is heating up and the mad scramble for what’s left of $45 trillion
in real estate is guaranteed to leave homeowners homeless, pension
funds unable to pay their pensions and even some of the biggest
banks insolvent. A great housing goat rodeo was created when some
of the 65 million mortgages on U.S. homes didn’t follow proper legal
- Fraud by
homeowners who lied on their loan applications
- Fraud by
banks who didn’t follow proper legal procedures around the notarization
and processing of mortgage documents
- Fraud by
investment banks who packaged this junk and resold it to unsuspecting
funds promised returns to their pensioners they could never achieve
lies and more lies. In this jockeying for position, the only thing
guaranteed is Leona Helmsley’s Law i.e. "Laws and taxes are
for the little people". But the little people are starting
to fight back in the U.S. and we’ll get to that after we do a quick
review of the situation at hand and how we got there.
In the old
days, that would be pre-1980’s, banks and savings and loans actually
knew their customers and wrote and maintained loans on property
themselves. Something similar to this scene from It’s
a Wonderful Life where George explains to his depositors,
who came to withdraw their money, where it all went:
In those days,
the corner bank knew the customer, the house, the depositors, they
kept the records in a file cabinet at the bank – it was where
you went in to make your payment. Everyone knew that If you didn’t
keep up with the payments, the banker would foreclose on your property.
That part hasn’t changed.
In the 1980’s,
financial geniuses came up with a new product, a way for the investment
banks to make money from a market they couldn’t previously tap into
in a big way – the home lending business. As you can imagine,
it’s a huge market, in the trillions, and the way they approached
this market was to convince the originating banks, those who process
and write the loans, that they could get more access to cheaper
money. This would let them write more loans, generate more fees
and make more money by reselling the mortgage. It also eliminated
a lot of the risk of the loan, since it was almost immediately resold.
But buying an individual mortgage of several hundred thousand dollars
wouldn’t make sense for the large investors with billions to invest
or the investment banks, so they packaged them together in bundles
of millions of dollars worth of mortgages.
they had to solve was that many funds have rules on the quality
of investment they could invest in; some funds can only invest in
AA rated investments or better, others may have more flexibility.
The investment banks then carved up these large packages of mortgages
into tranches based on the pecking order of who got paid back first
and they rated them based on credit score. As an example, the first
20% repaid would be rated AAA, then next 20% might be rated BB and
so on. Each tranche represented a claim on the cashflow of the mortgages.
The mortgages were supposedly scrutinized and the packaging was
complete – it was called a Mortgage Backed Security (MBS).
Here’s a little more detail from Wikipedia:
guaranteed the first mortgage passthrough security of an approved
lender in 1968. In 1971 Freddie Mac issued its first mortgage
passthrough, called a participation certificate, composed primarily
of private mortgages. In 1981 Fannie Mae issued its first mortgage
passthrough, called a mortgage-backed security. In 1983 Freddie
Mac issued the first collateralized mortgage obligation.
In 1960 the
government enacted the Real Estate Investment Trust Act of 1960
to allow the creation of the real estate investment trust (REIT)
to encourage real estate investment. In 1977 Bank of America issued
the first private label passthrough, and in 1984 the government
passed the Secondary Mortgage Market Enhancement Act (SMMEA) to
improve the marketability of such securities. The Tax Reform Act
of 1986 allowed the creation of the tax-free Real Estate Mortgage
Investment Conduit (REMIC) special purpose vehicle for the express
purpose of issuing passthroughs. The Financial Institutions Reform,
Recovery and Enforcement Act of 1989 (FIRREA) dramatically changed
the savings and loan industry and its federal regulation, encouraging
loan origination. The Small Business Job Protection Act of 1996
introduced the Financial Asset Securitization Investment Trust(FASIT)
that is similar to the REMIC but is able to securitize a wider array
$9 trillion worth of mortgage related securities.