Here's One for the Little Guy
Monday, July 27, 2009 | Barbara CohenRating:
Ever wonder how so many Collateralized Debt Obligations (CDO) were able to get their footing? Of course, the banks are eager to blame the borrowers, who they say were reckless and bought homes above their income brackets. But no one talks about the bank's participation and the concept of "packaging."
Well, no one was really talking about it before this week, anyway. But that might be about to change. We'll get to "why" in a moment.
Just Because it's a Package, Doesn't Mean it's a Gift
Packaging is nothing new in the banking / brokerage world. It's the norm, not the exception. But in the case of CDOs, this was "packaging on steroids."
Because many of you may not fully understand what happened behind the scenes, and others of you may be facing foreclosure, I thought I would give you some insight into what happened this week that might help you understand or even take action if you are in foreclosure yourself.
What are CDOs? Wikipedia has this "unintelligible" definition -- collateralized debt obligations: a type of structured asset-backed security (ABS) whose value and payments are derived from a portfolio of fixed-income underlying assets.
Sounds ominous, doesn't it?
Here's a "behind the scenes" look at this gift that keeps on giving ... a lot of pain.
While many borrowers might have bought above their means, the banks were just as complicit in creating the CDO disaster.
Passing Notes
When you purchase a home with a mortgage, you sign a note. The loan-originating company sells the note to an investment banker or hedge fund and collects the full value of the note upfront. A copy of your note is created and stamped "paid in full." The loan-originating company has no right to foreclose because it received all its money when it sold the note.
Before greed took control of the market, the holder of the note (i.e., an investment banker) would store the note in a vault. If someone defaulted on their loan, the investment bankers would produce the note to prove they owned it and that they had bought it from the loan-originating company.
But greed changed all that.
Instead of vaulting the original note, those notes were "re-packaged" with thousands of other notes into what became known as CDOs. There were low-risk CDO mortgage packages, moderate-risk CDO mortgage packages and high-risk CDO mortgage packages.
The low-risk mortgage packages were easy to sell to conservative investors looking for long-term income. Most of those original packages are still valid and producing income.
However, the moderate-risk and high risk-mortgages were not easy to sell. To resolve this, these mortgages were re-packaged by mixing them with low-risk mortgages, and sold to conservative investors. The same mortgage could have been re-packaged and sold a dozen times.
Remember, the investment banker paid only one time for the instrument and only has the right to place the note in one package. Repackaging was a highly illegal use of mortgages.
In order to hide the trail of their activities, investment bankers destroyed the notes so no one could trace which CDO packages the note was actually put in. But since the notes are destroyed, ownership is difficult to establish.
Who Really Owns Your Loan?
When borrowers default on their loans, investment bankers want to foreclose quickly so they can retain some value to their mutual funds. They quickly sell the mortgage to a foreclosure bank. They can't sell the note because it was destroyed. This leaves the foreclosure bank vulnerable because it does not have proof that it owns the note.
Remember, the only thing that the borrower signed is a note. The borrower did not sign the right to repackage the mortgage. The only asset is the note that represents the actual property.
And even though the investment banker has a record of monthly payments that he sells to the foreclosure bank, this may not be sufficient to establish actual ownership.
When a borrower is foreclosed upon, the foreclosure represents a lawsuit. The foreclosure bank brings a lawsuit against the borrower for failure to pay. The bank is the plaintiff and the borrower is the defendant.
Since the borrower is the defendant, he has the right to call for "discovery." Discovery is the pre-trial litigation procedure in which both the plaintiff and defendant request relevant information and documents from each other. Discovery generally includes depositions, requests for inspection and document production. In the case of foreclosure, the defendant requires the plaintiff to produce the note.
The problem for the foreclosing bank is either it does not have the note at all because it was destroyed to stop the audit trail, or it says "paid in full" -- in which case, nothing is owed to the bank.
If the note has been modified in any way (even with a stamp on it), the defendant can say, "That is not the note I signed; produce the original note to prove you own it." The defendant can produce a copy of his original note that he signed. The bank needs to produce one just like it to prove ownership, not one that says "paid in full."
Deutsche Bank: The Warning, Not the Example
Here's one for the little guy that just happened to Deutsche Bank on July 14, 2009. This may now change the entire foreclosure situation in this country.
One New Jersey judge decided to take a stand by dismissing a foreclosure action brought by Deutsche Bank Trust Company of America. The defendants (borrowers) required Deutsche Bank to produce the note as part of their discovery process. According to the judge, Deutsche Bank Trust willfully refused to produce documents, despite the entry of three separate court orders.
The borrowers demanded the documents that would identify the true owner of the note and mortgage. They demanded a complete chain of title to ownership of the note and mortgage, along with payment application history. Finally, they demanded the documents showing how the note was used and whether it was repackaged by Deutsche Bank.
The court gave Deutsche Bank many chances and even extensions of time to produce the documents. The bank continually refused to produce the documents requested. So, the court took action.
The court ruled that Deutsche Bank is not permitted to re-file any foreclosure action until it is prepared to produce ALL of the discovery. The bank has numerous other cases pending with similar discovery requests, all of which are expected to be dismissed.
This has now become a precedent case for anyone being foreclosed.
That's not all.
Recently, Deutsche Bank lost a ruling in a New York case, finding against the bank in another foreclosure lawsuit. Deutsche Bank purchased a foreclosure through the Mortgage Electronic Assignment System (MERS). It was an invalid assignment and lacked standing to foreclose. (Again, no note was transferred.)
While in the courtroom, the judge demanded a "satisfactory explanation" as to why a large institution like Deutsche Bank would be interested in purchasing a "toxic" loan that has been in delinquency for 142 days.
It appears that Deutsche Bank is buying toxic assets to take advantage of what is known as "credit enhancements," a procedure that pays benefits to the bank if the borrower defaults.
The assignment of a mortgage and note already in default permits Deutsche Bank to realize "credit enhancement" profits while also allowing the bank to institute foreclosure. This is a “double dip” for Deutsche Bank and, of course, illegal. Deutsche Bank has been cut off from this as well.
I hate to say "I told you so," but trading futures reduces the chances of your being the victim of investment-banker fraud. The market can only do so much to you during the mere four minutes that you're in a futures trade!
The low-risk mortgage packages were easy to sell to conservative investors looking for long-term income. Most of those original packages are still valid and producing income.
However, the moderate-risk and high risk-mortgages were not easy to sell. To resolve this, these mortgages were re-packaged by mixing them with low-risk mortgages, and sold to conservative investors. The same mortgage could have been re-packaged and sold a dozen times.
Remember, the investment banker paid only one time for the instrument and only has the right to place the note in one package. Repackaging was a highly illegal use of mortgages.
In order to hide the trail of their activities, investment bankers destroyed the notes so no one could trace which CDO packages the note was actually put in. But since the notes are destroyed, ownership is difficult to establish.
Who Really Owns Your Loan?
When borrowers default on their loans, investment bankers want to foreclose quickly so they can retain some value to their mutual funds. They quickly sell the mortgage to a foreclosure bank. They can't sell the note because it was destroyed. This leaves the foreclosure bank vulnerable because it does not have proof that it owns the note.
Remember, the only thing that the borrower signed is a note. The borrower did not sign the right to repackage the mortgage. The only asset is the note that represents the actual property.
And even though the investment banker has a record of monthly payments that he sells to the foreclosure bank, this may not be sufficient to establish actual ownership.
When a borrower is foreclosed upon, the foreclosure represents a lawsuit. The foreclosure bank brings a lawsuit against the borrower for failure to pay. The bank is the plaintiff and the borrower is the defendant.
Since the borrower is the defendant, he has the right to call for "discovery." Discovery is the pre-trial litigation procedure in which both the plaintiff and defendant request relevant information and documents from each other. Discovery generally includes depositions, requests for inspection and document production. In the case of foreclosure, the defendant requires the plaintiff to produce the note.
The problem for the foreclosing bank is either it does not have the note at all because it was destroyed to stop the audit trail, or it says "paid in full" -- in which case, nothing is owed to the bank.
If the note has been modified in any way (even with a stamp on it), the defendant can say, "That is not the note I signed; produce the original note to prove you own it." The defendant can produce a copy of his original note that he signed. The bank needs to produce one just like it to prove ownership, not one that says "paid in full."
Deutsche Bank: The Warning, Not the Example
Here's one for the little guy that just happened to Deutsche Bank on July 14, 2009. This may now change the entire foreclosure situation in this country.
One New Jersey judge decided to take a stand by dismissing a foreclosure action brought by Deutsche Bank Trust Company of America. The defendants (borrowers) required Deutsche Bank to produce the note as part of their discovery process. According to the judge, Deutsche Bank Trust willfully refused to produce documents, despite the entry of three separate court orders.
The borrowers demanded the documents that would identify the true owner of the note and mortgage. They demanded a complete chain of title to ownership of the note and mortgage, along with payment application history. Finally, they demanded the documents showing how the note was used and whether it was repackaged by Deutsche Bank.
The court gave Deutsche Bank many chances and even extensions of time to produce the documents. The bank continually refused to produce the documents requested. So, the court took action.
The court ruled that Deutsche Bank is not permitted to re-file any foreclosure action until it is prepared to produce ALL of the discovery. The bank has numerous other cases pending with similar discovery requests, all of which are expected to be dismissed.
This has now become a precedent case for anyone being foreclosed.
That's not all.
Recently, Deutsche Bank lost a ruling in a New York case, finding against the bank in another foreclosure lawsuit. Deutsche Bank purchased a foreclosure through the Mortgage Electronic Assignment System (MERS). It was an invalid assignment and lacked standing to foreclose. (Again, no note was transferred.)
While in the courtroom, the judge demanded a "satisfactory explanation" as to why a large institution like Deutsche Bank would be interested in purchasing a "toxic" loan that has been in delinquency for 142 days.
It appears that Deutsche Bank is buying toxic assets to take advantage of what is known as "credit enhancements," a procedure that pays benefits to the bank if the borrower defaults.
The assignment of a mortgage and note already in default permits Deutsche Bank to realize "credit enhancement" profits while also allowing the bank to institute foreclosure. This is a “double dip” for Deutsche Bank and, of course, illegal. Deutsche Bank has been cut off from this as well.
I hate to say "I told you so," but trading futures reduces the chances of your being the victim of investment-banker fraud. The market can only do so much to you during the mere four minutes that you're in a futures trade!
(Please let us know what you think about Barbara Cohen's article.)
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Barbara Cohen
Contributing Editor
The Tycoon Report
Economic Calendar for the Week of July 27-31
TUESDAY, JULY 28
10 a.m. Conference Board Consumer Confidence
* Importance (A-F): This release merits a B-.
* Source: The Conference Board.
* Release Time: 10 a.m. Eastern on the last Tuesday of the month (data for current month).
* Raw Data Available At: http://www.tcb-indicators.org
The Conference Board conducts a monthly survey of 5,000 households to ascertain the level of consumer confidence. The report can occasionally be helpful in predicting sudden shifts in consumption patterns, though most small changes in the index are just noise. Only index changes of at least 5 points should be considered significant.
The index consists of two subindexes: consumers' appraisal of current conditions and their expectations for the future. Expectations make up 60% of the total index, with current conditions accounting for the other 40%. The expectations index is typically seen as having better-leading indicator qualities than the current conditions index.
Highlights
* The Consumer Confidence report for June from the Conference Board checked in at 49.3% versus 54.8% in the prior month and the consensus estimate of 55.3%.
* The disappointing read was driven by a drop in both the Present Situation Index (to 24.8% from 29.7%) and the Expectations Index (to 65.5% from 71.5%).
* The expectation that business conditions would improve over the next six months dropped to 21.2% from 22.5% while the belief they would worsen increased to 20.2% from 18.0%.
* The job outlook was also more pessimistic, according to the Conference Board, as those anticipating more jobs in the months ahead fell to 17.4% from 19.3%.
* Fewer consumers are expecting an increase in their income, as evidenced by a drop in that measure to 9.8% from 10.8%.
Key Factors
* The determination by the Conference Board is that the decline in the Present Situation Index continues to imply that economic conditions are still weak, though not as week as earlier this year. Additionally, the level of the Expectations Index suggests "less-negative conditions in the months ahead, as opposed to strong growth."
* This isn't the report the market was hoping for since it conveys a lingering sense of anxiety about recovery prospects.
* Although income gains are the main driver of spending, a dip in confidence isn't going to help the market's perspective on the consumer spending outlook, especially when juxtaposed with the understanding that the personal savings rate hit a 15-year high of 6.9% in May.
Big Picture
* Consumer sentiment indices get way too much attention. The simple fact is that sentiment does not correlate strongly with consumer spending and thus has little predictive value. Consumer spending correlates more closely with income. Sentiment tends to reflect well-known factors such as unemployment rates and gas prices more than it predicts future spending patterns.
WEDNESDAY, JULY 29
8:30 a.m. Durable Goods Orders
* Importance (A-F): This release merits a B.
* Source: The Census Bureau of the Department of Commerce.
* Release Time: 8:30 a.m. Eastern around the 26th of the month (data for month prior).
* Raw Data Available At: http://www.census.gov/ftp/pub/indicator/www/m3/index.htm
The durable orders release measures the dollar volume of orders, shipments, and unfilled orders of durable goods (defined as goods whose intended lifespan is three years or more). Orders are considered a leading indicator of manufacturing activity, and the market often moves on this report despite the volatility and large revisions that make it a less-than-perfect indicator. These problems can be minimized by looking at the breakdown of orders. The total number is often skewed by huge increases in aircraft and defense orders. An increase based solely on strength in one sector tends to be discounted, while the market is more impressed with broad-based increases in orders.
Highlights
* New orders for durable goods increased 1.8% in May and were up 1.1%, excluding transportation. That was good news from the standpoint that each number easily topped the consensus estimates, which called for a 0.9% decline in total orders and a 0.5% decline, excluding transportation.
* Shipments declined 2.1% to $169.9 billion. That was the 10th-straight month in which a decline was registered.
* Unfilled orders for durable goods slipped 0.3% to $747.5 billion and were down for the eighth straight month, suggesting capacity utilization rates won't be cranked up anytime soon.
* Nondefense capital goods orders, excluding aircraft, jumped 4.8% in May.
Key Factors
* Shipments will continue to factor as a negative (though not as much as before) in GDP estimates as the Q2 average of $171.69 billion currently stands 3.1% below the first-quarter average of $177.23 billion.
* The increase in nondefense capital goods orders, excluding aircraft, will be read initially as a positive indication for business investment spending activity, although it may just be a temporary pickup after declines of 2.9% in April and 1.4% in March.
Big Picture
* Durable goods orders trends were very weak in late 2008 and early 2009. This reflects the collapse of confidence in the business sector and poor credit market conditions. The rate of decline should ease and orders might stabilize in mid- or late 2009, but the outlook has to be described as grim. Overseas demand is particularly weak and exports are plunging. The business sector is in a deep slump.
FRIDAY, JULY 31
8:30 a.m. GDP: Gross Domestic Product
* Importance (A-F): This release merits a B.
* Source: Bureau of Economic Analysis, U.S. Department of Commerce.
* Release Time: Third or fourth week of the month at 8:30 a.m. Eastern for the prior quarter, with subsequent revisions released in the second and third months of the quarter.
* Raw Data Available At: http://www.bea.doc.gov/bea/dn1.htm
Gross Domestic Product (GDP) is the the broadest measure of economic activity. Annualized quarterly percent changes in GDP reflect the growth rate of total economic output. The figures can be quite volatile from quarter to quarter. Inventory and net export swings in particular can produce significant volatility in GDP. The final sales figure, which excludes inventories, can sometimes be helpful in identifying underlying growth trends as inventories represent unsold goods, and a large inventory increase will boost GDP but might be indicative of weakness rather than strength. The broad components of GDP are: consumption, investment, net exports, government purchases and inventories. Consumption is by far the largest component, totaling roughly 2/3 of GDP.
Highlights
* The component revisions to GDP were minor, resulting in only a modest revision to first quarter real GDP to -5.5% from a previously reported -5.7%. Nothing significant jumps out from the data.
* The upward revision to GDP was primarily the result of a smaller decline in inventories than previously reported. Government expenditures were also revised higher, showing just a 3.1% annual rate of decline compared to a previously reported -3.5%.
* Other key components were actually revised lower. Personal consumption expenditures were revised to 1.4% from 1.5%. Exports were revised to show a 30.6% decline from a previously reported 28.7% drop.
* Raw Data Available At: http://www.bea.gov/newsreleases/national/gdp/gdpnewsrelease.htm
Key Factors
* There were a number of minor component revisions for the final Q1 GDP report, but nothing that changes the relevant trends or anything that will alter economic expectations.
Big Picture
* The trends in the economy were moderately poor through the summer of 2008. Then, in September, the trends tanked along with the stock market. Some tech firms noted a significant drop-off in demand right after the mini-panic of mid-September. These worsening trends were readily apparent in the fourth quarter GDP numbers, and will remain so into 2009 as well.
Consumer spending is weakening and will only take a significant turn for the better once the declines in payroll moderate. Business investment is also in a sharp retrenchment. The stronger dollar clearly hurt export demand. A lot now depends on overall psychology and perceptions of how well the government responds to the financial market and other problems such as exist in the auto industry. The economic outlook is now as much a function of government action as it is of the traditional correlations and trends among macro-economic variables.
8:30 a.m. Employment Cost Index
* Importance (A-F): This release merits a B .
* Source: U.S. Department of Labor, Bureau of Labor Statistics
* Release Time: 8:30 a.m. Eastern, near the end of the first month of the quarter for the prior quarter.
* Raw Data Available At: http://stats.bls.gov/news.release/eci.toc.htm
The Employment Cost Index (ECI) is designed to measure the change in the cost of labor. The ECI compensation series includes wages and salaries and employer costs for employee benefits. The sum of the change in these two components equals the change in total compensation.
The ECI, which is released on a quarterly basis, is a less timely indicator of employment cost trends than the hourly earnings data in the monthly employment report. Hourly earnings figures for any given month are available during the first week of the next month, while ECI numbers for any given quarter are not available until a month after the quarter ends.
Benefits covered by the ECI include paid leave, insurance benefits, and retirement and saving benefits. Because these account for roughly 30% of total employment costs, their absence in the monthly earnings series leaves us with an incomplete picture.
Highlights
* The employment cost index (ECI) for the first quarter rose just 0.3% (not annualized). This is lower than expected and continues a trend toward smaller increases in costs to employers of compensation.
* Wages and salaries were up just 0.3%. Benefits rose 0.5%. The year-over-year increase in the total index fell to just 2.1% from 2.6% through the fourth quarter.
Key Factors
* Wages and salaries are up just 2.2% over the past year and benefits 2.0%. These lower increases for compensation reduce cost-push inflation pressure for businesses.
* For those looking for higher wage gains, government compensation costs were up 0.8% in the first quarter, and are up 3.1% over the past year. Apparently, private sectors reel in their costs more easily than governments.
Big Picture
* Employment costs are the major component of business costs. The trend in these data therefore have important implications for cost-push inflationary pressures and for profit margins. In recent quarters, the trend has been relatively steady to lower. The year-over-year total increase in the ECI has dropped below 3% for the first time in years. Weak overall demand in the economy should keep the ECI cost index on the current trend. At 2.1% this does not represent much inflationary pressure, as productivity gains of close to 2% leave unit labor costs rising at a modest pace near 1%. Now, with commodity prices having turned lower and economic demand softening, there simply is not much overall inflationary pressure at all.
9:45 a.m. Chicago Purchasing Managers Index
* Importance (A-F): The Chicago PMI merits a B.
* Source: Kingsbury International Ltd. and Institute for Supply Management-Chicago Inc.
* Release Time: Typically the last business day of the month at 9:45 a.m. Eastern
There are many regional manufacturing surveys, and they tend to be ranked in order of timeliness and the importance of the region. The New York and Philadelphia Fed's surveys are the first each month followed by the Chicago purchasing managers' report on the last day of each month. A few, such as the Atlanta and Richmond Fed surveys, are released after the Institute for Supply Management and are thought to be of little value.
The purchasing managers' reports are measured like the national ISM -- 50% marks the breakeven line between an expanding and contracting manufacturing sector. For the New York, Philadelphia and Atlanta Fed indexes, 0 is the breakeven mark. These surveys can be of some help in forecasting the national ISM.
Highlights
* According to the Institute of Supply Management-Chicago and Kingsbury International Ltd., the Chicago Purchasing Managers Index increased to 39.9 in June from 34.9 in May. That was better than the consensus estimate of 39.0 and above the 6-month average of 35.6.
* The June number improved month-to-month, aided by an uptick in new orders, which jumped to 41.6 from 37.3. In fact, increases were seen in every component index, although some increases didn't necessarily imply encouraging things.
* The inventories index went up to 34.2 from 31.5 and prices paid increased to 36.3 from 29.8.
* Separately, production improved to 39.3 from 38.1, order backlogs increased to 37.6 from 26.3, and employment edged up to 28.9 from 25.0.
* The full report is available at www.kingbiz.com
Key Factors
* A reading below 50 still connotes a contraction in manufacturing activity in this region, although the uptick from May implies the rate of contraction has slowed.
* This survey was better than expected, but one needs to be careful not to extrapolate too much encouragement from it just yet knowing that it follows on the heels of a very problematic period for the auto industry, which is closely linked to the Chicago region. In other words, it could simply mark a temporary bounce from a very depressed situation.
Big Picture
* The Chicago PMI has little overall economic value, and is only watched by the financial markets because it is usually released one day in advance of the similar national ISM manufacturing survey. A significant move in this regional survey will therefore sometimes be seen as having predictive value for the ISM index.
Source: Briefing.com
