Mortgage Securitization Part II

In a previous post on mortgage securitization, I argued that mortgage securitization – or any other debt securitization for that matter – was nothing more than a fraudulent scheme in which money is made through fees (and comissions) but that the scheme is sure to blow up at some point, but thanks to securitization not in the faces of the ones who reaped the benefits.

Here is some more evidence that supports that argument.

Let’s start – again, because it is one of the great sources – with Barry Ritholtz’s Big Picture, who hosts a post from ABS Investor Advocate. You’ll find quite a few other good posts there.

In his post ASF and NERA Rearrange the Deck Chairs, David J. Grais, a lawyer with 30 years experience in trials of complex financial and technical disputes, makes the following point:

There is only one question worth asking about securitization: why did securitization become the seedbed of the broadest and costliest epidemic of fraud in history? Until we face that question squarely and answer it honestly, securitization will remain in its coma. Unfortunately, the Obama Administration missed a chance to address that question in its plan to regulate the securitization market. (See the post immediately below.) ASF’s sponsorship of the NERA report is more insidious. By a combination of forbidding mathematics and emollient prose (“Recent experience appears to demonstrate readily that securitization is not inherently ‘good’ or ‘bad.’”), ASF tries to whisk us past that looming question and past the one measure that will best restore confidence in securitization: effective redress for investors against those that turned securitization from a useful financial tool into an orgy of misconduct.

The ASF report referenced in his post makes a few other interesting points, not at all positive for securitization (or the ASF). In fact, the report argues that securitization was a major contributor to the financial crisis (p. 10):

Our empirical analysis shows that increases in secondary market purchases have a positive and significant impact on the amount of mortgages credit per capita, with the non-agency sector displaying  a stronger impact in recent years. For example, the model suggests that a 10% increase in the secondary market purchase rate would increase mortgage loans per capita by 6.43% for a given Treasury rate of 4.5%. Higher incomes, lower unemployment rates, older borrowers, higher shares of borrowers from underserved areas, and strong price growth all correspond to higher loan amounts per capita. The results suggest that secondary market activities help increase credit availablitity to a greater extent in lower interest rate environments.

Or in other words, in environments where a loan issuer can borrow money cheaply, loans are doled out to people who normally could not get one or not one of that amount – presumably because they can’t afford it – and the rate of securitization increases (p. 10):

In addition, we document the increase in both the share of loans originated in underserved areas and the share of underserved loans sold to the secondary market. Both the dollar volume of originations in underserve dareas, as well as the share have increased since 1990 from $47 billion (16% of total originations) to as high as $609 billion in 2004 (26% of all originations).

Thus, no cheap funds and no securitization, no bubble. Please note that ‘underserved areas’ means low-income, high-minority census areas. On p. 12:

The models show that for all banks, as well as for groups of small and large banks, the total loan growth (adjusted for inflation) is positively affected by the securitization rate of a bank’s loan portfolio and the level of liquid assets for the period 1990 to 2006.
[…]
In addition, in the event of tigthening monetary policy, higher levels of securitization have a more pronounced effect on small banks than on large banks. This is possibly due to the fact that large banks have greater access to the capital market, and generally have lower credit risks. Thus, when facing a monetary tightnening, large banks are still able to obtain external funding at a relatively low cost.

So this system of securitization benefits the large banks in the end, because they can more easily absorb adverse economic conditions, i.e. the higher cost of borrowing funds. Isn’t it funny how the whole systems is set up to benefit just a few.

It is interesting to see who holds the mortgages and the ABSs. From Fig. 1 taken from the report (p. 20) we see that many of them, 48%, are held by GSEs, i.e. mostly Fannie and Freddie. Whoever had them privatized did a disservice to the country and helped bring the current crisis about.
They were supposedly privately run, but still had the implicit backing of the full faith and credit of the United States.
In effect this made it possible to off-load the risk from the private sector to the public sector, while the profits were made in, and remained in (tax-reductions, anyone?), the private sector.

Holders of Home Mortgages and Securities

Holders of Home Mortgages and Securities

In sum the report makes a case against securitization not for it.

Might all this be just bad luck, incompetence and greed-induced blindness without any (criminal) intent behind it?

No.  We are looking at an persistent effort throughout more than thirty years. During this period all safe-guards that were put in place by FDR were concisouly removed one after another and new attempts to regulate were crushed. Thereby establishing a system that benefited a handfull of billionaires and their cronies, while the government, that means the taxpayer and citizen, was left holding the bag and paying the bill.
What we have here is a giant money laundering scheme intended to extract money from unsuspecting people by seemingly legal means, wash that money and then put it into the bank accounts of some people.
As written in the report (p. 78):

In brief, the securitization process involves the creation of a special purpose entity or a trust which becomes the owner of the loans. The trust is usually a bankruptcy-remote, special purpose vehicle (a subsidiary of either the originator or an investment bank) that underwritees the securities. The trust structure is used because it is exempt from taxes, allows the originator to treat the transaction as a loan sale, and insulates investors from the liabilities of the originator and issuer.

In a strict sense this might appear to be legal because the laws allow for this, but is it really? I don’t tink so. Laws to such an end violate the Constitution.
But even if it was legal, who has had these laws written?
Well, the same people who are the profiteers of all these ‘coincidences’. Well, I guess that’s just another coincidence then.
You can’t even opt-out, because of pensions, 401(k), social security, etc. They’ll get your money anyway, even if you are not investing yourself.

Here is an example of how the lawmaking process works. In How Safe is the Harbor, ABS Investor Avocate writes that

Just before the final vote in the House, the following section was inserted:Rule of Construction – No provision of [the Act] shall be construed as affecting the liability of any servicer or person … for actual fraud in the origination or servicing of a loan or in the implementation of a qualified loss mitigation plan, or for the violation of a State or Federal law, including laws regulating the origination of mortgage loans, commonly referred to as predatory lending laws.

The act in question here is the Helping Families Save Their Homes Act of 2009. What would have happened if that passage had not made it into there?
Servicers would have cleared themselves of any previous wrongdoing like violation of state lending laws, breach of contractual duties. ABS Investor Advocate:

To many, this will sound like common sense. Of course servicers cannot wrap themselves in the flag of mortgage modifications and wipe clean the slate of violations of state lending laws, breaches of contractual duties, or outright fraud. But this illustrates the insidious part of legislation like servicer safe harbor. Investors can no longer take for granted common-sense, everyday assumptions like the enforceability of contract rights and the priority of first over second liens.

Exactly. But what does common sense account for if the law says otherwise? Not much in a court of law. You may feel like the moral winner, but you’ll still lose out in court. This way, they could make rape, pillage and slavery legal again. They might even profit from you dying while working for them, oh wait, that’s already a reality.

Oh, by the way did you know that refinancing your loan makes your non-recourse loan (bad for the lender, good for you) a recourse loan (good for the lender, bad for you)? Karl Denninger has the story.

Just another coincidence, I guess.

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