Posted on Thursday, October 7, 2010
Two new posts today articulate where the battle lines are beginning to take shape in the Mortgage Foreclosure Fraud mess. Because few mortgages are held on bank balance sheets, having been sold into Mortgage Trusts which support Mortgage Backed securities (MBS), there are parties who may find themselves at cross purposes. Then again, mortgage investor coalitions may try to hang together, lest they all hand separately. Regardless of the extent to which groups of investors do or do not become antagonistic, individual renegades will doubtlessly stir the pot.
So this Zero Hedge post points out, while referencing the WSJ, that three of the parties involved in the typical deal form a sort of triangle. I guess this is like a love triangle, after the lovin'? They are connected to one another but also opposed to one another. The mortgages are held in a Mortgage Trust. Cash flow from the Trust is paid out to the various classes of bondholders. There are always Senior bondholders and Junior bondholders. Much of the paper referred to as "toxic" is that held by Junior bondholders. They take the first loss. With the declines in real estate values and large numbers of defaults, the first losses are quite large and may in some cases be 100% for Junior classes. But, while the Mortgage Trust still lives, the loan Servicer must advance moneys to make the interest payments on the bonds. So the longer the Trust is alive, the more payments the Junior bondholders get. The Senior bondholders don't like this. In seeking their recovery, they would like the Trust to unwind as quickly as possible and the recoveries to be credited to them. They do not want to trade time for cash flow, because some of that cash flow goes to other creditor classes. Because these classes are at cross purposes, the likelihood of litigation is very high.
To wit: junior bondholders will rejoice as they will receive payments for the duration of the halt/moratorium (these would and should cease upon an act of foreclosure), while senior bondholders will suffer, as the deficiency money will come out of the total "reserve" in the pooling and servicing agreement set up by the servicers. As for the servicers themselves, they should be "reimbursed by funds in the trust for all costs related to litigation and extra processing of foreclosures, provided they follow standard industry practices." In other words, it will now become "every man, sorry, banker for themselves" as each party attempts to preserve as much capital as possible given the new development: juniors will push for an indefinite foreclosure halt, seniors will seek an immediate resumption of the status quo, while the servicers stand to get stuck with billion dollar legal and deficiency fees if it is found that "standard industry practices" were not followed. Alas, it would appears that the servicers have by far the weakest case, and the impact to the banks, whose sloppy standards brought this whole situation on, will be in the tens if not billions of dollars. Oh, and suddenly both junior and senior classes will be embroiled in very vicious, painful, and extended litigation with the servicers. Lots of litigation.
As you can see, the litigation will doubtlessly be directed at the loan servicers who created this next generation of destruction. If it can be proven that the loan servicers did not follow the proper servicing procedures, they will be liable for damages. We are talking billions of dollars in damages.
Naked Capitalism raises additional issues around the jockeying that is taking place. The servicers are mostly large banks and Ally Financial. Three of these have suspended foreclosures while the do document reviews to determine the extent of the problem, and to buy time for lawyers and lobbyists to cast about for solutions like Ringwraiths looking for Frodo.
Per Naked Cap:
Yves here. This development reveals how this battle is likely to play out. Now that judges in some states are starting to take these dubious, potentially fraudulent measures seriously, the next line of attack is to get the more bought and paid for Federal government to intercede on behalf of the banks. As the e-mail by the Ohio Secretary shows, this is a state versus Federal rights issue. And the problem is that these solutions will be depicted as "efficient," just as securitizations and other "innovations" were.
And while efficiency in theory is a good thing, it must always be kept secondary to the overall integrity of the system, otherwise, you run the risk of breakdown. Using dubious arguments to overturn well settled law to get the banking industry out of a monster mess it created is a Faustian bargain. It makes it abundantly clear what is really at stake here, which is the rule of law. Banks that were quick to defend unjustifiable pay deals by invoking "sanctity of contract" have no inhibition about ignoring their own contracts to pad their bottom line, and ultimately, the wallets of top executives.
Rather than deal with the considerable consequences of these abuses, the banks are prepared to bulldoze well settled state laws to give them an easy way out. And I'm not basing my view on this story alone; I had a conversation yesterday with a Congressional staffer who matter-of-factly said (but with little understanding of the underlying issues) that Congress would intervene on behalf of the industry, via its authority over national banks.
The "document reviews" are being done internally and any report on the findings should be taken with several grains of salt. The interest of the banks is to minimize their culpability.
A referee will be needed to sort this out. Perhaps Sheriff Elizabeth Warren will step into the gap.