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The Impact of Error From Securitization to Foreclosure

Posted By Barry Ritholtz On October 15, 2010 @ 12:00 pm In Derivatives,Foreclosures,Legal | Comments Disabled

There are quite a few misunderstandings, denials, and exaggerations floating around as to what the final outcome might be of “Fraudclosure.”

At the current stage, we really do not know how extensive the problems are. We could make wild and unsubstantiated conclusions, but we prefer reason and logic.

So let’s break this down as to the primary concerns. As I see this, what facts are revealed and how these errors get resolved will determine the resolution of the current fiasco, as well as the costs.

1. Errors in Securitization:  We have learned that many of the Residential Mortgage-Backed Securities (RMBS) were constructed in a way that did not include two key components: The Mortgage Note, and the Assignment of that Note. Because of this, the subsequent sale and resale of both mortgages and CMOs have confused or even lost the chain of title.

We do not know exactly how many structured products contain errors of Notes or Assignments, but a rough estimate is “More than a few.”

2. Securitization Warranties:  Structured Fin products come with warranties that assure a buyer they were created properly (i.e., legally). The short cuts noted above may place the underwriters at risk of Putbacks. The buyers of flawed structured products get to return the CDOs.  One analysis from Branch Hill Capital put the exposure of BofA alone at $70B — but the truth is, we have no idea of the total number.

3. MERS: It appears that electronic mortgage filing was little more than a legal fiction, designed to save banks and securitizers a billion plus dollars in filing/transfer fees. The risk in doing these things down and dirty (aka on the cheap) is that in many cases, we have lost the ability to determine exactly who is the lien holder of record. (Repeat after me, “There is no Free Lunch“).

4. Assembly Line Financial Services:  Like MERS, the costs of doing things fast and cheap — versus doing them correctly – has been revealed as far greater than advertised. Could mass securitization have taken place without these shortcuts, bad documentation, and illegalities? If the true costs of doing this correctly were actually accounted for, could sub-prime securitization even have occurred at half the size and pace it did?

5. Regulatory Oversight: The banks have demonstrated — yet again — that they are too irresponsible and reckless to operate without strong oversight. Just a few quarters after being bailed out for their reckless lending, they find themselves in trouble for irresponsible foreclosure proceedings and all manner of illegal behavior. Is it they — or we — who never learn history’s lessons ?

6. Selling REOs & Foreclosed Properties:  Relative to the economy, here is the greatest concern: Banks are sitting on millions of foreclosed properties. Given their mishandling of foreclosures, there are now credible concerns that Title companies will not insure new REO transactions due to the banks’ administrative negligence. Without Title insurance, these houses are worth from 25-50% less than they would have otherwise sold for at REO sale or auctions. If this affects a million REOs times even $100k, that is a lot of money. And, it is potentially much worse.

7. Government Ownership of Banks Is Bad: When the government has a substantial stake in major financial institutions, they fail to discharge their duties of enforcing the law. Under normal circumstances, the reckless illegality we have seen from banks  would have caused the US Attorney to become involved in the investigations. Instead, the nation’s chief law enforcement officer has a conflict of interest.

Yet another reason why:

8. Bailouts Are Bad: We once again see the fallout from rescuing reckless, irresponsible financial entities. Had we performed GM-like prepackaged bankruptcies, these issues would not exist. Courts would be resolving the errors in equity (doing what was fair to all parties). Instead, this becomes yet another potential taxpayer headache.

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Possible Solutions: This is going to be challenging to resolve, as the parties involved are sophisticated investors who will seek to enforce their warranties and contracts via the courts.

The resolution of this could include the flawed structured mortgage products getting put back the to the original underwriter/securitizer. The banks have acted somewhat responsibly, albeit belatedly, voluntarily stopping foreclosures until they can resolve these problems.
But do not misunderstand these circumstances: These are problems of the banks own making, and we should make sure that the costs of these do not fall to the taxpayers.


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