Saturday, January 3, 2009


1. Issuing Mortgage Loans Knowing the Borrower Would Default/Everyone Makes Money & Transfers the Risk of Default Via a Wall Street Securitization: I have seen many stories over the past several months similar to one on the front page of the WSJ this morning.  It shows a house condemned as unfit for human occupancy.  The bank had foreclosed on the mortgage.  The buyers at the foreclosure sale paid $15,000 for it just to tear it down.  According to the WSJ, the borrower had no job for 13 years.  She had a history of not paying her creditors.  She admittedly had a drug and alcohol problem but had possibly been sober for some time.  She received a $103,000 from a local lender, not pursuant to any federal program to further home ownership or to help minorities as far as I could tell.   Now get this, the lender hired an appraiser to value this not fit for human habitation house at $132,000.  The lender took over 6 grand in fees and made another 3 grand a few days later selling the loan to Wells Fargo.  That bank then bundled that loan together with 4050 other mortgages and sold the trash (85% were subprime with blemished credit histories) to HSBC.   Now, everybody is making good money taking fees and commissions, assorted other cuts, until you reach the other victims, the unfortunate ones who bought interests in this pool of toxic trash from the banks.    Moody's and S & P get into the act by rating the pool AAA.  Well, if it was not rated AAA, how could it be sold and if it was not sold then the rating agencies would not be paid.  Now, guess the end of this story.

Everyone from the original mortgage lender to the banks that sold and packaged the loans make money, making money was contingent on getting all of the deals done with the final step in the process being to unload the trash on investors who would be left holding the bag like the Teacher's Retirement System of Oklahoma that bought $500,000 of this pool.  By November, 25% of the loans were delinquent or in foreclosure.

As I mentioned in a previous post, you need to understand what was happening. Partly, it meant taking advantage of a poor person who could not afford the mortgages on the home.  Of course, she would take the money.  The reason it was offered was to book profits throughout the entire chain of ownership of this mortgage until the risk of loss was shifted to investors who believed, perhaps in a gullible fashion, that the AAA stamp of approval by the rating agencies actually meant something that you could actually rely on when investing.  This topic of the rating agencies complicity in the mortgage crisis is discussed in other posts.

2.  No Skin in the Game Leads to Irresponsible Lending: In short there were no underwriting standards for these loans.  There were given with the intent of being sold to investors who had no connection with the borrowers and who mistakenly had faith in the ratings assigned to the mortgage pools.   No one in the chain of blame had any skin the game.  Profits were generated only if the transaction happened.  Making the transaction happen was the only thing that mattered to those in the entire chain of transactions.   When you delve into what happened, the common source is the investment banks and other large financial institutions providing the funding to firms who then solicited borrowers, any borrower who had a pulse, to sign the loan document.  Without the funding those intermediaries, now bankrupted by the hundreds (Implode-O-Meter), they would have never had the capital to start the process in any meaningful way.  Without the flood of money coming from what most people then regarded as respected financial institutions, there would not have been the loosey goosey underwriting standards that emphasized the deal above all other considerations.   A good description of this process is given in Ralph Muolo's book Chain of Blame. 

 It was just not the house that was unfit but everyone who participated in this process. 

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