Foreclosure Fraud Machine

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.

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.

Automated Greed Factories: How Soulless Banking Is Crushing the Economy

Richard Eskow — Mon, 11 Oct 2010 10:50:58 -0400

Two seemingly unrelated stories from the past week illustrate a fundamental problem with today's financial system. While this problem may seem "philosophical" or abstract, it's very real, and we won't put our economy back on a sound footing until we get a handle on it. The problem is this: Banking institutions no longer want to perform the human functions they've performed for a thousand years. Financing has become a robotic form of mass production, designed to generate ever-increasing wealth within an artificial system by draining it from the real world.

In a word, banks have lost their souls.

A recent report blames last May's "flash crash" on software run wild, while the new "robo-signing" mortgage scandal looks a lot like (and is) old-fashioned fraud. The "flash crash," which caused the stock market to plunge 600 points and bounce back within minutes, was computer-driven. In the "robo-signing" scandal the "robots" weren't machines, but bank employees who "mechanically" signed legal statements without checking their accuracy. But both are symptoms of a common disease. They both stem from the banks' insatiable desire to earn the maximum amount of money while expending the minimum amount of effort ,with the least possible real-world interaction. That's led to a mechanized form of banking that's devouring the economy.

Whether it's computerized trading or "robot" bankers, greed is the Ghost in the Machine.

Bankers with soul?

It may sound odd to speak of banks or bankers as having once had "souls." While it's true that they may not have had soul in the same way that, say, Otis Redding did when he sang "These Arms of Mine," financiers have always played a certain human role in the economy. They existed to make sure that capital was available when it was needed, whether it was to outfit sailing fleets for an voyage or plant seeds for next year's grain harvest. While bankers have never been confused with philanthropists, their role in well-functioning economies was clearly defined and useful.

Bankers throughout history lived and worked in the real world. Somebody had to inspect the granaries of ancient Egypt to see if they were full or not. The bankers financing a trading fleet had to meet the ship's captains, inspect the riggings, and make sure there was room in the holds for the treasures of the East. Back then, the money people did whatever they needed to do to see that their money was being safely handled. That's because there were never too many degrees of separation between a bank's money and events in the physical world.

That's changed. For a long time there have been financial transactions that dealt only with other financial transactions, rather than concrete phenomena. But these "abstract" transactions have grown exponentially with the explosion of derivatives and other sophisticated instruments. And it's easy money, comparatively speaking. You won't find anybody from Goldman Sachs inspecting the wheelhouse of a four-masted clipper ship bound for Madagascar.

Automated greed machines

It's natural for anybody, no matter what their level of income, to want the maximum amount of income for the minimum amount of work. This aspect of human nature only becomes a problem when society gives them too much power to indulge that urge. That's exactly what's happening today.

Take automated banking - or "algorithmic trading," as it's now known. The idea isn't evil - or if it is, then I have a streak of evil myself. Back in my systems analyst days (the early 1980's) I went to my bosses with a proposal for something similar, just like hundreds of my contemporaries probably did. I was told that it was too risky, and that automation couldn't substitute for human judgement. That was before it had become clear that large financial institutions could count on being bailed out if they got into trouble.. That was before the financial sector metastasized to gobble up 40% of the nation's profits, and before the growth of derivatives and similar transactions made the disconnect between "real world" economic activity and non-reality-based financial dealings so extreme.

Today it's a different story: Welcome to the Brave New World. "High frequency trading" - automated transactions that buy and sell massive numbers of transactions faster than the human brain can react - now accounts for a reported 73% of all US equity trades. In its report on the "flash crash," the SEC identified six different types of players: "Intermediaries, High Frequency Traders, Fundamental Buyers, Fundamental Sellers, Noise Traders, and Opportunistic Traders." Not a rigging inspector among them ...

A Wall Street Journal article traces the (de)regulatory decisions that helped turn the stock market over to unsupervised computer programs, leading to so-called "dark pools" where trading takes place outside traditional market exchanges.

The house always wins ... and the software runs the house

The result is a system of such complexity that nobody really understands how it works. It's a system where computers, and those who own them, don't just react to changing prices: They can control them. These ultrafast transactions also provide an ideal way for traders to engage in "front running," making money by placing trades for themselves a millisecond ahead of those their customers ask them to make. Since the financial market is dominated by a few large players like Goldman Sachs, each of them has enough data to manipulate the market in their own benefit without ever being detected.

(To this day, nobody has explained yet how the four largest banks - Bank of America, Citigroup, Goldman Sachs and JPMorgan Chase - went an entire quarter without losing money in their trading operations for even one day. The chances of that happening by chance in a legitimate system are infinitesimal.)

The mortgage market: Incentives to lie (and be lied to)

Mike Konczal's introduction to bank mortgage fraud includes a series of charts that nicely illustrate the separation of mortgage-backed securities from real-world economics. His illustration of the transactional layers between a homeowner and a mortgage-backed security shows how remote a trust holding these securities is from the actual banking transaction. What's more, it shows where the incentives exist to lie and exaggerate the value of the mortgages being sold.

Not only have financial institutions lost the incentive to touch and inspect the physical objects (homes) behind their loans, but many of them have had the incentive not to know if they're being lied to. That dovetails perfectly with the incentive that sellers had, which was to lie to them.

As with algorithmic trading, all that mattered was to accelerate the buying and selling process. Traders like Goldman Sachs could make money on each trade, while speculating on the overall outcome to make evey more money. In software terms, the process became the output. As a result, the speed with which these mortgages were bought and sold left the actual chain of ownership to many of these homes in question.

Why bankers become robots

Now that many of these houses are in foreclosure, lazy and fraudulent bankers chose to "robotize" themselves by signing documents for court statements without bothering to verify their accuracy. But these documents were affidavits which, as one of Yves Smith's readers points out, "is a legal document which can substitute for live witness testimony in court ... (requiring) that the witness swears to tell the truth, is competent and has personal knowledge of the facts they are testifying about ... (and) swears to tell the truth by being placed under oath by the notary."

These are not "paperwork errors," as bankers and many compliant journalists have described them. Signing an affidavit when you don't know it's true is a crime. In many cases, the banks had to know the claims in these documents couldn't be proven. In a way, they had no choice but to submit fraudulent documents. Their financial edifice was a house of cards, and without proof of their claims they were forced to add more cards to it. "Robo-signing" was the natural next step, after the "robo-lending" and "robo-betting" that built the house of cards in the first place.

This behavior is the end result of lazy, greedy, non-reality-based banking. It is the ultimate - and probably inevitable - product off a system that has turned banks into factories for the automated production of profits without any connection to the outside world.

The soul of a dead machine

The bankers signing these documents were performing a criminal act. But they were also like Mickey Mouse as the Sorcerer's Apprentice in Fantasia, running harder and harder to keep up with the creatures they had animated to do their bidding. As for the "flash crash," we've been assured that new "circuit breakers" will prevent future calamities. But we've also seen a series of subsequent "mini crashes," including one plunge in aluminum prices that was described as the "Jumpin' Jack Flash mini crash" (after the Whoopi Goldberg hacker movie, not the Stones song.)

How did the system get so irrational, so abstract, so voracious and uncontrollable? Another story this week tells us. The US Senate, acting as swiftly and invisibly as a algorithmic trading program, approved legislation that would have created new hurdles for people trying to protect themselves banks from illegal "robo-signed" documents. After a public outcry the President refused to sign the bill, but its very passage showed how a mechanized banking sector can use campaign contributions and political connections as its robotic arms and legs.

While they've been convincing us how busy and important they are, bankers have actually been doing less and less real work, with less grounding in reality as the rest of us know it. The Soul in the Machine has died, especially at the largest and most powerful banking institutions - the ones that remain Too Big to Fail and Too Inhuman to Live.

Don't just repair the machines. Give them a different purpose.

Sure, "circuit breakers" are a good idea, and so are the other reforms many of us focus upon. But while we're all debating the Basel III accord or the "finreg" bill, it's easy to lose sight of the bigger picture. Banking has become detached from human experience and turned into a mechanical, self-replicating function, one that exists only to grow and perpetuate itself.

The real solution is to return banking to its original function as a source of capital for real-life human activities. That means encouraging banks to once again become lenders, rather than merely speculators, while cracking down on all forms of human and "mechanical" lawlessness." Banks can certainly automate themselves, but "cyborg finance" will need to obey Isaac Asimov's Three Laws of Robotics, with special attention to Law #1: "A robot may not injure a human being or, through inaction, allow a human being to come to harm."

I don't disagree with Jon Stokes when he compares the entire stock market to "a single, very big piece of multithreaded software" (in an essay that will be particularly intriguing to geeks like this writer). The only problem with the analogy is that it doesn't go far enough. The entire economy is being driven by software now. Software's only as good as the intentions, knowledge, and wisdom of its programmers. Things aren't going to change until we take the source code back from the people running things now.

As programmers have always said: Garbage in, garbage out.

_______________________________________________________________

This post was produced as part of the Curbing Wall Street project.

Too-Big-For-Paperwork: Fixing Wall Street's Foreclosure Fraud Disaster

Zach Carter — Fri, 08 Oct 2010 14:43:51 -0400

Anybody looking for a primer explaining why the current foreclosure fraud issue is a major systemic risk for the financial system should check out Mike Konczal's new post for the Roosevelt Institute. I'm going to try and simplify it even further here, and present the only serious avenue available to solve the problem.

Three parties stand to lose big. The most obvious is homeowners—they're being slapped with enormous, illegal fees invented by fraudulent documents, and frequently being illegally exiled from their homes.

Next are the mortgage servicers. These are the mortgage industry's debt collectors, and their mere existence often creates huge conflicts of interest that have made the foreclosure mess much harder to clean-up. The dominant servicers are owned by megabanks—Bank of America, JPMorgan Chase, Wells Fargo, Citibank and GMAC control the vast majority of this work. A massive loss for a mortgage servicer means a massive loss for a massive bank.

Mortgage servicers are supposed to collect payments and negotiate with troubled borrowers in order to maximize the returns to investors. Who are these investors? Hedge funds and banks that bought mortgage-backed securities during the housing bubble.

The basic job of a mortgage servicer is to collect payments from borrowers, and pass them on to investors. If borrowers stop paying, servicers have to make those payments to investors out of their own pocket—until they actually foreclose. At foreclosure, the servicer gets to recoup its costs. So in many cases, servicers have a very strong incentive to cut whatever corners they can in order to recoup their costs and avoid forwarding more money to investors (This is only part of the story—since the servicers are megabanks, the other assets of the servicer bank can give the servicer wing an incentive to stall the foreclosure process like crazy—more on that in another post).

The point is, in many cases, servicers have a clear incentive to cut corners to speed up the foreclosure process, and stand to lose a lot of money if they don't.

Servicers should have a set of key documents for every mortgage that has been bundled into the securities they operate. But they don't. Why? Because the original bank who sold the original mortgages to homeowners never handed over the documents when the security was created.

That brings us to the investors. Mortgage-backed securities involve different levels of risk—investors don't just buy one security composed of lots of mortgages. Instead, the pool of mortgages is cut into different pieces according to how risky they are. The riskiest bits fetch the highest monthly payments for investors, but are the first to take losses if the mortgages go bad. The safest parts bring in lower monthly payments, but are the last to take losses.

Investors who have the safe parts of the security want to see the foreclosure process burn through as fast as possible. The faster it goes, the lower the expenses for the servicer, and the more these investors will be able to recoup after foreclosure.

But investors who have the risky parts of the security have the exact opposite incentives. They want foreclosures stalled for as long as possible, so that the servicer has to keep forwarding them payments for as long as possible. The servicer doesn't take its cut from the investors after foreclosure, it takes them from the sale of the house. So the risky investors (junior bondholders in finance-speak) are hoping to delay foreclosures, while the safer investors (senior bondholders) are hoping to stall for time, since time means more payments.

So there's a war going on right now between risky and safe investors, many of which have different risk positions in different securities.

But servicers don't have the necessary documents, and they can't get them. The Florida bank lobby says that destroying mortgage documents was standard operating procedure during the bubble years. If you can't provide the documents, then in many cases, you simply do not have the right to foreclose at all. That means catastrophic losses for both safe investors and servicers, since they never get to recoup any losses.

So no matter what happens, the most obvious, immediate losses and the most serious long-term legal liability are at the big mortgage servicers. These are all megabanks. And investors of all stripes are going to do everything in their power to stick the investment banks who created these securities with the bill. These are also megabanks.

As Mike emphasizes, there are $2.6 trillion worth of mortgage-backed securities out there. That's more than enough in potential losses to sink every major bank and hedge fund in the United States.

There are two ways to deal with this. One is to bailout the banks for engaging in systematic, documented fraud, and further screw over the homeowners they're defrauding by changing the legal standards for mortgage documentation. This is what the bank lobby wants, and it is obviously unacceptable. This won't only hammer homeowners, it'll also blast investors who hold the risky end of mortgage-backed securities.

The other is to adopt a massive principal-reduction program which creates new, real documents for every troubled borrower in the country, and reduces their debt burden so that they don't end up in foreclosure. This solution means catastrophic losses for investors, but not as catastrophic as being unable to foreclose.

But barring another massive bailout, our biggest banks are right back up against the wall again, no matter what happens. And they'll keep coming back to the brink of insolvency so long as they remain too-big-to-even-file-their-damned-paperwork.

Break up the banks.

Obama Must Reject The Foreclosure Fraud Bailout

Zach Carter — Thu, 07 Oct 2010 13:05:02 -0400

UPDATE: President Obama vetoed the foreclosure fraud bailout this afternoon, but plenty of other battles are already raging. Rep. Alan Grayson, D-Fla., is calling for Treasury Secretary Timothy Geithner and the newly-established Financial Stability Oversight Council to investigate the foreclosure fraud scandal as a systemic risk to the U.S. economy.

That's a major step. Thus far, Geithner has been hostile to efforts that would provide foreclosure relief to troubled borrowers. But given the fact that the current scandal involves straightforward fraud, the absolutely massive scope of this fraud, and the potential havoc it stands to wreak on banks' bottom lines, the government may finally step in to help homeowners. Obama made clear today that he will not support a stealth bailout for foreclosure fraud. With the right pressure, the administration may very well act to help borrowers, not bankers.

Meanwhile, state attorneys general are filing lawsuits against big banks left and right, and calling for a major moratorium on foreclosures.

ORIGINAL POST:

Unbelievably, the U.S. Senate has approved legislation making it easier for banks to get away with foreclosure fraud. The bill would make it much harder for consumer advocates to show that banks are engaging in fraud, bailing out megabanks who cut corners in order to boost bonuses and slap borrowers with massive, illegal fees. The political fight between big banks and troubled homeowners is on, and President Barack Obama must take a side.

If President Obama signs this legislation into law, he’s sending a clear signal that his administration stands ready to bailout the banks again, whatever the consequences for American homeowners. The new legislation is a clear attempt to provide legal cover to GMAC’s robo-signing scandal, and should be firmly opposed by Obama.

Banks are running into big trouble in foreclosure courts right now because they have kept shoddy mortgage records for years in order to cut costs and boost bonuses. Those records are so bad that banks routinely cannot prove that they have the legal right to foreclose on the homes they attempt to foreclose on. That’s a major problem, because banks have repeatedly demonstrated that they cannot be trusted to figure out their own foreclosures for themselves. They’ve foreclosed on people who haven’t missed any mortgage payments, and even on borrowers who have fully paid off their loans.

So banks and their lawyers have been fabricating documents, forging signatures, and lying to judges in order to go through with foreclosures. All of this is fraud-- especially when committed systematically, en masse by large corporations and their clients. It gets even worse when banks try to use fraudulent documents to slap borrowers with thousands of dollars in illegal fees.

The legislation currently awaiting President Obama’s signature tries to bailout banks on one aspect of this documentation problem. Banks push through a lot of bogus documents with the help of corrupt notaries. Notaries are people who witness some legal event, like the signing of a contract, and then testify in print that they saw the contract being signed. It’s one way for courts and lawyers to show that documents have not been forged.

But the major foreclosure fraud scandal at bailout behemoth GMAC that ignited the current furor involved what appear to be totally bogus notaries. One GMAC employee, Jeffrey Stephan, signed thousands of affidavits and had them all notarized in Pennsylvania, even though they were being used in foreclosure cases in many different states. Since different states have different standards for notary approval, these documents should have been unacceptable in the vast majority of state courts.

That made the GMAC scandal illegal in most states. But the GMAC scandal got much worse once Stephan acknowledged that he had never actually examined the affidavits before approving them. All of Pennsylvania’s notaries who signed off on the Stephans Documents were totally unreliable. They were approving fraudulent documents en masse.

So for the Stephens Documents, there are two levels of impropriety—the notaries who didn’t do their homework, and Stephens, who illegally robo-signed hundreds of thousands of documents.

The bill approved by the Senate on September 30 addresses the notary side of things. It says that all states must accept a notary from any other state, and even allows notaries to sign-off on electronic documents. That means notaries don’t have to be present at the signing of documents—somebody can forge a document, scan it into a computer, and ship it off to a notary for approval, replicating the GMAC scam online.

The good news is that the GMAC documents were still illegal even without the false notarizations. The fact that Stephans robo-signed these without examining them was itself an act of fraud (barring other extenuating circumstances). So even if this bill is signed by Obama, wronged homeowners have some hope for redress.

But the legislation would still create a major new hurdle for borrowers seeking relief. If a bogus notarization is deemed legal, it’s much harder to prove that the document itself is just a big fat fraud. Most states only accept notarizations from their own state—this makes perfect sense for mortgages. Nobody from Pennsylvania needs to fly-in to witness my mortgage closing in Virginia—a Virginian notary will do just fine.

By requiring any state’s notarizations to be acceptable nationwide, the bill establishes a new race-to-the-bottom in standards: Whichever state has the weakest notary rules gets all the business. It means all of the crap Pennsylvania notaries on the GMAC robo-signings would be deemed acceptable in any state. Borrowers could still challenge the GMAC robo-signings, but it would be much harder to win the challenge, since an official, authorized notary had stated that the fraudulent robo-signings were in fact legitimate.

The bill is an obvious attempt to bailout banks from the consequences of their own bonus-fueled shortcuts—shortcuts which are being used to slap individual American families with tens of thousands of dollars in illegal fees. President Obama has no business bailing out our biggest banks again—especially on the backs of troubled borrowers those banks are attempting to defraud.

And the future political ramifications are dire. If this bill proves insufficient to bailout GMAC, JPMorgan, Bank of America, and the other major banks implicated in the foreclosure fraud scandal, there will be future legislative efforts to help them. If this bill becomes law, then politicians will have created political cover for the next round of bailouts, which will be characterized as a mere “technical fix” to this attempt.

President Obama must veto this bill. American homeowners deserve to be protected from fraud. The American government shouldn’t be bailing out fraud.

Organized Crime: Wall Street's Foreclosure Fraud Machine

Zach Carter — Wed, 06 Oct 2010 10:08:54 -0400

Just when you thought Wall Street couldn't defraud the economy any further, it went ahead and did it. After pushing millions of borrowers into foreclosure with fraudulent loans, big banks are now being implicated in a massive new fraud scandal involving the foreclosure process itself. All over the country, banks and their lawyers are resorting to outright fraud in order to kick people out of their homes and slap them with huge, illegal fees. It may be the biggest scandal of the entire financial crisis, one that could result in epic losses for the nation's largest banks.

We've been hearing for years about the horrific mortgages bankers pushed borrowers into, the outrageous scams they deployed in dumping these mortgages on investors, and the lies they told to their own shareholders about those mortgages in order to boost bonuses. Fraud was a major part of this machine at every stage of production, but the foreclosure fraud being uncovered by lawyers today appears to be the broadest scandal to emerge from the mortgage mess thus far.

Yves Smith has done an outstanding job covering this scandal, so be sure to check out her posts for all the details, but here's the basic story: Banks intentionally skimped on their mortgage paperwork during the housing bubble—it cut their costs and made the sale of mortgage-backed securities more profitable. A basic, standardized part of the mortgage process at many banks included forging or destroying key documents, or never bothering to write them up in the first place. Those reckless procedures have been applied to millions of mortgages issued over the past decade, and allowed inflated bonus checks to be written for years. But things are about to get very ugly for the banks.

Mortgage documentation has been so shoddy that banks can't actually prove that they own the mortgages they want to foreclose on. This isn't a small scandal, it isn't a minor clerical issue, and it isn't a problem that banks deserve help from taxpayers to solve. Wall Street has simply not performed the basic tasks necessary to track ownership of its assets. Imagine a car manufacturer being unable to document the sale of automobiles. The basic business has broken.

If banks can't prove that they have the right to foreclose, they're not allowed to foreclose. The borrower gets to keep the house—even if he or she has stopped making payments on the mortgage. So banks—and the scummy law firms they hire—are resorting to all kinds of new tricks in order to foreclose (see Andy Kroll's excellent article detailing the sharks who operate these law firms). They're creating new documents, forging signatures and lying to judges. This is all fraud.

And this fraud doesn't only help banks cut costs—it also enables lawyers to slap troubled borrowers with huge, illegal fees, squeezing them for money even after they've been tapped out on mortgage payments. If you can't pay the foreclosure fees in court, debt collectors will chase you down and garnish your wages for years to come. These are massive fees—tens of thousands of dollars assessed on individual families for the luxury of being booted out of their home, all made possible by fraudulent documents, forged paperwork, and straightforward lies.

The ownership chain for mortgages is so complex—one bank issues a loan, which is sliced and diced into multiple mortgage-backed securities and sold to multiple investors—that the right to foreclose is not clear without precise and meticulous paperwork. If banks don't keep these records, there is no way for them to prove the losses or profits they make from a given loan.

Banks can’t even keep track of what houses they actually have the right to foreclose on. In addition to slipping illegal fees into the mix, the financial establishment is slamming incorrect foreclosures through the legal pipeline. Banks are actually kicking people out of homes who have been paying their mortgages on time. In some cases, they're even evicting borrowers who have already paid off their loan.

When banks can't get the documents they want, they resort to still more drastic measures. Banks are violating the law by physically breaking into peoples' homes, stealing their belongings and changing the locks. Add breaking and entering and larceny to the list of crimes committed by banks in the foreclosure process.

This scandal ought to put people behind bars. When somebody breaks into your home and steals your stuff, he goes to jail. But it also creates very serious problems for the entire financial system—if banks can't prove they own mortgages, how can we trust their quarterly earnings statements? How can the bonuses based on those earnings be justified?

In other words, the inhumane and illegal way banks have treated their borrowers is only part of the fraud scandal Wall Street now faces. There is also the makings of a massive corporate accounting scandal—one that easily rivals Enron and WorldComm in its scope.

GMAC, Bank of America and JPMorgan Chase—three of the largest mortgage servicers in the nation—have already frozen foreclosures in 23 states. These are the states in which banks must obtain a court order to proceed with a foreclosure, but there is every reason to suspect that the same illegal practices are occurring in other states. Shoddy documentation has been a standardized element of the mortgage process for years—it has just been easier to prove this malfeasance in states that require courts to sign-off on foreclosures.

When housing prices are in decline, banks lose money on foreclosures. Today, the average loss on a foreclosed subprime or Alt-A mortgage is about 63 percent, according to data analyzed by Valparaiso University Law Professor Alan White. But if banks can't actually take over the home, a foreclosure is far worse for the bank—it can't cut its losses on an unpaid loan by seizing the house and selling it. If borrowers assert their rights, and courts uphold the law, some of the nation’s largest banks are about to take massive, unexpected losses.

That fact—combined with the prospect of shareholder lawsuits over improper accounting—should radically change the landscape for foreclosure relief and broader financial reform. Most banks cannot afford to go to zero on every mortgage they own from the housing bubble. If troubled borrowers stand up to their banks, the resulting losses could easily jeopardize the solvency of some major firms. This gives reformers and policymakers a critical tool to demand stronger medicine for Wall Street: Give us real reform, or we'll let you go under.

Lock 'em up, then break 'em up.

Will Wall Street's Foreclosure Fraud Save Troubled Borrowers?

Zach Carter — Mon, 27 Sep 2010 13:42:48 -0400

I'll have plenty to say about the escalating foreclosure fraud scandal later this week. For now: This is a big, big deal. It isn't a clerical error, it's an aggressive attempt to slap borrowers with thousands of dollars in illegal fees for the luxury of being foreclosed on. And what's more, this absurd, shady business was priced into the entire mortgage securitization scheme from the get-go. Banks have been fudging their documentation for years in order to cut costs and score higher profits from securitization—the business model has relied on this corner-cutting since day one of the housing boom.

The good news is that borrowers can use this epic fraud to defend themselves. If a bank can't prove that it has the right to foreclose on a borrower by showing the proper documentation to a judge, then it doesn't have the right to foreclose. This is a tremendous opportunity for neighborhood advocates. Make them pony up the docs, it might just save your home. The problem isn't restricted to GMAC—foreclosure counselors and attorneys talk about the issue of forged or destroyed documentation all the time, and we already know that JPMorgan Chase and Countrywide (now Bank of America) have major documentation problems. Including GMAC, that's three of the biggest players in every aspect of the mortgage market.

If courts actually follow the law here, we get the best of both worlds—big losses for Wall Street on their predatory loans, and borrowers who get to stay in their homes (mortgage-free, at that). The only question is whether these mortgage losses prove so severe that Wall Street banks come back begging to the government for another bailout. If so, it's an opportunity to do what should have been done in 2008—break up these financial monsters into smaller creatures that don't require bailouts when they fail.

Yves Smith quotes a mortgage banker who assumes that Congress will simply legislate this problem away for Wall Street. Don't count on it. Nobody-- not even the most subservient Wall Street sycophant in the Republican Party—is eager to bailout Wall Street again, particularly to spare megabanks the costs of explicit, documented fraud.

The trick, of course, is making sure that the courts actually follow the law.