financial fraud

10 Reasons To be Suspicious About Wall Street's Facebook Fiasco

Richard Eskow — Tue, 22 May 2012 21:31:35 -0400

Three of Wall Street biggest and best-known financial institutions handled the Facebook IPO, so why were people immediately suspicious when the stock soared and then promptly tanked? Easy answer: Because three of Wall Street biggest and best-known financial institutions handled the Facebook IPO.

Each of them - Morgan Stanley, Goldman Sachs, and JPMorgan Chase - has a history of exactly the kinds of unethical and/or illegal behavior that might, just might, explain what happened with Facebook.

Mark Gongloff offers a good overview of Mr. Zuckerberg's Wild Ride, in which a stock that was offered at an IPO price of $38 soared to $45 and then plunged to its current (as of this writing) price of $31. A lot of people lost money - which means a lot of people made money, too.

Zuckerberg promptly sold his 30.2 million shares, netting a quick billion dollars and change. That tells you what he thinks of this investment.

Here are ten reasons why it makes sense to be suspicious of the Facebook IPO, starting with the fact that any overview of the three institutions which handled it might best be described as "rounding up the usual suspects":

1. Morgan Stanley has a history - and a culture - of tricking their own clients into making lousy investments.

It was Morgan Stanley's brokers who, in one notorious account, loved to brag "I ripped his face off!" after convincing one of the firm's own clients to buy a stock that the firm knew was lousy. (See Frank Portnoy's account in Fiasco.)

CNBC reports that "Morgan Stanley may have spent billions of dollars to support the (Facebook) stock price by buying shares in the market." This kind of market manipulation is common. They do these things to create an artificial sense of momentum when the market is turning against an offering. Investors don't know they're doing it at the time, of course. In this case, Morgan Stanley could have spend a billion dollars or more manipulating the stock price.

Now Morgan Stanley's being investigated by the SEC and the Commonwealth of Massachusetts, after reports indicated that its analysts were withholding crucial (and negative) information about the stock offering and at the same time sharing it with their own favored clients. That's a no-no.

2. JPMorgan Chase has a long rap sheet. What's another bust?

JPMorgan Chase is currently in the public time-out box for its botched derivatives trades in London - about which which it appears to have deceived its own investors (when it failed to tell anyone that the new, improved "risk model" it rolled out was not being used to analyze this London unit.)

When CEO Jamie Dimon said that laws may have been violated in that case, was he expecting people to be surprised? JPM has a long history as a corporate lawbreaker during Dimon's tenure. It paid millions to settle a long list of violations that includes illegally cheating veterans coming home from Iraq - or still risking their lives there. It gave up nearly three quarters of a billion dollars to settle charges of bribing public officials in Jefferson County, Alabama. (Jefferson County is bankrupt. JPM's executives are doing just fine.)

And JPMorgan Chase just gave up billions more to settle charges stemming from its rampant foreclosure fraud, which involve mass perjury and forgery conducted by a group of inexperienced youngsters that JPM employees called "the Burger King kids."

The JPM rap sheet's got a lot more offenses on it, but that should give you the general idea. Dimon loves to affect an air of respectability. But his outfit ain't the PTA, if you catch my drift.

3. Goldman Sachs is ... well, it's Goldman Sachs.

In one of its many notorious deals, ABACUS, Goldman Sachs lied to prospective investors about mortgage-backed securities. While it was telling investors that these securities were well-chosen and reliable, it was hiding the fact that they were actually being selected by an investor who was famous for betting against them.

Goldman recently settled a $22 million lawsuit for illegally sharing confidential information with its preferred clients, which is a form of insider trading, using internal meetings called "huddles."

That's a lot like the conduct that's being investigated at Morgan Stanley, and the questions it raises is the same one: Was this IPO designed to fail? Barring that, did insiders only tell a few favorites once they knew it would fail, so that they could all get rich betting against the suckers who didn't know any better?

Who's huddling who in the Facebook deal?

4. Goldman Sachs already tried to evade the law for Facebook once before.

If at first you don't succeed ...

At the time we asked, "Which Is More 'Gangsta,' (rapper) 50 Cent's Twitter Stock Pitch or Goldman's Facebook Deal?" We stand by our original conclusion: Sorry, Fitty.

Lloyd Blankfein's entourage tried to avoid SEC regulations that say a privately held company can't have more than 500 investors by defining many thousands of unrelated investors as a single group. They demanded a minimum $2 million investment - there ain't no sucker like a rich sucker - and pitched the deal in language that would embarrass a Nigerian email scammer:

"When you have a chance I wanted to find a time to discuss a highly confidential and time sensitive investment opportunity ... If you agree not to use information that we reveal to you ... I will be able to disclose the name of the company and provide you with more information..."

They should've started the pitch letter with the words "Dearest Beloved, My late husband the oil minister ..." As Nomi Prins noted at the time, the plan was to artificially inflate the value of these illegally-traded shares and then ""pawn off the overpriced goods on the clients."

They tried to run that little number back in 2010 but failed. Did they finally succeed this time?

5. There's no such thing as a free market.

Thanks to deregulation, our "free markets" ain't free - in fact, they're less free than at any time in modern history.

Nevertheless the anti-regulatory crowd insists on describing what we have today as a "free market," instead of what it really is: a financial funhouse where investors don't know until it's too late which pop-up vampire is a cardboard cutout and which one's really going suck their blood. "Ripped his face off" indeed.

That's not market economics, it's a horror show.

6. Facebook's a shaky investment anyway.

Think about it: With all the money they have at their disposal, Zuckerberg and his team still can't design a user interface that doesn't frustrate, aggravate, and infuriate millions of people every day. Sure, people use it - because everybody else does. But that was true of MySpace, too, until something better came along. Facebook has a mind-boggling number of users, and they spend an equally mind-boggling amount of time on it every day. But even Mafia Wars come to an end sometime.

What's more, the stock they're peddling isn't much to write home about. Their voting rights are highly diluted, so that the stock owned by Zuckerberg and other preferred holders has ten times as much voting power as everybody else's. Zuckerberg owns 18 percent of Facebook's shares, but has absolute control of the company with 57 percent of the votes.

When something's as overhyped as Facebook stock, it's caveat emptor time. You're throwing yourself at Zuckerberg's mercy, hoping he does better with the company than he has designing Facebook's account management features. (Tried changing your privacy levels lately?)

But if he mismanages your money you'll just have to bend over and get poked.

7. Mark Zuckerburg doesn't give a rat's you-know-what about investors or IPOs.

"A million dollars isn't cool," says Justin Timberlake as Sean Parker in that movie about Zuckerberg and Facebook. "A billion dollars is cool." It was a cool week for Zuckerberg, who just made another billion, but he doesn't think much of investors. Stephen Gandel lays out all the ways it shows, starting with the fact that Zuckerberg didn't want to take the company public and keeps reminding everybody about it. SEC rules - the same rules Goldman tried to evade last year - forced him into it.

Zuckerberg also kept blowing off investors at scheduled meetings. Frankly, that's a refreshing change from all the CEOs I've known who kowtow to them (and often game the numbers to impress them). But it doesn't exactly strengthen one's confidence that this offering was designed with the best interests of investors in mind.

And while CNN's Gandel concludes that Zuckerberg doesn't care about making more money, I'm not so sure. He's sure made a lot in the last few days. For its part, Goldman's already shown that it's willing to trade on insider information to help high-value clients - clients like Meg Whitman. They called it "spinning," and it involved rewarding executives who gave them a lot of corporate business (which uses their investors' money, not their own) shares in IPOs they're underwriting.

Whitman was forced to resign from its board and pay a multimillion-dollar fine after the story became public. If they'd "spin" for a piece of eBay's investment action, what motions would they go through for Facebook's?

8. These three players have a huge collective presence on Nasdaq.

Morgan Stanley and Goldman Sachs are almost always in the top ten in reported trade volume on NASDAQ, where Facebook was offered. And JPMorgan Chase provides financial backing to many of these deals. Together they represent a huge chunk of NASDAQ (and New York Stock Exchange) transactions. They control a lot of the trading flow and they're sitting on a lot of data.

That means they can manipulate the market in all sorts of ways. And they can leverage other people's money and make it work ... for them.

So while we're at it, remind me again: Why do we allow so few companies to dominate our financial market? It's called an "oligopoly," and it's bad. It's especially bad when they become too big to fail and can pretty much do whatever they want, knowing we'll rescue them again if - make that when - they screw up again.

9. There was a lot of automated trading of Facebook shares.

The roller-coaster ride for Facebook's stock also appears to involve very high volumes of electronic robo-trading, which always raises suspicions. That could just be a sign that the computer programs which now dominate our stock market (and which cry out for a financial transactions tax) didn't like the transaction. If so, they're smarter than most humans.

Or it could mean that these three firms, which together play a dominant role on Nasdaq, pulled a fast one of some kind. Somebody needs to analyze those 'flash' trades and find out.

10. Because they can.

Hey, these three underwriters can do whatever they want - and they know it.

Until some bankers get indicted - which doesn't seem likely anytime soon, given the glacial pace of the Administration's much-hyped (but now apparently forgotten) mortgage fraud task force - they can break any law or rule they want to break. What's the worst that could happen to them? If they get caught they'll negotiation another gigantic fine and let the shareholders (including working people's pension funds and 401ks) pick up the tab while they collect their bonuses and head off to the Hamptons.

So, until the Administration shows us some Wall Street indictments, the usual suspects will keep committing the usual offenses over and over. The Justice Department needs to get serious about investigating Wall Street fraud. And more states should join Massachusetts in investigating this deal.

This one goes to 11 ...

Do we know that's what happened with the Facebook IPO? No - and we won't know without a proper investigation. But we do know that the Facebook plunge reflects a classic scenario for shady traders who make money hyping a stock while secretly betting against it.

And we know that all three of these institutions are perfectly capable of doing it. They have the means, they have the motive, and - until our government does something about it - they have the opportunity.

So get on with it, Washington. You better update your status on those fraud investigations before it's too late.

10 Million Foreclosures: No Saving Pvt. Ryan This Time

William Neil — Mon, 31 Jan 2011 09:57:45 -0500

10 MILLION FORECLOSURES: NO SAVING PVT. RYAN THIS TIME

January 31, 2011

Dear Citizens and Elected Officials:

Preface

Having conceived of this essay in mid-October, and having worked on it now for nearly four months, it almost goes without saying that we were very curious to see what President Obama would have to say about its subject - Foreclosures - in his State of the Union address on January 25th. We had just finished quoting, in our draft essay, Howard Glazer, a former housing policy official under the Clinton Administration, who now advises, among others, the National Association of Realtors. In a September, 2010 front page New York Times story on “housing woes,” he had this to say about the administration’s policies: “ ‘The administration made a bet that a rising economy would solve the housing problem and now they are out of chips…they are deeply worried and don’t really know what to do.’” The Times itself ran no less than five editorials about foreclosures between their initial October 15th one and the end of November. In that October 15th lead editorial, they were very critical of the President’s handling of the growing fiasco: “Throughout this crisis, the Obama administration has been far more worried about protecting the banks than protecting homeowners…the banks that got us into this mess can’t be trusted to get us out of it.”

So with this story building throughout the fall, and with the New York Times leading the charge, what did the President and the Times have to say about it during the big address, and the immediate follow-up commentary? Nothing - exactly nothing: not about the scope of it; not about the nationwide legal morass which was turning into a Hobbesian nightmare threatening to boomerang on the banks and investors alike and trigger yet another phase of the financial crisis; and not a word about the failure to send a single senior official from the mortgage originators or the major Wall Street banks (and company) to jail, which is a crisis of trust and accountability for the entire society; and not a word about those 10 million already, or about to be, foreclosed upon, homeowners.

So what might explain this sudden silence in January of 2011? Certainly the appointment of William M. Daley, a senior executive at none-other-than J.P. Morgan Chase, and who supervised their lobbying efforts, as President Obama’s new Chief of Staff, is part of the answer. It has been bolstered by the fact that JP Morgan’s Chief, Jamie Dimon was in Davos, Switzerland, complaining that he’s sick and tired of the “‘constant refrain – bankers, bankers, bankers.’” (The reporters and analysts we quote in our essay have a chant of their own to answer Mr. Dimon about the foreclosures: “fraud, fraud, fraud.”) And certainly the Times lead editorial from the same Friday (January 28, 2010) edition which quotes the unhappy Mr. Dimon in the business section, fills in another part of the answer with its opening sentence reading that “President Obama is smart to extend an olive branch to American businesses.”

But to get a more complete explanation of the sudden silence on foreclosures, and a fairer description of the nation than that presented in the President’s speech, we need to turn to two other “State of the Union” addresses, ones very different in content and direction than the President’s. The first was William Greider’s, appropriately entitled “The End of New Deal Liberalism, and it appeared in the January 24, 2011 print edition of The Nation, although the online addition appeared weeks earlier, so we had it very much in mind as we were in the home stretch of our Foreclosure essay. Of Obama’s overt stance astride the center-right, Greider says it now confirms that “the corporate sector has its arms around both political parties” – and around much else as well. Instead of “pragmatism,” Greider calls it “surrender.” Compromise? “This is capitulation posing as moderation.” Although he never uses the term “social contract,” there is no doubt that what was left of ours from the New Deal is gone, and what isn’t gone is overtly threatened: “A lot of Americans…sense that the structural reality of government and politics is not on their side.” Yet despite the still reigning Right-corporate-center framework, “people want government to be more aggressive in many areas – like sending some of the financial malefactors to prison.”

The second alternative “State of the Union” address was delivered by the President of the AFL-CIO, Richard Trumka, at the National Press Club on January 19th, a week before the President’s. We had the pleasure of hearing it in person, thanks to invitations from the AFL-CIO and one of our attentive readers, Rick Sullivan. Trumka’s speech, like Greider’s essay, was about a disappearing social contract, although he too never used the term. Trumka was introduced, in fact, by someone representing those who are being left out of the current social contract, such as it is, by a firefighter named Stan Trojanowski, who was there, when needed, on 9/11/2001, but who, like other first-responders, was kept waiting seven years by the “Alice-in-Wonderland” political climate in Washington to be made whole for their fateful, day-of-days’ inflicted medical problems.

As you consider the fate of the foreclosed upon in this essay, and the escape from accountability by those responsible for the financial system failures that led to the crisis, we would like you to keep in mind this brief passage from Trumka’s speech, which we thought was the most powerful moment of it, and which resonates, not entirely by coincidence, with the title and theme of the essay which follows:

It’s a funny thing, when the firefighters arrived at the World Trade Center on September 11th and started that long climb up the stairs to rescue the bond traders trapped on the upper floors, it didn’t occur to any of them to call up and ask, ‘What’s it worth to you for us to come and get you?’ So how did we come to the point where our country’s ruling class thinks that firefighters like Stan and teachers and nurses are the problem, and people like Lloyd Blankfein and Rupert Murdoch are the solution?

Here are the links to the two “other” State of the Union addresses: http://www.aflcio.org/mediacenter/prsptm/sp01192011.cfm

http://www.thenation.com/article/157511/end-new-deal-liberalism

For our readers’ convenience, we have broken the essay in two parts, with Part II following in about 3-5 days, under the same title. As always, we have included the entire essay as one MS-Word attachment, and we’ll send it out with each part.

When you finish with them, we hope that you will agree with us that in the “Great American Moral Dialectic” – the question of who gets responsibility, or blame, when things go bad, especially in the economy – the “sinning” individual or the “systemically dangerous institutions” - the balance held in those great scales of justice, and the burdens, will have shifted from the borrowers, the foreclosed upon, to those designing the lending programs, including the mysterious “MERS” operation.

MERS stand for the Mortgage Electronic Registry Systems, Inc., conceived of by some of our favorite Wall Street banks, and others, like former Countrywide CEO Angelo Mozilo. It has not only managed to drain some $30 billion of revenue from county governments since being set up in 1997, but has done so while evading any serious, sustained public debate, or legislative vote, whether by state governments or Congress. MERS now claims to “manage” (an ironic phrase in light of the reality) the paperwork for more than 60% of the outstanding mortgages in the country.

So when President Obama reminded our nation, at the very end of his State of the Union speech, that we still are capable of “big things,” we wonder if he was aware of what a really big thing MERS had become, unbeknown to 99.9% of our citizens, and what a perfect symbol it would be for the corporate domination of both political parties. We also wonder what our “Constitutional Conservatives” make out of its rise, since we present to them, and the rest of our readers, powerful testimony which declares that MERS has turned long-standing legal precedents of state real property registration and law on their heads - in some cases nearly 400 years worth of precedents.

This is just one of the many surprises in store for our readers, to be matched in Part II by accounts of a significant train of legal troubles for J.P. Morgan Chase, starting in Jefferson County, Alabama, but also involving Philadelphia, Pennsylvania and many Italian municipalities, and eventually culminating with the participation of eight of its bankers in “the biggest criminal conspiracy in the history of the 198-year-old municipal finance market.” And now on to Part I.

Bill Neil
Rockville, MD
w.neil@att.net

PART I

Introduction
All through the fall of 2010, as a backdrop to the catastrophic election of November 2nd, newspapers were filled with stories about foreclosures and, once again, a faltering real estate market. Many of these accounts were genuine horror stories, no way around it: banks or their stand-ins foreclosing on the wrong house, foreclosing even on some up-to-date with their payments, or who had been deliberately urged to fall behind in order to qualify for federal rescue programs. And then, perhaps the ultimate outrage, told on the front page of the New York Times on December 22: one of breaking into a California woman’s vacation home, removing all manner of her cherished possessions, including the wooden box holding the ashes of her deceased husband, and barring her future entry by installing new locks. That was the tale of Mimi Ash, a particularly sad, brutal and tangled one, yet ending on a note of resignation, with her giving up on saving a house with violated memories, but not on legal claims for damages for the way her situation was handled.

Reading that story by Andrew Martin, “In a Sign of Foreclosure Flaws, Suits Claim Break-Ins by Banks,” and many others with a similar flavor, it’s easy to get lost in the myriad details of the foreclosure process, and what the legal rights and wrongs actually are. Many of the stories involved lost paperwork, the “note,” the mortgage itself, and the file folder which should shed light on the original underwriting and documentation for the mortgage loan. At minimum, the note and the mortgage should be part of the “luggage train” as the ownership of a mortgage is passed from party to party. Instead, the paperwork seems to have become, from the banking side, so much disposable “baggage.” Or, as we will later see, from another perspective, crucial evidence from financial crime scenes. And then there’s worse: robo signings for rapid processing of foreclosures, re-creations and outright forgery of documents, with the implications only coming home to roost when a judge in a courtroom clamps down and states that the law has been violated. The initial millions of foreclosures are still intimately tied to the world of subprime mortgage originations, but now as we write, and for a good part of 2010, the tale of home owners just entering the whirlpool is a more prosaic one of ordinary mortgages going under because of lost jobs, the end of 99 weeks of unemployment compensation, and the more “traditional” American health care horror stories. We’re going to help you make sense of some of these details, but try not to get you lost in them

For the important narrative behind 10,000,000 (or more) foreclosures is one with much broader ramifications. It’s the one concerned with moral and social obligations, how we as a nation either do or don’t care for one another, and who we blame for the colossal scale of this economic and social calamity – individual borrowers or the economic institutions that were the lenders. We hope to demonstrate that the moral balance scales have shifted, as the story has unfolded, from one which initially blamed those taking out the mortgage loans, to one heavily tilting against those originating them, passing them on, and building a financial house of cards upon the mortgage debt securities constructed by bundling together the faulty, very likely fraudulent individual loans. This is not to paint the initial loan recipients as entirely innocent parties; a minority certainly were not, but most likely, as we read the evidence, the majority had no idea of what would befall them when the terms of the loans suddenly shifted in two-to-three years. During 2006-2007, the mortgage-backed securities operations of Wall Street became a veritable casino, one taking bets via credit default swaps on whether and when it all, or a part of it, would collapse. At its core, this calamitous compilation rests upon the accountability, fairness and trust levels in our society – or their absence. We also read this at times outrageously complex storyline with a parallel guiding theme: the breakdown of countervailing powers - government and civic institutions – which failed to check the accumulated power of 30 years of aggrandizement by Wall Street and other complicit and compliant portions of the FIRE sector – and which at times issued it a virtually blank check.

And the story isn’t over by any means. The shifting values of the securities created from the millions of individual mortgages once totaled in the trillions of dollars, and their final resting places - at the Federal Reserve, with private investors and public pension funds, with the banks themselves, or in murky special purpose vehicles and other off-balance sheet hiding places – is dependent on the ultimate scope of the foreclosure calamity and the four trillion dollar gap in value between the mortgages on the books – and their current real estate appraisal value - which is expected to be down another 5-10% in 2011.

Following this logic, it’s a question of whether, in a nation which is the world’s leader in locking up what it judges to be its least consequential citizens – locking them up by the millions - a process which some have called “The Great Incarceration,” anyone with white collar criminal inclinations is going to do jail time for what not only was the biggest financial bubble in world history, but also what some have consistently claimed is also the biggest financial fraud ever recorded. We invite the historians of such matters to add or subtract their qualifiers and inflation adjustments from centuries long gone by so that the claims can be fairly adjudicated.

Laying Down the Marker on Fraud
Now fraud is a powerful word to use, and we don’t employ it lightly. But there was no way around the word as it kept turning up, time and time again, in the reading we were doing over the past four months. Authors of editorials, magazine articles and books about subprime and foreclosures couldn’t stop employing the word. In fact, it’s been on our mind too for some time now, going back almost two years, to February of 2009, when William K. Black, the law professor who is most closely following the “control fraud” evidence trail, first alerted us to the potential significance of the “paperwork” problems - and the mortgage files themselves. Just as forensic anthropologists and pathologists often proceed from the smallest scraps of physical evidence or subtle disturbances at a crime scene, so too our “white collar criminologists” have become very interested in these allegedly prosaic yet seemingly very hard to locate mortgage notes and files. And protruding into the stories of missing notes and folders comes an even stranger tale, that of an economic “coup de main” that threatens to transform nearly four centuries of established property law and its county based recording and registration system, all without having obtained any formal Congressional or state political sanction – the Mortgage Electronic Registration Systems, Inc., aka as MERS. But we don’t want to get ahead of the story here.

We first wrote about Professor Black’s worries in our March 29, 2009 essay entitled A Fireside Chat on the Cusp of History. The context for his concerns was set out on page five, where we noted that “rumors of citizen anger over the lack of indictments related to the financial crisis have reached House Financial Services Committee Chairman Barney Frank.” Here’s how we framed up the issue for Chairman Frank, on the next page:

Confused as to where to start, Chairman Frank? William K. Black, who teaches law and who has a background as a “white-collar criminologist and former financial regulator,” has some suggestions in his article “The Two Documents Everyone Should Read to Better Understand the Crisis,” which appeared on the Huffingtonpost.com on Feb. 25th, 2009. He starts off by stating that the “FBI has been warning of an ‘epidemic’ of mortgage fraud since September of 2004.” Yes, that’s right, 2004. The agencies named by Mr. Frank above might want to check with the FBI on that. Just trying to be helpful, here. The first document to look at ought to be the Email which a senior manager of S&P, the ratings firm, sends to one of his credit raters who apparently has had the temerity to ask to examine the actual mortgage loan files behind the derivatives he is supposed to grade. Manager to curious rater: “‘Any request for loan level tapes is TOTALLY UNREASONABLE!!! Most investors don’t have it and can’t provide it…’” Second document: the Fitch rating service conducted a close examination “of a small sample of subprime loan files” after the disaster was apparent. Black quotes from Fitch’s findings: “‘The result of the analysis was disconcerting at best, as there was the appearance of fraud or misrepresentation in almost every file.’” Should we mention, as a “passing by this way” comment, that Black points out that the major banks still don’t have the actual loan files and that therefore the upcoming “stress test” so talked about will not be an accurate reading of how their mortgage-backed-securities will behave – a crucial factor in determining their solvency, we might add? And what are the implications for Sec. Geithner’s new plan, which is going to put these shaky things back on the market (he hopes)?

The Early Origins of Subprime Fraud
Fraud. There it is again; the word appears on the very first page of the Prologue of Michael Lewis’ spellbinding book, The Big Short: Inside the Doomsday Machine (2010). Lewis, to be fair, is speaking about himself and others like him, and far too modestly, we might add. Why, he asks, rhetorically, would “The Street” turn over the handling of billions of dollars of other people’s money (as well as its own proprietary funds), to clueless neophytes like himself, being a trainee at Salomon Brothers in 1985? Looking back from the wreckage of 2007-2009, he writes that “I confess some part of me thought, If only I’d stuck around, this is the sort of catastrophe I might have created.” In reality, Wall Street was very interested in smart, socially adapt Ivy Leaguers like himself (Princeton), generalists who could be taught the very basics of finance and mixed, in just the right proportions, with the nerdier mathematical modelers and econometricians, both to be led by the brash trading floor types who direct the major firms in the 1990’s and on into the new century and their rendezvous with the “Doomsday Machine.”

It doesn’t take Lewis long to sketch out for us the first foreshadowing of what is to come, as he tells us about the two pioneer analysts of subprime mortgage lending in the early 1990’s, Sy Jacobs of the small investment bank Alex Brown, and Steven Eisman at the better known, but still comparatively sleepy firm of Oppenheimer and Co. We will hear a lot more about Steve Eisman later on, but in the very first chapter it’s Sy Jacobs who senses the proclivities of the firms bringing new forms of credit to the poorer reaches of American society. It is a pass-along industry already selling its mortgage bonds to others as quickly as it can, and therefore it is already “fraught with moral hazard: ‘It was a fast-buck business…Any business where you can sell a product and make money without having to worry about how the product performs is going to attract sleazy people.’”

Now readers, it’s time that you, with Michael Lewis’s help, meet fraud’s oldest brother - shifty accounting - which also goes by the alias “opacity.” And trying to shine a light through that opacity, we learn about one Vincent Daniel. “Vinny” is a lower middle class sidekick to the upper middle class Eisman, who comes to share a distrust of The Street’s conventional wisdom, but still, like Eisman, wants to make a lot of money from the dissenting views. Although Lewis doesn’t quite say it this way, they are unconventional, but still good capitalists, who, along with another quirky hedge fund protestant, Michael Burry, and another slightly more conventional figure, Gregg Lippman, who works for Deutsche Bank, supply the very human side to the fantastic tale of history’s greatest financial abstractions, and resulting calamity – or is that crime - as some would have it?
In Lewis’ hands, Lippman also takes on the role as the living metaphor for Wall Street’s “trust” problem, a pervasive one that we also saw throughout his book Liar’s Poker, which was published back in 1989.

Before Vinny joins Eisman at Oppenheimer, Lewis tells us about Vinny’s first job, as a “junior accountant” with Arthur Andersen auditing Salomon Brothers. It seems like a minor detail, but it’s a theme that will run through Lewis’ book, and our essay, and indeed, it’s one that runs throughout the financial history of the past thirty years: Vinny “was instantly struck by the opacity of an investment bank’s books…He concluded that there was effectively no way for an accountant assigned to audit a giant Wall Street firm to figure out whether it was making money or losing money.” Now Vinny’s problem is that a couple of his virtues – curiosity and honesty – don’t always quite fit with the reality of the accountant’s role in our system, or perhaps the current system itself, so his boss at Arthur Andersen tells him, after one too many questions: “‘Vinny, it’s not your job. I hired you to do XYZ, do XYZ and shut your mouth.’” (And we wonder, dear readers, whether that brief glimpse of dialogue has as familiar a ring to it for you as it does for us?).

But those virtues make him a good fit with Eisman, who tells him to take an early data dump about subprime mortgages and lock himself up in a room with it, and not come out until he understands what in the world is going on in that sector. And that’s how Vinny Daniel comes to take that very first close look at the subprime world’s data, emerging with the sense that the field “had the essential feature of a Ponzi scheme.” Eisman releases a report on the subprime industry in September of 1997 and Lewis explains that it “trashed all of the subprime originators; one by one, he exposed the deceptions of a dozen companies.” They are outraged of course, but even though they are operating in the flushest of economic times, the great boom of the late 1990’s, they all end up going bust in the wake of the Russian bond default and the collapse of the uber hedge fund Long Term Capital Management in 1998. Lewis’ epitaph is that “their failure was interpreted as an indictment of their accounting practices…No one but Vinny, so far as Vinny could tell, ever really understood the crappiness of the loans they had made.” Our readers should note, for future reference, that Vinny wasn’t working yet from the individual mortgage loan files themselves, but the best “pooled” data available from the ratings agencies in the 1990’s. Later we’ll see how this theme resonates right up to the present moment in 2010 with disputed testimony given to the Financial Crisis Inquiry Commission on September 23rd, 2010, about similar, but more detailed data offered to the ratings agencies, from a mortgage loan “due diligence” firm, Clayton Holdings, said to be “Wall Street’s foremost.”

“It Was Blatant Fraud.”
Before we leave the first chapter of Lewis’ The Big Short, we wanted to give you some further flavorings from his coverage of Steve Eisman’s descents into the consumer finance sector, this time homed in on one of the pioneers of home equity loans, the now “engulfed” old-line firm called Household Finance Corporation. It’s 2002, and Eisman has left Oppenheimer and is now working as an analyst for a large hedge fund called Chilton Investment, but he’s still looking more closely than his peers into the murky shadows that seem to be thrown up by this sector. He’s wondering how HFC is growing by leaps and bounds in the wake of the dot.com bust and the struggling economy of the new century. So he looks at an accounting sleight of hand contained in the company’s sales document for its home equity loans and finds that by spreading the length of a 15 year fixed interest loan over 30 “hypothetical” years, an actual interest rate of 12.5% is being portrayed to the consumer as 7%. “‘It was blatant fraud,’ said Eisman. ‘They were tricking their customers.’” Stepping out of his formal hedge fund role as analyst, Eisman turns into a consumer protection pit-bull, launching a “single-minded crusade against the Household Finance Corporation.” He grabs the trouser leg of the attorney general of Washington state, where a local newspaper expose has turned up hundreds of fleeced second mortgage customers who have now learned the true interest rate they are being charged. Eisman demands to know why the AG isn’t “‘arresting people,’” but instead is greeted with a legal shrug on the grounds of not disturbing a “powerful company.”

In an outcome that will sound all-too-familiar by 2010, the CEO doesn’t get jail time; instead, consumers in 12 states who brought a class action suit get an out-of-court settlement for $484 million dollars. Lewis writes that “Eisman was genuinely shocked. ‘It never entered my mind that this could possibly happen…this wasn’t just another company – this was the biggest company by far making subprime loans. And it was engaged in just blatant fraud. They should have taken the CEO out (Bill Aldinger) and hung him up by his…Instead they sold the company and the CEO made a hundred million dollars.’”

(Editor’s note: When we read this tale from Lewis about his chief protagonist, Steve Eisman, a certain mental image popped up from our New Jersey days in the 1980’s and 1990’s. Were we confusing Finn Caspersen’s Beneficial Corporation with Household, both having strong emphasis on consumer financing? As it turns out we were only slightly off track. Wikipedia reports that Beneficial was purchased by Household International, Inc. in 1998 for $8.25 billion in stock; then, as author Lewis has noted, Household “sold itself and its giant portfolio of subprime loans, for $15.5 billion to the British financial conglomerate the HSBC Group.” Going a bit further using Wikipedia, we learned that on March 2, 2009, “it was announced that HSBC would no longer accept new business from HFC/Beneficial, and would eliminate 6,500 jobs.” However, as is sometimes the case with Wikipedia’s style, it was also noted, without much of a logical transition, that “children of former full-time Beneficial employees are considered for scholarships to four Maryland institutions of higher learning: Hood College, Johns Hopkins University, St. John’s College and Washington College.” Yet the story doesn’t end there; under the HSBC piece at Wikipedia, we learn that it was “formed from the legal entity that had been known as Household International” and that “it is now expanding its consumer finance model to Brazil, India and Argentina, and elsewhere.” We have no idea what HSBC’s current “consumer finance model” is, but we hope it’s not the same one from Bill Aldinger’s days; maybe author Lewis could give these lucky nations’ consumer protection agencies Steve Eisman’s contact numbers so he can do some further “due diligence” – just in case.)

Due Diligence Firm Clayton Holdings Spills the Beans
“‘Fraud, plain and simple’” – that was the comment of Eliot Spitzer on his talk show in the immediate wake of the September 23, 2010 revelations from testimony in front of the Financial Crisis Inquiry Commission (FCIC) , held in Sacramento, California. We might have missed the entire blow-up were it not for an article which appeared online in the New York Times several weeks later, William D. Cohan’s “How Wall Street Hid Its Mortgage Mess,” from October 14th. The revelations came from the testimony of current and former officials of an important “due diligence” firm, Clayton Holdings, which was given the task by Wall Street banks to “review the loan files” which their mortgage backed-securities would grow out of, and to see whether they were up to the original lenders “underwriting standards, regardless of how stringent or weak they were,” an important qualification in this saga, pointed out in another article, by Gretchen Morgenson, “Raters Ignored Proof of Unsafe Loans in Securities, Panel is told,” which appeared on September 27th, also in the NYTimes. It’s important because a good portion of what Clayton was looking at in their sample of 911,000 mortgage loans – just 10% of the total issued between January 2006 and June 2007, were loans issued by the very problematic “originator” industry, most of which have gone bankrupt or had their remnants purchased in the wake of the great crisis. And these originator firms had hardly developed a reputation for their own “due diligence” and underwriting standards. Indeed, as law professor William Black has pointed out, the line between “subprime loans” and “liars loans” and “stated income loans” is a very blurry one, and much of his work over the past few months has been to help the public understand that the bulk of the lying was by the lenders, rather than the borrowers, although there was certainly fraud being committed by some borrowers as well. A little later on, we will see Professor Black rise to eloquent sarcastic heights as he ridicules the notion that “millions of working class Americans managed to defraud financially sophisticated lenders.” (From “Lenders Put the Lies in Liar’s Loans, Part 2, at Huffington Post.com, November 10, 2010.)

But here’s what really caught our attention about the coverage of the testimony of D. Keith Johnson, a former president, and Vicki Beal, a current senior vice president at Clayton Holdings. It wasn’t so much that only 54% of loans examined in that just under a million sample met the underwriting standards, such as they were, or that this appalling figure didn’t deter the banks from including substantial percentages of the 46% of the substandard ones into the packages of mortgage securities they sold to investors. And it wasn’t so much that Clayton Holdings attempted to interest the major ratings firms – Moody’s Investors Service, Standard and Poor’s, and Fitch – in their important data and service offerings – but failed. These revelations, that the major Wall Street Banks didn’t weed out enough of the substandard loans – or pass adequate information along to the investors that bought them - and that the ratings firms themselves didn’t seem to want to look very closely at data that might have called into question their “AAA” ratings for many of the securities built out of such loans – formed the basis for much of the reaction of the financial press. For example, Cohan quotes the FCIC hearing testimony of law professor Kurt Eggert of Chapman University in Orange County, California: the investors “‘should have been given loan-level detail for every pool for which securities were issued…Instead, they got vague, boilerplate language about ‘underwriting,’ and that there were ‘substantial exceptions,’ whatever that means. They should have gotten the due diligence reports that we just heard described…Why weren’t they given the underwriting reports by the originators who knew what exceptions were given and why?’” (Readers should hang onto to this question, because we’ll later see some very damning answers as to “why” so many in what L. Randall Wray calls the “home finance food chain” were, and still are, so file phobic in the foreclosure fiasco). And Cohan also quotes the reaction of Felix Salmon, who writes a business column for Reuters: “‘if I was one of the investors in one of these pools, I’d be inclined to sue for my money back. Prosecutors, too, are reportedly looking at these deals, and I can’t imagine they’ll like what they find.’” In laying his article out the way he did, Cohan can’t help but be led to one of the questions troubling so many, and which we asked in the begging of this essay: why, “so far, not a soul on Wall Street has been found to be criminally liable for the practices that led to the financial crisis?” Here’s the article at
http://opinionator.blogs.nytimes.com/2010/10/14/how-wall-street-hid-its-...

Trying to Put the Beans Back In
These were important revelations and questions flowing out of the hearing, to be sure, and ones that many citizens might have missed, given the poor coverage of the Commission hearings, the fact that this one was held in California, and that there also was a major election dominating the fall news. But what really caught our attention was an “Update from October 15” tacked on at the very end of Cohan’s article: “In a surprising turn of events, Paul Bossidy, Clayton’s chief executive, wrote this letter to the F.C.I.C. on September 30th, a week after the hearing, disavowing Beal’s sworn testimony.” It was more than a hint that very sensitive and important issues to Wall Street had been given attention they didn’t like, and Clayton’s pushback was a sign of just how much the stakes were growing. And that led us to Shahien Nasiripour’s (business reporter at the Huffington Post) coverage of the implications of the pushback in his article from October 5th, “Pandering to Clients, Firm Distances Itself From Wall Street Whistleblower’s Testimony,” which supplies even greater detail than Cohan’s.

Now it’s not so easy to impugn the testimony of a former president whom a company’s own SEC filing from 2007 described as “‘difficult to replace’ and whom the firm depended on ‘in large part’ for its ‘future success,’” according to Nasiripour’s account. But that’s what Clayton attempted to do in its push back efforts, claiming that Clayton was never actually offering the reports and data in question, just it’s overall services, and then going a step further to indicate that these were very preliminary and contingent data sets that hadn’t been properly vetted - you get the idea. Reporter Nasiripour had his own pushback against Clayton’s revisionism: “But even if those reports were bogus, Clayton never indicated that during public testimony, despite ample opportunities. During the hearing, Johnson testified alongside Beal in an almost conversational format …Beal was flanked by legal counsel for Clayton. At no point did Beal or a Clayton attorney interject and try to rebut Johnson or challenge his claims.”

How damaging was former president Johnson’s testimony on the flawed mortgage loans the Wall Street banks would later process and sell as mortgage-backed bond/derivatives to its clients? Joshua Rosner, managing director at Graham Fisher & Co., and a commentator who shows up in quite a few business press articles, weighs in this way in the Huffington Post piece: Johnson’s testimony “‘should have a phenomenal effect legally, both in terms of the ability of investors to force put-backs and to sue for fraud…’” Oops, there’s that word again, fraud. Here’s the posting at
http://www.huffingtonpost.com/2010/10/05/clayton-holdings-financial-cris...

But not everyone would agree about the investors’ chances, or whether D. Keith Johnson, the former head of Clayton, was the hero/whistle-blower Nasiripour defends in this article. We are referring to Yves Smith, over at the nation’s most popular financial blog site, Naked Capitalism, which we have recommended to our readers and which we visit regularly. On September 28th, 2010, Yves had a post suggesting that Mr. Johnson was trying to shift the blame off his employers, the investment banks, and onto the ratings agencies who weren’t interested in his data. She also wondered why, given the information Clayton obtained in these reports, Mr. Johnson didn’t go to the SEC or the media, and apparently waited until 2010, when she says the three year statute of limitations on securities underwritings would have run out. She also claims that Clayton didn’t surface in the saga of mortgage troubles until “January of 2008, when the New York Attorney General’s office announced that Clayton had been granted immunity and would be providing information to the prosecutors on Wall Street’s bad practices in subprime land. Why on earth did Clayton need immunity? And what from?” She also reminds us that we haven’t heard back from AG Andrew Cuomo (now NY Governor) on the outcome of his investigations, and that seems still to be the case in early January of 2011. But, as we said above, we’re intrigued by the pushback against Clayton, and we were curious too about Clayton’s role in a $102 million dollar settlement with the Attorney General of Massachusetts in June of 2010, a settlement against one of the surviving Wall Street banks, Morgan Stanley, a role mentioned both in Yves Smith’s posting and Gretchen Morgenson’s NY Times article from September 27th. Here is Yves’ posting at
http://www.nakedcapitalism.com/2010/09/rating-agencies-the-subprime-blam... . . (And yes readers, that AG would be none other than Martha Coakley, who lost that painful special election for the US Senate to Scott Brown on January 19th, 2010.)

Morgan’s Morass in Massachusetts, 2005-2007
Now Yves Smith’s spin on the Massachusetts’ settlement is that Morgan Stanley was heeding Clayton’s due diligence findings and weeding out a substantial number of poor quality loans from the notorious and failed subprime lender New Century, whose bankruptcy “in March of 2007 marked the real trigger point for the financial crisis.” But with New Century running into trouble with other Wall Street funders on the same poor loan quality grounds, Morgan Stanley plays the seemingly gallant rescuer and buys more loans “in an attempt to keep the lender afloat,” according to Ms. Smith. So with these institutional heavies in the foreclosure/subprime saga seemingly converging here in yet another settlement matter, we thought we would take a closer look and downloaded the unusually detailed three page press release from the Massachusetts’ AG’s office, and the 37 page Assurance of Discontinuance,” both dated June 24, 2010. Based on what we found in this longer document, we’re going to have to respectfully disagree with Yves on this one, but we’ll give you the grounds so you can make up your own mind. It seems to us that based on this Assurance document, that Morgan Stanley, rather than aiding and abetting New Century, given Clayton’s findings of so many dubious loans, ought to have, just as Ms. Smith suggests that D. Keith Johnson should have done, gone to the SEC, the Federal Reserve or other pertinent regulators to blow the whistle on New Century. We quote now from pages 9 and 10 of the legal settlement document:

#24. In late 2005 and early 2006, Morgan Stanley began rejecting greater numbers of New Century loans as a result of these findings. By March 2006, New Century complained about these rejections and pressured Morgan Stanley to increase the percentage of New Century’s offered loans it purchased, suggesting that it would begin shifting its business to other buyers.

#25. In April of 2006, as Morgan Stanley wrestled with the possibility of losing New Century’s business, Morgan Stanley’s subprime mortgage team discussed a number of possible responses to this situation. As a result of these discussions, one of Morgan Stanley’s senior bankers purchased loans that Morgan Stanley’s diligence team had initially rejected. According to Morgan Stanley’s records, 228 loans were purchased in this way. Morgan Stanley’s diligence team began to be more responsive to New Century’s desire to include additional loans in the purchase pools.

#26. In Morgan Stanley’s 2006-2007 New Century pools, the large majority of loans reviewed by Clayton were identified by Clayton as having some types of exception. Most loans had multiple exceptions…

#28. During 2006 and 2007, Morgan Stanley waived exceptions on and purchased a large number of loans found by Clayton to violate guidelines…and purchased a substantial number of New Century loans found by Clayton to violate guidelines without sufficient compensating factors. (Our Emphasis.)

Here’s the link at:
http://www.mass.gov/Cago/docs/press/2010_06_24_ms_settlement_attachment3...

The press release is here at: http://www.mass.gov/?pageID=cagopressrelease&L=1&L0=Home&sid=Cago&b=pres...

(Editor’s Note: Unlike some other legal settlement documents, these are actually quite readable and can serve as a primer for the more generic relationships between Wall Street banks and the mortgage originators, especially the Assurance document here, in PDF format. And it has pretty straightforward definitions of terms used as standards for judging the quality of loans made by the originators, getting into matters of appraisal quality, proof of income (the “Stated Loan” category of lending) and measures (stated as ratios) which show just how catastrophic the variable interest loans were when the rates reset after the initial “teaser” period – details to be sure, but part of the evidence trail needed to build a case for successful legal actions against the major players in this system. And system it certainly was: mortgage originators, due diligence firms, ratings agencies, Wall Street banks, and the “servicers,” the four largest of which are banks themselves. We are by no means singling out Morgan Stanley here. They just happen to be the bank caught up in this particular settlement and the cross references stemming from Clayton’s unfolding role as it surfaced via testimony in front of the Financial Crisis Inquiry Commission.)

But it turns out that the pushback by the due diligence firm Clayton against its own former president wasn’t the only instance of sworn public testimony being challenged this fall. Another symbolically, and perhaps substantively very important instance surfaced in late November. In this case, the refuted testimony came from an actual court proceeding, a personal bankruptcy one in New Jersey, as reported by Bloomberg News on November 30, 2010. Once again, it is the paperwork trail concerning mortgages and their notes, important for, among other things, foreclosure proceedings, which is at the center of the controversy. Before saying more about this case, however, it is time to introduce a couple of mortgage/foreclosure vocabulary terms which will continue to surface in whatever you read about these matters over the next few months. And trust us, there is going to be a lot written about the legal proceedings on foreclosures.

A Primer on the Foreign Language of Foreclosure
In writing about one such case from Massachusetts, the Ibanez case in early January, 2011 Yves Smith at Naked Capitalism reminds us that “what we call a mortgage consists of two parts: the promissory note (the borrower IOU) and the lien (confusingly called the mortgage or in some states, a deed of trust.)” In other writings, she compares this note to a blank check, one for hundreds of thousands of dollars, which must legally be signed in “wet ink” by each new holder, no matter how many the links in the great chain of securitization that may be. Then comes University of Utah law Professor Christopher L. Peterson’s brilliant written testimony to the House Judiciary Committee on December 2, 2010 on the topic “Foreclosed Justice: Causes and Effects of the Foreclosure Crisis.” Peterson’s testimony is centered on the emergence of the MERS – the Mortgage Electronic Registration Systems, Inc. in the 1990’s, created by the large banks and other mortgage lenders, and all the trouble it is causing homeowners and the courts today. Because MERS has also become the near universal stand-in for all the investors and the managing trusts interwoven with the mortgage backed-securities derivatives, the legal troubles of MERS are sending shock waves throughout the entire mortgage-investment infrastructure, including the Wall Street banks themselves. We will take a closer look at what Peterson says (and provide you with a link to his testimony later in this essay), but for now it’s his command of the legal vocabulary surrounding foreclosures and mortgages that merits our attention. MERS, Peterson asserts, is claiming to be a “separate corporation that is acting solely as nominee for Lender and Lender’s successors and assigns” but also that “MERS is the mortgagee under this Security instrument,” and says lenders distributed this language in “boilerplate security agreements included in mortgages around the country.”

One problem causing the confusion, Peterson writes, is that “MERS purports to be acting as a nominee – a form of agent. On the other hand, it also is claiming to be an actual mortgagee, which is to say an owner of the real property right to foreclose upon the security interest. It is axiomatic that a company cannot be both an agent and a principal with respect to the same right.” So if MERS is the mortgagee, then it can record mortgages “in its own name,” but “both MERS and financial institutions investing in MERS-recorded mortgages run afoul of longstanding precedent” from “a still vital line of cases” from the 19th century which have held that “mortgages and deeds of trust may not be separated from the promissory notes that create the underlying obligation triggering foreclosure rights.”

Bank Pushing Back Against Damaging Court Room Testimony
And that’s exactly why the personal bankruptcy case from New Jersey looms as so important, and why testimony from a Bank of America employee was brusquely refuted by an attorney’s from a Washington, DC law firm speaking for the bank. According to the Bloomberg article of November 30th by Prashant Gopal and Jody Shenn, witness Linda DeMartini, who came to Bank of America when it acquired Countrywide, and who had a decade of experience with that loan originator in management and training positions, testified in 2009 “that it was routine for the lender to keep mortgage promissory notes even after loans were bundled by the thousands into bonds and sold to investors…” The U.S. Bankruptcy Judge, Judith H. Wizmur, apparently believed DeMartini, because she ruled that the homeowner’s mortgage company, “now owned by the Bank of America, had failed to deliver the note to the trustee.” The attorney for Bank of America said that “it was the policy of Countrywide Financial Corp…to deliver notes as called for in its securitization contracts…‘This particular employee was mistaken in what she said,’” the attorney asserted. Not only was De Martini mistaken, but so too, apparently, was the local attorney for Bank of American, when he “argued in court that notes weren’t moved in part because of the risk of losing them,” said Larry Platt, a Washington attorney “designated by the bank (Bank of America) to answer questions about the case,” according to the Bloomberg article. This case, called the Kemp case because of the claim on the home of John T. Kemp, is drawing a lot of attention. Adam S. Levitin, a Georgetown law professor who testifies frequently on the foreclosure crisis, is quoted in the article as saying that “‘If the notes weren’t properly transferred to the trusts, then investors have the mother of all put-back claims…’” Yves Smith also weighed in on November 30 at her Naked Capitalism blog: “We have been told separately that a senior industry executive also said no one in the industry transferred the notes.” Here’s the Bloomberg article at http://www.bloomberg.com/news/2010-11-30/bofa-mortgage-morass-deepens-af...

Taibbi Visits the “Rocket Docket” Foreclosure Court in Florida
It was also in November of 2010 that we came across two articles which, in none-too-subtle ways, again called our attention to the possibility that much of what happened in the subprime lending system from 2005-2007 was out-and-out fraud. The first was by the now well-known journalist Matt Taibbi of Rolling Stone magazine, who had the “visionary” idea to actually spend some time in a foreclosure court, listening to the proceedings and calling in the necessary specialists to translate for him – and us. His findings reminded us of Vinny Daniel’s reaction to that first accounting assignment of his – to audit Wall Street’s Salomon Brothers’ books – in The Big Short: “opacity.” Here’s Taibbi’s take, early in the article: “Like everything else related to the modern economy, these foreclosure hearings are conducted in what is essentially a foreign language…It took days of interviews with experts before and after this hearing to make sense of this single hour of courtroom drama.” It’s a measure of what Taibbi came up with that we counted about 21 uses of the term “fraud,” or its near equivalents, in his 12 page article.

We need to point out that Taibbi ended up sitting not in a regular court room, but in a special housing court that was set up by the Florida legislature in July of 2010 with a specific mandate to clear out at least 62% of the backlog of foreclosures that were jamming up the regular Florida court system. It’s presided over by retired judges, and it’s pretty clear that Taibbi is none-too-impressed by the one presiding when he visits, and, as we’ll see, the judge later has a chance to exchange professional evaluations with Taibbi, so to speak. We, in turn, “judge” this article to be one of the best we’ve read to enable readers take a quick introductory course in the foreclosure fiasco. One of the things that recommends it most is the fact that Taibbi found a way to ground himself in actual case realities, so that he ends up tempering his white-hot accusations – and generalizations - about the causes of our financial crisis – with the facts that are – or aren’t - in actual physical folders sitting on a table in front of a judge. These folders and their missing facts also stand in for legal and economic justice for US citizens about to lose their homes.

Let’s look at two cases that came to the court’s attention, in just that one hour of court time. The first is about a couple from Jacksonville who have fallen behind in their payments – and their case is in court for the second time. They’re lucky enough to be represented by an attorney, James Kowalski, one with a growing national reputation. Most of the cases that come before this court have no defense counsel, and in most instances the defendants don’t show up, and Taibbi makes it clear that at least this judge is ready to stamp “foreclosed” on these without looking too closely at the details of the files. Florida is one of 23 states, “judicial foreclosure states,” that require a judge’s approval before eviction. The first time through the case was a wash because in just three contradictory paragraphs, the plaintiff, Bank of New York, claimed that it “ ‘owns and holds the note,’” that the note also was “ ‘lost or destroyed,’” and finally that “‘plaintiff cannot reasonably obtain possession of the promissory note because its whereabouts cannot be determined.’” But low and behold, Taibbi writes, they’re back in court, several months after the first case was dismissed, this time with the note and one that appears to be properly stamped. Only now the dates for the chain of possession of the notes don’t make sense (Taibbi, as he is known to do from time to time, states this much less formally than we have), and JP Morgan and a “new” firm called Novastar now appear to complicate the chain and the timing of the alleged possession of the note. Then there is a added problem about that newly found and stamped promissory note; Bank of New York is going to do a little legal “hedging”: “ ‘Plaintiff owns and holds the note,’” it claims, “ ‘or is a person entitled to enforce the note,’” Taibbi writes. In other words, we’re back to what law professor Peterson taught us in his testimony just a few pages ago: “a company cannot be both an agent and a principal with respect to the same right,” or, put another way, can’t be both mortgagee and nominee - “a form of agent.” The judge doesn’t, however, dismiss the case and make a ruling; the bank in question will get yet another shot, 25 days later, “to come up with better paperwork,” in Taibbi’s skeptical words.

In the last case Taibbi brings to our attention, the defendant, “a recent divorcee delinquent in her payments,” is in court representing herself, what is called a “pro se defendant.” She catches an unexpected break when it turns out that the lawyer working for the firm standing in for the banks turns out not to have the legal folder at all – so the judge has no paperwork in front of him. The case will come back for a hearing at a later date though. But Taibbi decides, spontaneously, apparently, that he wants to talk to the woman facing foreclosure. So he leaves the court room to follow her. The judge has other ideas, very different ones. He apparently has heard of Taibbi’s work: “‘This young man…is a reporter for Rolling Stone. It is your privilege to talk to him if you want…It is also your privilege to not talk to him if you want.’” Please note the language, if we may, for moment, get “legal” with a judge: privilege is it, and not a right, to talk to a reporter? Apparently it is a privilege in the eyes of this judge. Taibbi writes that the attorney who has helped bring him into the court “receives an e-mail from the judge actually threatening her with contempt for bringing a stranger to his court,” and going further, that “‘we ask that anyone other than a lawyer remain in the lobby.’”

But that’s after the fact. Taibbi does manage to catch up with the woman facing foreclosure, Shawnetta Cooper, who does manage to have her own file with some interesting paperwork. And Taibbi is quick to pounce: “It’s not hard to find the fraud in the case. For starters, the assignment of mortgage is autographed by a notorious robo-signer – John Kennerty, who gave a deposition this summer admitting that he signed as many as 150 documents a day for Wells Fargo.” According to Kennerty, Wells Fargo got the mortgage on May 5, 2010 but Cooper’s file has a document which shows that Wells Fargo sued Cooper on February 22nd, 2010; “In other words, the bank foreclosed on Cooper three months before it obtained her mortgage from a nonexistent company.” (Wachovia, that is.)

It’s instances like these that lead Taibbi to proclaim that “virtually every case of foreclosure in this country involves some form of screwed-up paperwork. “‘ I would say it’s pretty close to 100 percent,’ says Kowalski.” Attorney James A. Kowalksi of Jacksonville, Florida, should know a bit about it; he was the attorney who blew the whistle on the robo-signing practices of GMAC (General Motors Acceptance Corporation), in a case in Pennsylvania in 2006 (our eyes widened when we read that date and thought about the implications) where he wasn’t looking for trouble – he was just taking “what he thought would be a routine deposition.” Now he’s been asked to testify in front of the House Judiciary Committee (in Panel II, along with our University. of Utah law professor), and has done so on December 2nd with a compact and powerful five page statement (which can be found at the link for Professor Peterson.) A Legal Aide attorney who Taibbi quotes in his article right after Kowalski takes it a bit further than “screwed-up paperwork”: “‘The fraud is the norm,’ she says.”

There’s an interesting tension that runs throughout Taibbi’s description of what he found from his visit to Florida’s special housing court – what is called by locals the “rocket docket.” It’s one that should be familiar now to our readers, because it’s one we’ve repeatedly called your attention to, what Brown University political scientist James A. Morone has named the “Great American Moral Dialectic”: who do we blame when things go badly wrong - individuals or “society?” (See his book, Hellfire Nation:The Politics of Sin in American History.) We called your attention to this dialectic during the health care debate. Now it runs right down the center of the still growing, and already massive foreclosure crisis.

Taibbi begins by making clear where he stands on the new Florida special courts: “Their stated mission isn’t to decide right or wrong, but to clear cases and blast human beings out of their homes with ultimate velocity. They certainly have no incentive to penetrate the profound criminal mysteries of the great American mortgage bubble of the 2000’s, perhaps the most complex Ponzi scheme in human history…” But the average citizen isn’t following this story closely: they understand that many people are losing their homes, and “that some of the banks doing the foreclosing seem to have misplaced their paperwork.” The personal sin side of this equation is about “homeowners not paying their damn bills.” As one bartender in Jacksonville tells Taibbi they “‘had it coming to them.’” But throughout the essay Taibbi chips away at the sin side, by spelling out in detail the three cases that pass before him – all of which involve borrowers falling behind in their payments – yet presenting the readers with the overwhelming impression that the entire mortgage-banking-foreclosure system has broken down, and worse: it is deeply involved in a many-faceted program of outright fraud. And that represents the corrupt economic system side of the dialectic. He doesn’t condone those borrowers who knew better and tried to take advantage of a system that was at the same time clearly trying to take advantage of them – after all, there is such a thing as American culture, “the culture of take-for-yourself now, let someone else pay later wasn’t completely restricted to Wall Street…

But many of these homeowners are just ordinary Joes who had no idea what they were getting into. Some were pushed into dangerous loans when they qualified for safe ones. Others were told not to worry about future jumps in interest rates because they could just refinance down the road, or discovered that the value of their homes had been overinflated by brokers looking to pad their commissions.

Indeed, our law professor Peterson, who is a bit more cautious in his judgements than Taibbi, states in his congressional testimony that “one former mortgage lender has estimated that in the mid-2000’s approximately 70% of brokered loan applications submitted to mortgage lenders involved some form of broker encouraged fraud.” (That would be, we learn in a footnote, Richard Bittner, from his book Confessions of a Subprime Lender: An Insider’s Tale of Greed, Fraud and Ignorance, 2008)

Taibbi is busily at work, tugging on those moral scales that hang just above the dialectic, however, tipping them over, bit by bit, case by case, from the self-sin side to the societal-economic side: “in reality, it’s the unpaid bills that are incidental and the lost paperwork that matters. It turns out that underneath that little iceberg tip of exposed evidence lies a fraud so gigantic that it literally cannot be contemplated by our leaders…”

Taibbi keeps working those scales, part crusader, part detective, until he reaches the conclusion that all the little paperwork problems are pointing him towards a devastating conclusion:

Why don’t the banks want us to see the paperwork on all these mortgages? Because the documents represent a death sentence for them. According to the rules of the mortgage trusts, a lender like Bank of America, which controls all the Countrywide loans, is required by law to buy back from investors every faulty loan the crooks at Countrywide ever issued.

Here’s the link to Taibbi’s article at http://www.rollingstone.com/politics/news/matt-taibbi-courts-helping-ban...

(Editors Note: It would seem that Taibbi is once again on target and ahead of the curve here, having written this in November (we downloaded it November 10; it appeared in the November 25th newsstand edition of Rolling Stone). On Monday, January 3, 2011, Bank of America announced it had reached a settlement with Fannie Mae and Freddie Mac to buy back some of those “troubled” Countrywide loans that these much maligned quasi-public lenders, aka GSEs, originally bought - $2.5 billion worth in this case. The New York Times article which reported the settlement put the banking industry’s potential collective buy back from Fannie and Freddie, insurance companies and other private investors at somewhere between $20-$150 billion – quite a bit of a projected “markdown” from the estimated total of $2 trillion dollars of bad loans that were originally pedaled. Here’s the Times’ article at http://dealbook.nytimes.com/2011/01/03/fannie-and-freddie-continue-to-co... . Please take notice as well that the article reports that “Fannie and Freddie are also looking to collect from other large lenders, including Wells Fargo, Citigroup, and Washington Mutual, now owned by JP Morgan Chase.”

Everywhere You Look in Foreclosure Land: Fraud, Fraud, Fraud
It isn’t just red-hot Rolling Stone reporter Taibbi who is on the fraud trail. Purely by chance, we were steered to a Florida paper, The Palm Beach Post, where reporter Kimberly Miller writes on January 9th that a “comprehensive presentation given last month by investigators in the Florida attorney general’s economic crimes division meticulously outlines problems in how banks went about taking back those homes. The report includes pages of allegedly forged signatures, false notarizations, bogus witnesses and improper mortgage assignments. It implicates the banks, their servicers and law firms for contributing to the foreclosure conundrum.” Florida is such a documented mess that the New Jersey court system is citing “flaws in six Florida foreclosure cases,” on its way to a possible shutdown of ongoing foreclosures in the Garden State, and “where six of the nation’s largest lenders are expected at a Jan. 19th hearing to show proof why the courts should not stop their foreclosures.” (Editors note: We thank reporter Miller for filling us in on further Florida findings and proceedings, but, as we observed on January 10th, with an online posting to her story, we were curious as to why she didn’t mention the special court system that the Florida legislature had set up in July, the one Taibbi mentions, because the thrust of her article is that Florida itself is in “the docket,” the title of her newspaper article being “State Guilty of ‘delusional behavior’ in slow response to foreclosure chaos, critics say.” But hey, that’s part of our job, to make connections and help fill in some of the missing pieces from the fragmented nature of journalism today.)

If Matt Taibbi takes his time and grounds his conclusions of massive fraud based on a close look at cases from one day in Florida’s special “housing court,” economist L. Randall Wray’s (Professor of Economics at the University of Missouri-Kansas City) article, which appeared on the New Economic Perspectives blog site on November 23rd, is an all-out polemic against the mortgage lending “finance food chain…every link” of which “was designed to promote fraud.” That’s what Wray says in his opening sentence and he doesn’t let up for four pages. On page two he cuts right to the chase on all those lost and then contradictory foreclosure documents: “The truth is that the banks purposely destroyed the documents and created a superficially sloppy system because that made it easier to perpetrate fraud – accounting fraud, tax fraud, and document fraud – in order to enrich management. Fraud, Fraud, Fraud.” We learn from his article that “The Florida Mortgage Bankers Association admits that its members purposely destroyed the notes on the belief that electronic registry was sufficient, more modern, and carried no paper trail…Most notes were probably never transferred from the brokers – many of whom went bankrupt – putting mortgages and securities into a hellish limbo.”

MERS Mimics for REMICs
A good portion of Wray’s polemic is devoted to the wonders of MERS, that electronic registry system for mortgages that we introduced earlier in this essay, and that we will return to very shortly when we take a closer look at Professor Peterson’s congressional testimony about it. Wray wants to introduce us, however, to yet another possible fraud angle involving MERS. This one centered upon tax fraud, which means that once again, just as Peterson maintained, MERS is caught up in at best, contradictory claims, and at worst, fraudulent ones, involving the IRS rules governing REMICS – Real Estate Mortgage Investment Conduits. REMICS are supposed to be the resting places for mortgages “that were typically securitized and pooled,” and under detailed IRS regulations, the paperwork must show that the REMICS hold the mortgages in trust, and Wray adds that “there must be a clear paper chain of title through the securitization and sales. Without the paperwork, the securitizations may not be legal, and could subject investors to back taxes and penalties. And in 45 states the notes are require for foreclosure.” And remember too, that as a matter of established law, according to Professor Peterson, the notes and the mortgages cannot be separated. So what’s the problem here? Well, according to Wray, MERS claims to physically have possession of the mortgages (or remember the hedge, be an agent for the mortgagee!) so that it can avoid paying the repeated fees to the county registry offices, as the mortgage loans continually change hands, but the IRS law (and NY Trust law) require that the REMICS must have them to get the tax break. We suppose that next MERS and REMICS will get together and claim that because of electronic transmission at the speed of light – the actual mortgages and their notes can be in two places at once, virtually, at least. Unfortunately, the law still seems to require physical possession of the documents. Oops. Wray doubts they can pull it off: “So MERS wants it both ways at once: for the purpose of the REMIC tax advantage, MERS is only a database; but for the purpose of the securitizations and avoidance of county fees, MERS is the owner of the mortgages. Nice work if you can get it – tax evasion and fee avoidance.”

Now there was an additional point to Wray’s yelling “FRAUD, FRAUD, FRAUD” in the already fraud-wrought mortgage-foreclosure-housing “marketplace.” He wanted us to support Representative Marcy Kaptur’s (D, Ohio) bill, H.R. 6460 (in the old 111th Congress, 2009-2010) that would forbid Fannie and Freddie from purchasing any new mortgage that is registered with MERS, (a big step, because no one else is buying them) and that would get HUD to study “the creation of a federal land title system to replace MERS while protecting the rights of state and local governments.” This bill came in response to the mortgage industry attempts to fully legalize MERS and the current mess of the status quo with the Congressional passage of the “Interstate Recognition of Notarizations Act of 2009,” (that should have been of 2010) which President Obama pocket vetoed on October 8th, 2010. According to the New York Times article from Oct. 10th, this bill “had sponsors from both parties and was so uncontroversial in Congress that it passed without roll-call votes – in the House by a voice vote in April and in the Senate by unanimous consent last week.” The House was unsuccessful in attempting a veto over-ride on November 17th, failing to get the 2/3 majority needed by a 185-235 vote. The bill may have been “uncontroversial,” but when we checked the Congressional record at “Thomas,” the bill, H.R. 3808, had only three house sponsors and two senate ones – usually not an indicator of an uncontroversial bill – more a hint that many didn’t want to be on record for supporting a bill that doesn’t exactly have the “saints marching in” behind it. So was it stealth or lack of controversy? Well, based on what we’re about to cover on MERS, perhaps it’s just as well that it was stealth, because the idea that so sweeping a transformation of four centuries (in some cases) of real property law, rooted in public county recording systems and authorized by each state’s land title statutes could change without a sustained congressional debate – or one in statehouses – and without controversy, doesn’t leave we citizens with much reassurance about a fair and equal process. Here’s the link to Wray’s article at http://neweconomicperspectives.blogspot.com/2010/11/support-representati... . But now it’s time for an even closer look at MERS and what may have been going on in that sweeping congressional vote.

MERS: “…a deceptive and anti-democratic institution…”
We’ll take that closer look starting with that startling testimony presented to the House Judiciary Committee by Professor Peterson of the University of Utah on December 2nd, 2010. It’s remarkable as much for its boldness as its clarity – and clarity about MERS and the foreclosure process is not easy to come by. We’re hoping that those members of Congress who were voting by “acclamation” to ratify MERS just a few months earlier sat up and noticed what he said in the very beginning of his statement: “…that MERS is a deceptive and anti-democratic institution designed to deprive county governments of revenue…undermining mortgage loan and land title record keeping.”

His testimony should also have an ironic ring to it for American conservatives and Tea Party members. We don’t know what Professor Peterson’s political sympathies are, but in this testimony he’s a defender of a state and county based law and land/mortgage recording system (real property lien system, in contrast to the personal property lien recording system usually maintained by Secretaries of State, which includes corporate registries) that, depending on the state, has been around since the 17th century in some cases, and one that if it is going to be dramatically altered by the private banking/mortgage “system,” ought to at least have a full public debate in the statehouses, and the Congress, if it comes to that. Here’s how he goes about structuring his criticism of what actually unfolded with the creation of MERS, Inc., the Mortgage Electronic Registration Systems, Inc., based in Reston, Virginia and whose parent company goes by the name MERSCORP, Inc. The rough outline is this:

In the mid-1990’s mortgage bankers decided they did not want to pay recording fees for assigning mortgages anymore. This decision was driven by securitization – a process of pooling many mortgages into a trust and selling income from the trust to investors on Wall Street… to avoid paying county recording fees, mortgage bankers formed a plan to create one shell company that would pretend to own all the mortgages in the country…Even though not a single state legislature or appellate court had authorized this change in the real property recording, investors interested in subprime and exotic mortgage backed securities were still willing to buy mortgages recorded through this new proxy system…Now about 60% of the nation’s residential mortgages are recorded in the name of MERS…For the first time in the nation’s history there is no longer an authoritative, public record of who owns land in each county…County real property records that hold only a reference to the MERS system now have a systemic break in chains of title.

“…a corporate structure so unorthodox as to arguably be considered fraudulent.”
Although he doesn’t get into the tax fraud charges that we have just seen L. Randall Wray make over the IRS rules pertaining to the securitization trusts, the REMICS, which also claim to hold legal title to the mortgages, Peterson notes the irony that they are “the same mortgages that MERS claims to own,” and has a blunt legal observation to add to the irony: “Anglo-American law includes no tradition that supposes two different simultaneous legal titles for the same interest in land.” Peterson maintains that MERS legal position at several crucial points is “incoherent”; but so too is its corporate structure, one that is “so unorthodox as to arguably be considered fraudulent.” That’s the strongest charge in the testimony, aside from the political one that MERS is a “deceptive and anti-democratic institution,” and the fiscal one that it has been deliberately “designed to deprive county governments of revenue.” Given the normal run of congressional testimony, we’re wondering why these accusations haven’t been splashed across the front pages of newspapers, and Peterson celebrated all across the political spectrum for sounding the alarm over such troubling and unsanctioned alterations in long-standing legal structures.

So what is it about MERS corporate structure that is arguably fraudulent? Could it be that despite taking on the responsibility for tens of millions of mortgages (60% of some 47 million) and the perhaps even greater challenge of tracking their many changes of ownership under the pooling, servicing and transferring arrangements demanded by “securitization,” MERS does it all with around 45 employees of its own (according to a Washington Post article from January 2, 2011)? So how could they possibly do that – they must be the world’s most efficient corporation; just shows you
what the private sector can do when turned loose, run rings around all those county recording clerks…Except that’s not what is going on: “MERSCORP simply farms out the MERS, Inc. identity to employees of mortgage servicers, originators, debt collectors and foreclosure law firms. MERS invites financial companies to enter names of their own employees into a MERS webpage which then automatically regurgitates boilerplate ‘corporate resolutions’ that purport to name the employees of other companies as ‘certifying officers’ of MERS.” So that’s how MERS manages to “grow the business” (as the business press would have it) into “twenty thousand assistant secretaries and vice presidents…even though neither MERSCORP, Inc. nor MERS, Inc pays any compensation or provides benefits to them.”

Now we aren’t attorneys, although we were accused of practicing law without a license in land-use matters in New Jersey (jokingly, we like to remember), but this sure sounds like more than “arguably fraudulent” to us, especially when Peterson chimes in that “MERS even sells its corporate seal to non-employees on its internet web page for $25.00 each…(That comment left us wondering about the first case Matt Taibbi described for us in his visit to the rocket-docket housing court in Florida, where attorney Kowalski is looking at documents in their second round of court hearings: “ ‘There’s a stamp that did not appear on the note that was originally filed,’ Kowalski tells the Judge. (This business about the stamps is hilarious. ‘You can get them very cheap online,’ says Chip Parker, an attorney who defends homeowners in Jacksonville.”)

A corporate structure that is “arguably fraudulent.” But MERS also has an elusive, yet seemingly very useful “dual” legal identity that pushes hard against homeowners when it is in “foreclosure” mode, but then, when homeowners are lucky enough to get their own legal representation to push back with “counterclaims challenging the legality of mortgage brokers, lenders, trusts, or servicers, MERS hides behind its claim of nominee status.” Now Professor Peterson has some very interesting and complex things to say, at this point of his testimony (Page 13) about how MERS has facilitated keeping “predatory lending litigation” separate from “foreclosure litigation,”and how MERS serves as a legal shield, and then proxy, for the subsequent owners of the mortgage interest of the first lenders - firms like Countrywide - which attracted lots of “predatory lending litigation.” To be blunt, Peterson says “that MERS abetted a fly-by-night, pump-and-dump, no-accountability model of structured mortgage finance.”

Peterson does not stop at this accusation, however. He reaches perhaps his finest powers of “jury persuasion” when he issues two magisterial summations that further illustrate powerful and troubling economic trends that we have been writing about for almost three years now. The first is that “MERS represents the mortgage finance industry’s best effort to create a single, national foreclosure plaintiff that always has foreclosure standing, but never has foreclosure accountability.” The second, which had occurred a few pages earlier, also advances the one, “universal market” theme,” but adds yet another dimension: usurpation of public functions: “MERS’ attempt to ‘capture every mortgage loan in the country’ is an effort to supplant the public land title recording systems’ lien records, many of which predate the Constitution itself, with a purely private system.” (Our emphasis in both quotes.)

So perhaps John Grey, writing in False Dawn: The Delusions of Global Capitalism (1998), which we recommended for our summer reading list in August of 2010 (See Summer Reading for When Markets Rule), was not so far off base when he stated that the United States’ pursuit of the world’s purest brand of “free markets” was the last Utopian project bequeathed to us by the Enlightenment of the 18th century. Already by 1998 Gray was dubious that the American push for “a single global market,” one driven in part by the Enlightenment ideals of efficiency and reason (and the pursuit of lusher markets and higher profits in the distant geography of “emerging markets”) was going to succeed; the world was pushing back with many different types of capitalism, and a good part of it was not anxious to build their financial sectors around Wall Street’s preferences. There was another major strand of thought in his book, though: “democracy and the free market are competitors rather than partners.” Of course, as so much in Grey’s book, that notion ran against the conventional wisdom of center-right thinkers like Francis Fukuyama and his book The End of History and the Last Man (1992), but writing as social democratic observers of the past 30 years, we couldn’t fail to notice the implied higher sovereignty of financial markets, especially the bond markets, over the range of economic policy choices available to candidates, wherever they might wish to appear on the political spectrum. And as we’ve written numerous times over 2009-2010, the threat of the bond “vigilantes” ride has come back to dominate economic policy discussion, in Europe, directly, and in the U.S., by putting debt and deficit reduction plans ahead of directly dealing with the appalling unemployment rate and the reality of 10-13 million foreclosures. Despite all the damage caused by the Wall Street “doomsday machine” financial model, it certainly looks as if those close to the Street are still in charge of policy, confirmed by President Obama’s choice of William M. Daley as his new Chief of Staff and Gene Sperling as head of his economic team.

With these thoughts in mind, we have to admit that we were still struck with amazement, if not complete surprise, to discover the story of MERS and foreclosures. As Professor Peterson tells the story of its creation in his testimony, it is a clear tale of concentrated financial power executing an end run around long standing legal precedents and political traditions. Furthermore, and this adds to our sense of amazement, MERS was doing it on the sacred playing field of land-ownership property and recording traditions, and the clear prerogatives of local and state government in this area, going well back, in some cases, before the adoption of the U.S. Constitution. Not only that, but the counties were losing a substantial source of revenue (just how much we’ll see in a moment). How was this possible to pull off, without so much as ever reaching our ears and eyes until the past three months? What force of man, or nature, could divest counties of a substantial source of revenue without even so much as a political murmur? MERS was organized in 1995 and actually up and running by 1997, and this story is just breaking now, fifteen years later. Should we take Professor Peterson’s testimony at complete face value?

How did MERS pull it off?
The Washington Post had an interesting article on January 2, 2011, entitled “First, the electronic mortgage superhighway. Then, the pileup.” Matt Taibbi’s second Rolling Stone article on foreclosures (posted on January 1: “An Extremely Long Metaphor to Explain Mortgage Chaos.”) called our attention to it, and we were curious to see who turned up in the account, and how MERS was handled.

First, there is a quote from Professor Peterson, the one about MERS structure being “arguably fraudulent.” That was a bit of a surprise, being strong stuff. But what about the important issue of MERS avoiding political authorization for what it has created, either in Congress or the states (after it was created, it did get Minnesota to ratify what it was doing, the only state to bring its land recording act in line with MERS’ wishes.) Well, there it was on the very first page, a sort of oblique answer to Peterson’s accusations, without every mentioning what we quoted. MERS, in the organizational form of the Mortgage Bankers Association (MBA) apparently went to the “county recorders” to “unveil” its plans on March 4, 1994. There were critics, and their reservations are noted at several places in this article by Arian Eunjung Cha and Steven Mufson, but it is not clear if it was put before “the county recorders” for a formal vote, and if it was, what the results were. We do learn that Mark Monacelli, “a county recorder in Duluth, Minnesota, who was the lead negotiator for the association representing recorders from most of the nation’s 3,600 counties,” didn’t like the way it came out: “‘MERS turned out to be something completely different than what we originally thought.’” We do learn, later in the article that “in the mid-1990’s, some of the recorders lobbied states and Congress for legislation to block the creation of MERS but failed.”

This is fascinating stuff to us, because the term “negotiator” for the “association” implies some form of semi-formal rule making process between the MERS promoters and a category of county employees – which does a very good job of evading the question Peterson poses: why wasn’t state legislative authorization sought, or county by county approval by freeholders, or by Congress, if indeed that body has the constitutional authority to override long traditions of state law practice in this area? The article doesn’t make it clear: who in government authorized Mr. Monacelli to be “lead negotiator” and what legal and political “standing” did the results obtain?

Now taken as a whole, this was not a terribly favorable article for the idea of MERS, or its current state of functioning and standing before the increasing number, and variety, of legal eyes scrutinizing it. But two other aspects of the article trouble us. The first is the loss of revenue to the counties, which Professor Peterson gives emphasis too, without putting a magnitude on it. However, in this Post article, it is not a “lost revenue” issue for government at all, it is a cost and savings issue, and efficiency issue, for the mortgage bankers. A Merscorp spokesperson is quoted as saying “‘that it helps borrowers…has kept costs low….’” A bit later, MERS is touting that “it had saved the banking business $1 billion in recording fees and other costs.”(Transferring paperwork, for example).
Contrast this with Professor Peterson’s assertion, on page two of his testimony, that “in the mid-1990’s mortgage bankers decided they did not want to pay recording fees for assigning mortgages anymore.” It is footnoted, and in the footnote (number 10) he refers to an article by Phyllis K. Slesinger & Daniel McLaughlin, from 1995, “describing an Ernst & Young study commissioned by mortgage bankers to study how much money they could avoid paying to county governments through the MERS system.”

So how much revenue is MERS depriving county governments of? Matt Taibbi, in his New Year’s Day article, says “some estimates place the total at about $200 billion.” Others we’ve seen have said $30 billion. We decided to look further, and that led to an Associated Press article going all the way back to November 10, 2010, by Michelle Conlin and Curt Anderson: “Bypassing county fees may cost banks.” In it, we find a baseline figure of $2.4 billion coming from MERS CEO R. K. Arnold from testimony in 2009 which said that “assuming each mortgage it tracks had been resold, and re-recorded just once, MERS would have saved the industry $2.4 billion in recording costs.” Of course, the process of securitization means mortgages have changed hands up to twelve times, sometimes more, over their effective lives. So $30 billion over the years may be a rough ball park figure. But now the story gets even bigger, and this is the first we’ve seen this angle, so thanks to the Associated Press for it. Two lawyers in Reno, Nevada, according to Conlin and Anderson, “have filed suit in 17 states alleging that banks cheated counties out of billions of dollars…the suits were filed in California, Nevada and Tennessee and 14 undisclosed states where the case are still under court seal.” The lawyers, Robert Hager and Treva Hearne, picked these states “because their laws allow what are called false claim suits, in which citizens can take legal action against companies that may have cheated the government.” Because of the possibility of collecting substantial penalty fees, “the California suit alone could cost MERS $60 billion in damages and penalties from unpaid recording fees.” Perhaps that’s where Taibbi gets his huge figure from.

But these legal filings aren’t the only enlightenment which this Associated Press article offers. Another is to actually name what the Washington Post’s work called “the biggest players in the mortgage business – the MBA, Fannie Mae, Freddie Mae and Ginnie Mae” who set up MERS in the early 1990’s. The AP story, however, adds a few other names besides the favorite public whipping boys Fannie and Freddie, thereby clarifying things just a bit by expanding the Post’s rather truncated list: “MERS owners are all the big mortgage companies, including Bank of America, Citigroup, Wells Fargo, JP Morgan Chase and GMAC.” The CEO of JP Morgan, Jamie Dimon, we also learn, may have just caught a whiff of things to come when he stops using MERS for foreclosures in 2008.

The AP article also gives a slightly greater understanding of the missing political pieces of the puzzle: why weren’t the banks being challenged by the counties and the states when MERS was being set up, if for no other reason than loss of revenues – and there were plenty of other good reasons too:

Counties complained about the lost revenue after MERS was implemented, but they rarely tried to challenge the new way of doing business… ‘It smelled like it could be a scam from hell,’ said Gary Ott, the county recorder in Salt Lake County, Utah. From the beginning, many county officials were uneasy about the idea. But most were loath, and lacked the resources, to take on the financial industry. Those who did complain to legislators and reporters say they had a hard time getting anyone to take notice. (Our emphasis.)

One county recorder did challenge MERS. Edward Romaine from Suffolk County in New York State, saw the loss of $1 million a year of revenue – and that MERS failed “to even maintain a clear chain of title on a property.” He was supported by the Attorney General of New York, but MERS sued in 2001 and won on appeal in the highest state court. Conline and Anderson report that “the court found that a county clerk lacks the authority to refuse to record MERS transactions.” Now that’s a remarkable finding, it seems to us, because haven’t we just learned from the Washington Post article that MERS saw fit to “negotiate” with the county recorder’s association back in 1994 – all the more reason to ask where the higher ranking county, state and federal officials were back in the 1990’s when this system got rolling? But then again, that was the 1990’s, the culmination of the liberation of finance from governmental constraint.

Now let’s see: who was the President when all this was unfolding, 1992-1998? Wasn’t it the man with perhaps the most comprehensive knowledge of American politics ever to hold the office since FDR…none other than the great de-regulator himself, William Jefferson Clinton? President Clinton famously announced that the era of Big Government was over; he wasn’t as clear as philosopher John Gray has been as to what was going to replace it, but right here, as we’ve seen, out of a rear view mirror unfortunately, was the power of the financial industry, appointing themselves as the universal replacement for the old fashioned land registry system and a long-standing tradition of federalism, of state and county power in these matters. It was part and parcel of the trend towards the privatization of public functions. As the Right’s ideology demanded “no new taxes,” “smaller government” and “free markets,” old industrial towns in Pennsylvania saw their school boards try to raise revenue by swallowing the bait - and hooks - of Wall Street’s “interest rate swaps,” and other local governments swallowed too for the “variable interest rate bonds” offered in the now collapsed “auction-rate” market. Bloomberg news reporters Martin Braun and William Selway have written that “dozens of municipalities have paid banks billions to get out of swap contracts” gone bad. At least Citigroup and UBS had to give back some $7 billion in settlement costs for customers left hanging by the failure of the “auction-rate” market. Greece, struggling to make the cut-off limits for their public debt levels in order to get into the European Monetary Union in 2001, turned to Goldman Sachs for creative ways to raise cash by turning over formerly public revenue streams to private parties, including airport landing fees, lottery proceeds and highway tolls (according to the lead story in the New York Times from February 10, 2010: “Wall St. Helped to Mask Debts Shaking Europe.” The article also indicates that JP Morgan Chase was “helping” Italy in the 1990’s with currency rate swaps. Here at http://www.nytimes.com/2010/02/14/business/global/14debt.html.

Looking back over what we have just written, in light of President Obama’s State of the Union address from January 25, 2011, and the follow-up New York Times editorial just three days later (“Obama and Corporate America”), we are led to ask whether the still necessary yet subordinate role of the federal government outlined by him marks any significant reversal of the trends of the past 30 years, which includes his two Democratic predecessors, Jimmy Carter and Bill Clinton? One could make a better case, a decent one, for his first two years in office, on that score. Now, heading into 2011, we have his two key recent staff appointments – William Daley and Gene Sperling (plus the GE-Jeffrey Immelt honorary); his failure to even mention the bank-sensitive topic of foreclosure; his reiteration of what we thought “reinventing government” under Al Gore was all about – “merging, consolidating and reorganizing” the federal government, yet once again – we guess still not lean enough; the meekness and private sector deference with which he approaches the unemployment situation, placing the federal budget deficit and debt reduction as a clearly more important mission (with likely tragic consequences for the economy, and with the poorest citizens left as minor footnotes on the shrinking pages of the old social contract); the freeze on domestic spending, now extended for five years. Put all this together with the conservative austerity trend lines in the statehouses: attacks on public employees and their pensions, cutting spending, laying off workers, looking for ways, in many cases, to privatize public functions, all things the president did not talk about as he stressed the great race for international economic competitiveness, and a boiling down of the American Dream to the stark elements of entrepreneurship, innovation, and education – and what you have readers, is, as we said a year ago, “Everything a Moderate Republican Should Be.” This Center-Right ideological orientation, planted by Reagan in 1980 made better (but not great) sense applied to the domestic economy as it stood in the 1970’s, not as it stands today, in 2011, with our far greater maldistribution of wealth, imbalances in power between the private sector and public regulators and any countervailing civil powers, whether they be citizen movements or organized labor, references to which were also noticeably absent from the President’s speech.

If the facts surrounding the rise (and the character of) MERS are troubling to you, especially its emergence under the two terms of a Democratic president, and suggest, along with the many fraudulent features of the foreclosure crisis, more than just a few problems with this one-sided political economy sketched out for the nation by President Obama, wait until you see the role the banks played – with a leading one by J.P. Morgan Chase – in what unfolds next in Part II.

In Jefferson County, Alabama, in Philadelphia, Pennsylvania, in Milan and the Umbria region of Italy, JP Morgan bankers have been in trouble - some indicted, some convicted, some having served prison time already – because of their roles in a variety of municipal funding outrages, often involving complex interest rate swaps and other creative derivative devices, and nefarious connections with go-between financial “advisory” firms. Some of that we were already aware of, and wrote about in 2008, but what we just discovered by revisiting the Jefferson County-Birmingham, Alabama situation was that as many as eight JP Morgan bankers, along with six from Bank of America and eighteen employees from 16 other companies, including parts of General Electric and UBS AG, are in deep legal trouble for what two Bloomberg reporters are calling “the biggest criminal conspiracy in the history of the 198-year-old municipal finance market.” (involving Guaranteed Investment Contracts – GICs.)

The details will follow below, but what is most remarkable to us now, in light of the president’s State of the Union address, and the two “alternative” addresses we’ve recommended to our readers, is that JP Morgan Chase’s serious train of legal troubles were not enough to prevent the selection of William M. Daley as President Obama’s Chief of Staff (no reflection upon him personally), and what may be even worse for our republic, is that they were not even mentioned in the seven major media accounts we looked at commenting on Daley’s appointment. That’s despite the fact that one of the former JP Morgan bankers who pled guilty “to rigging investment contracts and derivatives in a federal antitrust investigation” did so at the very end of November, 2010, according to the Bloomberg account. He was the eighth person to have plead guilty in the criminal conspiracy, preceded a week earlier by a former star derivatives’ salesman for Bank of America. Even though it was happening in a federal courtroom in Manhattan (and not Kansas), and despite these two reporters’ good work in following the shadowy case, the pleas might as well have been happening on Mars, because no one else seems to be aware of them, or to be willing to “signify” them, least of all those serious “vetters” who work at the White House. But now…on to Part II of the essay.

House Tries to Bail Out Foreclosure Fraudsters, Again

Zach Carter — Wed, 17 Nov 2010 08:01:02 -0500

A month ago, President Barack Obama vetoed a bill that would have made it far more difficult for borrowers to prove that banks were engaging in foreclosure fraud. The bill was a complex, highly technical bailout for megabanks that have defrauded millions of borrowers, flaunted the rule of law and and driven our economy off a cliff. The legislation passed both houses of Congress quietly and without much attention, but once consumer advocates sounded the alarm, Obama rejected the legislation, and the bill appeared dead.

Not anymore. Despite widespread public anger and presidential rejection, the House will vote on the issue again today in an attempt to override Obama's veto. The legislation was reintroduced by Rep. Bobby Scott, D-Va. The bill would require every state to accept notary signatures from any other state. This essentially defeats the purpose of notarization itself, since a notary is supposed to attest to having first-hand knowledge of a specific case. If two parties sign a mortgage contract in Ohio, a notary from New York probably wasn't there to watch it happen.

In foreclosure fraud, this is important because banks are robo-signing documents in order to cover-up problems with their loan documentation. In the GMAC scandal that ignited the recent controversy, a robo-signer named Jeffrey Stephan had hundreds of thousands of these documents notarized in Pennsylvania, even though they concerned foreclosure cases all over the country. If courts have to accept out-of-state notarizations, it becomes much more difficult to demonstrate that GMAC is committing rampant fraud.

The bill would also allow notaries to sign-off on electronic documents-- something that also defeats the basic purpose of a notary. A notary is essentially a credible witness, but if they can sign off on electronic documents, they don’t have to be present at the signing of documents to collect fees. Somebody can forge a document, scan it into a computer, and ship it off to a notary for approval, replicating the GMAC scam online. Banks have been using electronic tricks to get around technicalities like "signatures" on "contracts" of late-- they scan a signature from one document and electronically copy it to others.

I don't have much more to say about this issue than I did in October. It's despicable for Congress to be contemplating a bailout like this for openly criminal activity.

Policymakers in Washington, D.C. are moving all over the place on the foreclosure crisis. Yesterday, key officials from Bank of America and JPMorgan Chase were grilled before the Senate Banking Committee. Consumer advocates and academics repeatedly caught the bank officials lying or misleading Senators about the way banks treat borrowers, and the incentives currently in place that encourage banks to illegally foreclose on borrowers. Committee members clearly wanted to appear angry-- Sen. John Tester, D-Mt., even said "some heads will roll" when he heard that banks actually encouraged borrowers to miss payments in order to qualify for loan modifications. This kind of thing happens all the time, and once the borrower actually misses a payment-- after being encouraged to do so by the bank-- the borrower gets foreclosed on.

But at the same time, the Federal Reserve is pushing a new regulation that would effectively strip borrowers of their only federal remedy to fight illegal predatory lending. Now the House is considering bailing out Wall Street again, directly on the backs of the borrowers they've defrauded. We'll be counting the votes.

UPDATE:

Rep. Scott's PR guy just told me the Congressman just happened to be around to make a procedural vote. He says Scott "was in the wrong place at the wrong time" and does not support the legislation. David Dayen at Firedoglake argues that this entire reconsideration of the bill is likely a separation of powers dispute between Congress and President Obama regarding the technical procedure Obama used to veto the bill. The legislation may not even come up for a vote. Or it might, for separation of powers purposes, and the result might be bad.

The Elephant In The Foreclosure Fraud Room: Second Liens

Zach Carter — Thu, 21 Oct 2010 13:56:06 -0400

There’s been plenty of recent media attention to the prospect of investor lawsuits over fraudulent mortgages and mortgage securities. But investor lawsuits against mortgage servicers could be even more damaging than these other lines of legal inquiry. The four largest banks hold nearly half a trillion dollars worth of second-lien mortgages on their books—loans that could be decimated if investors successfully target improper mortgage servicing operations. The result would be major trouble for the financial system. The result would be major trouble for too-big-to-fail behemoths.

Mortgage servicers are the banking industry’s debt collectors. They accept payments and forward them along to investors who own mortgage securities-- servicers themselves don’t actually own the mortgages they handle. This is a recipe for trouble for a variety of reasons, but one of the biggest problems is the fact that the nation’s four largest banks also operate the four largest mortgage servicers. Bank of America, Wells Fargo, JPMorgan Chase and Citigroup service about half of all mortgages in the United States. They also have multi-trillion-dollar businesses whose interests often conflict with those of mortgage security investors.

The most glaring conflicts involve second-lien mortgages. Much of the foreclosuregate coverage has focused on first-liens—ordinary mortgages that people take out when they want to buy a home. But during the housing bubble, banks frequently sold second-lien mortgages in an effort to cash-in on inflated home prices. If you’ve had a mortgage for a few years, and paid down $30,000 of your home’s value, a bank might try to sell you a new $30,000 loan, backed by the equity you’ve accumulated in your house by paying your first mortgage.

In fact, banks were much more aggressive than this. Usually homeowners have to put up a certain amount of money up-front when they buy a house—this is the down-payment. But the profits available from mortgage securitization were tempting. Banks could issue a mortgage, sell it off to investors, and not have to worry about any potential losses. So banks got around down-payments by selling a second-lien mortgage at the same time they sold the ordinary first mortgage. The second-lien would be used to pay the down-payment on the first lien.

This is a neat trick, but if home values decline just a tiny bit, the second lien mortgage becomes almost immediately worthless. If a borrower can’t pay the first lien, the second lien is wiped out entirely. Similarly, if a bank modifies a first lien to lower a borrower’s overall debt burden, the second lien is also wiped out.

That’s a big deal, because even when home prices have declined dramatically, losses from foreclosure on first liens only eat up about 58 percent of the value of the loan, according to Valparaiso University Law Professor Alan White. The second lien, by contrast, is 100 percent gone.

The fact that four giant banks own almost half a trillion dollars of second-lien mortgages makes things very tricky. If a borrower gets into trouble on a first-lien mortgage, the mortgage servicer has three options. It can 1) foreclose, or 2) offer a loan modification that reduces the borrower’s overall debt burden (principal reduction), or 3) tweak the payment plan, charge some immediate late fees, and try to keep the borrower paying on the current debt level (extending the life of the loan, forgiving missed payments, lowering the interest rate).

If either of the first two are adopted, the second lien is wiped out. If the third option is pursued, the bank buys an extra few months of payments for the second lien. When the payment plan proves unsustainable, the bank can work out a new payment plan with the borrower, and hope for the best. This third tack often proves destructive for both borrowers and the first-lien owners. Tweaking payment plans can exhaust a borrowers’ savings and makes them unable to afford a meaningful loan modification. At the same time, it can generate fees for the servicer that investors ultimately pay for.

Many investors believe that banks are servicing first-lien mortgages for the benefit of second-liens. That’s because the megabank servicers own the second liens, while mortgage security investors own the first liens. This is a conflict-of-interest. A servicer is supposed to maximize the value of the first-lien for the investor. But it's conceivable that servicers--JPMorgan Chase, BofA, Citi, Wells Fargo-- are systematically screwing over both borrowers and investors in order to maximize profits on second-lien mortgages that are, by any reasonable economic analysis, already worthless.

It’s not clear how widespread this problem is. Academics and investors have been harping on it for literally years. But the market’s view about second-lien mortgages couldn’t be clearer. Second-liens trade at 25 cents on the dollar or less in the secondary markets. If a bank wants to sell a second-lien mortgage to another investor, it has to take a loss of at least 75 percent in order to do so. But regulators have allowed banks to account for their second liens at 90 percent or more of their original value.

Not every second-lien features this conflict-of-interest, and borrowers won’t abandon every second-lien. But <a href="http://rortybomb.wordpress.com/2010/03/09/principal-writedowns-and-the-fake-stress-test/">it’s easy to imagine hundreds of billions of dollars in losses on second-liens</a> hitting the four biggest banks (<a href="http://rortybomb.wordpress.com/2010/03/09/principal-writedowns-and-the-fake-stress-test/">see Mike Konczal's analysis from March here</a>). And the more investors learn about shoddy documentation in the foreclosure process, the more legal ammunition they have against servicers.

This, ultimately, is the most significant aspect of the letter investors wrote to Countrywide this week. Investors are pressuring Countrywide—a mortgage servicer owned by Bank of America—to push losses from about $16.5 billion worth of mortgages back onto the bank that securitized those mortgages. In this case, the bank that securitized the loans was another division of Countrywide, so the bank isn’t going to comply with the letter, since it means eating losses itself, and the situation is almost certainly headed for lawsuit territory (see Andrew Leonard’s explanation of the case here).

But that letter indicates that investors are organizing to go after improper mortgage servicing itself, not just fraudulent loan and security sales. That means investors are trying to sack banks with second-lien losses—and second-lien losses could easily dwarf the other losses that analysts have focused on so far.

Foreclosuregate Fallout: How Bad Can It Get For Wall Street?

Zach Carter — Wed, 20 Oct 2010 15:37:06 -0400

Foreclosure fraud is ruffling a lot of feathers on Wall Street, and while the full scope of losses remains unclear, even major banks are now acknowledging that this is a multi-billion-dollar disaster, not just a set of minor paperwork headaches.

So how bad will it get for Wall Street? There are several disaster scenarios in which the housing market simply shuts down, where the potential losses for Wall Street are simply incalculable. But even situations that do not directly rip apart the basic functioning of the mortgage system could be enough to shut down one or more big banks, creating serious trouble for the financial system, and a major test of the recent Wall Street reform bill.

JPMorgan Chase loves using its research department to push its political agenda, and the bank is currently characterizing the foreclosure fraud outbreak as a set of "process-oriented problems that can be fixed." That puts them in the rosy optimist camp for this crisis, and they're projecting a total of $55 billion to $120 billion in losses for the entire industry, spread out over a few years.

But take a look at the analysts' methodology. The actual scope of losses gets drastically larger if you just change a few arbitrary assumptions.

JPMorgan's analysts look at about $6 trillion in mortgages issued between 2005 and 2007—this is the height of the bubble, but it excludes plenty of lousy loans issued in 2003, 2004 and 2008. They then estimate defaults of $2 trillion and losses of $1.1 trillion on those defaults.

So far, these estimates are reasonable. According to Valparaiso University Law School Professor Alan White, banks lose about 58 percent of the value of a subprime loan at foreclosure. JPMorgan is estimating 55 percent. The notion that one-third of mortgages issued at the height of the bubble will default may seem extreme, but the analysis includes both first-lien mortgages and second-lien mortgages (home equity loans). For houses with multiple mortgages, there's going to be a double-hit when the first lien goes bad. Right now, the official statistics from Mortgage Bankers Association indicate that 14 percent of first mortgages are delinquent or in foreclosure. The longer unemployment stays near 10 percent, the higher that figure will go.

Things don't get out of control until JPMorgan's analysts start deploying their assumptions. First, they assume that Fannie and Freddie will attempt to sack banks with losses from 25 percent of the defaults they see. Of those 25 percent, they assume Fannie and Freddie will successfully force banks to eat losses on 40 percent, leading to total losses of 10 percent. Why 25 percent? Why 40 percent? The analysts don't say. JPMorgan expects private-sector investors to be able to saddle banks with just 5 percent of foreclosure losses, citing a host of technical legal hurdles that make it hard for investors to have their cases heard in court.

So JPMorgan's loss projections are nothing more than a guess—and a low-ball guess at that. JPMorgan is assuming that only five to 10 percent of looming foreclosure losses will actually hit big banks. Change that assumption—20 percent, 60 percent, 80 percent—and things get far worse for Wall Street than JPMorgan's "worst-case" scenario predicts.

Let's consider the exposures of a single bank to put things in context, and let's pick Bank of America, since analysts seem to agree that BofA has the most to worry about right now. They were a big issuer of mortgages themselves, but they also purchased the notoriously predatory Countrywide Financial and also picked up securitization behemoth Merrill Lynch in 2008, giving them far more problems (hilariously, BofA actually paid cash to acquire these balance-sheet-busters).

The most dire estimates for losses on Fannie and Freddie loans at BofA have come from Christopher Whalen at Institutional Risk Analytics and Branch Hill Capital. Whalen has estimated $50 billion in Fannie and Freddie losses for the megabank, while Branch Hill has estimated $70 billion.

The trick is, BofA has $2.1 trillion in total exposure to Fannie and Freddie, according to Whalen. That means even Branch Hill's massive loss projection only amounts to a loss rate of about 3.5 percent.

As of July 2010, Fannie Mae had a serious delinquency rate of 4.82 percent—these are loans where families have missed at least three payments, but haven't been evicted. For Freddie Mac, the number is 3.83 percent. Not all of those losses can be pushed back on the banks, but those numbers will go up as the unemployment rate stays high. Tip the scales just a few percentage points and it's easy to envision catastrophic losses for banks.

But there's reason to believe that Bank of America is in even worse shape with regard to Fannie and Freddie than any of its peers. Countrywide was the single largest provider of loans to Fannie Mae during the housing bubble. Literally 28 percent of the loans Fannie Mae bought up in 2007 came from Countrywide. Fannie even featured a full-page, smiling photograph of Countrywide CEO Angelo Mozilo in their 2003 Annual Report (.pdf, see page 16).

It's much easier for banks to lose money on bad loans they sold to the GSEs than it is for them to lose money on securities they sold to purely private-sector investors. The fact that Bank of America's most notorious wing was the top provider to Fannie Mae during the peak years of the housing bubble does not bode well for the bank's balance sheet.

But this is just exposure to Fannie and Freddie. The private sector is angry about all kinds of things—from wronged borrowers to deceived investors. Investors are already organizing against both mortgage servicers—for improperly handling troubled loans—and against investment banks—for selling them garbage. They aren't just angry about fraudulent foreclosures—evidence is mounting that mortgage servicers can't even handle the profits from mortgages correctly, and aren't sending investors reliable, verifiable payments.

Yesterday investors sent a letter pressuring Countrywide's servicing arm to push losses from bad mortgage bonds back on the bank that sold them. Legally, it's a complicated maneuver, since Countrywide itself issued those bonds—but that just shows the multiple levels at which megabanks like BofA are exposed to fraud losses. Their original sale of mortgages to borrowers, the packaging of those mortgages into securities, the handling of payments and foreclosures, and the accounting for all of these activities—all of this is about to be subjected to serious fraud examinations by people who are trying to make money.

Up until yesterday, big banks thought they had a get-out-of-jail free card on investor lawsuits. Investors have to bring together 25 percent of the buyers of any mortgage bond in order to sue the bank that issued it—even if the actual lawsuit is an open-and-shut fraud case. Investors had not been cooperating. But yesterday's letter to Countrywide is a big deal—even though it's not (yet) a lawsuit, some of the biggest names in finance were going after Countrywide's cash: BlackRock, PIMCO and even the New York Federal Reserve.

Bill Frey, who runs the hedge fund Greenwich Capital, has organized a massive clearinghouse of mortgage investors for the express purpose of bringing lawsuits against big banks that issued bogus mortgage-backed securities. He told me this afternoon that he's about to move: In the next couple of weeks Greenwich and other investors will bring big lawsuits against major banks.

Will these combined troubles be enough to sink any big banks? If investors can win a couple of lawsuits, easily.

Don't Believe The Bank Lobby: Foreclosure Fraud Is Bad For Homeowners And The Economy

Zach Carter — Mon, 18 Oct 2010 16:51:40 -0400

The bank lobby is spreading a host of silly myths about the foreclosure fraud outbreak in an effort to downplay the scandal and minimize concerns over potential bank losses that have emerged in the blogosphere. Housing Wire’s Paul Jackson spouts most of them in his post today. Jackson does acknowledge a host of major problems for banks that have been recently highlighted by the blogosphere, but he’s still spreading serious misinformation on foreclosure fraud and its potential effects. Banks routinely rip-off borrowers in the foreclosure process, and the blogosphere's uproar over foreclosure fraud is more than justified.

First, the agreement. Jackson agrees that there is enormous potential for investors to bring fraud cases against banks and win them. He calls them “real concerns, many hundreds of billions of dollars worth of concerns.” The blogosphere has done a terrific job highlighting this, with Felix Salmon shouldering most of the burden.

Jackson’s real critiques are pretty weak:

“‘Robo-signing’ is a procedural issue. Period . . . . Until someone can provide consistent and repeated evidence suggesting that the information contained within ‘robo-signed’ affidavits is factually incorrect — not just some of the time, but most of the time — the end result of this mess is nothing more than a very public, brand-damaging, headline-making procedural blip . . . . If false debt amounts were being pushed by banks onto the courts en masse, you can bet all the apple pie in America that every single one of us would have heard about it by now, too.”

First, we have heard about false debt amounts being pushed by banks onto the courts en masse. The best account is a 2008 paper by Harvard University Law Professor Katherine Porter (she was at Iowa then), examining mortgage servicing documentation in bankruptcy. Banks demand illegal fees from borrowers all the time, and resort to shoddy documentation to get away with it. How bad can this get? Ask Porter:

“In one egregious case, a mortgage company filed a proof of claim for more than $1 million when the principal balance on the note was $60,000.”

Take a look at some of Porter’s other findings: More than 18 percent of the time, servicers don’t even bother to file proofs of claim documenting the mortgage debt owed or the fees charged. Of the proofs-of-claim filed, 41 percent of the time, servicers don’t even supply the note, while 16 percent of the time, they don’t bother to itemize the fees they charge, much less justify the amount. Of the itemized fees, 43 percent were assigned to categories that didn’t fit the servicing industry’s own standards.

In many cases, these fees are so high that borrowers lose their homes thanks to the fees, not trouble meeting the monthly payment.

Let me emphasize that Porter’s study applies to foreclosure costs reviewed by a judge in bankruptcy—the most vigilant legal arena available for troubled borrowers. The robo-signing scandal is not playing out in bankruptcy court, it’s playing out in ordinary courts with much less rigorous standards. Banks simply try to prove that they have the necessary documentation to foreclose and are charge appropriate fees. They don’t have the actual document laying out this information, so banks are robo-signing fraudulent affidavits swearing that they really do have the right to foreclose and charge every fee they’re levying.

Given Porter’s findings in bankruptcy courts, this activity is very likely covering up widespread abuses in ordinary court. Note Jackson’s bizarre commitment to a majoritarian threshold for scandal. If 15 percent of foreclosures in the United States since the housing bubble burst have been unnecessary and fraudulent rip-offs, that is a scandal of monstrous proportions. We’ve already witnessed more than 6 million foreclosures this cycle—a 15 percent scam rate is nearly 1 million defrauded borrowers. That should be an outrage.

Jackson also claims that “Commentators have hopelessly conflated ‘robo-signing’ with other long-standing and/or played-out mortgage issues.”

Nope. Commenators have used the robo-signing outbreak to highlight other documentation problems that banks have created for themselves. Servicer misconduct has indeed been well-covered, as is the outbreak of fraud in the sale of mortgages to borrowers. Even the staggeringly dishonest due diligence operations that banks deployed to rip-off investors has been public for months. We know that banks have used robo-signers to cover their tracks in some arenas, there's a natural interest in investigating other areas of documentation trouble (especially Felix Salmon's mortgage bond fraud story).

Jackson does the best job of defusing these related scandals with his argument that the fate of the Mortgage Electronic Registration System (MERS) has already been decided in court. In effect, banks have been using the electronic MERS system to show their right to foreclose instead of paper documents, and several courts have upheld their right to do so (though others have not). But it's hard to understand Jackson's out-0f-hand dismissal of MERS trouble when the legal standing of MERS was raised on a Citigroup conference call with investors last week. This is not yet resolved.

But what I find most ridiculous is Jackson’s claim that commentary on the scandal has obscured other real problems:

“The real brewing issue in the markets right now currently is one of investor confidence, borne most lately of horrible remittance reporting from servicers. Investors have had it with inaccurate reports from servicers, and some are threatening to ditch MBS markets altogether.”

“Remittance reporting” means “profits that mortgage servicers detail and forward to investors.” Shoddy documentation in the foreclosure end have been the focus of much of the commentary thus far. In that element of the scandal, banks are trying to minimize potential losses from shoddy documentation. But Jackson makes a very good point: documentation problems are so bad that servicers aren’t forwarding the right profits either, or documenting them.

Why this is indicative of some blogosphere-wide over-reaction is beyond me. Jackson is effectively saying that the problem is much broader than the blogosphere has so far reported, and made an excellent point regarding the scope of potential problems.

Jackson also makes a good point about investor lawsuits. There are indeed significant technical hurdles that make it difficult for investors to sue banks over fraud in the mortgage-backed securities process, and this has been underreported. But that is far from the end of the story. When hundreds of billions of dollars are at stake, investors usually try to get their hands on it. And what’s more, it’s an appeal to a technicality on an issue where banks (and Jackson’s parroting of banks) are pretending to take the substantive high-road. Don’t worry, robo-signing is just a ‘procedural’ issue! Investor lawsuits are probably going to gut us on the merits, but technicalities will make it difficult for the cases to be heard!

The Breakdown: Zach Carter and The Nation's Chris Hayes Talk Wall Street Fraud

Zach Carter — Fri, 15 Oct 2010 14:29:07 -0400

Chris Hayes from The Nation talked to me for his excellent weekly podcast, The Breakdown. We're talking about foreclosure fraud, mortgage-backed securities fraud, illegal mortgage fees, and all kinds of really nasty things happening on Wall Street. Give it a listen:

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Also note that the intro music for The Breakdown is superior to all other music intros in audio journalism.

The Subprime Swindle And The Foreclosure Fraud Cover-Up

Zach Carter — Tue, 12 Oct 2010 17:00:39 -0400

There are plenty of reasons why the foreclosure fraud crisis sweeping the nation's housing market is an economic disaster. Banks are charging borrowers illegal fees, kicking the wrong people out of their homes and even hiring thugs to illegally break into houses. But the fundamental scam is much worse than these shameful acts. Fraud in the foreclosure process conceals a second, more massive fraud: the astonishing levels of mortgage fraud perpetrated by subprime lenders during the housing bubble. These frauds don't just expose big banks to epic losses, they expose bigwig bankers to prison time.

Clearly, we're dealing with a lot of different frauds here. Tomorrow, I'll detail one of the smaller-bore problems with foreclosure fraud: providing cover for illegal fees that lenders charge to troubled borrowers. But today I'll discuss a much different and much bigger scandal. During the housing bubble, banks falsified documents on a massive scale in order to issue as many toxic subprime loans as possible. This was straightforward mortgage fraud, and the current wave of fraud in the foreclosure process is covering it up.

In 2004, the FBI sounded the alarm about an "epidemic" in mortgage fraud. This was right at the beginning of the real subprime explosion—things got much worse as the housing bubble inflated. What's more, according to the FBI, 80 percent of mortgage fraud is committed by lenders.

Bankers and mortgage brokers didn't just make reckless loans to borrowers who couldn't afford them. They also illegally falsified documentation in order to push borrowers into loans they could not afford. This was not a con perpetrated by irrational poor people attempting to live beyond their means—it was committed by perfectly rational lenders, who knew they could make a handsome profit by selling these garbage mortgages off to investors.

We know about how these frauds were incentivized at specific lenders thanks to anecdotes collected banks that actually went under during the crisis. When Washington Mutual collapsed in September 2008, it was one of the largest banks on the West Coast, with $350 billion in assets. It wasn't a small-time specialty shop operating off the grid—it was a regulated bank, overseen by the Office of Thrift Supervision, subject to standard consumer protection regulations and federal anti-fraud statutes. Yet the bank engaged in systematic, knowing fraud which its executives allowed to continue unpunished. As Sen. Carl Levin, D-Mich., emphasized in a hearing this April, the company even rewarded some of its employees who committed fraud by promoting them.

Why all the dodgy dealing? Bigger bonuses. During the housing bubble, Washington Mutual CEO Kerry Killinger took home between $11 million and $20 million every year.

This type of mortgage fraud is not the scam that consumer advocates are currently sounding the alarm about. That's a much different fraud. When banks go to foreclose on borrowers, they do not have the documentation necessary to prove they actually own the mortgage. Banks can't document their right to foreclose, so they're fabricating documents, forging signatures and lying to judges to push them through. So how are the two frauds related?

Fraudulent mortgages are, by definition, illegal. Banks that issue them can be sued, and the bankers involved can be tried in court and sent to prison. Bankers very much want to avoid both of these scenarios.

But it's also illegal to package fraudulent loans into securities and sell them to investors—especially if you don't tell investors that the security is full of fraudulent loans. It's securities fraud, and bankers also don't want to lose huge amounts of money on that line of business.

If you're a bank that packages mortgages into securities and sells them to investors, and you know your securities are full of fraudulent loans, you might not want to transfer all the necessary documents detailing the loans. Those documents, after all, would reveal that your securities were completely illegal—and that you are responsible for any losses stemming from them.

For intermediaries like securitizers, fraudulent loans are the best kind of loans—they're literally too good to be true. So long as nobody ever pins the legal liability on you, you can make a lot more money from fraudulent loans than you can make on loans that actually make financial sense. Fraud-packed securities fetched much higher prices than mortgage securities packed full of boring, legal mortgages, and led to much bigger bonuses.

In today's foreclosure fraud scandal, mortgage servicers—the housing industry's debt collectors—don't have the legal documents necessary to move on a foreclosure. They don't have the documents because the banks who created the securities never handed them over. And without those documents, it's far more difficult to prove that the securities and the underlying mortgages are illegal.

So this isn't about "paperwork" or technicalities. This is about preventing the basic fraud at the heart of the financial crisis and the Great Recession from being prosecuted.

That, ultimately, is the big danger for Wall Street, and for the policymakers who have provided economic cover for megabanks. Wall Street banks aren't worried that their mortgage servicing costs may increase while the "track down" paperwork—they're worried that the entire $2.6 trillion mortgage-backed security market is about to land on their doorstep, with punitive damages and prison sentences tacked on.

Apologists for CEOs spent much of the summer complaining about the "uncertainty" that new regulations and tax policies supposedly create for businesses and investors. If potential taxes were an economic problem, just wait to see how financial markets respond to a fresh $2.6 trillion hole in the banking system created by fraud.

Worst of all, U.S. taxpayers own a huge portion of these securities. Fannie Mae and Freddie Mac have enormous portfolios of subprime-mortgage backed securities, and the Federal Reserve purchased large volumes of mortgage securities in order to sustain the housing market as it collapsed. The government has no choice but to deal with this mess, if only to cut its own losses. Whatever the policy the government pursues, Rick Santelli and his friends will be sure to complain about a bailout for "losers," but something has to be done. It's not a question of bleeding hearts, it's a question of basic justice for homeowners, investors and taxpayers.

Axelrod Is Wrong: Obama Must Protect American Families From Wall Street Fraud

Zach Carter — Mon, 11 Oct 2010 13:32:56 -0400

If senior White House adviser David Axelrod’s comments this weekend are any indication, the Obama administration is woefully misreading the foreclosure fraud crisis currently gripping the U.S. economy. Axelrod refused to commit the administration to a national moratorium on foreclosures, and mischaracterized a massive, systematic fraud perpetrated by Wall Street banks as a set of unfortunate “mistakes.” This is not a minor scandal and it will not simply go away. President Barack Obama needs to stand up for the middle class and protect our economy from Wall Street theft. If he doesn’t, the economic and political price will be devastating.

The full transcript of Axelrod’s appearance on CBS’ Face the Nation with Bob Shieffer is here, but here are his key comments, emphasis mine:

“It’s bad for the housing market and it’s bad for these institutions which is why they’re scrambling now to-- to go back through and-- and-- and through their documentation for all of this as they should. The President was concerned enough to veto a bill that came to him last Thursday, that would have unintentionally made it perhaps easier to make mistakes. . . . I’m not sure about a national moratorium because there are, in fact, valid foreclosures that-- that-- that probably should go forward. And where the documentation and paperwork is-- is proper, but we are working closely with these institutions to make sure that they expedite the process of going back and reconstructing these and throwing out those that don’t work . . . . Our hope is that this moves rapidly and that this gets unwound very, very quickly.”

Let’s straighten some facts out first. Lenders aren’t just making “mistakes”—they’re fabricating documents, forging signatures and lying to judges in order to illegally throw people out of their homes and slap them with thousands of dollars in illegal fees. Consumer advocates were not worried that the bill Obama vetoed on Friday would make it easier for lenders to make “mistakes”—they were worried it would make it harder to expose rampant, systematic fraud committed by Wall Street banks against American families.

Nor is this a problem that can be resolved quickly. Banks are resorting to fraud for a reason—they don’t have the documents that prove they have the right to foreclose. It’s not like JPMorgan Chase or GMAC need to dig through a filing cabinet to find the right form—the form doesn’t exist. Banks willfully, knowingly destroyed key documentation in order to cut costs and boost bonuses. Other banks that bundled these mortgages into complex securities didn’t ask for this documentation for the same reasons.

This creates legal liabilities for the banks that can push them into failure. A lot of these securities were packed with fraudulent mortgages—loans where banks falsified borrower information in order to push them into predatory loans. Investors who bought these mortgages have been trying to force banks to repurchase the fraudulent loans. But now that banks cannot even document which loans they own, the entire fraudulent mortgage securitization framework may land on the banks’ doorstep. If that happens, we’re going to see some very big banks go under.

What does all this mean for borrowers? We’ve already seen plenty of cases in which banks are foreclosing on the wrong homes—kicking out borrowers who haven’t missed any payments, or borrowers who are working with the bank on receiving a loan modification to keep them in their homes. But even for borrowers who have stopped paying their mortgages, the fraud process creates serious dangers. Banks charge all kinds of fees on borrowers when they foreclose—fees that often amount to thousands of dollars. The current wave of fraud is enabling an onslaught of grotesque, illegal fees. When you create new documents and forge signatures, you can claim people agreed to ridiculous things they never agreed to, tell ridiculous lies about the house being foreclosed on, and generate thousands of dollars in improper fees.

In other words, banks and their lawyers are breaking the law to steal from borrowers facing financial hardship. This impropriety may create losses so big that megabanks are going to fail. Smart political leaders need to get out there right now and prove that they are backing American families, not Wall Street elites. A foreclosure moratorium is the first step, the second is a major new initiative to reduce mortgage debt to a level that borrowers can afford—that prevents foreclosures and keeps this mess from spiraling into a financial calamity. The mortgage market needs to reflect economic reality, not inflated banker dreams.

Other leaders have figured this out. If Obama refuses to stand up for the middle class, he’ll be hanging many embattled Democratic members of Congress out to dry, politically undercutting them on an issue of household financial security in the middle of a brutal recession. Swing-state Democrats like Senate Majority Leader Harry Reid, D-Nevada, Rep. Debbie Wasserman-Schultz, D-Fla., and Rep. Alan Grayson, D-Fla., Rep. John Conyers, D-Mich., and Carolyn Kirkpatrick, D-Mich., have already endorsed foreclosure moratoriums. Attorneys general in Connecticut, Massachusetts, Illinois, California, Iowa, Texas, and Ohio have either imposed state-wide moratoriums or investigations into foreclosure fraud, and Ohio is already suing GMAC. Why does the president want to kneecap members of his own party?

What’s more, Axelrod’s comments put the White House on the same side as Republican Whip Eric Cantor, R-Va., a Wall Street crony who voted to bailout the big banks with no strings attached, but refused to support Wall Street reform. For his services, Wall Street rewarded Cantor with $2.1 million in campaign contributions for the 2010 elections. Here’s what Cantor said on Fox News Sunday:

“If you impose a moratorium on foreclosures, what you're telling people and institutions that lend money is they do not have the protection to take the risk they need to, to extend credit so people can get a mortgage . . . . You're going to shut down the housing industry if that's the case . . . . People have to take responsibility for themselves.”

Cantor’s reasoning is, of course, complete nonsense. People do need to take responsibility for themselves, which is why the government has a responsibility to stop banks from systematically defrauding borrowers on an epic scale. But note Cantor’s positioning on the issue. He claims that if the government does anything to help troubled borrowers, that assistance will cause a financial catastrophe. It's a phony story that completely ignores the financial catastrophe already brewing, one created by massive Wall Street fraud, not the government's big, bleeding heart. Cantor is peddling a monstrous lie, but if Obama doesn’t push-back against it, he will politically hamstring any opportunity to fend off the economic fallout from this mess, and leave troubled borrowers at the mercy of Wall Street predators.

Wall Street Wrecked The Economy, Not Big Government

Zach Carter — Tue, 21 Sep 2010 10:02:18 -0400

Over at bloggingheads, my CAF colleague Bill Scher discusses the new international banking standards with Conn Carroll, a conservative blogger for The Heritage Foundation. Carroll actually agrees with a lot of what I have to say about Basel III, but I he draws conclusions from my post that overemphasize the role of regulation and ignore the insane lobbying and outright fraud that Wall Street deployed to create a crisis.

The fact that Carroll and I can agree on this stuff (to an extent) shouldn't come as a terrible shock—Wall Street reform is about the basic functioning of the economy—it's not an issue that needs to ignite ideological conflict. Here are his key comments:

"I like the acknowledgement that the problem of this last financial crisis had to do with a problem of regulation."

Nothing wrong there. You'd have to be insane to believe that financial regulations—or the regulators who implemented them—were up to snuff. But here's where I part ways with Carroll:

"When this economy started melting down and the financial crisis happened . . . the reason is regulation. It wasn't because of the free market, it was because of Basel II with their regulations saying that AAA-securities were an asset that qualified created a huge demand for all of these mortgage-backed securities."

Basel II was indeed terrible, and the credit rating agencies were totally corrupt (quite possibly fraudulent) operations. But you can't blame Basel II and the rating agencies for all of the Wall Street excess that created the crisis. Basel II didn't force banks to buy up lousy mortgage-backed securities that rating agencies had evaluated improperly. Nobody required banks to rely on bad ratings alone. Bankers and traders were paid very well to find assets that would enrich their firms. They got it completely wrong, destroyed their companies and nearly destroyed the global economy. The fact that rating agencies also got it completely wrong doesn't excuse this behavior, nor does the fact that regulators also relied on rating agencies. Bankers found loopholes, exploited them and wrecked the economy.

In other words, the financial crisis is a story about regulation allowing reckless behavior, not a story about regulation encouraging reckless behavior. Bad regulations let the free market to run amok—they did not tie the market's hands and require market actors to do reckless things they really didn't want to do.

Plenty of people at major Wall Street banks knew that they were courting disaster, but went ahead in the quest for bigger bonuses. Everybody on Wall Street who packaged mortgage-backed securities and collateralized debt obligations knew the rating agencies were meaningless, because they had to work with those same rating agencies in concocting their own toxic securities.

What's more, plenty of people on Wall Street knowingly bought the toxic securities that they themselves created. ProPublica has documented the most damning case of this practice, a situation in which banks sold crappy CDOs to investors, but actually purchased risky parts of the CDO themselves in order to establish fake demand for the entire product. Merrill Lynch was the most frequent offender in this respect, but Citigroup and Goldman Sachs adopted the same scheme.

Rating agencies and Basel II didn't force Goldman to concoct a "shitty deals" and brag about them over email, and they didn't force Lehman Brothers or Bank of America to adopt Enron-style schemes to conceal debt from investors.

The lousy financial regulations that lead up to the crisis were not written by wild-eyed consumer advocates unaware of the potential consequences. They were written by policymakers who were extremely sympathetic to the global financial elite, and in many cases, by policymakers who were members of the global financial elite. They knew these rules wouldn't do much to affect banker behavior, which is why they pursued them.

That point applies to just about every faulty regulatory maneuver preceding the crisis. In the U.S. alone, policymakers lifted leverage caps on Wall Street investment banks, deregulated the derivatives market, repealed Glass-Steagall and refused to regulate the mortgage market. That was because regulators had been corrupted by the financial establishment, not because it's just impossible for regulators to figure out how to write decent financial rules.

None of this, of course, implies that international regulators should continue to rely on rating agencies or exclusively rely on any risk-weighted capital requirements. On this, Carroll and I agree. Whatever the criteria for risk-weighting, Wall Street will come up with some way to game those rules. When they do, we'll all wish Basel III had imposed a meaningful, hard leverage cap as a back-up.