How the Proprty Bubble was facilitated

[dieseltaylor]

A long but very interesting article on the introduction of a "pretend" mortgage company that allowed mortgage companies to avoid paying filing fees to counties, and facilitated the bundling of mortgages easily.

If there was ever an example of why gritty systems are better than electronic slickness this is it. If after you read it you do not see that the old method was better/safer for the population whilst the new system was a tax dodge then you are naive.

http://www.alternet.org/story/149189/dude%2C_where%27s_my_mortgage_how_an_obscure_outfit_called_mers_is_subverting_our_entire_system_of_property_rights?page=5

I have to admit to being shocked at the combined idiocy and greed rampant in the US mortgage industry. Perhaps because I also know that some companies trashed the paperwork giving title. It is gobsmackingly insane.

[costard]

... It is gobsmackingly insane.

..but not incompatible with the dominant myths of the society. Don't worry DT, it's only got another two years to run, then KABLOOIE!, the whole things gonna turn to ****.

Just don't be standing too close when she blows, ya?

[Stalins Organ]

An interesting read.

I guess it depended on teh market - with a total population of only 4 million or a bit more, I guess New Zealand only amounts to 1 or maybe 2 large US counties?

We didnt' need anythnig like this to have our own property bubble - just cheap mortgages facilitated by foreign owned banks looking to lend all their available funds.

AFAIK there was no securitization here, no CDU's (or whatever), no interest holidays, no Govt required lending profiles or quota's.

But it still all went mammaries uppermost - AFAIK because the cheap funds from overseas dried up - for which I guess MERS can take its share of the credit (sic).

[MSBoxer]

One also needs to take government regulations which in effect forced banks to make sub-prime loans in order to extend the dream of home ownership to a larger percentage of the population. Then the government allowed the creation of bundled securities to "spread" the risk and reduce the exposure of the two primary NGOs which underwrote a majority of the loans.

This led to the increase in home values due to simple supply and demand, drove up costs, increased profits for banks and spurred construction. Of course this was not a sustainable model and we are all seeing the results.

It is interesting that the creation of the program cited in the article coincides with the expansion of the Community Reinvestment Act....hmm could it just be a coincidence?

[dieseltaylor]

MSBoxer - well thats a load of crock. The extension of homeownership beyond those who could have afforded it under responsible criteria was not in itself a major cause of the bubble. That required chicanery with a vast number of pigs at the trough all eager not to let on what was going on as they got rich.

http://en.wikipedia.org/wiki/Financial_crisis_of_2007%E2%80%932010

A prime cause was the relaxation of sensible deposit ratios for banking type operations, the ramping of lending based on falsely rated paper, criminality in forging applications to show high earnings , and AIG being completely stupid [or more probably individuals paid off to accept rubbish].

Anyway to show what nice guys they are see what BoA are doing now. You ask for the legal proof they own your mortgage and they cut your credit rating. And they hassle people who show they have been falsifying document signings.

http://www.alternet.org/story/149302/as_bank_of_america_tries_to_strong-arm_consumers%2C_will_wikileaks_bring_it_to_its_knees?page=entire

Does it not seem strange that if a Bank provides a mortgage, and you believe it may have been sold on, that you want to know who you are due to pay the money to? If they own the mortgage it should be perfectly simple to provide the evidence. If they have sold it on then should thye not be able to say to whom - and it should have been registered properly at the county office. ooops no that brings back to subverting the system whereby the Banks tried not to pay filing fees .. what was it say $30.

What a ********* mess. And like nobody called foul? Or this is a broken system? What was going on in the US?

[MSBoxer]

It appears that financial experts disagree with you about the CRA's role in the bubble.

http://www.businessinsider.com/the-cra-debate-a-users-guide-2009-6

http://www.forbes.com/2009/02/13/housing-bubble-subprime-opinions-contributors_0216_peter_wallison_edward_pinto.html

Predictions from 1993 and 2000

http://query.nytimes.com/gst/fullpage.html?res=9F0CEED6133EF933A25750C0A965958260

http://www.city-journal.org/html/10_1_the_trillion_dollar.html

[dieseltaylor]

Your first expert is substantially demolished here and here:

http://blogs.reuters.com/felix-salmon/2009/06/25/john-carneys-bizarre-crusade-against-the-cra/

http://www.federalreserve.gov/newsevents/speech/kroszner20081203a.htm

BTW I did agree that it had perhaps a minor role, and given the comments by the FederalReserve guy truly minor, however the major point about fraudulent sales and greed feeding greed as outlined in the long Wikipedia article were the main drivers.

Perhaps you could give your views on what their responsibility for the crash was?

BTW the central tenet of your piece is that the CRA drove down lending standards, I have worked for the three major banks so I am very au fait with lending and lending criterias. An institution does not have to lend and one of the Banks had a reputation for being a cautious lender. Others like the Scottish banks were incredibly lax and both went seriously tits-up. Cheap money feeding a lending frenzy.

Like it has never happened before in banking history? That is what is so so annoying - it is basic history. How come nobody but nobody spilled the beans on this idiocy.

[MSBoxer]

I never stated that the CRA was the prime cause, but wanted to point out that the government had a role in the collapse. When the Government tells banks that they must loan money to those with greater risk, then facilitates that with relaxed regulations it has an impact. Of course the fact that the financial institutions saw an opportunity for increased profit with less oversight added a great amount to the inflation

Thank you for the links, but I feel that the articles I linked to have a bit more weight than a spokesman from the Federal Reserve and a contributor to the Huffington Post. I am not saying that either is wrong, but one works for the government that had a hand in the problem and the other has a clear preference for the very policies that CRA supported.

Again, I never intended to state the CRA was the prime cause. I believe that this is a case of Government programs with good intentions being implemented poorly, loosening of regulations and corporate greed creating the "Perfect Storm".

Edit - After posting this I took a look to see if I could find any posts on Huffington from Felix Salmon, and while he is cited many times, a quick search does not result in any articles posted by Mr. Salmon. One of his online profiles listed him as a contributor, but it appears that the profile may not be accurate.

[dieseltaylor]

I would agree thta successive administrations and Goverment bodies have all got their fingers in and the ineptness is breathtaking. To my mind there is little practical difference between the parties in how they allow business to write the agendas.

This following piece shows how Wall Street helped matters along - hugely. It makes me squirm to see that the perpetrators of what is actually a fraud on shareholders are running free. And of course wealthy

Two years before the financial crisis hit, Merrill Lynch confronted a serious problem. No one, not even the bank's own traders, wanted to buy the supposedly safe portions of the mortgage-backed securities Merrill was creating.

Bank executives came up with a fix that had short-term benefits and long-term consequences. They formed a new group within Merrill, which took on the bank's money-losing securities. But how to get the group to accept deals that were otherwise unprofitable? They paid them. The division creating the securities passed portions of their bonuses to the new group, according to two former Merrill executives with detailed knowledge of the arrangement.

The executives said this group, which earned millions in bonuses, played a crucial role in keeping the money machine moving long after it should have ground to a halt.

"It was uneconomic for the traders" -- that is, buyers at Merrill -- "to take these things," says one former Merrill executive with knowledge of how it worked.

Within Merrill Lynch, some traders called it a "million for a billion" -- meaning a million dollars in bonus money for every billion taken on in Merrill mortgage securities. Others referred to it as "the subsidy." One former executive called it bribery. The group was being compensated for how much it took, not whether it made money.

The group, created in 2006, accepted tens of billions of dollars of Merrill's Triple A-rated mortgage-backed assets, with disastrous results. The value of the securities fell to pennies on the dollar and helped to sink the iconic firm. Merrill was sold to Bank of America, which was in turn bailed out by taxpayers.

What became of the bankers who created this arrangement and the traders who took the now-toxic assets? They walked away with millions. Some still hold senior positions at prominent financial firms.

Washington is now grappling with new rules about how to limit Wall Street bonuses in order to better align bankers' behavior with the long-term health of their bank. Merrill's arrangement, known only to a small number of executives at the firm, shows just how damaging the misaligned incentives could be.

ProPublica has published a series of articles throughout the year about how Wall Street kept the money machine spinning [1]. Our examination has shown that as banks faced diminishing demand for every part of the complex securities known as collateralized debt obligations, or CDOs, Merrill and other firms found ways to circumvent the market's clear signals [2].

The mortgage securities business was supposed to have a firewall against this sort of conflict of interest.

Banks like Merrill bought pools of mortgages and bundled them into securities, eventually making them into CDOs. Merrill paid upfront for the mortgages, but this outlay was quickly repaid as the bank made the securities and sold them to investors. The bankers doing these deals had a saying: We're in the moving business, not the storage business.

Executives producing the securities were not allowed to buy much of their own product; their pay was calculated by the revenues they generated. For this reason, decisions to hold a Merrill-created security for the long term were made by independent traders who determined, in essence, that the Merrill product was as good or better than what was available in the market.

By creating more CDOs, banks prolonged the boom. Ultimately the global banking system was saddled with hundreds of billions of dollars worth of toxic assets, triggering the 2008 implosion and throwing millions of people out of work and sending the global economy into a tailspin from which it has not yet recovered.

Executives who oversaw Merrill's CDO buying group dispute aspects of this account. One executive involved acknowledges that fees were shared, but says it was not a "formalized arrangement" and was instead done on a "case-by-case basis." Calling the arrangement bribery "is ridiculous," he says.

The executives also say the new group didn't drive Merrill's CDO production. In fact, they say the group was part of a plan to reduce risk by consolidating the unwanted assets into one place. The traders simply provided a place to put them. "We were managing and booking risk that was already in the firm and couldn't be sold," says one person who worked in the group.

A month before the group was created, Merrill Lynch owned $7.2 billion of the seemingly safe investments, according to an internal risk management report. By the time the CDO losses started mounting in July 2007, that figure had skyrocketed to $32.2 billion, most of which was held by the new group.

The origins of Merrill's crisis came at the beginning of 2006, when the bank's biggest customer for the supposedly safe assets -- the giant insurer AIG -- decided to stop buying the assets, known as "super-senior," after becoming worried that perhaps they weren't so safe after all.

The super-senior was the top portion of CDOs, meaning investors who owned it were the first to be compensated as homeowners paid their mortgages, and last in line to take losses should people become delinquent. By the fall of 2006, the housing market was dipping, and big insurance companies, pension funds and other institutional investors were turning away from any investments tied to mortgages.

Until that point, Merrill's own traders had been making money on purchases of super-senior debt. The traders were careful about their purchases. They would buy at prices they regarded as attractive and then make side bets -- what are known as hedges -- that would pay off if the value of the securities fell. This approach allowed the traders to make money for Merrill while minimizing the bank's risk.

It also was personally profitable. Annual bonuses for traders -- which can make up more than 75 percent of total compensation -- are largely based on how much money each individual makes for the firm.

By the middle of 2006, the Merrill traders who bought mortgage securities were often clashing with the powerful division, run by Harin De Silva and Ken Margolis, which created and sold the CDOs. At least three traders began to refuse to buy CDO pieces created by De Silva and Margolis' division, according to several former Merrill employees. (De Silva and Margolis didn't respond to requests for comment.)

In late September, Merrill created a $1.5 billion CDO called Octans, named after a constellation in the southern sky. It had been built at the behest of a hedge fund, Magnetar, and filled will some of the riskier mortgage-backed securities and CDOs. (As we reported in April with Chicago Public Radio's This American Life and NPR's Planet Money, Magnetar had helped create more than $40 billion worth of CDOs [3] with a variety of banks, and bet against many of those CDOs as part of a strategy to profit from the decline in the housing market.)

In an incident reported by the Wall Street Journal [4] ($) in April 2008, a Merrill trader looked over the contents of Octans and refused to buy the super-senior, believing that he should not be buying what no one else wanted. The trader was sidelined and eventually fired. (The same Journal article also reported that the new group had taken the majority of Merrill's super-seniors.)

The difficulty in finding buyers should have been a warning signal: If the market won't buy a product, maybe the bank should stop making it.

Instead, a Merrill executive, Dale Lattanzio, called a meeting, attended by among others the heads of the CDO sales group -- Margolis and De Silva -- and a trader, Ranodeb Roy. According to a person who attended the meeting, they discussed creating a special group under Roy to accept super-senior slices. (Lattanzio didn't respond to requests for comment.)

The head of the new group, Roy, had arrived in the U.S. early in the year, having spent his whole career in Asia. He had little experience either with the American capital markets or mortgages. His new unit was staffed with three junior people drawn from various places in the bank. The three didn't have the stature within the firm to refuse a purchase, and, more troubling, had little expertise in evaluating CDOs, former Merrill employees say.

Roy had reservations about purchasing the super-senior pieces. In August 2006, he sent a memo to Lattanzio warning that Merrill's CDO business was flawed. He wrote that holding super-senior positions disregarded the "systemic risk" involved.

When younger traders complained to him, Roy agreed it was unwise to retain the position. But he also told these traders that it was good for one's career to try to get along with people at Merrill, according to a former employee.

But Roy and his team needed to be paid. As they were setting up the trading group, Roy raised the issue of compensation. "The CDO guys said this helps our business and said don't worry about it -- we will take care of it," recalls a person involved in the discussions.

The agreement, according to a former executive with direct knowledge of it, generally worked like this: Each time Merrill's CDO salesmen created a deal, they shared part of the fee they generated with the special group that had been created to "buy" some of the CDO. A billion-dollar CDO generated about $7 million in fees for Merrill's CDO sales group. The new group that bought the CDO would usually be credited with a profit between $2 million and $3 million -- despite the fact that the trade often lost money.

Sharing the bonus money for a deal or trade is common on Wall Street, arrangements known as "soft P&L," for "profit and loss." But it is not typical, or desirable, to pay a group to do something against their financial interests or those of the bank.

Roy made about $6 million for 2006, according to former Merrill executives. He was promoted out of the group in May 2007, but then fired in November of that year. He now is a high-level executive for Morgan Stanley in Asia. The co-heads of Merrill's CDO sales group, Ken Margolis and Harin De Silva, pulled down about $7 million each in 2006, according to those executives. De Silva is now at the investment firm PIMCO.

By early summer 2007, many former executives now realize, Merrill was a dead firm walking. As the mortgage securities market imploded, high-level executives embarked on an internal investigation to get to the bottom of what had happened. It did not take them long to discover the subsidy arrangement.

Executives made a sweep of the firm to see if there were other similar deals. We "made a lot of noise" about the Roy subsidy to root out any other similarly troublesome arrangements, said one of the executives involved in the internal investigation. "I'd never seen it before and have never seen it again," he says.

In early October 2007, Merrill began to purge executives and, slowly, to reveal its losses. The heads of Merrill's fixed income group, including Dale Lattanzio, were fired.

Days later, the bank announced it would write down $5.5 billion worth of CDO assets. Less than three weeks after that, Merrill raised the estimate to $8.4 billion. Days later, the board fired Merrill's CEO, Stan O'Neal.

Eventually, Merrill would write down about $26 billion worth of CDOs, including most of the assets that Ranodeb Roy and his team had taken from De Silva and Margolis.

After Merrill revised its estimate of losses in October 2007, the Securities and Exchange Commission began an investigation to discover if the firm's executives had committed securities fraud or misrepresented the state of its business to investors.

But then the financial crisis began in earnest. By March 2008, Bear Stearns had collapsed. By the fall of 2008, Merrill was sold to Bank of America. In a controversial move, Merrill paid bonuses out to its top executives despite its precarious state. The SEC turned its focus on Merrill and BofA's bonuses and sued, alleging failures to properly disclose the payments.

As for the original SEC probe into Merrill Lynch's CDO business in 2007, nothing ever came of it.

In litigious America how come no shareholder has sued the Board in their persoanl capacities ? Is it only now that the evidence is seeping out? Or should it be criminal charges - sure looks like it.