How The Securitization Of Mortgages Impacts The Average Citizen

Posted 07 Dec 2010

Trace: Welcome back to the Podcast. I have with us Aaron Krowne, who operates, the Mortgage-Lender-Implode-o’ Meter. Welcome, Aaron!

Aaron: Hey Trace, good to talk to you again.

Trace: Live from DC, it sounds like. So, we were talking about a little bit before the show about this foreclosure gig and robo-signing, about how it erodes the foundation for the entire securitisation market.

I have actually got a friend who’s a commercial appraiser and he says that that market is pretty much completely frozen; securitising these large mortgage-backed securities, things of that nature. Can you talk a little about this foreclosure gig and about this robo-signing has affected the securitisation of mortgages, and how that is going to impact the average citizen.

Aaron: Well, there’s two parts. There’s the on-going part, and then there’s what has already been securitised. I’ll mostly talk about what has already been securitised. It can be compared to when the sub-prime crisis was blowing up big. Six months or so after I started and the media started catching on, and the basic theme was that you had these bad loans, and these pools of loans, that were packaged and re-packaged sometimes and sliced and diced and distributed around the world.

In many cases, these banks buying from the pool of other banks. So they were all over the place, and it was discovered that some of the loans were originally with such low standards that they started going bad in huge numbers, rapidly and they were popping up all over the place. It was like whack-a-mole, or an Easter egg hunt with rotten Easter eggs. And they were popping up later –especially the ones that hadn’t been found originally.

So it caused people to flee from the market, wholesale, and it destroyed the market in terms of issuance because no one wanted to issue, and no one wanted to fund the loans and it destroyed the bonds that had been issued and it really spread a contagion all over the bond market because nobody knew what these things were.

So, that’s been in a sense sorted out, you have the fed and the other financial authorities buying out these pools and taking them onto their books, and spending whatever money needs to be spent to bail out the banks that own them.

In that sense they have smoothed that part of the crisis over. But what robo-signing, and what’s underneath it, foreclosure gate, shows is that there’s other sorts of rot in the system that spread far and wide and have not been accounted for.

This is more than just whether the T’s have been crossed and the I’s are dotted in doing the paper work. This is actually whether the loans were transferred properly into trusts, because when you securitize loans they are put into a trust entity, which is a semi-separate entity and if that’s not done right, then you lose the authority to foreclose, you lose tax privilege status, potential investors lose recourse, and by some accounts by some very intelligent people, you have this as the rule, not the exception.

Trace: Yeah and when we’re talking about this, due process, one of the fundamental tenants in real estate property law is you have to have stuff properly recorded. You have the properly record the deeds, you have to properly record the mortgages, and the way the real estate law has evolved, because it’s tied to the land, it’s very much a county by falls under the umbrella of state law, property contract court law, those are state functions.

So, the judge in the county where I grew up in Florida, he’s the Duvall County judge who said they’d committed fraud on the court with this robo-signing in the foreclosure that you’re talking about. Now, what exactly did they do with MERS because they didn’t want to pay the local recording and filing fees, right?

Aaron: Right. That’s maybe the core reason or the genesis of this, is they wanted a more efficient system so that they could securitize the loans and move them around and resell them and things like that. I think it might go a little deeper, that it actually become easier to sell the loans multiple times in what they call hypothecate and re-hypothecate them, which is basically another form of money-printing.

But even if you accept that it was just for the efficiency reasons, basically they didn’t do their legal homework on how they would need to set this up, to make it legally viable, and they just went ahead with it anyways. Even Fanny and Freddy endorsed it and bought into the system and are a core part of this and as we are finding out, judges in courts around the country are waking up.

Trace: And this might have been that they made a calculated choice based on the moral hazard that, well we can just override the state law, or we can jus not pay attention to it, and privatise the gains so that people who securitised all these things are getting paid to create them, they are getting paid their bonuses for selling them, and then when the proverbial crap hits the fan, because of the moral hazard they say, “oh, well we’ll just retroactively go back with federal pre-emption and federal law and try to fix this".

And that was the bill they tried to pass retroactively deal with all these fake notarised documents, but then that got struck down because of popular outcry.

Aaron: Well, that’s part of it. I don’t think that that bill would have done much because it wasn’t just the notarisation; it was also the nature of the assignments and transfers. So, that would have been step 1 for retroactively legitimising this. But even if they got a slew of the retroactive fixes passed, those would still be ex post facto laws which would still be subject to widespread court challenge.

Trace: And it would still be unconstitutional.

Aaron: It would still be unconstitutional. So it wouldn’t make this huge legal firestorm go away, and even though they have halted foreclosures and they have fired certain law firms and they have stopped using MERS, and are going back and trying to do the recording locally like they are supposed to. That’s doesn’t retroactively fix the problem.

All these loan pools are now tainted. Just like with sub prime, you don’t know really what the value is in them because you can’t recover value on a loan like you used to be able to when you were able to foreclose. And in addition to the lack of ability to be able to sell that property and pocket what you can, you have the legal fees for fighting battles on these.

Anybody can challenge their foreclosure, and if they find that there’s not an authority to foreclose, if the assignments weren’t done correctly, then you are stuck, as an investor note holder. So we really don’t know the scope of that at this point.

Trace: And it can be huge.

Aaron: And I think it is. We’re talking trillions of dollars of essentially new bad loans that we thought were ok, or that were popularly thought to be ok. So, in absence of a massive rescue program, where say they get Fanny and Freddy to buy up massive amounts of troubled loans, essentially printing the money to do it, I don’t see how they are going to fix this.

Trace: But even if they do print that money up... you’re familiar with the liquidity pyramid, what’s happening is that people are selling their mortgage backed securities or whatever and buying something further down on the pyramid. So all that that’s going to do is print more of the fiat currency illusions that go up the pyramid and evaporate in their purchasing power anyway, so it’s not like that’s going to be able to fix the problem and restore the illusory wealth that had existed because of this fiction that the banks have perpetrated, probably to get their short term bonuses and things of that nature. Right?

Aaron: Well, yeah, there’s many trillions of dollars of what we call value of what was assumed to be in the housing stock when they ran up the bubble, and the banks ran up the bubble and they are really at the core of this; the feds and the banks. And they are never going to get that back.

Trace: Because it never existed.

Aaron: Exactly. They never existed. People are never going to get that back, but that doesn’t stop politicians from printing money...

Trace: ...from trying.

Aaron: Yeah. And making promises, and basically shifting the damage off of themselves and shifting the blame off of themselves and that’s exactly what these bank bailouts mean, they mean executives, and to some extent share holders of these companies, get bailed out while the public more directly takes the brunt.

Trace: So, privatising the gain, socialising the losses. Which is the same thing that has eroded the solidarity of European banks also, isn’t it?

Aaron: Right. Exactly. It’s going on everywhere and it’s a global phenomena, absolutely. I think that were going to see more waves of this where there’s just massive problems with the loans, how they were done, or the valuation or they will find that massive fraud was embedded and it happened during the bubble and it happened, like you said, it’s going to cause this irreversible trend of people over time, not necessarily month by month but year by year moving out of paper assets that are very hypothetical in value and moving into more concrete assets because those are the only places where they can be sure to preserve what’s left of their wealth.

Trace: Right. You know, you want to saw you’re a saver, you consume less than you make or produce, and so you have this excess capital, what do you do? We used to loan it to people, so they could build suburbia. But now, we aren’t necessarily...

Aaron: Yeah I mean, what do you do with it? People ask me, “what should I invest in? Where should I put my money to be safe?”. And usually they don’t want to hear “put it in gold, or put it in silver”, because that’s what loony people do, right? But I don’t have much else to tell them.

Trace: You don’t want a mortgage where you don’t have the right to necessarily foreclose?

Aaron: I mean, unless you are really going to do a lot of work, I wouldn’t even buy real estate. You really need to do your homework to know where it’s actually likely to go up on its merits, as opposed to just getting into a huge Ponzi scheme, so there’s no easy answer and I don’t see many refuges for wealth in the land of paper.

Trace: About 5 years ago I had a friend who I had lunch with, and he said “hey, I’m thinking of buying a condo” and I said “no, don’t buy a condo right now! They’re expensive.” And he said “well, what should I do?” and I said “Well, buy silver or gold.” Well, he did not buy the condo.

He’s one of the people who actually took my advice – who would have thought?- and we had lunch about a year ago and we were talking about these things and he said “Yeah, I am still buying my gold and silver, so when should I buy my condo?” and I was like “well, probably not yet. But where exactly are you, because you didn’t buy the condo.”

Based on the market that he was going to buy the condo, we will assume it was a $420,000 condo, and we’ll assume that we would have put 10% down, and then we’ll assume the difference that he would have paid between the mortgage and rent he just would have bought silver every month. Well, in those 3 years and a half, between when we had the conversations, if he had bought the condo, he would have had a mortgage of about $360 000 and the condo would have been worth conservatively about $350,000, probably less. If he had bought the silver, he would have had enough silver to buy about a third of the condo at its current price. Just in three years, by being on the right side of the trend.

Aaron: There are even more extreme examples out there in a number of episodes with my family where I gave similar advice and some people took it, and some people –usually most people- didn’t , and there are many cases 4 times worse off, or more.

Trace: Yeah, so I think that I can agree with you that I don’t necessarily like the metals, particularly at these all time highs, where they are getting quasi-expensive. But the other side of the coin is i don’t want little fiat illusions that are just figments of people’s imaginations that are just represented by some digit on a webpage, I don’t want that.

Aaron: Well, my point is that we are really not even at the half way point is in discovering where all the rot is in the paper investments, which is the majority of the financial world. I see that process is really getting into its high-momentum phase of breakdown and turning a point in sediment where it actually becomes popular knowledge that you want to have a lot of precious metals and not just be in paper, and not just be trusting the government and their bonds.

Trace: And of course you have got the other component, you know there’s a reason why tax codes encourage people to go into debt and get real estate as opposed to buying the metals and that’s because when people “own” their houses, they have a lot more at stake in social peace and tranquility.

I mean obviously you don’t want to riot and burn down your own house. But now we are seeing that being completely eroded and I mean look at what’s happening over there in Europe; you had Paris, and you had Ireland and you got Greece and so these things could also be coming here and that’s another reason not to own real estate, it’s because of that potential risk.

Aaron: Right, you really see this sediment turning, where I can see that some places prices are fair, especially if you are buying distressed real estate, the sediment is the beginning point where people are just beginning to rule out real estate completely, it’s almost like a generational thing but it’s in response to just how far the other direction went as a society and there’s always an over correction in the other direction with any bubble.

Trace: And we’re just getting started, huh?

Aaron: I think we are. I know you say that the metals are expensive, but you know I think the increase has been modest especially compared to making up lost ground for the many years that were likely manipulated to the downside, so you know I think there is quite a ways to go.

Trace: I agree, this is going to be a long generational bull market. It might take another 25-30 years before we see the turn happen and a lot of it depends on how quickly we do it politically. Anyways, I think we are out of time so thank you very much for coming on the podcast today!