SEC Waking Up: Madoff Conspirators Face Charges — Now About Those Mortgage Bonds

After a long slumber of non-regulation and failure to bring charges for securities fraud the SEC is finally getting into the "game" --- the culture of fraud on Wall Street. When the Madoff story broke it was inconceivably large. $60 Billion generated through a PONZI scheme --- selling securities or taking money under a prospectus that promised that the flow of money would be invested for the benefit of the investors. The hallmark of such schemes is that they eventually fail when people stop buying the securities or depositing money. At that point the money deposited with the fraudster eventually fails to provide the funds necessary to keep paying investors the return they were promised and fails to cash out investors who want their money back. It fails because the scheme was either not to invest the money at all or to seek cover under investments that clearly were never going to be in compliance with the prospectus or any other standard of investment.

So now we ask again, what about the MBS players? Mortgage-backed securities dwarfed the Madoff scheme. $13 trillion-$20 trillion or more was taken from investors under a prospectus that promised funding of mortgages of the highest quality. Like Madoff, the investment bankers took what they wanted before they used the money to pay back investors or fund mortgages. And when they did fund mortgages they intentionally inserted false entities as lenders --- entities with no relationship to the investors. The effect was a conversion of the intended investment into an unsecured loan to either the investment bank or the borrower and no claim to bring against the borrower,directly or indirectly. The secured interest was destroyed and then claimed by the Banks. The claim for repayment was also converted to the benefit of the Banks, who then "traded" in their proprietary account in which the gains were kept by the Bank and the losses were tossed over the fence to the investors under a pooling and servicing agreement that was ignored except for laying off the losses on the investors.

When investors stopped buying MBS the scheme promptly collapsed. Investment banks still continued to advance money to investors directly or indirectly through the subservicers. They did this for the same reason any PONZI operator pays his "investors" (victims) --- to keep them buying into the investment pool and to create the illusion that nothing is wrong. At the same time the Banks were advancing money on alleged mortgage loans, they were declaring loans in default, foreclosing and claiming losses in their "ownership" of the mortgage bonds they had sold to pension funds. Eventually even the taxpayer became an unwitting and unwilling investor to save the world from the brink of economic collapse. It was believed the Banks were in trouble because they had recklessly lost money in risky trades. This was never true.

And now the massive deluge of Foreclosures continues the fraud. Just as the investors were not represented at the closing of alleged mortgage loans, they are not represented in Foreclosures. The banks are foreclosing in their own names --- cutting off the investors completely when the bank takes title to the property at the foreclosure sale --- and cutting off insurers, CDS counter parties, guarantors, and other co-venturers and co-obligors from seeking refunds or forcing the repurchase of the loans that were never subject to any form of underwriting standards of the industry.

The money they took off the top, the money they received from third parties who waived rights to collect from the borrower, was converted from a trade on behalf of their principals --- the investors (victims) who thought that their money was being deposited with the investment bank to fund a REMIC trust. The investor money became the bank's money. The investors' ownership of loans, notes, mortgages, and bonds became the property ofthe banks and so it stays today, except for the settlements with investors who are suing and except for the long list of fines and penalties leveled on the banks for pennies on the dollar. The pending BOA Article 77 hearing in which the insurers are pointing to the incestuous relationship between the "trustees" of the REMIC trusts and the investment banks is starting to come back and haunt both the trustee, who knew there was no funded trust, and the bank that was merely Madoff by another name.

So the payments due to investors stopped or were cut back without credit for the money received by the investment banks as agents of the investors. Thus the account receivable of the investor is kept away from the courts because it would show vastly different balances than the balance claimed by the servicer's and banks. The balance is much lower than what is represented in court. And it probably has been eliminated entirely when the net is cast over principals and agents' receipt of funds. The Foreclosures are wrong. They simply continue the fraud and ratify by judges' orders the theft of money, loans and what should have been notes payable to the investors or the REMIC trust that was never funded -- and therefore could never have purchased the loans.

If the money was applied properly most of the investors would be covered by the money that still remains in the banks that they are claiming as their own capital. Applied properly in accordance with generally accepted accounting principles, this would reduce the account receivable from the loans. It would also by definition reduce the corresponding account payable from the borrowers, making modification and settlement easy ---but for the interference of the servicers and investment banks who are trying desperately to hold onto their ill-gotten gains.

BOA, Deutsche Bank, Countrywide

FOR the last two weeks, a justice in New York State Supreme Court has heard testimony in one of the most pivotal cases of the financial crisis. The hearings will tell whether Bank of America can extinguish legal liability for more than a million Countrywide Financial loans by paying $8.5 billion in cash and agreeing to loan servicing improvements in a settlement struck with 22 investors in 2011.

But the case, being heard by Justice Barbara R. Kapnick, extends far beyond the impact of the settlement on Bank of America’s balance sheet. It is also laying bare an industry practice that has put investors in mortgage securities at a disadvantage and reduced their financial recoveries in the aftermath of the home loan mania.

The practice at issue involves trustee banks overseeing the vast and complex mortgage pools bought by pension funds, mutual funds and others. Trustees like Bank of New York Mellon were paid by investors to make sure that the servicers administering these mortgage deals, known as trusts, treated them properly. Trustees receive nominal fees — less than a penny on each dollar of assets — for the work.

But when mortgages soured, trustees declined to pursue available remedies for investors, such as pushing a servicer to buy back loans that did not meet quality standards promised when the securities were sold.

In other words, this case highlights a problem with trustees: they are a dog that could have barked but didn’t.

Before mortgage securities were undone by troubled loans, trustee inaction was not an issue. Trustees collected their fees at minimal effort and investors were satisfied.

But because trustees are hired by the big banks that package and sell the securities, their allegiances are divided. Sure, investors are paying the fees, but if a trustee wants to be hired by sellers of securities in the future, being combative on problematic loan pools may be unwise.

Trustee practices are under the microscope in Justice Kapnick’s courtroom because Bank of New York Mellon is the trustee overseeing all 530 Countrywide mortgage deals covered by the proposed $8.5 billion settlement. The trustee is supporting the deal between Bank of America and the 22 investors that include BlackRock, Pimco and the Federal Reserve Bank of New York. Losses by all investors in the securities are projected at $100 billion.

While lawyers for BlackRock and Pimco were negotiating this deal, other investors in the securities were not at the bargaining table. Nevertheless, they must abide by the settlement’s terms.

Some outside investors, including the American International Group, have objected, saying $8.5 billion is inadequate given the mountain of problem loans it covers. Lawyers for A.I.G. contend that Bank of New York put its interests ahead of other investors outside the settlement process. Had the trustee been more aggressive with Bank of America, the servicer administering the troubled securities, investors would have received more money in a settlement, A.I.G.’s lawyers say.

Bank of New York Mellon argues that the settlement is reasonable and that it has always acted in the best interests of all investors. 

But over the last two weeks, arguments and testimony have shed light on behind-the-scenes dealings during the settlement negotiations with Bank of America. Some of these details raise questions about the trustee’s assertiveness on behalf of all investors.

A crucial issue: the trustee didn’t request individual loan files from Bank of America to help determine how many mortgages had problems and, therefore, whether $8.5 billion was a reasonable recovery. A trustee has the right to request those files for investors who cannot get them on their own.

When loan files have been examined, recoveries have been far greater. Last year, for example, Deutsche Bank agreed to reimburse Assured Guaranty, a bond insurer, for 80 percent of losses on eight residential mortgage securities it had insured.

Asked about the basis for the $8.5 billion settlement, Kent Smith, a Pimco executive with experience in loan servicing, testified on June 7 that it came in part from an estimated percentage of problematic loans that was provided to the investors by Bank of America. But on cross-examination, he said the estimate was far lower than it would have been if Bank of New York Mellon had examined specific loan files.

The estimate, 36 percent, meant that just over one-third of the loans had violated underwriting representations and warranties made to investors. But a review of the loan files would have pushed the figure as high as 65 percent, he testified.

Additional testimony raised questions about fairness during the settlement talks. The 22 investors who struck the deal held at least 25 percent — a required threshold for taking action — in only 215 trusts, less than half the 530 covered by the settlement. No other investors had an advocate at the bargaining table. Asked who was representing investors outside the negotiating group, an in-house lawyer for Bank of New York Mellon said he did not know.

Then there’s an e-mail from Jason H. P. Kravitt, Bank of New York Mellon’s outside counsel, recounting how he told Bank of America that on one important point its and the trustee’s “self-interest” were aligned — neither wanted the Countrywide securities to go into default. If they did default, the trustee would have been forced to increase its oversight of Bank of America, adding to its costs. If the trustee did not sue the bank, investors could. 

Referring to a default, Mr. Kravitt said he told a Bank of America lawyer, “We don’t want it either, Chris.”

Asked about these matters, Kevin Heine, a Bank of New York Mellon spokesman, said, “We believe an $8.5 billion bird-in-the-hand settlement with significant servicing improvements is a far better result for all investors than the likely outcome following years of costly litigation.”

Trustees argue that they do not make enough money overseeing these loan pools to act on investors’ behalf. But this could be resolved if the Securities and Exchange Commission allowed or encouraged trustees to use trust assets to pay for loan reviews or litigation.

Justice Kapnick’s decision is not expected for months, and will affect only this settlement. But the revelations in her courtroom send a message to investors who might have expected trustees to protect their interests with more vigor. 

A note from livinglies

 by Neil Garfield

Editor's Comment: Finally the questions are spreading over the entire map of the false securitization of loans and the diversion of money, securities and and property from investors and homeowners. Read the article below, and see if you smell the stink rising from the financial sector. It is time for the government to come clean and tell us that they were defrauded by TARP, the bank bailouts, and the privileges extended to the major banks. They didn't save the financial sector they crowned it king over all the world.

Nowhere is that more evident than when you drill down on the so-called "trustees" of the so-called "trusts" that were "backed" by mortgage loans that didn't exist or that were already owned by someone else. The failure of trustees to exercise any power or control over securitization or to even ask a question about the mortgage bonds and the underlying loans was no accident. When the whistle blowers come out on this one it will clarify the situation. Deutsch, US Bank, Bank of New York accepted fees for the sole purpose of being named as trustees with the understanding that they would do nothing. They were happy to receive the fees and they knew their names were being used to create the illusion of authenticity when the bonds were "Sold" to investors.

One of the next big revelations is going to be how the money from investors was quickly spirited away from the trustee and directly into the pockets of the investment bankers who sold them. The Trustee didn't need a trust account because no money was paid to any "trust" on which it was named the trustee. Not having any money they obviously were not called upon to sign a check or issue a wire transfer from any account because there was no account. This was key to the PONZI scheme.

If the Trustees received money for the "trust" then they would be required under all kinds of laws and regulations to act like a trustee. With no assets in a named trustee they could hardly be required to do anything since it was an unfunded trust and everyone knows that an unfunded trust is no trust at all even if it exists on paper.

Of course if they had received the money as trustee, they would have wanted more money to act like a trustee. But that is just the tip of the iceberg. If they had received the money then they would have spent it on acquiring mortgages. And if they were acquiring mortgages as trustee they would have peeked under the hood to see if there was any loan there. to the extent that the loans were non-confirming loans for stable funds (heavily regulated pension funds) they would rejected many of the loans.

The real interesting pattern here is what would have happened if they did purchase the loans. Well then --- and follow this because your house depends upon it --- if they HAD purchased the loans for the "trust" there would have no need for MERS, no trading in the mortgages, and no trading on the mortgage bonds except that the insurance would have been paid to the investors like they thought it would.

If they HAD purchased the loans, then they would have a recorded interest, under the direction as trustees, for the REMIC trusts. And they would have had all original documents or proof that the original documents had been deposited somewhere that could be audited,  because they would not have purchased it without that. Show me the note never would have gotten off the ground or even occurred to anyone. But most importantly, they would clearly have mitigated damages by receipt of insurance and credit default swaps, payable to the trust and to the investment banker, which is what happened.

No, Reynaldo Reyes, it is not "Counter-intuitive." It was a lie from start to finish to cover up a PONZI scheme that failed like all PONZI schemes fail as soon as the "investors" stop buying the crap you are peddling. THAT is what happened in the financial crisis which would have been no crisis. Most of the loans would never have been approved for purchase by the trusts. Most of the defaults would have been real, most of the debts would have been real, and most importantly the note would be properly owned by the trust giving it an insurable interest and therefore the proceeds of insurance and credit default swaps would have been paid to investors leaving the number of defaults and foreclosures nearly zero.

And as we have seen in recent days, there would not have been a Bank of America driving as many foreclosures through the system as possible because the trustee would have entered into modification and mitigation agreements with borrowers. Oh wait, that might not have been necessary because the amount of money flooding the world would have been far less and the shadow banking system would be a tiny fraction of the size it is now --- last count it looks like something approaching or exceeding one quadrillion dollars --- or about 20 times all the real money in the world.

At some point the dam will break and the trustees will turn on the investment banks and those who are using the trustee's name in vain. The foreclosures will stop and the government will need to fess up tot he fact that it entered into tacit understandings with scoundrels. When you sleep with dogs you get fleas --- unless the dog is actually clean.