The Real Toxic Assets - Derivatives (whatever they are)

This posting will begin a 3 part series, to be finished by week's end, where we try to make understandable the un-understandable. Obviously the topic continues to be the "Stimulus Package", TARP, TALF, and the latest entry into the lexicon of acronyms, the PPIFs. PPIF stands for "Public Private Investment Funds". These are going to be the repository of those evil and lurking "Toxic Assets".

(cartoon from The New York Times)

A short recap: - mortgages were sold that had the interest rate adjust ("ARMs"), on both prime and sub-prime borrowers, to the point that some homeowners could not pay the monthly payment. These, along with perfectly fine loans were then bundled together in $500,000,000 or larger pools, and sold to Wall Street firms which made them into saleable securities akin to a bond. They were then resold as investment quality bonds, in smaller pieces, to investors all over the Country and the world. After all, what could be safer than an investment, paying interest, that was backed by Home Mortgages. Everything was fine until the adjustments started to occur and delinquencies looked as if they would be greater than expected. The investments, Mortgage Backed Securities, "MBS", were no longer worth as much as everyone thought they were because of the fear of more defaults and foreclosures, so panic selling began, until no one would buy any of these MBSs. Because no one knew the exact value, IT WAS DECIDED, that the value would be ZERO, or something close to it and they became "Toxic Assets". (RECAP OVER)

The assets were no more toxic then than they were at the start. In reality, the true asset was the underlying collateral - home mortgages. How many would go to foreclosure and how much would be recovered was unknown, but there are a lot of percentages between 0% and 100% - none were used!! There were 2 hidden issues: 1. With the mortgages being bundled as MBSs and sold as bonds to investors (earlier posts please) no bank or lender or any one who sold them was at risk. The investors might lose some money, like they might on any corporate bond or a mutual fund, but the lenders were home free. 2. A little understood evil was waiting to steal the souls of all who succumbed to good interest rates - DERIVATIVES.

What is a "Derivative"? Simply put - a BET, a gamble that something will happen based on something else; like during the World Series, betting not on which team will win or lose but whether the score of both teams will be higher or lower than the number of strokes Tiger Woods takes in the first 3 holes of his current tournament. THIS STUFF REALLY HAPPENS!!! Here, it was a bet that mortgages would default in record numbers. It seemed like a safe bet to take, and had been for the past 50 years; mortgages had a more or less constant and predictable default/foreclosure rate.

Let's get an example that most of us understand more easily - LIFE INSURANCE. When you buy a life insurance policy, you are betting an insurance company that you will die before you have paid more in premiums than the policy will pay to your beneficiaries. The Insurance Company takes the BET, because they know that on average, very few policy holders dies before either paying in more than the death benefit, or simply let the policy lapse after many years of paying. The insurance company, having hundreds of thousands,or millions of other people buying and dying, have sophisticated mathematicians (actuaries they are called) who prepare statistics on the probability of someone dying.

For example, if you are healthy and 30 years old, and do not race cars, and want to buy a $25,000 policy, the company will say "fine" and charge you a modest monthly premium. They can do this because they have statistical proof that very few 30 year old healthy people die. If you are 70, the chances of death before paying a lot of premiums is far greater, so the payments are much higher.

REGARDLESS OF THE SITUATION, YOU ARE BETTING THE COMPANY YOU WILL DIE WHILE YOU ARE INSURED AND BEFORE YOU HAVE PAID A FORTUNE, AND THEY ARE BETTING THAT YOU WON'T. That is gambling/betting/buying chances... The company can do this because they sell hundreds of thousands of policies and the statistics prove them right enough of the time. Basically, you and hundreds of thousands of others pay premiums, and the Insurance Company pays relatively few claims. They get to keep the profit!

To be certain that the Company has guessed correctly, it will bet another and bigger insurance company to bet that the insurer might be wrong. The bigger company which has even more statistics takes the bet and collects easy money. It has bought a derivative - a bet not on the life of the insured, but a side bet on whether the first company will have to pay the claim. This second bet is DERIVED from the first bet -the insurance policy itself. It is equivalent to the bet on Tiger's golf game.

What would happen if a disease struck all of the 30-40 year olds and they died, leaving the older people only - the people who have less time to live (and pay premiums according to the math guys)? Easy - the company would not be able to pay all of the claims. The bigger company which had to pay the smaller company who issued the insurance policies might default. Both companies might go bankrupt. So, the bigger company bets with even bigger company etc. What happens is that there might be 7 bets that the 30-40 year olds will live long. If they don't, 7 companies have to pay and 7 companies might file bankruptcy.

Were any of the assumptions wrong? Yes and no. It was a first time event, all those young premium payers dying, but they did die. Would that make all policies bad no. It does point out that betting that a mortgage will go bad (OKAY CALL IT INSURING AGAINST IT GOING BAD) or any other such bet is fraught with potential disastrous problems. The biggest of these is the fact that there could be 5,6,7 or 100 bets on that 30 year old's life.

These DERIVATIVES, these side bets, are some of the main issues that "broke" A.I.G.

What happened in the financial markets that have left us with trillions in debt is next in this 3 part series.

Author's Copyright by Richard I. Isacoff, Esq., March 2009

rii@isacofflaw.com

http://www.isacofflaw.com/

Mortgages, Foreclosures, and Other Monsters Under Your Bed

NPR had a piece on the 13th discussing the issues dealt with here in days past, namely the mortgages servicers/securitization problems. Specifically, the inability for anyone to do anything until the "government" passes a law or buys the Mortgage Backed Securities from investors at "market value" and then passes that savings to homeowners in a refinance.

The issue is that the investors, which may be individuals or mutual funds or retirement funds etc., who own the securitized loans, want the high returns they were promised; they do not want to take less, nor do they want to have the MBS sold for less than 100% of the "face value" (the outstanding balances of principal and interest of all of the loans in the MBS) of the security. Remember, as confusing as this is, that a MBS is like a corporate or municipal bond. It is merely a way for mortgage lenders to spread the risk, of loans they have made, among literally thousands of individual or corporate investors. (see 1/3/09 posting ).

Congress carefully avoided the question in the most recent stimulus package. The President is at a loss because of all of the competing interests, both in government and out. "Wall Street" wants the Government to guarantee 100% of the investment, as do all of the pension plans, mutual funds, and others who own Mortgage Backed Securities. (Ownership, as I write of it here, may mean nothing more than $1,000 of a worker's 401K, invested in the XYZ Mutual Fund that owns $5 million of MBS out of a fund of $100 million. The individual therefore owns 1/1000th of 1% of the $5 million of MBS that his/her mutual fund owns. The more staggering numbers are that the $5 million of MBS that the worker's mutual fund [the ENTIRE FUND, not just that worker's share] owns is only 1% of the entire Mortgage Backed Security which was worth $500 million when it started.) So, some "shares" or ownership rights are as small as 1/100th of 1/1000th of 1%

The others who have a stake in the outcome are the brokers who buy and sell the MBS as securities, the companies who service the loans in the MBS, the Banks who act as Trustees for the MBS, and the HOMEOWNERS / BORROWERS who are being foreclosed, and the lobbyists for all of the aforementioned.

Right now, nearly all of the Lenders have put a hold on foreclosures - some under March 6th (JP MorganChase, Morgan Stanley, Bank of America), some until the 12th (CitiGroup) and others, voluntarily, maybe, as requested by John Reich, who is the out-going Director of the Office of Thrift Supervision (Federal Savings Banks "FSBs", state-chartered Savings Banks with FDIC Insurance, Savings and Loans "S&Ls" etc) in a memo to all regulated thrift institutions on Feb 12th.

Mr. Reich summed up what we the issue with which we have to contend. Everyone is hoping that the President's team will have a plan - within weeks. The problem took years to get where it is and our new administration is supposed to have the quick fix ready by March 6th?. Perhaps the banks and Thrifts that have made loans and still own them can work with a simple payment reduction formula. They still own and control the loan so it is a case by case decision made by the LENDER.

Congress has not been able to agree on much of anything - they are now going to try to tackle the Wall Street conundrum of Mortgage-Backed Securities and all of the voices that will be shouting, "Let someone else take the loss - we just made the investment and we WILL NOT ALLOW any reduction in our return on our investments. By the way, everyone who has his/her retirement money in mutual funds that own the MBSs will say the same thing. Someone has to accept a loss or the federal government will spread the loss to all of the taxpayers in the country.
What's fair? Nothing, but we have to do something.

Author's Copyright by Richard I. Isacoff, Esq, February, 2009

rii@isacofflaw.com
http://www.isacofflaw.com/

Mortgages, Foreclosures, and Help for Homeowners

According to RealtyTrac, a company that watches foreclosures nation-wide, the rate of foreclosure increases has dropped. While there was only an 18% increase in foreclosures during January of this year as compared to January 2008, that is still a hefty increase. Put in perspective though, they also report that 1 in every 466 US homes is in foreclosure. Startling? Sure, but that is only two-tenths of one percent or .2%. Is this high - yes but, we have not gone beyond the point of no return.

Perhaps this view will be against the trend, but I believe that there will be another spike in foreclosures in March. Homeowners have had the "luxury" of moratoriums on new foreclosures is a loan is with FannieMae or FreddieMac; that ended on January 31st. Additionally, many states had stopped all actions against homeowners to give everyone time to figure out what to do. NO ONE DID!

The new "Stimulus" bill, passed last night will help the economy in general, and therefore ultimately help homeowners, especially those who are currently out of work. BUT, the trickle-down effect will take time and 1000s of homes will be lost in the interim. The basic question remains: How do we (the government) stop foreclosures, or a least give the average homeowner a fighting chance?

The problem traces right back to Wall Street when mortgages were securitized, when no one had any risk except investors in the financial markets. The worst part of the securitization, after taking into account that the elimination of risk allowed dreadful loans, is that no one entity has any authority to allow real modifications on the mortgages that are in these bundles packages called "Mortgage-Backed Securities"(please refer to prior posts, specifically December 22 and January 3.) The people borrowers deal with when they call for help is the Servicer. They just collect checks, send bills, make sure taxes are paid etc. They do all of the administrative work but HAVE NO AUTHORITY to change terms of the loan.

Many of the attorneys who represent Mortgagees(Lenders) against Mortgagors (Homeowners) have stated that they would and will recommend a modification in line with my suggestions but their client, the SERVICER, does not have the right to change the terms enough to matter. The agreements among the Servicers, Trustees (the banks who manage the MBS and "hold" the assets for the benefit of the investors), Financiers (the companies/banks/lenders that puts the package of loans together for sale) specifically prohibit a change in the rate, principal amount etc.

Congress must provide Mortgage Servicers with some type of guaranty that they will not be sued if they modify loans. Congress can reform the Bankruptcy Laws and give Judges the right to determine if a mortgage should be modified; they can pass a law that indemnifies Servicers for Modifications assuming the modification is based on a full evaluation of the Borrower's circumstances; or what ever other solutions the Treasury, the Federal Reserve, Congress, or Wall Street determines will allow Servicers to make the changes necessary to stop foreclosures that are being forced by adjustments up in rates and down in housing values.

At least we are moving forward. Congress has taken the first step; the second one better come quickly.

Author's Copyright by Richard I. Isacoff, Esq, February 2009

http://www.isacofflaw.com/
rii@isacofflaw.com

The Bill is Passed - No Relief for Homeowners

The Senate passed their version of the stimulus package which now has to be reconciled with the House's stab at it. All this means is that now the 2 branches of Congress have to see if they can agree on a compromise to each other's ideas on how to put money into the economy.

Startling... or maybe not... is the fact that there is no direct relief for homeowners facing foreclosure. Congress has not approved a change in the Bankruptcy law that would allow the Court to modify residential first mortgages. Further, they have not set up any new mechanism to help homeowners at risk of losing their homes due to adjustments in interest rates, or due to loss of jobs (3.6 million in 14 months), or for any other related catastrophic economic problem now facing a family in a house with a big "FORECLOSURE SALE" sign in the front (or back) yard.

John Olver, the Congressman for this District, a man who I admire and who has worked hard for his constituents, has said nothing. His office, specifically his Legislative Assistant responsible for the finance and banking portion of the Congressman's long list of pending issues, has not returned calls. There has not been a single press release dealing with what is being done to keep people in their homes, and to stop the slide of the economy caused by the acceleration of foreclosures and the resulting loss of value of other homes in the area. This also affects the value of the "Toxic Assets" called Mortgage-Backed Securities.

Until Congress addresses the housing issue in a meaningful way, and until the affect on the financial markets allows stability, we will be in this downward cycle that keeps gaining speed. in reality, Congress is faced with dealing with the symptoms, not the cause. Perhaps they believe that the bleeding must stop before the patient dies, and then they can treat the cause. Based on history, even if the hemorrhage abates, and the bleeding of the economy seems to get better, the cause is so severe (bad loans, lax regulations, fraud etc), that the patient (our economy) will die of complications: foreclosures; banks getting more and more property that no one can buy; no loans except to credit-perfect borrowers; and banks hoarding the cash they got from the government to make loans rather than lending money to help real people.

THERE ARE NO EASY ANSWERS. The only thing we do know is that normally you look for the cause of a problem and fix it/them one at a time. Here, home mortgage lending was the primary reason the markets crumbled and lending became a thing of fairy tales and nothing is being done to fix it.

One last illustration: HOPE NOW, a federally funded program to assist homeowners to save heir homes, which anticipated helping 400,000 foreclosure risks, has has TOTAL APPLICATIONS of 451 and has finished 25 loans. THE PROGRAM IS A FAILURE. What is being done to fix it?- Nothing!

Author's Copyright by Richard I. Isacoff, Esq February 2009

http://www.isacofflaw.com/
rii@isacofflaw.com

Help on Stimulus Bill

Have you received the latest communication for your U.S. Senator, or from your Congressman, about the economic problem and what he/she is doing to fix it? Neither have I, because there has not been one! President Obama, in is address to the nation last night said, to Congress, that it is time to stop playing games. I do not believe for a minute that anyone thinks it's a game, but the President was right: Congress is playing politics. Does the "stimulus package" have to be perfect? No, but THERE HAS TO BE SOMETHING FAST!

This blog has been mainly about the mortgage and surrounding financial crisis, and for the time being it will have an emphasis on that issue, which is and will be the most significant issue confronting all of us in the U.S., and the world, for the next few years. I will continue to try to explain what is happening in terms that we all can understand. Right now, politically, we are seeing old time Republican v Democrat fighting. No progress, just bickering. The commitment of money to Iraq took less time than Congress has been deciding whether fixing roads is a better program to help the economy than giving tax cuts to business so they can reinvest.

Some ideas and suggestions: Spending on infrastructure like roads and highways has a great positive effect on the entire economy. There are road contracts that cause hiring. The contracts also create new jobs. The contractors have to buy materials which helps the manufacturers and suppliers. Then they have to employ people. Those people getting hired, need to have good transportation, eat lunches etc. They have to buy work clothes. Stores get to sell clothes, and restaurant (even take-out) food. And the cycle get going.

THERE ONLY WRONG DECISION RIGHT NOW IS NO DECISION. The financial markets are waiting for the U.S. to get our act together and do something. At this point, whether we commit $100 billion more or less to the program does not matter. If we do not spend what we can now to shore-up the economy, the 500,000 jobs that will be reported as lost in January, and the 2 million jobs that were lost in the past 4 months will have been the tip of the iceberg. Just remember the ending of the movie Titanic - as has been written here before, "HOW LONG CAN YOU TREAD WATER?"

CALL YOUR CONGRESSMEN/WOMEN AND YOUR SENATORS. ASK HOW THEY ARE VOTING. IF THEY SAY THEY HAVE TO OPPOSE THE PRESIDENT'S PLAN ASK WHY!

Author's copyright by Richard I. Isacoff, Esq, February 2008

http://www.isacofflaw.com/

rii@isacofflaw.com