22 October, 2010

John Robb explains the mortgage crisis

From Global Guerrillas.  I think he's on to the essence of things here.

The reason I spent the time to explain this, is that this could be one of the factors (along with currency wars and sovereign defaults) driving a massive financial crisis over the next year or so.


Here it is.  Traditional mortgages are simply contract between you and your local bank:

  • You agree to pay a certain amount every month (principal + interest) until the loan is paid off.
  • Your home (the title) is collateral on that loan.
  • If you don't pay the amount specified, your home is forfeit.

However, global banks wanted to take these dull mortgages and turn them into something institutional investors could purchase.  So, they developed a complex process to do this.

First, they sold the loans to the institutional investors (as securities that they are allowed to purchase according to their charters) by removing the collateral, your home's title, from the loan. 

Second, they put the title in a special pool that "simulated" the effects of collateral on the loans they sold.  To accomplish this, the banks had to a create a complex process to comply with the myriad rules controlling real estate transactions (state, interstate commerce, etc.) and federal tax laws.  Further, this process was very rigid.  It to be completed in a specified time (within the year of the securitization) and in a specified way in order to be legal.

However, and here is where things went really wrong.  The banks, and their representatives didn't do the paperwork, as required by law, on millions of mortgages.  Why?  In some cases the process of filing the paperwork was considered too expensive and was put off.  In other cases, it was avoided because it could trigger unwanted liability given the claims made by the sellers of the loans to investors (as in:  the quality of the loans was very high, when they had reason to believe this was otherwise).  

In any case, the collateral was never actually transferred properly.  So, the loans that were sold to investors became simple contracts:

  • You agree to pay a certain amount every month (principal + interest) until the loan is paid off.

Note that there's nothing more to this loan.  No collateral.  No foreclosure for non-payment.

Let's make this very, very clear: there's no real collateral for the loans.  No collateral, and if you don't pay the mortgage your home is NOT at risk.  As people figure that out, all hell will break loose.

Note: I'm not an attorney, and I'm not giving advice.  But can anybody tell me what's wrong with this argument?

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