Livinglies's Weblog

A YIELD SPREAD PREMIUM IS A FEE PAID TO A BROKER FOR CREATING A FRAUDULENT PROFIT BY LYING TO THE CUSTOMER WHO BUYS A FINANCIAL PRODUCT. This particular lie would be about the rate on the loan.

One would think this was already illegal and one would be right. Not only is it specified in the Truth in Lending Act and other state and federal laws governing deceptive lending practices, it is also covered by RICO and common law actions for fraud. YSP fees and other forms of undisclosed compensation, of which there were many, are all illegal. These fees are illegal and are all due back to the borrower, along with attorney fees, interest, and potential treble damages. And states and federal government agencies that collect revenue should be interested in all this undeclared income “earned” tax-free.

Up until the era of securitization, YSP fees were limited to those situations addressed by this “new” FED ban — where a mortgage broker convinced a borrower to take a higher interest rate in exchange for some perceived advantage that was in fact disadvantageous to the customer — like coming to the table with less money in exchange for a virtual guarantee of foreclosure down the road. But what this ban does not address directly is the the “tier 2” YSP, in which the second broker was the investment bank. Nor does it take a shot at the trillions in YSP fees ripped out of our economy up until now, which the taxpayers have guaranteed thanks to the TARP, US Treasury and Federal Reserve programs in the fall of 2008. In a hot election year, government and Wall Street guessed correctly that nobody would realize what hit them until long after the deed was done.

While the first YSP was abhorrent, paying brokers thousands of dollars for each bad loan, the second one, also undisclosed, paid investment bankers a profit that sometimes exceeded the loan itself. In the first instance the lie was that this loan is better for you because your initial payment is less, your down payment is less or whatever. In the first instance the lie was first to the prospective borrower, and second to the investor who was advancing money under the supposition that the money would be used to fund loans that had the usual risk of non-payment — which is to say that the odds were in their favor that on balance they would get the return they were looking for, get their principal back and minimize the small balance of defaults with proceeds of foreclosures.

The first lie was predicated on an even bigger lie to both the borrower and the lender (investor): that the property was worth more than the loan, so it was covered by a security interest that would minimize or eliminate the risk of an actual loss. This lie was compounded by the lie that housing prices never go down and they had the appraisals and ratings form official rating agencies to prove that these were transactions whose value was the highest grade available in the marketplace.

The compounded lie was used to convince borrowers that the fact that they knew they could not afford the loan payments when the loan reset to its real terms was “offset” by the “fact” that the broker “guaranteed” the house would later be refinanced at a higher value in which the payment would again be reduced and the borrower would actually receive extra cash. This passive return on an investment meets the definition of the sale of a security, qualifies as a fraudulent unregistered securities transaction, and should land some people in jail. So far, though, the bulk of public opinion continues to blame the victim. The fact that in a transparent transaction where the real facts were disclosed most borrowers would never have signed and no investor would have advanced money is still mysteriously being ignored by policy makers and the courts. Yet it is as plain as day.

This brings us to the second BIG LIE which was that the loan met underwriting standards for the industry, was verified in all the appropriate ways, and the money advanced by the investors was being used to fund loans, not illicit profits. All the lies overlap. The worse the loan the higher the “yield spread premium” to the broker and the higher the yield premium to the investment banker. If the lender (investor) and the borrower knew that the actual amount funded by the lender was $450,000 but the loan was only $300,000, how many people do you think would have allowed or completed that transaction. If they knew that a $150,000 yield spread premium was kept by the investment banker  on a $300,000 loan, how many readers think that NOBODY would have asked “hey! Where is the other $150,000?” How many readers think that ANYONE would say that 50% of the loan amount is a reasonable fee for the investment banker to keep?

Although they make it sound complicated the method was conventional and simple: keep the borrower and lender far away from each other so that neither one actual knew the true facts of the transaction. In other words, your standard con game.

This is why the securitization searches are SO important in confronting your adversary in a mortgage dispute. The title search is important, but the securitization search is what really traces the money. And NOBODY in the financial industry wants you to be able to trace the money because if you do, then investors and borrowers who are suing in greater and greater numbers are going to know where the money went, who got it, and they are going to want it back because it was procured by outright lies.

NOTE: The tier 2 YSP runs counter-intuitive to most people so they keep putting it aside. But it lies at the heart of the mortgage crisis. So I’ll explain it AGAIN here. I’ll use a brand new example taken from the above. It is oversimplified to make the point, but it makes the double point that every financial transaction should be allocated to every loan where it is appropriate to do so, which is why your action for ACCOUNTING and DISCOVERY is so important.

1. Teachers Pension Fund of Arizona is limited to AAA rated investments, which means the equivalent of U.S. Treasury obligations. They seek the highest possible return without going outside the lines of the primary restriction: NO RISK. They understand that in a market where AAA returns are running at 4% they are not going to get 8% without substantially increasing their risk, which is not allowed. The fund managers basically have the job of making sure that investments stay within guidelines, and that liquidity is maintained to pay the benefits to retired Arizona teachers. The fund managers generally rely upon the rating agencies (Moody’s, Standard and Poor’s, Fitch etc.) but they also “peek under the hood” now and then to make sure everything is OK. Generally they rely upon 2 or 3 investment brokerage houses that have world wide reputations to “protect” and whose objective is to keep the pension fund as a long-term client. It’s been like this for decades, so the hum drum of daily activity lulls everyone into a semi-comatose state.
   
2. So when Merrill Lynch tells them they have this “innovative financial product” that “everyone” is buying and that has the AAA rating but provides a higher return of say 5% AND is further insured by AIG and/or AMBAC, the fund managers, wanting to look pretty to management of the fund, buy some of these exotic creatures. In our case we will say for example that the fund invested $450,000 in exchange for a promised return on investment of 5%.
3. Thus our pension fund managers have partied with $450,000 and they are expecting 5% interest (RISK-FREE) which is, in dollars, $22,500 per year. And they expect the investment bank to pick up a few basis points as their fee on this no-brainer risk free investment transaction.
   
4. The investment bank goes to its mortgage aggregator, let’s say Countrywide (now Bank of America/BAC), and says give me a $300,000 loan on which the borrower has agreed to pay $22,500 in interest. CW does a quick calculation and arrives at the obvious result: Merrill Lynch is asking them for a $300,000 mortgage loan whose stated rate of interest is 7.5%. Just to check their math they multiply $300,000 times the 7.5% rate and sure enough, it is $22,500 annual interest.
   
5. CW goes to its loan originator, and asks for a $300,000 loan with a nominal rate of 9%, with a teaser payment of only 1%, because they want to make sure there is plenty of money to pay the yield spread premium to the mortgage broker, and to collect service fees, transaction fees etc.
   
6. The loan originator goes to the prospective borrower who qualifies for a 5 1/2% loan fixed rate for 30 years and can easily pay that. But that is not what Merrill Lynch, CW, or the loan originator want in order to earn their ridiculous fees.
   
7. The loan originator assigns a “loan specialist” who has received been certified as a mortgage analyst after a total of 7 seconds of training on his way up the elevator to the 13th floor where his cubicle is filled with prospective deals. His conviction for mail fraud, wire fraud, and prison sentence is behind him now because this new company doesn’t care about his past.
   
8. The loan specialist is given a script to convince the borrower against paying 20% down payment, and to take a loan that allows them to pay only 1% interest only for two years. At $250 per month payment, the savings per month is enormous and the loan specialist further entices them with the fact that this is a bona fide transaction backed up by Quicken Loans or some other originator who has done the math and they have figured out that this works best for the customer.  Not only that, home prices are forecasted to continue rising by 20% per month, so in a year they will able to refinance and take out an extra $100,000 with even Lower payments.
   
9. If the borrower takes the bait, everyone gets what they want except the borrower who is in for some nasty surprises down the road when the payments rise substantially above anything the borrower can pay. This loan is identified as being in the junior tranches of a securitized pool, but subject to a credit default swap which was sold by the senior tranche thus contains toxic waste loans without anyone being the wiser. [This “sale” initially shows MORE INCOME in the senior tranche but creates an enormous liability — the equivalent of having purchased the worst of the toxic waste loans. Thus the senior tranche “safe” asset was converted into a horrendous liability that was as guaranteed to fail as the lowest tranches. The trick on the secondary transaction was that the investment banking firm had the proceeds of the credit default swaps payable to themselves instead of the investors, by labeling the transaction as a proprietary trade instead of a fiduciary transaction].
   
10. If the borrower doesn’t take the bait, then the loan is done at 5 1/2% and is identified as being in the senior tranches of a securitized pool by virtue of a spreadsheet without any assignment, indorsement or delivery of or recording of actual documents.
    
11. So to summarize, on a $300,000 loan, the investment bank made $150,000 which was used to fund the outsized and illegal yield spread premiums to the mortgage brokers, who were incentivized to make the worst loans possible because the investment bank’s spread increases exponentially every time they get a bad loan. The Arizona Pension Fund is not wise to the fact that only $300,000 of their money was actually invested in a mortgage. Nor do they know the quality of the mortgage is virtually ‘guaranteed to fail” much less AAA.
    
12. Once the loan fails, the Pension Fund does not in theory ask any questions about what happened to all the money — except now, many investors ARE asking that that question and I encourage readers to keep track of those cases, since the discovery responses and pleadings will be very revealing regarding your own actions as borrowers to recover damages, interest, attorney fees etc for TILA, RICO and other violations.
    

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August 16, 2010

Fed Adopts Rules Meant to Protect Home Buyer

By DAVID STREITFELD

The Federal Reserve on Monday moved to end a controversial lending practice that had helped propel the housing boom to unsustainable heights and then accelerated its collapse.

The Fed announced that it was adopting new rules banning yield spread premiums, which allowed mortgage brokers and lenders to gain additional profit from loans by charging borrowers higher-than-market interest rates.

Reaction to the change was muted. For one thing, the recent package of financial reforms passed by Congress this summer already addressed the issue. And some thought a ban should have been imposed long ago, at a time when it could have directly affected loan quality.

Michael D. Calhoun, president of the Center for Responsible Lending, described the action as “a real milestone,” but he said that he had been trying to convince regulators for at least 15 years that yield spread premiums were no more than illegal kickbacks.

Many borrowers had little idea of what a yield spread premium was, even when it was costing them money.

Traditionally, mortgage brokers were paid directly by the home buyer. The rise of the premium allowed the brokers to be compensated by the lender as well. Lenders in effect started paying bonuses to brokers who brought them high-interest loans that were naturally coveted by mortgage investors.

From there, critics said, it was a short step for some brokers to put unsuspecting buyers into these loans and tell them it was the best deal they could get. Subprime lenders in particular often used yield spread premiums.

“People didn’t just happen to end up in risky loans,” Mr. Calhoun said. “Mortgage brokers and other people on the frontlines were getting two to three times as much money to push buyers into those loans than they were into 30-year fixed-rate loans. So what do you think happened?”

Brokers argued that it was frequently in the interest of the borrower, especially a low-income buyer, to pay a higher rate in exchange for bringing less cash to closing.

Attempts at reform achieved little, and during the housing boom the yield spread premiums became ever more prevalent. In many cases, groups like the Center for Responsible Lending found, borrowers never realized they were paying both higher fees and a higher rate.

While the new rules prohibit payments to a lender or broker based on the loan’s interest rate, they do allow for compensation based on a fixed percentage of the loan amount.

To avoid steering the buyer into a loan that is offering less favorable terms, the rules now say that the borrower must be provided with competing options, including the lowest qualifying interest rate, the lowest points and origination fees, and the lowest qualifying rate without risky features like prepayment penalties.

The National Association of Mortgage Brokers, which had long argued that efforts to reform the premium unfairly singled out its members, pronounced itself satisfied with the new rules.

The Fed rules “put everybody on the same footing,” including brokers and banks, said Roy DeLoach, executive vice president for the brokers’ association.

The rules take effect in April. Similar, and in some ways broader, rules in the financial reform bill will take effect later.

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