Saturday, October 9, 2010

US: Cautionary Tale of deregulated Banking

Below, a video from Jon Stewarts Daily Show on the Foreclosure Gate (crisis). The basic question is how house mortgage loans were done and were there errors and flaws in the paperwork (equivalent to Sri Lanka transfer of deed and recording in Land Registry) due to fraud or gross negligence.

The Daily Show With Jon StewartMon - Thurs 11p / 10c
Foreclosure Crisis
Daily Show Full EpisodesPolitical HumorRally to Restore Sanity

This is a non trivial issue for not only foreclosure, but mortgages that are current and the US economy, for the following reasons.
a) Total mortgage debt of the US is 14 trillion. Even if 10% of the mortgages are questionable, thats 1.4 trillion !.
b) These mortgages were bundled up and sold as Mortgage Backed Securities (MBS, Residential (RMBS) and Commercial (CMBS)). These are cash flow assets like bonds, where the cash flow is generated by the mortgage payments. These MBS were then sold to among others
  • To pension funds such as CALPERS. So if these MBS start loosing value and default in cash flows what happens to pension funds and their ability to pay the pensions.
  • Other banks and other Financial institutions such as Asset Management companies. These MBS are considered Level 2 or 3 assets, i.e. hard to value. What happens to the balance sheets of these institutions, could they be insolvent.

c) Were the rise in house prices, due to lax lending standards compounded by fraud and negligence in the processing of documentation. Will an owner of a Underwater Mortgage (Mortgage is greater than the current value of property) be able to question (have recourse against) lenders. i.e. In plain English, lenders pushed up prices by giving loans to all and sundry, without the right paperwork. Now that the reality is apparent, the prices of houses have dropped and the house owner is paying through his nose for an overvalued house. Can the house owner sue the lender?. Even if a few house owners, start litigation, regardless of the courts decision its going to create havoc in house prices, mortgages and the whole shebang.

So the whole housing securitization market is a mess. Currently the thinking is there are two options out of the mess.
a) Pass regulation that accepts the shoddy paperwork by banks overriding all accepted real estate practices and law. i.e bail out the banks and screw the home owner.
b) Modify existing mortgages to reflect current house prices and re-do paperwork. Then the MBS securitized with these mortgage are at best going to be devalued (Not going to address if thats considered a default and what it does to CDS' s taken against the MBS. That means the bank balance sheets are screwed.

This is really a cautionary tale, of how de regulated lending and banking (repeal of the depression era Glass-Steagall Act) can destroy even the largest economy. Golden Key, was just a blip (I know those who lost life savings think other wise) in the Sri Lankan Economy. Imagine if the commercial and state banks were allowed to operate like Golden Key.

You can read more on this at

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