Hypothesis about Bush Bailout Plan-Article from SF Chronicle
I thought this article was fantastic in that it hypothesized a more plausible (to me, anyways) reason for the "Bush" bailout plan.
:)melonleftcoast
From: San Francisco Chronicle
December 9, 2007
MORTGAGE MELTDOWN
Interest rate 'freeze' - the real story is fraud
Bankers pay lip service to families while scurrying to avert suits, prison
By: Sean Olender
New proposals to ease our great mortgage meltdown keep rolling in. First the Treasury Department urged the creation of a new fund that would buy risky mortgage bonds as a tactic to hide what those bonds were really worth. (Not much.) Then the idea was to use Fannie Mae and Freddie Mac to buy the risky loans, even if it was clear that U.S. taxpayers would eventually be stuck with the bill. But that plan went south after Fannie suffered a new accounting scandal, and Freddie's existing loan losses shot up more than expected.
Now, just unveiled Thursday, comes the "freeze," the brainchild of Treasury Secretary Henry Paulson. It sounds good: For five years, mortgage lenders will freeze interest rates on a limited number of "teaser" subprime loans. Other homeowners facing foreclosure will be offered assistance from the Federal Housing Administration.
But unfortunately, the "freeze" is just another fraud - and like the other bailout proposals, it has nothing to do with U.S. house prices, with "working families," keeping people in their homes or any of that nonsense.
The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value - right now almost 10 times their market worth.
The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.
And, to be sure, fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies - all the way up to senior management - knew about it.
I can hear the hum of shredders working overtime, and maybe that is the new "hot" industry to invest in. There are lots of people who would like to muzzle subpoena-happy New York Attorney General Andrew Cuomo to buy time and make this all go away. Cuomo is just inches from getting what he needs to start putting a lot of people in prison. I bet some people are trying right now to make him an offer "he can't refuse."
Despite Thursday's ballyhooed new deal with mortgage lenders, does anyone really think that it can ultimately stop fraud lawsuits by mortgage bond investors, many of them spread out across the globe?
The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC.
The problem isn't just subprime loans. It is the entire mortgage market. As home prices fall, defaults will rise sharply - period. And so will the patience of mortgage bondholders. Different classes of mortgage bonds from various risk pools are owned by different central banks, funds, pensions and investors all over the world. Even your pension or 401(k) might have some of these bonds in it.
Perhaps some U.S. government department can make veiled threats to foreign countries to suggest they will suffer unpleasant consequences if their largest holders (central banks and investment funds) don't go along with the plan, but how could it be possible to strong-arm everyone?
What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back. The time to look into this is before the shredders have worked their magic - not five years from now.
Those selling the "freeze" have suggested that mortgage-backed securities investors will benefit because they lose more with rising foreclosures. But with fast-depreciating collateral, the last thing investors in mortgage bonds ought to do is put off foreclosures. Rate freezes are at best a tool for delaying the inevitable foreclosures when even the most optimistic forecasters expect home prices to fall. In October, Goldman Sachs issued a report forecasting an incredible 35 to 40 percent drop in California home prices in the coming few years. To minimize losses, a mortgage bondholder would obviously be better off foreclosing on a home before prices plunge.
The goal of the freeze may be to delay bond investors from suing by putting off the big foreclosure wave for several years. But it may also be to stop bond investors from suing. If the investors agreed to loan modifications with the "real" wage and asset information from refinancing borrowers, mortgage originators and bundlers would have an excuse once the foreclosure occurred. They could say, "Fraud? What fraud?! You knew the borrower's real income and asset information later when he refinanced!"
The key is to refinance borrowers whose current loans involved fraud in the origination process. And I assure you it was a minority of borrowers whose loans didn't involve fraud.
The government is trying to accomplish wide-scale refinancing by tricking bond investors, or by tricking U.S. taxpayers. Guess who will foot the bill now that the FHA is entering the fray?
Ultimately, the people in these secret Paulson meetings were probably less worried about saving the mortgage market than with saving themselves. Some might be looking at prison time.
As chief of Goldman Sachs, Paulson was involved, to degrees as yet unrevealed, in the mortgage securitization process during the halcyon days of mortgage fraud from 2004 to 2006.
Paulson became the U.S. Treasury secretary on July 10, 2006, after the extent of the debacle was coming into focus for those in the know. Goldman Sachs achieved recent accolades in the markets for having bet heavily against the housing market, while Citigroup, Morgan Stanley, Bear Sterns, Merrill Lynch and others got hammered for failing to time the end of the credit bubble.
Goldman Sachs is the only major investment bank in the United States that has emerged as yet unscathed from this debacle. The success of its strategy must have resulted from fairly substantial bets against housing, mortgage banking and related industries, which also means that Goldman Sachs saw this coming at the same time they were bundling and selling these loans.
If a mortgage bond investor sues Goldman Sachs to force the institution to buy back loans, could Paulson be forced to testify as to whether Goldman Sachs knew or had reason to know about fraud in the origination process of the loans it was bundling?
It is truly amazing that right now everyone in the country is deferring to Paulson and the heads of Countrywide, JPMorgan, Bank of America and others as the best group to work out a solution to this problem. No one is talking about the fact that these people created the problem and profited to the tune of hundreds of billions of dollars from it.
I suspect that such a group first sat down and tried to figure out how to protect their financial interests and avoid criminal liability. And then when they agreed on the plan, they decided to sell it as "helping working families stay in their homes." That's why these meetings were secret, and reporters and the public weren't invited.
The next time that Paulson is before the Senate Finance Committee, instead of asking, "How much money do you think we should give your banking buddies?" I'd like to see New York Sen. Chuck Schumer ask him what he knew about this staggering fraud at the time he was chief of Goldman Sachs.
The Goldman report in October suggests that rampant investor demand is to blame for origination fraud - even though these investors were misled by high credit ratings from bond rating agencies being paid billions by the U.S. investment banks, like Goldman, that were selling the bundled mortgages.
This logic is like saying shoppers seeking bargain-priced soup encourage the grocery store owner to steal it. I mean, we're talking about criminal fraud here. We are on the cusp of a mammoth financial crisis, and the Federal Reserve and the U.S. Treasury are trying to limit the liability of their banking friends under the guise of trying to help borrowers. At stake is nothing short of the continued existence of the U.S. banking system.
Sean Olender is a San Mateo attorney. Contact us at insight@sfchronicle.com.
This article appeared on page C - 1 of the San Francisco Chronicle
:)melonleftcoast
From: San Francisco Chronicle
December 9, 2007
MORTGAGE MELTDOWN
Interest rate 'freeze' - the real story is fraud
Bankers pay lip service to families while scurrying to avert suits, prison
By: Sean Olender
New proposals to ease our great mortgage meltdown keep rolling in. First the Treasury Department urged the creation of a new fund that would buy risky mortgage bonds as a tactic to hide what those bonds were really worth. (Not much.) Then the idea was to use Fannie Mae and Freddie Mac to buy the risky loans, even if it was clear that U.S. taxpayers would eventually be stuck with the bill. But that plan went south after Fannie suffered a new accounting scandal, and Freddie's existing loan losses shot up more than expected.
Now, just unveiled Thursday, comes the "freeze," the brainchild of Treasury Secretary Henry Paulson. It sounds good: For five years, mortgage lenders will freeze interest rates on a limited number of "teaser" subprime loans. Other homeowners facing foreclosure will be offered assistance from the Federal Housing Administration.
But unfortunately, the "freeze" is just another fraud - and like the other bailout proposals, it has nothing to do with U.S. house prices, with "working families," keeping people in their homes or any of that nonsense.
The sole goal of the freeze is to prevent owners of mortgage-backed securities, many of them foreigners, from suing U.S. banks and forcing them to buy back worthless mortgage securities at face value - right now almost 10 times their market worth.
The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.
And, to be sure, fraud is everywhere. It's in the loan application documents, and it's in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies - all the way up to senior management - knew about it.
I can hear the hum of shredders working overtime, and maybe that is the new "hot" industry to invest in. There are lots of people who would like to muzzle subpoena-happy New York Attorney General Andrew Cuomo to buy time and make this all go away. Cuomo is just inches from getting what he needs to start putting a lot of people in prison. I bet some people are trying right now to make him an offer "he can't refuse."
Despite Thursday's ballyhooed new deal with mortgage lenders, does anyone really think that it can ultimately stop fraud lawsuits by mortgage bond investors, many of them spread out across the globe?
The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC.
The problem isn't just subprime loans. It is the entire mortgage market. As home prices fall, defaults will rise sharply - period. And so will the patience of mortgage bondholders. Different classes of mortgage bonds from various risk pools are owned by different central banks, funds, pensions and investors all over the world. Even your pension or 401(k) might have some of these bonds in it.
Perhaps some U.S. government department can make veiled threats to foreign countries to suggest they will suffer unpleasant consequences if their largest holders (central banks and investment funds) don't go along with the plan, but how could it be possible to strong-arm everyone?
What would be prudent and logical is for the banks that sold this toxic waste to buy it back and for a lot of people to go to prison. If they knew about the fraud, they should have to buy the bonds back. The time to look into this is before the shredders have worked their magic - not five years from now.
Those selling the "freeze" have suggested that mortgage-backed securities investors will benefit because they lose more with rising foreclosures. But with fast-depreciating collateral, the last thing investors in mortgage bonds ought to do is put off foreclosures. Rate freezes are at best a tool for delaying the inevitable foreclosures when even the most optimistic forecasters expect home prices to fall. In October, Goldman Sachs issued a report forecasting an incredible 35 to 40 percent drop in California home prices in the coming few years. To minimize losses, a mortgage bondholder would obviously be better off foreclosing on a home before prices plunge.
The goal of the freeze may be to delay bond investors from suing by putting off the big foreclosure wave for several years. But it may also be to stop bond investors from suing. If the investors agreed to loan modifications with the "real" wage and asset information from refinancing borrowers, mortgage originators and bundlers would have an excuse once the foreclosure occurred. They could say, "Fraud? What fraud?! You knew the borrower's real income and asset information later when he refinanced!"
The key is to refinance borrowers whose current loans involved fraud in the origination process. And I assure you it was a minority of borrowers whose loans didn't involve fraud.
The government is trying to accomplish wide-scale refinancing by tricking bond investors, or by tricking U.S. taxpayers. Guess who will foot the bill now that the FHA is entering the fray?
Ultimately, the people in these secret Paulson meetings were probably less worried about saving the mortgage market than with saving themselves. Some might be looking at prison time.
As chief of Goldman Sachs, Paulson was involved, to degrees as yet unrevealed, in the mortgage securitization process during the halcyon days of mortgage fraud from 2004 to 2006.
Paulson became the U.S. Treasury secretary on July 10, 2006, after the extent of the debacle was coming into focus for those in the know. Goldman Sachs achieved recent accolades in the markets for having bet heavily against the housing market, while Citigroup, Morgan Stanley, Bear Sterns, Merrill Lynch and others got hammered for failing to time the end of the credit bubble.
Goldman Sachs is the only major investment bank in the United States that has emerged as yet unscathed from this debacle. The success of its strategy must have resulted from fairly substantial bets against housing, mortgage banking and related industries, which also means that Goldman Sachs saw this coming at the same time they were bundling and selling these loans.
If a mortgage bond investor sues Goldman Sachs to force the institution to buy back loans, could Paulson be forced to testify as to whether Goldman Sachs knew or had reason to know about fraud in the origination process of the loans it was bundling?
It is truly amazing that right now everyone in the country is deferring to Paulson and the heads of Countrywide, JPMorgan, Bank of America and others as the best group to work out a solution to this problem. No one is talking about the fact that these people created the problem and profited to the tune of hundreds of billions of dollars from it.
I suspect that such a group first sat down and tried to figure out how to protect their financial interests and avoid criminal liability. And then when they agreed on the plan, they decided to sell it as "helping working families stay in their homes." That's why these meetings were secret, and reporters and the public weren't invited.
The next time that Paulson is before the Senate Finance Committee, instead of asking, "How much money do you think we should give your banking buddies?" I'd like to see New York Sen. Chuck Schumer ask him what he knew about this staggering fraud at the time he was chief of Goldman Sachs.
The Goldman report in October suggests that rampant investor demand is to blame for origination fraud - even though these investors were misled by high credit ratings from bond rating agencies being paid billions by the U.S. investment banks, like Goldman, that were selling the bundled mortgages.
This logic is like saying shoppers seeking bargain-priced soup encourage the grocery store owner to steal it. I mean, we're talking about criminal fraud here. We are on the cusp of a mammoth financial crisis, and the Federal Reserve and the U.S. Treasury are trying to limit the liability of their banking friends under the guise of trying to help borrowers. At stake is nothing short of the continued existence of the U.S. banking system.
Sean Olender is a San Mateo attorney. Contact us at insight@sfchronicle.com.
This article appeared on page C - 1 of the San Francisco Chronicle
Comments
Thanx...great post.
Great article. Considering the way investors went after Bear Stearns when their hedge funds imploded, it's totally plausible that the big banks are muchly concerned about being sued.
People have been asking about the next bubble, I think this is it......
....I can hear the hum of shredders working overtime, and maybe that is the new "hot" industry to invest in......
..
I thought that at some point, the large investment bankers selling mortgage backed securites/CDOs were abile to eliminate all of their potiential liability.
Liability was transferred back to the wholesale lender.
The contract between the wholesale lender and the retail mortgage broker DOES contain buyback provisions. For example, if the loan contained fraud or if the loan was not originated in compliance with state and federal law, the wholesale lender could ask the broker to buy the loan back.
But, I believe the investment bankers have no liability in due course. I have no reference for this, but I can try to find one for you.
I think the courts will probably have to decide this one. I suspect that many investors, who were assured by the bankers that they were investing in AAA-rated paper, will be looking for someone to sue. As a rule of thumb, you sue the party with the deep pockets first - and the ratings agencies don't have much money - so safe bet is that they go after the bankers.
Here's a piece from Mish's blog about the start of what will probably be a wave of these lawsuits.
CDOs: Here Come the Lawyers
I do not pretend to be an expert on this subject, but it appears Bear Stearns is still busy defending itself from lawsuits resulting from their hedge fund implosions of last summer (see links below). The detail that keeps arising consistently is that investors were supposedly unaware of the risks involved, implying fraud. And of course, as DJO points out, how can AAA rated investments be risky?
The ratings agencies should be able to dodge lawsuits because of their disclaimers: "Any user of the information contained herein should not rely on any credit rating or other opinion contained herein in making any investment decision."
So, are other I-banks immune from the following type legal actions? I don't think so.
Shareholder Sues Bear Stearns Over Subprime Exposure
.....A Baltimore-based investor, Samuel T. Cohen accused Bear Stearns and its top executives of "recklessly" buying up billions of dollars in subprime loans and failing to take adequate reserves for the large amount of bundled loans in its portfolio.
"Due to increasing delinquency among subprime mortgage borrowers and the impending subprime mortgage crisis, these actions were reckless," the lawsuit says.
Mr. Cohen also alleged that the big bank schemed to hide its "tremendously risky subprime mortgage portfolio" from investors by overstating its financial condition......
Hedge Fund Investors File Legal Claims Against Bear Stearns
Lawyers representing investors of one of the two Bear Stearns hedge funds that collapsed over the summer have filed claims with a regulatory body alleging that Bear Stearns failed to disclose conflicts of interest or how risky its trades were, and that it covered up "the true state of affairs" at both failed hedge funds before they imploded. .......
.
Just when I thought I was actually beginning to understand how this stuff works ...............
CDOs Under Fire
.....CDOs inevitably require a bankruptcy-remote special purpose vehicle or limited liability corporation, both of which are designed to separate the performance of the issuing bank from the performance of issued notes. The performance of CDOs, in other words, depends on the performance of the underlying collateral portfolio, not on the performance of the issuing institution. CDOs also require the services of a portfolio manager to manage the underlying collateral portfolio and a trustee to make sure all the various cash flows go to the appropriate tranches........
.
I speculate that maybe issuing I-banks are protected from liability related to financial performance of various investment vehicles like CDO's, but if I am interpreting the situation correctly, it appears that disgruntled investors are claiming fraud due to misrepresentation of risk. That's a whole different ball game, right?
..
Subprime Crisis Raises Claims Risks, Warns Marsh
NEW YORK, August 20, 2007 – Marsh, the world's leading insurance broker and risk adviser, is warning the financial services sector, including insurance companies, hedge funds, banks and ratings agencies, that they may be exposed to greater directors' and officers' liability (D&O) and errors and omissions (E&O) liability claims in the wake of the current subprime mortgage crisis......
......Potential litigation arising out of D&O and E&O liability, include:
Lender lawsuits against banks -- Since lenders are unable to do business without capital, some have been forced to file bankruptcy when they were asked to buy back loans. It is likely that there will be claims of improper margin calls and flawed valuation of underlying collateral on the part of banks and other institutions that purchased or financed the loans.
Shareholder suits against lenders, accountants, trustees, and underwriters -- Subprime lenders that have gone into bankruptcy may well face extensive accusations. Shareholders could make claims of misrepresentation and omission related to accounting for residuals, as well as claims of bad valuation and poor underwriting standards.
Insurer lawsuits against lenders -- Large insurance claims on failed sub-prime collateral may lead to accusations of poor underwriting (misrepresentations and omissions) on the part of lenders.
Investors suits against trustees -- To the extent that bondholders are not paid, there will be claims of breach of fiduciary duty on the part of the trustees responsible for the distribution of cash-flow.
Trustee suits against lenders and underwriters on behalf of investors -- Potential claims are likely to be along the lines of fraudulent conveyance and breach of contract related to loan servicing.
Individual investor lawsuits -- If and when the investors in mortgage-backed securities post poor returns as a result of failing sub-prime backed investments, the individual investors may accuse the funds of not taking on suitable and prudent investments and failing to follow investment guidelines and standard risk management procedures. There also may be claims of misrepresentations, omissions, bad pricing and mark-ups. .....
.
Wheeee! There's fun to be had by all!
..
This must not bode well for the insurance industry, either.
Anyone else have any articles on that? I'll post if/when I find them.
Oh looky! One investment bank suing another!
Barclays sues Bear Stearns over hedge fund collapses
Barclays is suing Bear Stearns for allegedly misleading it over the performance of two collapsed hedge funds that were used as collateral for a $400 million (£200 million) loan......
.....It claims that it was defrauded by the unit and Matthew Tannin, a Bear Stearns fund manager, with the help of Ralph Cioffi, another executive....
.....Barclays alleges that Mr Cioffi and Mr Tannin misled it over the value and security of the funds, the High-Grade Structured Credit Strategies Fund and the High-Grade Structured Credit Strategies Enhanced Leverage Fund.
In the court papers Barclays also claims that Bear Stearns dumped troubled investments in the riskier of the two funds.
It states: "Bear Stearns, BSAM and Cioffi hatched a plan to make more money for themselves and further to use the Enhanced Funds a repository for risky, poor-quality investments by creating a new investment vechicle called Everquest Financial Ltd ... co-led by Cioffi and through which he stood to benefit personally." ....
..
melonleftcoast - I found this, which supports what you were saying:
Credit Default Swaps
.....When faced with pending defaults, it should be expected that lenders and bondholders that have swapped out their risk will be
much less willing to grant a troubled borrower concessions
that might otherwise provide an opportunity to navigate a short-term crisis. In such a case, it may be in the best interests of such lenders or bondholders to await the occurrence of a credit event, thereby allowing them (as protection buyers) to trigger a settlement on the swap and recover par on their investment....
..