patrick.net

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...

That is exactly what I meant, SFBB. Look, I'm done defending legislation that hasn't even been written yet. It's nothing more than a twinkle in Barney's eye at this point. Regardless of what happens, I'm in favor of anything that sheds more light on the process, holds more stakeholders accountable and dries up dark pools of liquidity that fund reckless lending and stupid borrowing. In concept, I think this idea is not from left field. You guys have fun, I'm out for the night...

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?

Arguably, why wasn't the mortgage industry like this earlier?

They're in the sales business - there's no reason why they shouldn't have always been like used car salesmen.

If anything, they've finally caught up to modern day business practices.

This is madness. I do not see how investors should be on hook. If the FB gets into a bad loan due to bad information he deserves to be homeless.

Similarly, I do not see how tobacco companies should be liable for the health of smokers. Nobody forced them to smoke.

Space Ace & HelloKitty,

I'm sorry, but I'm having trouble with the whole punish-the-MBS-investors thinking. Shouldn't the actual criminals (not bystanders) get punished? And shouldn't the punishment fit the crime? Let's break it down here:

Retail mortgage broker: Aggressively hard-sells unqualified FBs option-ARM/NINJA loans because those provide the highest secret kick-backs (YSPs) from loan originator. Sometimes, actively enages in outright fraud by lying to FB, falsifying loan papers and/or using bait-n-switch tactics.

Loan originator (big bank or Wall Street firm): Provides perverse incentive structure for Mr. Broker to encourage sale of toxic loans, the more toxic the better. Fails to perform due diligence on FB's finances/ability to pay, because they know they will just bundle the loan into MBS pools and sell the risk downstream to suck...er, investors. After collecting a hefty fee, of course.

MBS-issuing agency (Wall Street firm or GSE): Buys the toxic loans, bundles into MBS/CDOs, assigns a risk category (Tranche), then sells to investors and collects their fee.

MBS investors: Buys the MBS, CDOs, or other derivatives in bond form. Pays a premium according to risk tranche (AAA, Alt-A, BBB, etc.). Includes FCBs, hedge funds, pension funds & mutual bond funds. Some of the ultimate MBS holders are Joe 6pack retail investors who hold them in their pensions/IRAs/401ks. Joe 6pack has no clue what these things really are, nor the risks associated with them. Most of them (GSE-issued, AAA) are commonly described as "safe", conservative investments.

Investors shouldn't be on the hook, but the mortgage bankers definitely should.

If my cousin were not financially shrewd, or financially more established, he could have easily become a victim of the current predatory lending practice. Not a lot of home buyers can create their own excel spreadsheet to compare loan repayment schedule, NPV analysis, interest rate sensitivity test etc. Even the mortgage "consultant" can't. Only those coming up with the product know the full implication and therefore devise the commission plan for each product accordingly.

You can't expect home buyers to be that financially savvy. Most of them are not, nor should they be. Getting into a mortgage loan is like buying a very expensive option that can turn your life upside down, it should be regulated just as heavily as the rest of financial industry.

A fun debate on its own, but not the point I was going after. In our economic system we seperate investors from officers and directors because it would go against public policy for someone to fear being sued if they buy shares or put up capital for a venture. Even when a veil is pierced and officers and directors are attached personally, the shareholders are excluded because they have nothing to do with the day to day operations or decisions of the business. Even in setting up a partnership we have a concept of a limited partner who is basically the same role. He just puts up the money and his risk is only limited to the money he puts into the business. Someone did allude to the checks the system has which is a dilligent investor who doesn't want to lose his money won't invest in a company likely to be sued or fined for unethical/illegal activity.

For the sake of argument, I accept as a given that the FB was totally misled, defrauded, lied to, pressured or whatever by some shady boiler room broker.

NOOOOO!!!!!!!!

Why on earth would you think they are nutty? :0

HK,

I think 1) and 2) may be unreasonable, but 3) definitely is. All governments in the world encourages home ownership, such encouragement just comes in different flavors, some in the form of first time buyer assistance, some in reduced stamp duty for first time home buyer, some in the form of mortgage int rate deduction. The US tax policy is certainly most aggressive in pushing home ownership, but we are not without competition.

I have yet to see a government that deters its people from buying a home.

MY LIST OF OTHER ‘MAD’ GOVT IDEAS:

all nuts yet they are law.

Lowering the tax burden lowers the necessary price to acheive a certain financial goal, it also makes it easier to make the decision to sell which lowers the price of homes. It lowers the barrier of entry for you guys who do one day want to buy. Plus it balances out because the government will have a net defecit if people are able to take a capital loss deduction when prices don't work out.

Prop 13 does have the opposite effect I grant you, but it is founded in being right. Why should someone who owns for the long term all of a sudden be forced out when their neighbors do stupid things like buying a 3x the real value. That's not fair.

I almost see some merit on the mortgage deduction, but my belief is that all interest should be deductible like it used to be. That would put a bit of a clamp on HELOC which are basically just a loophole for guys like me who used to want to shift non deductible debt to be deductible. That was actually a very powerful marketing tool.

The best way to encourage homeownership is *outlawing* NIMBYism and other zoning regulations. Just let them build, build, and build.

Prop 13 does have the opposite effect I grant you, but it is founded in being right. Why should someone who owns for the long term all of a sudden be forced out when their neighbors do stupid things like buying a 3x the real value. That’s not fair.

IF we must have property tax the best way is have it base on the rental equivalent value. This way, it is just a form of consumption tax.

Cities wouldn't function without zoning though. I say let the city planners design the city, and let the free market value the parcels for their intended use. There are idiots out there who would put a polluting business right next to a school.

I think it is fair the way it is. I could compromise on the 2% annual increase cap, and let the annual increase be the greater of CPI or 2% so long as the assesed value is moving upwards.

So if we agreed on the subsidy principle what would you have them do? Would you instantly remove the deductibility or would you phase it out?

I do agree with you btw. The normal burden on the buyer would be unchanged with or without deductibility, I just in general look at taking tax deductions aways as being the same as a tax increase.

I say let the city planners design the city, and let the free market value the parcels for their intended use. There are idiots out there who would put a polluting business right next to a school.

Fair enough.

Maybe with the current lower brackets we could look at phasing some of those loopholes out. Keep in mind that the effect is on the lower income groups in this country. Basically it is a tax on the poor.

So if we agreed on the subsidy principle what would you have them do? Would you instantly remove the deductibility or would you phase it out?

I would say flat tax and no mortgage interest deduction. :)

So he shopped around for rates, and every outfit obviously salivates over such a customer.
OO,
I have to disagree with your cousin's methodology. The point of going to a mortgage broker is so you don't have to "shop around". I tried this briefly (going to different lenders), once, and it is waste of time. And yes, the tricky part is finding a decent mortgage broker. You do this by interviewing friends, familly and people within the REIC that you trust. I agree he should run from the room if someone is suggesting a product that is totally off base. There are honest brokers out there who will earn their keep (and repeat business/referrals) by finding you the best deal around.

trader,

I think way too many people are pointing fingers at the wrong guys.

There are lots of FBs who defraud the banks, no doubt about that, but when you look at the power balance between those who give out the money and those who receive the money, who actually has an upper hand?? Why didn't FBs get the same treatment 10 years ago?

The real culprit of all this is Wall Street, which decouples the risk and reward for each of the parties. Here is the risk and reward for each of the parties:

FB: taking on the risk of the home appreciation or depreciation way beyond his affordability, reward could be huge but so is downside, aside from getting scammed on a bad rate structure

mortgage banks: risk is negligible as long as he can pass on the loans, reward is commission, the more loans they originate, the more they make, but no substantial upside

Wall Street: risk is negligible since they have the "formula" to price the risk right and they are enough willing investors downstream, and after all, they are the middleman only. However, the reward could be huge due to the brokering volume, and when they twist their model a bit to influence how the pools are priced, we are talking about tens of millions of upside to be shared among a pool of 100s of people.

Investors: huge risk, little reward, well the biggest risk will be born by the retail investors, since the mutual fund managers are only playing with OPM, and they will pocket that annual management fee whatever the return is.

So the bagholders will be the FBs and the investors, aka, the small guys.

My wife and I went to her school reunion last year, there's not shortage of guys in their late 30s making millions annually, all HF and wall street types, at least a couple of them are in the MBS field. Without such a skewed risk reward pattern, nobody can be making that much at that age just by pushing paper around.

It's just the principle of partnership IMO. My current thinking (yes I change) is that you have government make social policy (like planning) let the free market take care of what it naturally would then the remaining areas based on social need or spillover potential naturally either falls into the government turf or through various mechanisms can be obtained through PPPs which are Public Private Partnerhsips. It's basically what I did my thesis on that's why I may seem a little opinionated about it.

I would say flat tax and no mortgage interest deduction.

Especially at the higher brackets. When it is all figured out some of these high rollers pay a smaller percentage than you and I do through some idiotic loopholes you have ever seen.

Yes but the problem is that all the goverment ’subsidies’ simply have the effect of raising the prices by the exact amount of the subsidy.

Exactly.

Why does the government "need" to favor one asset class (house flipping vs. daytrading) or one type of shelter (rent vs. buy) over another? Are we really running out of houses?

Why should the tax code reward unproductive activities (flipping/RE speculation)?

Why should loanowners enjoy superior rights/tax benefits over renters?

Why should early-born loanowners (Boomers, Silent Gens) enjoy superior rights/tax benefits (Prop. 13) over later-born loanowners?

Why should the tax code be as thick as a phonebook and require a law degree to decipher?

Tax code is kept thick so that CPA and tax lawyers get to keep their customers. You don't want a lot of CPAs and tax lawyers on the street, do you?