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Guest Post: How Did the Banks Get Away With Pledging Mortgages to Multiple Buyers?

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Washington’s Blog

I’ve repeatedly documented that mortgages were pledged multiple times to different buyers. See this, this and this.

In response, some people (including one of the country’s top bankruptcy lawyers) have told me they don’t buy it.

Specifically, they ask such questions as:

  • With a mortgage sold to two different entities, wouldn’t the income from the mortgage be shown on the books of both entities?
  • Was the interest/principal payments that were made by the homeowner before they stopped being divided between both entities? If so, wouldn’t this have rung alarm bells immediately?
  • If only one was getting it, why didn’t the other entity immediately try to foreclose?
  • If there was one servicer involved, was the servicer covering the difference between what was collected and the payments actually made? If so, how did the servicer do this and still remain in business?
  • If two servicers were involved, why didn’t this come out sooner or were both servicers hiding this fraud?

So I wrote to some of the leading experts on mortgage fraud – L. Randall Wray (economics professor), Christopher Whalen (banking expert with Institutional Risk Analytics), and William K. Black (professor of economics and law, and the senior regulator during the S & L crisis) – to seek their insight.

Chris Whalen told me:

All good points, but the short answer is that nobody may have noticed until now. The issue of substitution and other games played by servicers makes exact tracking of loans problematic. It should show up in the servicers reports and should be caught, but there are a lot of things that go on in loan servicing that nobody talks about. Until about 2006, the GSEs and banks would advance cash and would substitute, but not now. The noble practitioners you heard from are all sincere and want to believe in intelligent design.

Whalen explained:

Prior to FAS [i.e. Financial Accounting Standards] 166/167, a defaulted loan might sit in a FNM/FRE pool for up to a year before the default was removed from the trust. The issuer would then place a new loan into the pool or “substitute” for the old loan. No purchase event was booked. The investor would never know. In fact, the issuer would keep paying interest on the original principal amount in those days. Now under FAS 166/167, the issuer must immediately repurchase the defaulted loan and take the loss less estimated recovery. That is why the pace picked up this year when it comes to repurchase demands.

You should refer your dubious and very naive friends to the case of National Bank of Keystone, WV. One of the worst failures per $ of assets in FDIC history. The management hid a Ponzi scheme in the loan servicing area for five years. Paid interest to investors with their own principal. Two auditors missed the fraud and later were sued by the FDIC acting as receiver for the dead bank. And this was a small operation. The big five are an even worse mess. Remember, when the seller of a loan and the servicer are the same, anything can happen. And it usually does.

Professor Black told me:

Double pledges (as they’re typically called, though one could pledge multiple times) are a well known fraud device. It is correct that one of the key purposes of adopting Article 9 of the Uniform Commercial Code (UCC) was to reduce the risk and frequency of this form of fraud. So, double pledges in the modern era require both (A) fraud (on the part of the borrower or purchaser) and incompetence, indifference, or corruption on the part of the original secured lender or their agents if the borrower is the fraudster or the purchasers if they are the fraudsters.

The two potential sources of fraud: A fraudulent borrower could pledge the same home as security for multiple mortgage loans. Title checks, by the lender/title insurer are so easy to conduct and so vital to protect the lender that this form of fraud is vanishingly rare. Alternatively, and far more likely, the lender could sell the mortgage to multiple buyers. Those buyers could have far lower incentives to check on prior pledges and less ability to check for prior pledges. The entity selling a loan to multiple parties (A) has a compelling incentive to hide the prior pledge(s), (B) is financially sophisticated, and therefore more capable of deception than a homeowner, and (C) can pick who to make the multiple sales to — allowing them to select the most vulnerable targets for fraud.

Subpart (C) provides the logical transition to the second requisite for multiple pledge frauds — vulnerable victims. The characteristics they would exhibit include (A) growing massively, (B) purchasing nonprime loans without fully underwriting the quality of the loans (and quality in this context inherently requires superb “paperwork”), (C) poor internal and external controls, and (D) opaque systems that make it extremely difficult to determine the beneficial owner and locate key mortgage documents that would reveal multiple sales. Unfortunately, these four characteristics were characteristic of many purchasers of nonprime mortgages. That is why I have long stated that the process was dominated by the financial sector equivalent of “don’t ask; don’t tell.”

Bottom line: the elite bankers and the anti-regulators have been so unwilling to
find the truth that no one knows how bad these frauds became. Finding the facts
is essential and can and should be done by reviewing samples of the loans pledged or sold to Fannie and Freddie and the Fed.

And professor Wray told me that record-keeping by servicers was terrible, and pointed me to the following article from the Tampa Tribune:

Peter Bakowski, a 58-year-old former Tampa mortgage broker, has admitted orchestrating a Ponzi scheme that involved more than 30 investors and institutions and more than 150 deals, documents show.

***

Bakowski sold the mortgage assignments to multiple investors, promising high rates of return and using all the money he generated to “keep the scheme afloat,” according to his plea agreement.

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21 comments

    1. Richard Smith

      It’s a very large detonation that went off some time ago, apparently without Deep Capture noticing.

      The process by which mortgages were synthesized, and the resulting calamity, is actually the climax of your blogger’s book “ECONned” (in Chapter 9, ultra-short version in appendix 2).

      Dig in your pocket, and have a read!

  1. Neil D

    In the face of this fraud, some Americans still insist on buying real estate. Some even buy foreclose properties from the banks! What are they thinking?

  2. pierre

    Yves,
    I am not sure you directly answered the bankruptcy lawyers questions. Between the lines you did, your references point in the direction. The lawyers need to understand that the investors didn’t actually buy “a mortgage”. People seem to think, logically so, that “Pierre’s” house was sold over and over again. When in fact, “Pierre’s” mortgage payments were sold over and over again, and sometimes (not all the time) my payments were sold to more than one person at the same time. And sometimes one investor bought Pierre’s kitchen, someone else the garage, and someone else the whole house. The investor bought a pool of cash flows, not property, and frankly didn’t care about the underlying properties as long as “everything worked”. The borrower, Pierre, got a loan to buy property. He also didn’t care who lent him the money or what happened after the fact. As long as everything was working.

    And when things stopped working, the investor took the hit on the (whole or portion) of the cash pool he bought into. He wasn’t about to forensically go an investigate every single property circumstance. That was what he paid the servicer to do. Whom he trusted. And besides, insurance will pay (hopefully). The borrower can’t pay, and trusts the right middle man to be the right person knocking on his door to go through the foreclosure process.

    This is a classic “financial information” arbitrage play. It invites fraud to the middle men because it creates a strong incentive to do so. One party only wants the property, the other only wants the cash. Neither shall meet. The middle man takes money from both sides.

    1. dejavuagain

      Rue the Day–

      But, the lack of payment would not be discovered immediately because of the opaque reporting by the servicers, as other describe here. That was the point of last week’s Federal Reserve as investor letter demanding more information.

      Here are the flaws in the system which facilitate Ponzi and other frauds:

      Servicer and originator – the same entity (as described on this blog).

      Substituting mortgages in MBS – this practice should not be allowed. If a mortgage is pulled from the pool, the MBS investors should receive hard cash in return, since there is an effective prepayment. Having to buy back the mortgage will be a great incentive by the sponsors not to jam junk mortgages into the pools.

      Servicer guarantee of cash flow – this is an evil. Where can the servicer get the cash except by diverting cash from other MBS payments. MBS investors should get used to variable monthly payments since, alors, a mortgage is not a bond. Any cash flow assurances should be external to the MBS – let the sponsor guarantee the cash flow.

      The MERS system – no authoritative source of assignee of individual mortgages.

      Limited rights of investors to required servicer compliance – wow, 25% required just to sue the investor.

      The entire approach to providing capital for residential mortgages needs to be rethought – or lets just go back 40 years.

  3. RueTheDay

    No offense, but I’m not buying that this was a widespread occurrence – for the very reasons you note in your post, namely, that it would be discovered immediately.

    The examples provided were examples of Ponzi schemes and houses being pledged as collateral more than once. They were not examples of a single mortgage being sold to more than one buyer.

    I’m not saying it never happened, because anything is possible, I’m saying I highly doubt it was widespread. At the end of Month 1, you’re going to have two parties expecting a payment. As far as scams go, this would not be a smart one.

    1. Attitude_Check

      The point is it was an intentional Ponzi. The banks “sold” the note twice and then paid the interest in the second note from the “excess” proceeds of the second sale. I assume they figured, more mortgages would be come available in the future and could replace the fraudulent second mortgage with another.

  4. AR

    So, the real money to be made in this scheme was in creating debt out of thin air upon writing millions of mortgages to mirror-foggers and taking bonuses based on the phony profits supposedly generated from theis debt, then inducing millions of savers and pensioners to monetize the debt by buying bonds based on the income flow afforded by the borrowers’ paychecks. Selling chances on the income stream multiple times over was where the perps made their real money. Advancing payments to the MBS, purportedly derived from the mortgage payments of millions of mirror-foggers (but much of it merely returned from the investors’ purchase money), is how the entire scheme was made to seem legitimate, and also served as a temporary cover-up, until the defaults were so massive that in order to maintain the artifice it was necessary for the perps to send their own ill-gotten profits to the MBS, or have the deep hole of missed payments cause alarm, investigations, and demands for putbacks……?

    Since the entire scheme was a fraud, the book-keeping was out of Madofff’s 17th floor. No wonder Asset-Backed Alert ‘grumbled over flawed remittances’ on 10/15/10. http://www.abalert.com/headlines.php?hid=73847

    No wonder it was necessary to create MERS, and wait for it to become the customary method of doing business in order to be able to rely on this artifice for hiding who was shuffling ‘paper’ therein. Why did all parties (except the courts, state legislatures, and county land offices, who weren’t asked) sign on with MERS, including the ratings agencies?

  5. rob adams

    From long employmment in oil exploration business, i am chuckling at a form of fraud long known in the business by which the mullets come into an oil play to invest with the con men who live there and know the interests and plays like no onne else. The con men oversell, just like in the fictional “The Producers”, and pray for a dry hole, obviously. Unlike the MBS mess, however, when a producer is completed, interest must be assigned and the interests must be recorded in the appropriate county publiic records with
    a “Division Order title Opinion” distributed to the owenrship interests to confirm their ownership based upoin public records including assignments of interest. Why is there succh a dichotomy in the MBS markets where, it seems, the laws of one state may be allowed to control the ownership interests of property in another; also, the assignment of “payment” rights seem to me to rest nevertheless in a documment based on real property, but there is no mechanism by which the investors may be assured that their recourse rests in real estate law, which is after all, the ultimate security for the instrument, but only seccurities law? What have i missed? Alternatively, why are big investors such idiots? Also, it seems odd, if the above is stated correctly, that mutliple securities interests can stop rengotiation of mortgages, but they cannot themmselves claim any real property interest. This is all very confusing. The oil business, for all its complexities, at least has quantifiable and required forms of transparent documentation based on public records.

  6. Doug Terpstra

    Thank you, George. A Ponzi scheme works until it doesn’t. Madoff was a brilliant genius then arch-villain. And the SEC, the Fed, the DOJ…looked on while the entire US economy was turned into giant Ponzi scheme.

    Per wordsmith James Howard Kunstler the mortgage notes were severed, sliced and diced by design:

    “Nowadays, these documents can hardly be located at all … they were ground out like e-coli infested bratwursts in strip-mall boiler rooms run by former used car salesmen, and pawned off wholesale (literally) on banks who served them up sliced-and-diced, sloppy Joe style, on CDO buns to credulous pension funds, cretinous insurance company yobs, double-digit IQ college endowment managers, and other such nitwits bethinking themselves the reincarnation of Bernard Baruch, not to mention foreign sovereign nations who bought this smallpox-blanket-grade investment paper by the container-ship-load and, finally, the innovative geniuses at the very banks who engineered the stuff and got stuck with tons of it themselves when, as they say, the music stopped.”

    “The Big Picture looks even worse when you figure in the mischief of so-called synthetic CDOs that represent the multiple securitizations of single underlying mortgages – God knows how many times each – which mean, curiously, that a lot of real estate is everywhere and nowhere at the same time, plus the Ponzi universe of credit default swap black holes just sitting out there waiting to suck whole civilizations into oblivion. Ollie to Stan: Well, here’s another fine mess you’ve gotten me into….”

    “…The bankers say, just bring a “lost note” letter to the closing. “The dog ate it.” Signed, Mom. Like, that’s an okay substitute for the rule of law. Oh, and, by the way, the dog ate the title, too.”

    http://kunstler.com/blog/2010/10/the-tombstone-blues.html

    Bernanke will now extend and pretend to reflate this gaseous Hindenburg with counterfeit QE2 … and then, when it all finally goes down in flames, profess Greenspan’s “shocked disbelief”. Who could’ve known that greed might not be good after all?

  7. AR

    RueTheDay:

    Catherine Austin Fitts, former Assistant Secretary of HUD, is worth reading about how mortgage fraud has been used by the elite to amass fortunes for decades. She writes:

    One of the dirty little secrets behind the housing bubble is the long standing partnership of narcotics trafficking and mortgage fraud and the use of the two in combination to target and destroy minority and poor communities with highly profitable economic warfare. This model is global. It is operating in counties throughout the world as well as in US communities. http://solari.com/blog/?p=2293

    And:

    America’s aristocracy makes money by ensnaring our youth in a pincer movement of drugs and prisons and wins middle class support for these policies through a steady and growing stream of government funding and contracts for War on Drugs activities at federal, state and local levels. This consensus is made all the more powerful by the gush of growing debt and derivatives used to bubble the housing and mortgage markets, manipulate the stock and precious metals markets and finance trillions missing from the US government in the largest pump and dump in history — the pump and dump of the entire American economy. This is more than a process designed to wipe out the middle class. http://www.dunwalke.com/introduction.htm

    More:
    http://www.metroactive.com/papers/sonoma/09.05.02/fitts-0236.html
    http://www.dunwalke.com/7_HUD_is_a_Sewer.htm
    http://www.dunwalke.com/16_Financial_Coup_d-Etat.htm

    1. JP Warchild

      4-step home defense plan:

      1)security cams w/motiondetector on perimeter
      2)pack of mastiffs
      3)no trespassing signs
      4)paintball gun (they get one warning), sniper rifle, tactical shotgun

      1. carping demon

        If you need:

        security cams w/motiondetector on perimeter
        pack of mastiffs and
        paintball gun (they get one warning), sniper rifle,
        tactical shotgun

        I think you’re beyond the point where a No Trespassing sign can be expected to be of any value.

  8. gregg

    A potential method for a tactical attack on the banks.I encourage EVERYONE in my situation to confront the banks/REs and sheriff upfront. The next sign may be on your home.

    I live on a private rural residential lane. One of the homes/parcels was recently “taken” back by the bank. The owner owed 1.4 mil, the bank is trying to sell it for .5 mil. So the vulture RE folks put up their “for sale” signs. In order to access this property they use an easment which is recorded in everyones deed on the lane.

    What I am going to do is this.

    The next time I catch the RE person accessing the property I’m gonna execute a citizens arrest for trespassing, they do not have proof of ownership, and are therefore not authorized to use the easement. I’m gonna hold em until the sheriff arrives, and we will have a discussion about whether these vampires are even legally authorized to ACCESS this property per the existing deeds easement. This property is a slice n dice bankster candidate good chance there is no paper saying they really own it, ergo they are trespassing in order to access the property.

    Look for the headlines…..”local farmer performs citizen arrest on RE agents for TREASPASSING over a deed defined easement which they do not possess.”

  9. Paul Tioxon

    “The two potential sources of fraud: A fraudulent borrower could pledge the same home as security for multiple mortgage loans. Title checks, by the lender/title insurer are so easy to conduct and so vital to protect the lender that this form of fraud is vanishingly rare. Alternatively, and far more likely, the lender could sell the mortgage to multiple buyers.”

    Submitted for yr approval, the strange case of ContiMortgage of Hatboro, PA. A victim of the 1998 currency crisis, goes under, after failing to close the takeover deal from GMAC. One of the problems with this early sub prime lender in residential mortgages was the churning of customers 2 or 3 times in 12 or 24 month period.

    The originators that sold their loans to Conti with very high interest rates, in addition to high fees, would treat their customers within a short period time to a refi at a monthly, money saving lower rate. So, the same home could be pledged for a loan by the same originator and the same wholesaler, Conti. This was a bonanza for the loan officers at the retail level. Selling an existing customer with a 15% interest rate was an easy task when offering an 11% rate, as soon as 6 months later. This could go on until there was no more equity left in home.

    But there was a problem. The retail originators had been told that the refis were causing a loss of money for Conti as well as the mortgage originators. The institution of selling a prepayment penalty of several points was given a yield spread premium incentive of 100 or more basis points. It became a regular feature by virtue of becoming a bonus cash cow for loan officers. As far as they were concerned, there were no loans in existence other than prepayment penalty(PPP) loans.

    Even then, mortgages were churned, this time with PPP. So, the same house, with the same lenders name on different closing docs would still be on one or more loans. How this was handled by ContiFinancial, the parent Co., in the securitization and servicing makes you wonder if this is not another source of multiple notes floating around for a single property. The entire loan portfolio after the ContiMortgage bankruptcy in 2000, went to a Utah company, Fairbanks, with no experience at all in this business. Regulators soon shut them down. The notes, however, lived on, sold to who knows who. And was there any clear accounting procedure to flag a single property with multiple notes, perhaps the original , which was refied by a subsequent note?

    With the churning of properties, the same name of the lender appears on all of the notes, making the repayment not as easy to discern, as when you jump ship and refi with another company. The loan amount goes up, but everything else looks the same. Could this be a way to generate confusion with multiple notes, indistinguishable from one another except for dollar amounts?

  10. mock turtle

    im reading all this with a mixed sense of horror and disbelief

    like many here i was braced for the tsunami in early 2007 and consequently my name was changed against my will, to cassandra , by my family and “friends”

    but for awhile i thought we could slowly, painfully, recover as we picked up the pieces and rebuilt from the wreckage of the crisis

    i no longer hold to that point of view, as now it seems clear the fraud is rampant thru out the system from loan origination, to structured finance, to mers, the reimic s and finally even the federal reserves acceptance of toxic waste in exchange for gov securities and the executive branch refraining from prosecution

    i fear that a nightmare awaits us and most of the leadership on both sides of the aisle have been corrupted

    somehow we have to get people like professor bill black in charge and in a position where the prosecutions can begin or we will loose the rule of law

    1. Paul Tioxon

      Oh, it gets so much better.

      AMERICAN BUSINESS FINANCIAL SERVICES INC.

      This was another canary in the mine that dropped dead. A harbinger of the big enchilada we are now feasting upon. This too is local to the Philadelphia Metro area. It was actually lured from the suburbs, to a historic John Wanamaker office rehab across the street from our spectacular French 2nd Empire designed City Hall. This has been unwinding since it went Chapter 7, over 5 years ago. The most recent update has an interesting note from the trustee. Can you guess what it says? Well, click on it to see for yourself, I don’t want to put words into anyone’s mouth with my agenda. That would be unfair and unbalanced.

      http://www.abfsonline.com/ABFS_Servicers.html

      I am sure that there were other nifty little operations in or around the several billion dollar range, per year in production, all over the country, that fell apart before things really took off. I wonder if even a guy, who is in charge of unwinding an operation through B Court, can’t say for sure who is servicing what loan, how can others with less exacting powers make clear cut determinations? And he has had 5 years to sort things out. HMMMMM?

  11. laughingsing

    Hiya –

    You wrote: ” Title checks, by the lender/title insurer are so easy to conduct and so vital to protect the lender that this form of fraud is vanishingly rare.”

    I am a newbie, so if this is a stupid question, yada yada . . . but –

    If the conveyance chain of the note is broken, does that also break the conveyance chain for the attached mortgage (which I THINK is the “title”?) If that is so, what would a title check show?

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