Senate Votes Against Homeowners' Rights

Photo from Article by By Mike Lillis in the Washington Independant

What could have been the best and least costly way to fix the housing market and to save countless homes from foreclosure has been snatched away. A piece of legislation that had become known as "The Durbin Bill", actually Senate Bill 61 which was sponsored and championed by Sen. Richard Durbin, has all but been permanently defeated when only 45 Senators voted to end a filibuster on the bill this past Wednesday (Note: A filibuster is a procedural rule that allows the opposition to proposed legislation to prevent it from being voted upon, by continuing the debate forever. It takes 60 senators to end the filibuster and stop the delay).

The bill, following the House or Representatives' lead, would have given Federal Bankruptcy Judges the authority to modify unfair primary residence first mortgages. First, it must be stated that the Judges have the authority and use it every day on almost every other type of loan. Sometimes the Lender is happy because the Judge will not modify the loan, and sometimes the borrower is happy because needed relief is okayed by the Court. Why then has this proposal brought about such intense debate and one of the most "gloves off" lobbying effort in a long time?

The simple answer is greed, but that does not really explain the full picture. Having worked in the Banking industry, as a banker, regulatory enforcer, and part-time lobbyist, I can attest to the power of the banking and finance lobbies. Why would this sector of the economy which has received billions of dollars, in fact, a trillion dollars, oppose the ability of a Federal Bankruptcy Judge to modify an unfair home mortgage? The explanation lies in the nature of home mortgages in today's financial market and in the new definition of a "Bank". The "banking" industry includes companies like Goldman Sachs, which do not make consumer loans, do not take deposits, do not have checking accounts, do not have ATMs, do not have branches, and do not have customers/depositors, except those few customers who buy SECURITIES. These so-called banks are really securities firms which put pools of mortgages together and sell them to pension plans, large companies, mutual funds etc.

Earlier posts have discussed the securitization of home mortgages into a type of derivative called mortgage backed securities. This pooling of hundreds of millions of dollars of mortgages into packages has caused them to cease being a loan from a bank to a homeowner, and to become a source of income, each mortgage contributing its fair share, for investors who bought not the mortgages, but the right to receive income from the pool of mortgages, the Mortgage-Backed Security (we will refer to these as MBS for the rest of this post).

The argument runs like this: Because the rate of defaults has risen well above predictions, the flow of cash is threatened to a point where the investors may not get what they "were promised"when they paid for their fractional share/piece of the MBS. It is critical to keep in mind at all times when thinking about this issue that the MORTGAGE as we think about it HAS CEASED TO EXIST for the purposes of the investment MBS.

The investors in the securities called MBS,do not want to have the value of their investment decreased. If enough mortgages in the package have the terms changed to lower the payments, the entire package will pay less than expected/promised, and therefore the entire package will be worth less than the investors paid for it. Also, we are referring to a pooling of mortgages where each pool might be $500,000,000 (1/2 billion dollars) or more. The financial stakes are enormous. This in fact is why the term "toxic assets" sprung up - toxic because they would harm or kill the value of the MBS AND no one knew to what value. Therefore the assumption was that they were worth nothing, or close to it.

Okay. So what does that have to do with the Durbin Bill to allow Bankruptcy Judges to change terms? EVERYTHING! If a borrower obtained a loan that had an interest rate which was at the market rate of maybe a bit higher, and it was an Adjustable Rate Mortgage (ARM) where after two years the rate would go up and where the loan could never go down below the original rate, the mortgage could be sold at a premium even if, in reality, it cheated the borrower who never was told about the rate increases. By allowing a Judge to determine that the mortgage was sold to the borrower under false pretenses, and misrepresentations, and therefore permitting the Judge to CHANGE/LOWER the interest rate, the owners of the MBS that owned the loan would lose, as explained above.

Again, if a Judge can state that a loan was unfair, and that the lender cheated the borrower, and therefore the terms have to be changed to make the mortgage fair, the entire structure of the MBS falls apart. If that happens, the "banks" who own them or have sold them, lose millions of dollars. This is because no one knows what the end rates will be or the amount of income any loan will pay, because a Judge could change it. There is NO CONCERN about the family, losing its home and being evicted because they were tricked into taking a loan with a moderate interest rate, not realizing that it would go up after 2 years by 3%, and then adjust every 6 months thereafter. The variations on the theme of bad loans have been discussed in earlier posts ( see the following postings: 3/18, 3/7, 2/21, 1/29, 1/3)

The "banking industry" lobbied the Senate not to allow Judges to make the determination that the loan is unfair. The attitude is that a borrower should have known better; that once you make a deal you MUST live with it, even if you were misled, lied to, cheated etc. What is lobbying? In its nice form it is just talking to members of Congress and expressing the opinion of the lobbyists client. In it TRUE form, it is pressuring Congress on a member by member basis to vote the way the Lobbyist/persuader wants by some of the following: threatening to move a large banking operation to another state; threatening to make no more campaign contributions if the vote isn't the "right" vote; threatening to support the Senator's/Congressman's opponent; threatening to pay for ads like the "Swift Boat" ads that hurt Sen. Kerry's presidential campaign; AND flat out bribery - money, houses, trips to where ever etc.

There are other players as well, like the companies that "RATE" the MBS, in a sense "kick the tires" to see how solid the investment really is. The companies have huge amounts of liability if the rating of the MBS market has been a sham. The stakes are huge -Billions of dollars for the investors,"banks", and the rating agencies!. Motive? "YOU BETCHA!" (thank you Governor Palin for the words to use)

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

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

"Credit Default Swaps" - Insuring Against Oblivion

We were dealing the the issue of DERIVATIVES. Okay - So I put too much into the last posting. Let's start this one in the middle; without the preamble.

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 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 (see the prior post - great analogy & reading).

BUT, 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? 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 or those mortgages.

With MBS, and the underlying mortgages, the type of Derivative is a CREDIT DEFAULT SWAP. It would be more accurate to it Credit Default Insurance, or (longer name here) "My BET that your loans will not default for which you pay me a lot of money." IT IS A SWAP OF RISK FOR MONEY. Nothing more -nothing less

How did we get here, and where do we go? (understand that there are more than $40 trillion in these Swaps and other Derivatives). The Final installment of the series will focus on how to keep the $40 trillion from wrecking (for real this time) the world economy

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

rii@isacofflaw.com

http://www.isacofflaw.com/

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/