 million in the equity of ABACUS 2007-AC1 (a long position) and, accordingly, that Paulson’s interests in the collateral section process were aligned with ACA’s when in reality Paulson’s interests were sharply conflicting. The deal closed on April 26, 2007. Paulson paid GS&Co approximately $15 million for structuring and marketing ABACUS 2007-AC1. By October 24, 2007, 83% of the RMBS in the ABACUS 2007-AC1 portfolio had been downgraded and 17% was on negative watch. By January 29, 2008, 99% of the portfolio had allegedly been downgraded. Investors in the liabilities of ABACUS 2007-AC1 are alleged to have lost over $1 billion. Paulson’s opposite CDS positions yielded a profit of approximately $1 billion.

The Commission’s complaint, which was filed in the United States District Court for the Southern District of New York, charges GS&Co and Tourre with violations of Section 17(a) of the Securities Act of 1933, 15 U.S.C. §77q(a), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. §78j(b) and Exchange Act Rule 10b-5, 17 C.F.R. §240.10b-5. The Commission seeks injunctive relief, disgorgement of profits, prejudgment interest and civil penalties from both defendants.

The Commission’s investigation is continuing into the practices of investment banks and others that purchased and securitized pools of subprime mortgages and the resecuritized CDO market with a focus on products structured and marketed in late 2006 and early 2007 as the U.S. housing market was beginning to show signs of distress.

Mortgage Meltdown: Fed Knew 4-5 years Ago — and Told Lenders

If you dig deep enough you will find that it wasn’t hard for regulators to figure out that we were heading for a “shock.” It wasn’t hard to figure out that there were abuses traveling downline to borrowers and upline to investors. And it wasn’t hard to figure out that the securities issued at both ends of the mortgage meltdown — the notes issues by borrowers and the bonds issued by SPV’s were over-rated and over-priced just as the underlying real property was over-appraised.

CDO managers were inventing derivatives on derivatives using “embedded leverage” to create new CDOs (CDO2, CDO3 etc) for the riskiest part of portfolios to make them look safer than they were and to get higher ratings than what they were worth. This pattern of dark matter being infused into the financial system created inevitable pressure on all facilitators including “lenders” to produce “product. And it was widely known that the argument being used was specious: first, they were spreading the risk they were mulltiplying it when these instruments came under pressure and second, the default rates used for ratings were average default rates when the CDO’s were composed of tranches heavily weighted with subprime loans. The real default rate was accordingly much higher than the projected default rate, giving the CDO managers room to wiggle on the value of the securities they were issuing. THE SIGNIFICANCE OF THIS IS THAT FED REGULATORS WERE BRINGING HEDGE FUND MANAGERS AND CDO MANAGERS IN FOR MEETINGS IN WHICH THEY WERE “ENCOURAGED” TO REIN IN THEIR ENTHUSIASM. ALL PARTIES KNEW THAT THE LOANS TO THE BORROWERS WERE HIGH RISK SECURITIES, AND ALL PARTIES KNEW THAT THE ABS INVESTMENTS AND THE DERIVATIVES OF THOSE ABS INSTRUMENTS WERE GOING TO FAIL. EVERYONE KNEW EXCEPT THE BUYERS OF THE ABS INSTRUMENTS AND THE BUYERS OF REAL ESTATE THAT WAS HYPER-INFLATED IN ORDER TO MOVE THE HUGE INVENTORY OF CASH THAT WAS CASCADING THROUGH WALL STREET.

The “lenders’ were being advised by regulators to hold back on these increasingly risky loans, to return to normal loan underwriting standards. But the “lenders” were encouraged, compensated and they thought protected by the securitization process. Thus their perception of risk (zero) coupled with their greed for fees, kept the process going and they in turn passed on the pressure to mortgage brokers and appraisers. THUS THE ARGUMENT THAT THE LENDER DID NOT KNOW FOR SURE, THAT THE LENDER CAN HIDE BEHIND PLAUSIBLE DENIABILITY IS A SHAM. 

Witness this article written in January, 2007 reflecting more than 3 years of Fed concern over the direction the financial markets were taking and showing that financial institutions were well aware of the Fed’s displeasure with what they were doing. 

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Central banks can’t determine how much leverage is out there

 Section:    

After the Flood:
How Central Banks Fret
About Failures
Once Liquidity Dries Up

By John Plender
Financial Times, London
Tuesday, January 30, 2007

http://www.ft.com/cms/s/539c92d0-b006-11db-94ab-0000779e2340.html

In September 1998 Bill McDonough, the then president of the Federal Reserve Bank of New York, corralled representatives of 14 leading banks into the Fed’s offices at 33 Liberty Street in Manhattan’s financial district and urged them to bail out the ailing Long-Term Capital Management hedge fund. It was a classic central banker’s response to a potential systemic crisis.

“Gentle pressure” is the euphemism often employed to describe such central bank bullying to persuade competing banks to collaborate in the common interest. The interesting question, in the light of huge structural upheavals in financial markets since 1998, is whether the nature of systemic risk has changed and whether a central bank could pull off the same trick today.

In the period between the break-up of the Bretton Woods semi-fixed exchange rate system in the early 1970s and the near-collapse of LTCM in 1998, financial crises were frequent. Yet for the best part of a decade an eerie stability has prevailed. Big financial institutions have collapsed, notably Refco, the derivatives dealer, and the Amaranth hedge fund. Yet neither initiated a systemic shock, even though Amaranth’s $6bn losses were greater than those of LTCM.

Many private sector bankers believe that the newer markets in credit default swaps, which investors use as insurance against corporate default, and collateralised debt obligations, packages of debt instruments used to back the issue of new securities, are inherently stabilising. That is because they spread risk more widely around the system. At the same time technology, which facilitates trading in complex new financial instruments, serves to make markets more efficient.

This, together with a big surge in global liquidity, has contributed to a dramatic decline in financial institutions’ concern about risk to the point where some companies are issuing securities at a zero or negative risk premium. The risk premium is the additional return over the return on risk-free government bonds that investors normally require as a reward for taking risk.

The credit euphoria in the markets, which has caused the yields of riskier bonds to move closer to the risk-free bond yield, is partly driven by the prime brokerage divisions of investment banks competing ferociously for hedge fund business. They have loosened lending standards and margin requirements relating to the amount of collateral they require to support a given amount of hedge fund debt.

Even central bankers, traditionally cautious about the consequences of financial innovation, see some advantages in the new world of high-octane derivatives trading. Tim Geithner, president of the New York Fed, points out that past crises would cause less damage today if they were to recur because of the greater dispersion of credit risk, the improvements in risk management, the size of the capital cushions maintained by banks and the improvements in many parts of the payment and settlements infrastructure.

That said, neither he nor any other leading central banker believes that we are witnessing the end of volatility or the demise of the credit cycle, though some youthful bankers in the private sector are prepared to argue that case.

According to Gerald Corrigan, a former president of the New York Fed who is now a partner in Goldman Sachs, there is a virtual consensus among leading practitioners and central bankers that “the statistical probability of a major financial shock with systemic features has got lower over time”. But there is also agreement that another major shock is likely and that the potential damage could be greater. Mr Corrigan gives three reasons for this increased toxicity: speed, complexity and tighter linkages across institutions and markets, as the system has become more integrated thanks to financial innovation.

“The trouble,” he adds, “is that we do not have the capacity to anticipate the timing and triggers of such a shock — every now and then stuff happens. And if we could anticipate the timing and triggers, the shocks wouldn’t happen.”

There is no shortage of potential accidents, ranging from an over-abrupt unwinding of global financial imbalances to a dollar collapse. A particular concern, raised at the World Economic Forum at Davos by Jean-Claude Trichet, president of the European Central Bank, is the likelihood that credit spreads – the gap between the yield on risky bonds and the risk-free rate – could widen sharply if perceptions of risk change, inflicting large losses on traders. The collapse of a hedge fund or bank might then cause widespread disruption in the markets.

In the euphoria that has accompanied the explosive growth of credit derivatives and collateralised debt instruments, there is not just a possibility that risk is being seriously underpriced. Much trading in credit derivatives assumes that liquidity — the ready availability of funds — will remain when any adjustment in credit markets takes place. Liquidity permits traders to close positions rapidly when risks and potential losses are escalating.

Christopher Whalen of Institutional Risk Analytics, a consultancy, argues that, given the lower risk premiums in credit markets, it may no longer be prudent to assume credit default swap contracts will be liquid when the adjustment comes. In other words, traders may be unable to escape from positions where losses are ballooning because nobody will be willing to deal. He notes that a hedge fund that sells insurance protection against default may depend indirectly upon another under-regulated hedge fund having the resources to meet that guarantee.

Maintaining confidence in counterparties, adds Mr. Whalen, is absolutely required for the game to continue; and the stability of the entire credit derivatives market rests on the notion that hedge funds will somehow have access to sufficient liquidity to meet their obligations. For some, that looks a dangerously optimistic assumption.

Jim O’Neill, head of global economic research at Goldman Sachs, recently remarked that “liquidity is there until it is not — that is the reality of modern markets.” The liquidity glut, he thinks, could reverse at any time. So much for what some claim is a secular increase in liquidity.

Optimists downplay the risk to the system of the potentially problematic credit derivatives, which are still only 7 percent of estimated total notional over-the-counter (that is, unquoted) derivatives contracts. Yet the New York Fed’s Tim Geithner emphasises that despite this underwhelming percentage, credit risk in the OTC derivatives market is large relative to more traditional forms of credit and is also quite large relative to the capital cushions and earnings of the major banks and investment banks.

He adds that these exposures are harder to measure because investments in credit derivatives contain “embedded leverage” where one’s exposure to profit or loss is multiplied many times compared to the same investment in the underlying conventional security.

The problem for central bankers is that “embedded leverage” has expanded phenomenally and does not appear on balance sheets, so it is impossible to quantify embedded leverage across the financial system.

In other words, no one can be sure how much capital to set aside as insurance against these leveraged bets going wrong. While risk management techniques have improved, they remain flawed in fundamental respects.

It is widely acknowledged, for example, that mathematical models of risk, which are used to stress-test derivatives, give too much weight to the low volatility of recent times. In other words, they use the recent past as a guide to predicting the future. In financial markets this is the one sense in which history is bunk, since financial shocks have a habit of coming from unexpected quarters.

These risk models can ignore the potential occurrence of very low-probability scenarios with potentially extreme outcomes, in which one big loss can wipe out several years of positive returns. Statistically driven models and risk metrics are poor at capturing these low-probability financial blow-outs. If stress-testing does throw up an outcome that looks scary, people in financial institutions tend to declare the result “unrealistic” because a conservative assessment of risk would put them at a competitive disadvantage to more “realistic” competitors.

Academics such as Harry Kat of the Cass Business School at the City University in London have produced evidence that many hedge funds are, in fact, pursuing trading strategies that can be relied on to produce positive returns most of the time as compensation for a very rare negative return. They are encouraged to do this by a fee structure that does not require the fund managers to pay back their earlier profit share to investors if an extreme event strikes and wipes out the fund.

At the same time, big financial institutions have no incentive to incorporate the potential costs and risks to the system of their own collapse in their market pricing. They prefer others to incur the costs of providing the “public good” of financial stability, while under-insuring against the risk of failure and under-investing in systems to enhance financial stability. So central banks and governments pick up the tab in the event of a systemic collapse.

Considerable work has been done by banking authorities and private sector institutions to address these problems, notably through the work of the Counterparty Risk Management Policy Group II headed by Gerald Corrigan. He characterises the objective as being to strengthen the shock-absorbers of the global financial system. The group’s recommendations were aimed primarily at the private sector, ranging from strengthening corporate governance to improvements in transaction processing.

Meantime, US and European financial watchdogs launched a probe before Christmas into lending to hedge funds and margin practices. This involves looking at risk-management in individual firms and telling them where they stand in relation to best practice, but without necessarily being prescriptive.

In essence, the goal of the authorities in dealing with potential shocks is damage-control and containment. As far as the co-ordination of bailouts is concerned, persuading bankers that they have a collective interest in rescuing competing financial institutions has never been easy, since most central banks have no legal powers to enforce such action. In a very different environment from that of 1998, it is a moot point whether a rescue would work when an institution deemed too big to fail finds itself in trouble.

Sir John Gieve, deputy governor of the Bank of England, has publicly questioned whether it would now be possible to put a failing firm’s bankers into a room and persuade them to do their stuff. He points out that firms nowadays often do not know who holds their shares and debt, and many investors are looking to take the hit and get out as quickly as possible. Others add that some banks’ proprietary trading desks might have short positions in a failing firm as well as outstanding loans, which could dilute their interest in joining a rescue.

Yet this is not something on which all central bankers agree. Tim Geithner acknowledges the difficulties of putting the lending banks in a room, but points out that we are now several decades into the securitisation of bank loans and dispersion of credit risk and there is no general increase in bankruptcies or decline in average recovery rates, though he adds that there are many other factors that may help explain this.

As for the conflicting interests within banks in relation to a failing firm, he adds that structurally, the banks have long positions in credit overall. It is worth noting too, that the New York Fed also has a big advantage in lender-of-last-resort operations relative to many European countries, including the UK, in that monetary policy decision-making and banking supervision are in the same institution, which minimises problems of communication and co-ordination.

Whoever is right, the one certainty is that lightning will eventually strike. The systemic crisis could arise in a conventional corner of the markets. But given the novelty, opacity and complexity of derivatives trading, and challenges that central banks face in trying to understand the risks involved, there is a high chance that the lightning will go there.

Mortgage Meltdown: Get Out of Jail Free Card from Paulson

Mortgage Meltdown: Get Out of Jail Free Card from Paulson

In the usual way of floating trial balloons before committing to anything, and without the whole hearted support from any of the many entities and people who have a dog in this fight, Paulson is “outlining” the proposal for “subprime relief.”

All information points to another intentional diversion from dealing with and getting disgorgement of money from hundreds, perhaps thousands of investment bankers, mortgage brokers, lenders, “retailers” and institutional sellers who converted assets to fees in a very simple scheme — churning, covered over by the complexity of “creative” derivative securities. 

Anyone can sell something if the cost is zero and the buyer actually thinks he is getting value. In fact, the sky is the limit because at no time is the market saturated with such a product. That is precisely why the “subprime mess” got so out of hand. And as Krugman points out today in the New York Times, we don’t know where or how how much toxic waste is buried. 

Paulson’s outline presents a plan that does little for the borrowers. It creates the illusion of a bailout when the investment world will not accept our word for anything (and so the illusion is doomed to failure). And the new wrinkle is that it puts the burden on the states and cities to do something about it, which in classical Washington political terms meaning that they are creating someone else to blame. 

Cities and states, already struggling are going to see significant declines in tax revenues and investment income, the value of investment funds and their assets specifically as a result of this mess. And it isn’t just a “subprime mess.” It is about the whole credit market. “Innovation” is just a code word for saying that we are going to create the illusion of money, everyone is going to buy into it because it looks free, and we will collect real fees while everyone else goes into the toilet.

And while we are all sleeping, CDOs and similar securities have been sold for 20 years based upon mortgages, credit card debt and dozens of other exotic theories of risk, none of which have any Triple-A merit but all of which have mysteriously been given the extremely high ratings as risk instruments. They have converted junk bonds to Triple A bonds with a stroke of the ratings pen. 

Meanwhile the co-conspirators, the U.S. Government and Wall Street innovators together with lenders with plausible deniability, and retailers of derivative securities that were sold not just deceptively but with outright lies and fraudulent ratings — they all get a free pass.

The sad truth is that investors are beginning to suspect that most of our market indexes are a hoax. They are probably mostly right. Vapor has been sold with the clothing of kings and queens. Unsuspecting people, government finance officers, financial institutions, fund managers, have been misled into destroying the value of what were real assets until they were invested into these exotic derivative securities, with the fraudulent ratings. 

The economy has been driven by consumer spending. Without liquidity offered by these exotic plans to lend money on credit cards and other consumer debt, whether securitized or not, the economy can’t run. Liquidity is drying up. Pumping more “money” into the system is not a long-term solution, it is a suicide pact for the dollar and for inflation. 

If we REALLY want to save our economy and its place in the world, we need to do something real, own up to the mistakes, hold the people who did it accountable, and make amends to the world as best we can. 

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