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The Mortgage Fraud Scandal is the Biggest in Human History
by L. Randall Wray
L. Randall Wray is a Professor of Economics at the University of Missouri — Kansas City.
We have long known that lender fraud was rampant during the real estate boom. The FBI began warning of an “epidemic” of mortgage fraud as
early as 2004. We know that mortgage originators invented “low doc”
and “no doc” loans, encouraged borrowers to take out “liar loans”, and
promoted “NINJA loans” (no income, no job, no assets, no problem!). All
of these schemes were fraudulent from the get-go. Property appraisers
were involved, paid to overvalue real estate. That is fraud. The
securitizers packaged trash into bundles that ratings agencies blessed
with the triple A seal of approval. By their own admission, raters
worked with securitizers to provide the rating desired, never looking at
the loan tapes to see what they were rating. Fraud. Venerable
investment banks like Goldman Sachs packaged the trashiest securities
into collateralized debt obligations at the behest of hedge fund
managers–who were allowed to choose the most toxic of the toxic
waste—then sold the CDOs on to their own customers and allowed the hedge
funds to bet against them. More fraud.
Indeed, the largest financial institutions were run by their management as what my colleague Bill Black calls “control frauds”. That
is, the banks used accounting fraud to manufacture fake profits so that
they could pay huge bonuses to top management. The latest data out on
Wall Street bonuses show that these institutions are still run as
control frauds, with another record year of bonuses paid by cooking the
books. The fraud continues unabated.
This is the biggest scandal in human history. Indeed, all previous scandals from around the globe combined cannot even touch this one in
terms of scale and scope and stench. This is the mother of all frauds
and it will be etched into the history books for all time.
Many have called for a national moratorium on foreclosures. Even some of the banks that have been run as control frauds have voluntarily
stopped foreclosing. And yet President Obama, ever the centrist, has
taken sides with the Securities Industry and Financial Markets
Association, which warns that “it would be catastrophic to impose a
system-wide moratorium on all foreclosures and such actions could do
damage to the housing market and the economy”.
No, it would expose the securities industry, itself, as the chief architect of the biggest scandal in human history.
Now we know that it was not just the mortgage brokers, and the appraisers, and the ratings agencies, and the accountants, and the
investment banks that were behind the fraud. It was the securitization
process itself that was fraudulent. Indeed, the securities themselves
are fraudulent. Many, perhaps most, maybe all of them.
Some are trying to argue that this is just a matter of some missing paperwork. A moratorium would allow the banks to get all their ducks in a
row so that they can supply all the documents needed to foreclose.
However, as reported by Ellen Brown (at Web of Debt) and by Yves Smith (at Naked Capitalism), the paperwork does not exist. Worse, as
Yves has discovered, the banks are furiously working to manufacture
documents, aided and abetted by companies like DocX that specialize in
“document recovery solutions”—for a fee they will create fraudulent
documents that banks can use in court.
The banks would like us to believe that in the speculative frenzy of the real estate boom they “forgot” to do some of the required
paperwork. That is not likely. The absence of the documents was
required to run the scam.
Recall that the banks invented “no doc” mortgages. This was not at the behest of no-account borrowers, high school dropouts with bad credit
histories who were duping investment bankers into making mortgage
loans they could not repay. No, these mortgages were created and
endorsed by originators and securitizers and credit raters to create a
patina of “plausible deniability” to be used later in court when they
were sued for fraud by investors who bought the securities and by the
borrowers who could not possibly service the mortgages. Because if the
originators had ever requested the documentation from borrowers it
would have demonstrated that the mortgages and the securities were
Similarly, the paperwork required for the securities was never done because the securities were fraudulent. Yves helps to explains why. The
trust that purportedly underlies a mortgage backed security must hold
the “note”—the borrower’s IOU (in 45 US states the mortgage that is a
lien on the property is an “accessory” to the note, and is not
sufficient to do a foreclosure). If the note is not conveyed to the
trustee (usually before closing but sometimes up to 90 days after
signing) the securities are no good.
This is not just some pesky little rule imposed by a pin-headed regulator. This is IRS code. As reported by Brown, MBSs are typically
pooled through a Real Estate Mortgage Investment Conduit (REMIC) that
must according to the Internal Revenue Code hold all the paperwork
demonstrating a complete chain of title. Done properly, taxes are
avoided. Since a number of intermediaries are usually involved from the
mortgage originator through to the trustee of the REMIC, there must be
endorsements all along the line. However, it now appears that most of
the original notes are still held in the loan originator warehouses.
There are no endorsements. The trustees do not have the notes.
Can anyone say “tax fraud”?
So why weren’t the notes conveyed to the REMICs? There seem to be two possibilities—probably both of them correct. Karl Denninger at
MarketTicker believes it was because the REMIC trustees feared an audit
by investors in the securities. If the documentation existed, it would
show that the mortgage loans were fraudulent. Far better to “lose” the
docs, then later manufacture new ones for the foreclosure.
According to Brown (quoting Steve Liesman and Neil Garfield), the other possibility is that the tranching process actually prohibited
assignment of the notes to the REMICs. Bundles of mortgages of varying
quality would be tranched into a variety of securities, say from AAA to
BBB. But no individual mortgage is actually assigned to a particular
tranche—until it defaults. When one defaults, it is assigned to a lower
tranche security and then the foreclosure process begins. This means
that from inception of that BBB security, there was no way to assign a
note to the trustee because the trustee did not know in advance which
mortgage would default. The REMIC trustees tried to get around that by
using a dummy conduit called MERS (Mortgage Electronic Registration
System) that would “hold” the mortgages and assign them to the proper
tranches later. But they do not have the paperwork either, and some
courts have rejected their claims as owners.
This is a complete mess. What President Obama must understand is that fraud is endemic at every level of the home finance food chain. We
were long told that securitized mortgages cannot be modified because of
the complexity involved—modification of most mortgages would require
consent of the holders of the securities that each have a piece of the
mortgage. But actually it is impossible to tell how many—if any—of
these securities holders have a legitimate claim on any of the
mortgages. Simply imposing a moratorium will not be enough—it will just
give the banks time to manufacture false documents, encouraging even
more fraud. Meanwhile, half of all homeowners with mortgages are
already underwater or are within spitting distance of being underwater.
Many of these are drowning because the epidemic of fraud perpetrated
by financial institutions destroyed our economy and caused housing
prices to collapse.
The President needs to try a different approach, consisting of the following series of steps:
1. Declare a national bank holiday that would close the biggest financial institutions—say, the top dozen or so. Send in the supervisors
to examine their books to uncover fraud. Determine which ones are
insolvent and resolve them. While resolving them, net their claims on
one another (including derivatives). Do not allow any insolvent
institutions to reopen, and do not use the resolution process to merge
institutions (we don’t need even bigger “too big to fail” banks).
Prosecute the crooks and jail the guilty.
2. Stop all foreclosures. Investigate and prosecute all institutions that have been selling or buying fake documents to be used in
foreclosures. Prosecute the crooks and jail the guilty.
3. Announce that all homeowners who occupied their homes on October 1, 2010 will be allowed to remain in their homes indefinitely. Create a
national mediation board to adjust all mortgage payments to “owner’s
equivalent rent”—the fair value of rent for the home. Establish a fund
to provide rental assistance to keep low income homeowners in their
4. Give purported mortgage holders 30 days to produce the original notes; if they cannot find them, hand the homes over to the
owner-occupants—free and clear of debt.
5. Create a process to allow securities holders to sue for recovery of value. This must be national—state courts will not be able to handle
the case load.
6. Direct the GSEs to refinance mortgages at a low fixed rate. Mortgages would be provided against real estate appraised at fair market
value to any borrower for a primary residence. The GSEs would pay
holders of existing mortgages only current fair market value. Those
holding these mortgages can seek redress through the process outlined in
step 5. Only in the case of borrower fraud would the homeowner be held
responsible for losses attributed to the refinancing.
7. There will be fall-out from losses. It is better to deal with the collateral damage directly than to prop up the control fraud banks. For
example, pension funds hold toxic waste securities as well as equities
in the control fraud banks, and by all reasonable accounting the
Pension Benefit Guarantee
Corporation is already insolvent. But it is better to directly bail-out pensions than to maintain the charade that
fraudulently created securities have value.
Bill Black likes to joke that economists are afraid to use the “F” word (fraud).
The President must come to realize that there is no other word that can be applied to the US home finance system. Until we deal
with the fraud we will never resolve this financial crisis.
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