patrick.net

Guys, I'll try to make one more point on this and then I'm done. (Whenever I hear the pitchfork-sharpening machine revving up in the background, I just leave the blog for a few days...) First, anytime someone mentions the word "fraud" on this board, everyone covers their hats (and their wallets) with tinfoil and screams about Casey Serin.

First of all, the article says zero about giving brokerages or bankers a free pass; it also says nothing about bailing out individuals who commited fraud. Can we assume, like reasonable adults, that some degree of fraud has been committed in the last ten years during this boom? When people who don't speak english are approached at the San Jose flea market and sold mortgages at 10X household income, this might actually be fraud. Don't kid yourself by thinking it hasn't been rampant. (Stupidity has been rampant too, but let's try not to assume that it was 100% of one or the other.)

Here's how I see the old days:

borrower -> bank

The bank holds the risk, the legal liability and the fiduciary responsibility. If bank hires shifty brokers, forges signatures on docs, inflates borrower income, etc. They are held liable.

Here's how I see it today:

borrower -> broker -> originator/warehouse -> investor

IN THE CASE OF FRAUD, SPECIFICALLY...
who do you propose should be on the hook? The mortgage broker who is now back at his old job selling cell phones at the mall? Is he going to pay people back for writing those fraudulent deals? How about the originator or the warehouse? Well, they in fact are on the hook. So let's try to call up New Century and get them to pony up money for the specific case of fraud committed. Oops. We're 37th in line... I hope there's some left when get to the front.

Everyone wants fiduciary responsibility but you completely miss the point that this can actually create fiduciary responsibility. Not being on the hook for anything means you don't give two $hits about fiduciary responsibility. If you might be held liable, you might actually take a look at what you're buying. Don't confuse this type of institutional investor with mom & pop.

"no one had enough incentive to keep the brokers in line"

True, and it's also their defense (or soon will be). We can go on and fault the ratings services (Moody's etc.) In my mind though it's the MB's themselves that still have the most egg on their face b/c they are the ones with the most DIRECT interface w/the consumer!

I don't expect Moody's to come down and rate e a c h_and_e v e r y stinking re-fi in the broker's pipeline of loans. It's equally unreasonable to expect institutional fiduciaries to grade this slop as well. There were breakdowns at several levels (and I'm not leaving the consumer out of this) BUT the MB had the greatest and most immediate economic benefit from this meltdown with the least amount of capital at risk.

Reckless investors shouldn’t receive any sympathy, Frank said.
Ohhhh.... I think we have found the ultimate "smoke test". We have all been wondering where the MBSs have been hiding. I believe someone on this board pointed out an overseas mutual fund they had was 40% invested in MBSs. Once Congressman Frank realizes that every pension fund and retirement account is "liable" (this is speculation), he may tone down his retoric. At least now we may actually find out where the bodies are buried.

In the last thread bruceb Says:

> Bill Gross at Pimco has written a great piece about
> the subprime mortgage housing market and it’s
> possible repercussions http://tinyurl.com/2zfsv6

I thought Randy might like to take a look at the URL since Gross also talks about Second Life.

Gross includes an interesting chart that shows that lenders were easing lending standards from 1991 to 1994 (I knew that rates were dropping from 1991 to 1994, but didn’t know that lenders were easing standards).

The tighter lending standards is just one more thing to add to the reasons why this crash currently underway will be worse than anything we have seen in the past.

P.S. This would be a good article for Patrick to link to on his main page…

FAB, I agree - I wondered also whether or not Bill Gross was checking in on this blog and others for material for this latest report of his.

PAR,

By and large... agreed. In that case the compensation model was totally out whack! Some guy (and I think I've seen him once or twice) that used to cell phones at the mall should *not* have been making 100-200-300K per year and those dollars would have been A) that much less the borrower was in the hole B) more of a risk premium to the investor or C) held in reserve by Mr. Cell Phone's employer to buy back loans he wrote that defaulted in the first year!

Anyway you slice it, these MB firms were giving out WAY too generous pay-outs with too little thought as to the consequences of the reckless hiring practices and internal policies.

PAR,

In short, they're all going to take in the @$$ (I just want to see the MB's take it first!) Once they're totally depleted, then and only then should we move upstream. There's plenty of "deep pork" to go around! :)

PAR,

Perhaps I was misreading you, so let me try to understand/paraphrase what you're getting at:

First of all, the article says zero about giving brokerages or bankers a free pass; it also says nothing about bailing out individuals who commited fraud.

I didn't see any proposed penalties mentioned for brokerages or bankers, only the MBS bondholders. But, hey, it's just some Bloomberg staffer's summary, so maybe there are some. I'll have to locate and read the actual bill (when it exists) to know for sure.

As far as "bailing out" individuals, you could say allowing them to sue MBS bondholders could be considered an indirect type of bailout, even if the taxpayer is not directly involved. If the individuals were really defrauded (and, yes, there are definitely cases where this was true), then should they be allowed to sue for damages? Perhaps, but why sue the MBS holder vs. the mortgage broker? (You know, the guy who "filled in" those income/doc sections for you, while glossing over all the fine print?)

This is why I meticulously avoid mutual funds holding any MBS. Sure, over the past few years, I lost out on mucho gains, but I still haven't done too badly.

PAR said:

Everyone wants fiduciary responsibility but you completely miss the point that this can actually create fiduciary responsibility. Not being on the hook for anything means you don’t give two $hits about fiduciary responsibility. If you might be held liable, you might actually take a look at what you’re buying. Don’t confuse this type of institutional investor with mom & pop.

Again, I'm all for creatin' some serious "FR" where none currently exists! The problem is, how to create it for the right people (perps)? Institutional managers may do the actual MBS buying (Fidelity, Vanguard, Pimco, etc.), but Mr. & Mrs. retail investor are the ones liable to take the financial hit if the investment Co. gets sued, no? I seriously doubt this proposal means Fidelity's CEO is going to be paying for legal fees out of his own salary & stock options, or am I missing something?

Barney Frank is a showboat and not much more. I would not vote for Barney Frank if I lived in his district.

SP,

That may have been Nouriel Roubini from an early CNBC interview. He said something almost identical to that just a few hours ago.

It sounds to me like what they're proposing is akin to holding liable investors in Enron/MCI. I suppose that the individual stockholders of those companies should be held accountable for fraud committed there, since they are the owners after all, and they're the ones that provided compensation to management.

While they're at it, just proclaim that people don't kill people, guns kill people. Sheesh.

astrid,

NOT... that there's anything w r o n g with that!

SP,

That guy on the radio may very well have been Nouriel Roubini:

http://www.rgemonitor.com/blog/roubini/187316/

He's been balanced in analysis, perhaps leaning a little toward the bear side on housing of late. But then again, who isn't these days other than the RE cheerleaders?

BearCat asked Barney Frank some questions so I sent them to Barney at his private e-mail address (his answers are below):

> 1. Should Reckless real estate investors (e.g.
> Casey Serin, people who take out 2/28’s, neg-
> am loans) get any sympathy, Mr. Frank?

Yes, Casey is a cute boy and we should put together a government program to help out any cute boys with man bags that may need our help.

> 2. Should Predatory borrowers, such as people who
> lied on their loans (e.g. almost everyone who went
> the stated income route), get off the hook Mr Frank?

Only Republicans should be punished for lying. It is OK if you are a Democrat and lie on a loan application or if you are a Democratic Congressmen and lie and say that you had no idea that your roommate was running a prostitution business out of your apartment.

> 3. It’s also good to look at the money flows. The flow of
> $$$ from Wall Street to the politicians (esp Sen Dodd)
> has already been discussed. Remember that Trial Lawyers
> are one of the big Democratic donor groups. Frank’s
> proposal will benefit them. Do we really need more lawsuits
> and more money going to lawyers?

Wall Street firms (that give to the GOP) need to be punished and we need more lawsuits (so trial Lawyers who give to the Dems will have more money).

P.S. I don’t really have Barney’s private e-mail address (or the private e-mail address of any other members of congress) but I’m pretty sure his answers would be fairly close to the ones above.

SP
"This here is a pig"

Yea this is slowly creeping back into the media.
It was clear to many that have known there is no difference
between subprime and Alt-A loans... just the media finally getting it.

What about lettuce-backed securities? Are similar actions being considered?

How about subprime Harley loans?

http://www.thestreet.com/_tscrss/markets/activetraderupdate/10347201.html

A double whammy for the Boomer - he's out of money, and there goes his peni$ extender!

Space_Ace,

Along about 2004 I lost sight of it altogether. I mean... why bother? The difference between a 500 FICO and an 800 FICO was about a 1/4 point or $53 a month in payment. FICO didn't matter, down payment didn't matter, pffft.

OT, but does Larry Birkhead have anything to do with Alt-A & subprime loans? That's all I can find any new stories about lately.

skibum,

Good on Doug Kass. Just a sensible guy. Kind of wonder why anyone would need to make a payment on a 10-15K motorcycle though? Is boomer THAT strapped? Uncanny correlation to subprime, isn't it?

Is boomer THAT strapped?

Clearly, boomer needs to strap one on.

Sorry about the crassness.

PAR, I sympathsize with the desire for a borrower who actually has been defrauded to be able to collect against a solvent party, but I think the bondholders should not be that party for three reasons.

First, as HARM and others have already pointed out, the bondholders are the ones who ultimately bear default risk. They eat the loss if the borrower cannot pay, and you are basically asking them to pay twice. If there is fraud, the bondholders are victims too. In fact, they are probably even more so because they are victims of not only fraud perpetrated against the borrowers but also victims of fraud perpetrated by the borrowers.

Second, the bondholders are the least capable of the parties in the chain to detect fraudulent borrowings. MBS represent interests in large blind pools of mortgages. The bondholders have no idea who the individual borrowers in the pools are and, even if you can get past the privacy concerns about making the details of each mortgage in the pool widely available, have no practical way of verifying the circumstances under which the loan was originated. I suppose the bondholders can assume the risk of a lawsuit and factor that risk into the purchase price for the bonds (or ask for a higher yield), but that's just another way of increasing the cost of borrowing -- which may be a good thing overall, but there are better ways to accomplish this result than opening the floodgates to lawsuits.

Third, MBS can be traded. If you extend liability to individual bondholders, how would you apportion liability as bondholders buy and sell out of particular bonds? In addition, a pool of mortgages gives rise to different tranches of MBS with different grades depending on payment priority. How would divide liability among the different tranches?

Call me cynical, but this just another example of politicians making asinine proposals for publicity purposes.

FAB (or anyone else for that matter who might have insight into this question),
How hard is it for originators to tell that a loan applicant has "multiple primary residences"? As far as I'm concerned, multiple loans to speculators who had no intention of living in the home is what caused this mess. Short of getting mutliple loans in a single month, is it correct to say that lenders turned a blind eye to the primary residence issue? For heavens sakes, bloggers seem to be the only one reporting on this type of fraud. I, for one, think an ownership rate of 69% is not unrealistic... of course this would be in a market where Casey could not defraud the system.

$53 Bucks can go along way each month...

$10 entrance fee
$ 1 can of 7-up
$42 exchanged for single -- 42 x $1 bills
having a 21 yo college hootie show off here snatch 1 ft from my
face for buck a pop.

When you get to my age thats PRICELESS !!!!

I would agree with PAR on this.

"Let the buyer be aware."

They bear the risk and rewards (and the blame
if anything goes wrong).

Otherwise they are asking for someone else to bear
final bill(costs) ... Well Im sure not the one for pay for it.

HARM said: Why sue the MBS holder vs. the mortgage broker

I don't believe it's a case of either/or and I don't think the article suggests this. The article doesn't say that you can't sue the broker. In fact, you already can sue the broker. That statute is already on the books. The MBS holder can also sue the broker. UBS just sued New Century for misappropriating funds: http://www.kesq.com/Global/story.asp?S=6333139&nav=9qrx

My interpretation here is that it's not shifting blame at all. It's widening the tent of blame--with specific regard to fraud--so that all participants in the value chain have some skin in the game. And, perhaps more importantly, the legislation is following the money. New Century is broke and the debtors are lining the block. Did they do bad things? Probably. But once their account hits zero, there's no more money to hand out.

Why should the bondholder skate and (in some cases where the defrauded individual has not defaulted) continue to earn money from a crime that's been committed? If you buy a stolen Picasso from me, it's not necessary for you to go to jail but that doesn't mean you should just be able to keep it.

If you buy a stolen Picasso from me, it’s not necessary for you to go to jail...

It is if one should reasonably have known that the Picasso was stolen.

Why should the bondholder skate and (in some cases where the defrauded individual has not defaulted) continue to earn money from a crime that’s been committed? If you buy a stolen Picasso from me, it’s not necessary for you to go to jail but that doesn’t mean you should just be able to keep it.

PAR, I'm not sure the stolen Picasso analogy holds up here. For one thing, the retail bondholder doesn't know if the "property" is really stolen (fraudulently obtained), and generally doesn't have a clue as to which specific mortgages these MBS bonds are really "backed" by. Wall Street is great at making pools of crap loans appear to be "safe" and "conservative", regardless of the reality.

Secondly (AFAIK --Randy, DinOR?), bondholders don't "continue to earn money" from defaulted loans pooled in MBSs. They can try to recover some of their initial investment from the broker or originator (per repurchase agreements), if they are still in business. If not, then good luck with that.

As you already pointed out, there is no direct relationship, much less personal interaction between fraudulent borrower and MBS bondholder:

borrower -> broker -> originator/warehouse -> investor

Of all the people to be placed on-the-hook for legal/fiduciary responsibility in mortgage fraud cases, I would say the MBS bondholder ranks at least a distant third, no?

Sandibe, as the article states, this type of law already exists in Jersey. Are you suggesting that there is no secondary market for loans originated in Jersey because nobody knows how to trade them? That markets will fail to adequately price in this additional risk? That investors have no appetite for Jersey MBS because they don't want to pay twice? And "paying twice" is not a fair argument. It's an additional cost but it's not 2X and it would be priced into the instrument at the time of purchase. If you have a greater liability, you'll demand a higher coupon rate.

What should happen in theory is that investors will stop buying as much crap and/or demand higher yields. You say that they are the least capable of detecting fraud but I'd argue that's because there is currently no incentive for them to look. You'd be surprised how much information the investor can obtain when there's skin in the game. The market also has an uncanny ability to price risk additional risk.

I think it's unfair to talk about these instruments like they're common stocks, flying around on e*trade. They are not commodities. They are like snowflakes and the rating agencies get paid a boatload of cash to do due diligence. Presently all they look for is likelihood of default.

HARM, I didn't say they'd continue to see revenue streams from "defaulted" borrowers. I said "defrauded" borrowers.

There are no laws today that make buyers of predatory/criminal loan pools liable.

Let us not confuse *enforcement* of the law with *existence* of the law. Enforcement is impossible with a law that does not exist

Trader,

Franks' proposal --as described in the Bloomberg article-- would not make knowingly buying fraudulent loans illegal. It would simply allow FBs to sue MBS investors in civil court after the fact (civil vs. criminal). You could still buy all the fraudulent loans you wanted --in fact you could still buy and sell pools of "ACME Fraudulent Subprime Loans, Inc." all day right in front of the SEC.

That's part of the problem with this proposal: it still does not really address the root cause of the problem (failure of loan originators & mortgage brokers to perform due diligence before handing out reckless loans & reselling them). Then it penalizes people at the very distant end of the MBS pass-through risk chain vs. those most actively/personally engaged in mortgage fraud. Lastly, it creates a new cottage industry for trial lawyers, in a society already choked with frivolous litigation.

I don't think the final bag holders should be the ones prosecuted for 'predatory lending', even if they bought the predatory loans. The ORIGINATORS are the ones who made the bad loan on purpose in exchange for money. They should be held liable, as should their firms. If you must have one more step up, the bank that made the actual loan can be included in the suit.

Buyer - MB - Originating Bank - WS - Investors

When the buyer defaults, the Investors lose, unless the buyer defaults quickly, in which case they can pass the loss back down to the OB. Most of the timebomb resets will be past the 180 day non-performing buy-back. The one person guarenteed to be in on predatory lending is the MB, and the entity most likely to be in collusion with the MB is the OB. Any legal liability beyond the loss of investment should stop there. Fraud on the buyer's part should be prosecuted, and fraud on the MB and OB's part should be legally actionable by the Buyer.

One thing I'm unsure about is what's going to happen to the homes owned by mutual funds. It seems like they'd have even LESS interest in hanging onto foreclosed homes, and if they can't force the bank to buy back the loan, they get stuck with the house, right? Can they use the REO infastructure already in place to sell their foreclosed homes?

HARM, I didn’t say they’d continue to see revenue streams from “defaulted” borrowers. I said “defrauded” borrowers.

How? Once lender fraud was proven in court and the loan invalidated/BK'd away, wouldn't that effectively be the same thing as a "default" from the MBS bondholder's perspective? Either way, they're no longer receiving an income stream from it.

HARM,

I think he means people who were put in predatory loans, but who are making hurculean efforts to keep the mortgage payments up to date.

Those people COULD have their loan restructured to a fixed rate, at the expense of anybody in the chain still standing, and continue to generate revenue for the MBS. However, the number of buyers who will fall into this category seems pretty slim.

My cousin was recently being upsold HELOC, I/O, negam loans.

He is about 70% equity since he bought over 10 years ago, and he is actually trying to refinance into a 10yr FRM cutting down from his original loan schedule of remaining 15+ years, so as to take advantage of the low interest rate while it is still there. He also has an excellent credit score of 800+. He has no other loans besides mortgage.

So he shopped around for rates, and every outfit obviously salivates over such a customer. However, instead of quoting him the best rate possible on what he wants, all of them tried to talk him into I/O loan to "lower" his monthly payment (come on, this guy is trying to pay off his mortgage ASAP), and some tried to "upsell" him into HELOC loans to "free up" his home equity for "home improvement". One outift even suggests that he should get a 5 year ARM that will reset later because the rate is "better".

Of course he didn't fall for any of these traps. But here begs the question, what has the mortgage industry become? A loan shark in disguise?

As one who is competing to put money into projects I have a slightly different perspective to pose to the board. A chain reaction happened when interest rates were pushed down by the fed. All of a sudden normal rates of return were slashed causing a huge surplus of cash which can't be allowed to sit idle. Mortgages and trust deeds had traditionally been very safe alternative investments to the safe rate so this caused a huge migration. Construction loans which used to be very safe and would return rates as high as 16% now barely will return 10% and there is actually real risk in it now. This is where the phrase there's more money chasing fewer deals comes from. In any case, trickling down to the regular mortgage markets, this is why lenders became more and more risk tolerant as competition for the deals further drove returns even lower than what they should be even given the fed increases. This is what caused the inverted yield curve IMO.

Palo Alto
investors in mortgage bonds should be liable for deceptive loans made by banks

I couldn't disagree more, but thank you for posting something that we can actually disagree on. In any case, investors are basically limited partners, like shareholders. If we were to extend this logic to an area most people can relate to, shareholders of Philip Morris should be personlly liable for healthcare costs of smokers, above and beyond their share value.

"We need a nutty Sarbanes-Oxley over reaction to really put the REIC in its place, they were all acting like the dot com/enron people the last 6 years.(hey are the same people??? hmmmm)"

I totally agree!

If anything SOX will add time for proper review of the transaction.
making sure everyone is on board.

Of course time is wasted if your a seller... therefore they will more likely
discount their asking prices.... and I have no problem with that...