Tuesday, September 9, 2008

The Mortgage Debacle -- Part II

More likely than not in the example cited below in Part I of this series of posts, Joe Consumer -- in all too many cases a.k.a. Joe Deadbeat -- never had anything to do with TTMCB. His dealings probably were with a mortgage broker, perhaps Honest Henry but more likely Shifty Sam.

These guys know what lenders like TTMCB and other entities higher up the financial food chain (which will be explained later) need to make a loan, and they fill out Joe's loan application and supporting documents accordingly. Even though mortgage brokers get paid by lenders such as TTMCB for originating loans, Honest Henry and others like him will not submit applications that do not meet a lender's criteria. Shifty Sam is . . . well . . . less punctilious so his largely fictional paperwork will meet the lender's requirements no matter what.

Remember, TTMCB is eager to put its funds to work. Loans it makes and has outstanding are earning assets for it. So it makes sure that the application and supporting documents and paperwork meet its lending guidelines. But they have little incentive to expend resources on ascertaining whether the real world facts comport to what is in their voluminous loan file.

TTMCB has little expectation that any particular loan will pose any risk of loss to it. Were TTMCB to retain ownership of the loan, it would need only a mail drop to receive Joe Consumer's monthly payments, Otherwise, having loaned out all its available cash, it could shut down its business.

That, however, is not what happens. TTMCB sells its Joe Consumer loan to a larger institution, probably as part of a package of similar loans. If it retains the "servicing" of the loan -- collecting the monthly payments to, and performing administrative tasks related to the loan for the new owner for a fee -- Joe Consumer may never be made aware of the fact that TTMCB no longer is the party that owns his obligation.

In any case TTMCB, having profited from the sale of Joe's obligation, now has something more than $1 million in cash and therefore is able to make additional loans.

The purchaser of Joe's loan also views the entire transaction as being without risk to it. If it retains the loan, it certainly has purchased it on a "recourse" basis, meaning that it has the right to compel TTMCB to repurchase the loan if it ever becomes "nonperforming." However, in all likelihood, the purchaser puts Joe's loan or the package in which it was included into a still larger package which it then sells to an even bigger financial institution.

And so it goes, higher and higher up the food chain to ever larger institutions.

A number of foreclosure actions have been brought to a halt because of the bizarre nature of this process. In these cases a court has required evidence that the foreclosing party actually owned the loan and therefore had the right to foreclose. The documentation of the successive sales transactions had become so lengthy and complex that it had become impossible or impractical to determine -- let alone prove -- the identity of the entity that actually owned a particular loan,

In any event, the huge loan packages ultimately end up either with Fannie Mae or Freddie Mack, which between them own or insure more than half of all U.S. residential mortgages, or with another giant financial institution. In the latter case, the institution may "securitize" the loans in its portfolio. Securitization simply means that it sells to pension and hedge funds, banks, insurance companies, and other big investors shares or portions of funds into which it has placed its loan portfolio packages.

No individual or entity in the entire chain of the above-described transactions perceives them as actually entailing any significant individual risk. Rube Goldberg -- for those old enough to remember him and his bizarre contraptions -- conceived any equally outlandish structure.

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