[NYTr] Collapsing Economy: Interest Rate "Freeze" - The Real Story is Fraud

[All the News That Doesn't Fit]

sent by Ed Pearl - Dec 14, 2007


SF Chronicle - Dec 9, 2007
http://sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/12/09/IN5BTNJ2V.DTL

By Sean Olender


Interest rate 'freeze' - the real story is fraud

Bankers pay lip service to families while scurrying to avert suits,
prison

New proposals to ease our great mortgage meltdown keep rolling in.
First the Treasury Department urged the creation of a new fund that
would buy risky mortgage bonds as a tactic to hide what those bonds
were really worth. (Not much.) Then the idea was to use Fannie Mae and
Freddie Mac to buy the risky loans, even if it was clear that U.S.
taxpayers would eventually be stuck with the bill. But that plan went
south after Fannie suffered a new accounting scandal, and Freddie's
existing loan losses shot up more than expected.

Now, just unveiled Thursday, comes the "freeze," the brainchild of
Treasury Secretary Henry Paulson. It sounds good: For five years,
mortgage lenders will freeze interest rates on a limited number of
"teaser" subprime loans. Other homeowners facing foreclosure will be
offered assistance from the Federal Housing Administration.

But unfortunately, the "freeze" is just another fraud - and like the
other bailout proposals, it has nothing to do with U.S. house prices,
with "working families," keeping people in their homes or any of that
nonsense.

The sole goal of the freeze is to prevent owners of mortgage-backed
securities, many of them foreigners, from suing U.S. banks and forcing
them to buy back worthless mortgage securities at face value - right
now almost 10 times their market worth.

The ticking time bomb in the U.S. banking system is not resetting
subprime mortgage rates. The real problem is the contractual ability of
investors in mortgage bonds to require banks to buy back the loans at
face value if there was fraud in the origination process.

And, to be sure, fraud is everywhere. It's in the loan application
documents, and it's in the appraisals. There are e-mails and memos
floating around showing that many people in banks, investment banks and
appraisal companies - all the way up to senior management - knew about
it.

I can hear the hum of shredders working overtime, and maybe that is the
new "hot" industry to invest in. There are lots of people who would
like to muzzle subpoena-happy New York Attorney General Andrew Cuomo to
buy time and make this all go away. Cuomo is just inches from getting
what he needs to start putting a lot of people in prison. I bet some
people are trying right now to make him an offer "he can't refuse."

Despite Thursday's ballyhooed new deal with mortgage lenders, does
anyone really think that it can ultimately stop fraud lawsuits by
mortgage bond investors, many of them spread out across the globe?

The catastrophic consequences of bond investors forcing originators to
buy back loans at face value are beyond the current media discussion.
The loans at issue dwarf the capital available at the largest U.S.
banks combined, and investor lawsuits would raise stunning liability
sufficient to cause even the largest U.S. banks to fail, resulting in
massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC.

The problem isn't just subprime loans. It is the entire mortgage
market. As home prices fall, defaults will rise sharply - period. And
so will the patience of mortgage bondholders. Different classes of
mortgage bonds from various risk pools are owned by different central
banks, funds, pensions and investors all over the world. Even your
pension or 401(k) might have some of these bonds in it.

Perhaps some U.S. government department can make veiled threats to
foreign countries to suggest they will suffer unpleasant consequences
if their largest holders (central banks and investment funds) don't go
along with the plan, but how could it be possible to strong-arm
everyone?

What would be prudent and logical is for the banks that sold this toxic
waste to buy it back and for a lot of people to go to prison. If they
knew about the fraud, they should have to buy the bonds back. The time
to look into this is before the shredders have worked their magic - not
five years from now.

Those selling the "freeze" have suggested that mortgage-backed
securities investors will benefit because they lose more with rising
foreclosures. But with fast-depreciating collateral, the last thing
investors in mortgage bonds ought to do is put off foreclosures. Rate
freezes are at best a tool for delaying the inevitable foreclosures
when even the most optimistic forecasters expect home prices to fall.
In October, Goldman Sachs issued a report forecasting an incredible 35
to 40 percent drop in California home prices in the coming few years.
To minimize losses, a mortgage bondholder would obviously be better off
foreclosing on a home before prices plunge.

The goal of the freeze may be to delay bond investors from suing by
putting off the big foreclosure wave for several years. But it may also
be to stop bond investors from suing. If the investors agreed to loan
modifications with the "real" wage and asset information from
refinancing borrowers, mortgage originators and bundlers would have an
excuse once the foreclosure occurred. They could say, "Fraud? What
fraud?! You knew the borrower's real income and asset information later
when he refinanced!"

The key is to refinance borrowers whose current loans involved fraud in
the origination process. And I assure you it was a minority of
borrowers whose loans didn't involve fraud.

The government is trying to accomplish wide-scale refinancing by
tricking bond investors, or by tricking U.S. taxpayers. Guess who will
foot the bill now that the FHA is entering the fray?

Ultimately, the people in these secret Paulson meetings were probably
less worried about saving the mortgage market than with saving
themselves. Some might be looking at prison time.

As chief of Goldman Sachs, Paulson was involved, to degrees as yet
unrevealed, in the mortgage securitization process during the halcyon
days of mortgage fraud from 2004 to 2006.

Paulson became the U.S. Treasury secretary on July 10, 2006, after the
extent of the debacle was coming into focus for those in the know.
Goldman Sachs achieved recent accolades in the markets for having bet
heavily against the housing market, while Citigroup, Morgan Stanley,
Bear Sterns, Merrill Lynch and others got hammered for failing to time
the end of the credit bubble.

Goldman Sachs is the only major investment bank in the United States
that has emerged as yet unscathed from this debacle. The success of its
strategy must have resulted from fairly substantial bets against
housing, mortgage banking and related industries, which also means that
Goldman Sachs saw this coming at the same time they were bundling and
selling these loans.

If a mortgage bond investor sues Goldman Sachs to force the institution
to buy back loans, could Paulson be forced to testify as to whether
Goldman Sachs knew or had reason to know about fraud in the origination
process of the loans it was bundling?

It is truly amazing that right now everyone in the country is deferring
to Paulson and the heads of Countrywide, JPMorgan, Bank of America and
others as the best group to work out a solution to this problem. No one
is talking about the fact that these people created the problem and
profited to the tune of hundreds of billions of dollars from it.

I suspect that such a group first sat down and tried to figure out how
to protect their financial interests and avoid criminal liability. And
then when they agreed on the plan, they decided to sell it as "helping
working families stay in their homes." That's why these meetings were
secret, and reporters and the public weren't invited.

The next time that Paulson is before the Senate Finance Committee,
instead of asking, "How much money do you think we should give your
banking buddies?" I'd like to see New York Sen. Chuck Schumer ask him
what he knew about this staggering fraud at the time he was chief of
Goldman Sachs.

The Goldman report in October suggests that rampant investor demand is
to blame for origination fraud - even though these investors were
misled by high credit ratings from bond rating agencies being paid
billions by the U.S. investment banks, like Goldman, that were selling
the bundled mortgages.

This logic is like saying shoppers seeking bargain-priced soup
encourage the grocery store owner to steal it. I mean, we're talking
about criminal fraud here. We are on the cusp of a mammoth financial
crisis, and the Federal Reserve and the U.S. Treasury are trying to
limit the liability of their banking friends under the guise of trying
to help borrowers. At stake is nothing short of the continued existence
of the U.S. banking system.

[Sean Olender is a San Mateo attorney.]