I got a very interesting report from a contact who is reasonably well plugged in with some of the government authorities that are taking a hard look at the foreclosure crisis.
Readers have no doubt heard of hedge fund manager John Paulson, whose famed subprime short bet is reportedly the most profitable single trade in history, netting him over $4 billion personally. Paulson famously reversed his stance in early 2009 and started buying distressed debt, including distressed mortgage securities.
Apparently he still has a substantial long position, because today a Paulson operative was making the rounds in DC, throwing temper tantrums about the impact various investigations might have on the residential mortgage backed securities market. He was particularly upset about the fact that the theory that we have discussed on this blog, that the problems facing deals where the notes were not properly conveyed (which we think are pervasive) are not easily remedied. As we have discussed, the “fixes” for the note conflict both with the provisions of the pooling and servicing agreement and New York Trust law.
Although Paulson’s minion reportedly got very angry, he did not offer a substantive critique or counterevidence to the thesis that these failings are very serious.
The party on the receiving end of this tantrum basically told the Paulson proxy that they were not changing course, but there is no way of telling whether his show of pique was more effective elsewhere.
This isn’t the first time Paulson has thrown his weight around to try to impede efforts that would help borrowers. Greg Zuckerman’s book The Greatest Trade Ever recounted at some length how Paulson first made threats and then lobbied to block swapping mortgages out of securitizations to facilitate mortgage modifications.
Per Zuckerman, In January 2007, Paulson employees heard that Bear Stearns traders had told investors on a couple of occasions that ” ‘It’s not so simple to short mortgages. A servicer can just buy mortgages out of a pool, so you guys will never be able to collect’ ” on the credit default swaps used to make the short wager.
Bear owned a mortgage servicer called EMC Mortgage Co., and Paulson staffer Paolo Pellegrini became worried that EMC would exchange poorly performing loans in a pool with refinanced healthier ones, or exchange them for different loans, or add cash to the pool, with the intent of avoiding a payout on the CDS. Pellegrini started making inquiries, and Bear sent him a fax showing him that in the documents, Bear had “reserv[ed] the right to work with EMC to adjust mortgages.” Furthermore, “a senior trader said Bear Stearns was proposing the new language to ISDA (the industry group responsible, among other things, for standard form documentation for credit default swaps). Adjusting loans that borrowers were hvaing difficulty paying could be effective public relations for Bear Stearns – the firm already had created what it called the EMC Mod Squad, a team working with local community groups to modify the home loans of delinquent borrowers.”
The lawyer at Paulson & Co. tasked to this effort was Michael Waldorf. After reading the document, Waldorf “stormed out of Paulson’s office, his pink hue turning a beet red as he shook with anger. ‘They’re going to manipulate the market!’ he bellowed. ‘They could take away’ all the firm’s winnings.”
Waldorf called others shorting subprime, including Greg Lippmann at Deutsche Bank and Kyle Bass, and then hired former SEC chair Harvey Pitt to lobby on their behalf. Pitt and Waldorf argued that “EMC could modify all the mortgages it wished – slicing a home owner’s mortgage payments actually might help Paulson because it would reduce the cash coming into mortgage pools. But, they argued, EMC couldn’t discuss its moves with Bear Stearns or switch mortgages just to keep a pool of subprime loans from running into problems.” After sufficient complaining, Bear Stearns withdrew its proposal.
So it appears this time that Paulson made a simple contrarian bet, based on insufficient due diligence, and again is relying on his financial firepower to make sure his trade works out as planned, no matter how many people get hurt in the process of maximizing his bottom line.
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It is an election year,the winds are blowing strongly and Paulson had best be facing the right way if he wants to win a pissing contest.
wonder how made-in-China, lead and cadmium tipped pikes and pitchforks would sell in the US these days?
Heh.
You read my mind.
When at the casino we call wall st. things don’t go the bets (my houses) way, you bring more drinks to the table, either ordered or not, change dealers and decks of cards.
Skippy…glorious to be king of the tables…eh…till you loose…they should try the Aussie game of two up…me thinks
Yves
Slighly off topic but check out Jesse’s post on the Fed laying a cease and desist on HSBC for various unspecified matters in including money laundering
Timing is interesting considering allegation against US Chamber of Commerce for laundering off shore chinese money into campaign contributions
Amoral emotional intensity.
John Paulson is not the sharpest tool in the shed. He’s just a glorified crook. He rigged a bunch of CDOs to explode and then bet against them. That took a certain level of criminality but intelligence? None at all. I am I admit drawn to the metaphor of the con, something about the times we live in. Con artists are clever, not smart. All Paulson did was run a successful con. He made a bet he knew he couldn’t lose. The next time around his lack of smarts showed. If he really understood the housing market, he never would have gone long on it in 2009. So like every other Wall Street genius when he bets wrong, he wants Washington to bail him out on his action.
We see this over and over. The MOTU are not smart. They are connected. The Goldman boys had to be rescued twice in a single week in September 2008. That’s about as far from smart as you can get. Their whole modus operandi is that they cheat. They cheat to win, and they cheat to avoid losing.
“He was particularly upset about the fact that the theory that we have discussed on this blog, that the problems facing deals where the notes were not properly conveyed (which we think are pervasive) are not easily remedied.”
I didn’t totally understand this. Was he upset that the deals are bad? That people are now publicly vocalizing that the deals are bad? Or that there aren’t any good fixes for the bad deals?
I can’t get further clarification at this hour, but my impression from the conversation is they don’t want the trust theory given ‘cred by the officialdom because it would mean the RMBS are worth less than most investors think now. It’s effectively unsecured paper if the problems are as widespread as we believe.
If you don’t buy the trust theory (and every heavyweight NY trust expert contacted so far endorses it), you can’t easily fix the RMBS. This isn’t “procedural” or “technical” or a mere “documentation” problem.
Yves, thanks for being on this story. Great reporting.
As you mentioned in another post, the entire RMBS market could grind to a halt. No trader/investor would know the status of a particular security.
But isn’t there a possibility that the seller of the RMBS would have to effectively refund the buyer’s? I have to imagine in the Reps and Warranties that effective and appropriate asset transfers and documentation are promised to the buyers. So, the buyers believed in good faith that the notes had been transferred. And all they received were ’empty boxes’. So if there was nothing in the trust, they did not receive the promised consideration. Ergo, the deal is unwound and they get their money back.
Of course, that’s after years of litigation, attorney’s fees, etc. And the banks couldn’t really afford that kind of hit to their capital…
> the entire RMBS market could grind to a halt
Hrm…Is this what QE2 is going to be? Just buying RMBS (emphasis on the latter two letters)?
Well, wouldn’t it just be somewhat ironic/poetic justice/worth another book if Paulson ended up doing a complete $4B u-turn with this last trade.
Of course, this would probably include having the big banks go down for good this time. At least the govies will lack any excuse to address the pay package issue.
Anyone here yet read the deposition of a former paralegal at the David J. Stern law firm? Unbelievable amount of fraud described. It would be a fluke if a single MSJ was not fraudulent.
http://4closurefraud.org/2010/10/07/exclusive-bombshell-of-foreclosure-fraud-full-deposition-of-tammie-lou-kapusta-law-office-of-david-j-stern/
Yves
If what you’re saying is true, how come the original buyers of the RMBS, who did lose a lot of money, and don’t care what the RMBS is worth now, aren’t taking GS etc to court for fraud?
A lot of money has already been lost on RMBS and surely some of the losers have enough legal and political firepower to get an investigation if there is really a basis for saying the mortgages were never conveyed.
The early losses weren’t the result of possible difficulties in foreclosing. Different fact set.
It is very hard to prove rep (representation) and warranty breaches. You need to do it on a loan by loan basis and show that the failure of the loan was due to misrepresentation as opposed to bad luck (say the guy lost his job). This is hard and costly to do. Rep and warranty suits are worth at most 10% of the value of the deal due to the difficult nature of proving why the losses came about.
“If you don’t buy the trust theory (and every heavyweight NY trust expert contacted so far endorses it), you can’t easily fix the RMBS.”
What do you mean ? NY trust expert think it is fixable or think it is not fixable ? It is probably too late to figure out double negatives…
Take some sleep and keep on the good work !
Not fixable. I need to watch use of parenthetical statements, too many asides just gets confusing.
Yves
Are you saying that even if the sellers of the MBS have created securities which are not in fact, mortgage backed, that the courts still be unlikely to force the MBS creators to refund more than a small fraction of the losses to the buyers?
I’m not familiar with American courts but I would have thought that fraudulently misrepresention like that would get you crucified in the courts.
Effectively, the statute of limitations has passed on the representations made in the underwriting documents. The private label RMBS market pretty much came to a screeching halt in May 2007. My understanding is the practical maximum is three years (technically, I think a one year notice period plus two year statute of limitations, but I’m sure a securities lawyer will pipe up with the proper details. This is the sort of thing that Google is not very good at tracking down).
Yves
Thanks for your answers.
Would the statute of limitations not be voided if the banks or their agents were continuously actively working to hide the misrepresentations, which is what I understand you think they may have been doing?
It looks like another example of their rigged law, if Yves is right about that.
Where it comes to things like fraud, a statute of limitations isn’t supposed to start running until the victim becomes aware of the fraud. It’s not supposed to be like, if you’re good at hiding the fraud and can run out the clock you’re home free.
But we’ve been seeing court decisions undercutting that, and probably statutes as well.
So maybe there is “foreclosure fraud”.
Here you can see a good clip featuring Karl Denninger about this.
But what about the ‘fraud’ of people “buying” (yuk yuk) houses and then not paying for them (for one reason or another)? And then maybe (?) getting to live in them for free because of some “foreclosure fraud”?
Excuse me for not crying for them.
I’m a renter. If I don’t pay my rent, I will be evicted. Meaning if I ignore the eviction notice and do not leave voluntarily, law enforcement will come and throw me out.
But Yves and sundry others won’t be writing any blog posts about that.
A few years ago, when this whole mess was brewing, I could have bought. But I refused to. I refused to because I saw it all as an absurd, unsustainable mania.
And I know damn well that a lot of the people who did buy knew themselves that they were marginal buyers/borrowers. But they bought/borrowed anyway because they thought they could rely on ever-increasing house prices to bail them out — they could always sell in six months or so if they got into financial trouble.
It’s all overwhelmingly disgusting.
Congratulations eh for not being in debt. There is blame everywhere. What about the serial mortgage brokers who kept refinancing the 74 year old hospital janitor in Seattle. Or the mortgage brokers who steered prime customers into sub-prime loans for the higher commissions.
Or the mortgage securitization schemes like Paulson’s which drove higher demand for sub prime loans that would fail.
Fishing for dementia and stupidity may be the only serious business in the US that has not been off shored yet.
It’s the banks who are the enemy of all of us. Don’t get sidetracked by rancor toward those who have just a little more or a little less than you do. That’s the oldest trick in their book, and too many people are still falling for it.
“Readers have no doubt heard of hedge fund manager John Paulson, whose famed subprime short bet is reportedly the most profitable single trade in history, netting him over $4 billion personally. Paulson famously reversed his stance in early 2009 and started buying distressed debt, including distressed mortgage securities.”
I recall, when, as a college student in an American History class, we covered the debate over the assumption of state Revolutionary War debt by the new federal government. One particular aspect of the debate that took place really stood out to me. Madison argued that the government should only make good to the ORIGINAL holders of the debt, not to people who bought the paper at a discount on the secondary market. As an Economics major, already starting to be steeped in the orthodoxy, this struck me at the time as a really odd position to take. But now I understand it COMPLETELY. Thank you Mr. Paulson for that.
Madison lost. Charles Beard’s “Economic Interpretation of the United States” details the number of debt speculators who sat in the first Congress that made the decision to reward speculation in war debt.
http://en.wikipedia.org/wiki/An_Economic_Interpretation_of_the_Constitution_of_the_United_States
I find Beard fascinating and increasingly relevant, despite the fact that he was largely ushered off-stage by the 1950s/60s academy.
“Although Paulson’s minion reportedly got very angry…”
So? Is that supposed to impress Capitol Hill? Or us for that matter? Since this asshat wants to side with the foreclosure mafia, what would prevent us to dip our pitchfork in some of this Hungarian Aluminum-based toxic sludge and tickle his gluteus with it?
Plus, doesn’t he love the smell of regulated capitalism in the morning?
A thought experiment: If private issue RMBS securitizations did not comply with designated state law the trusts do not exist. If the trusts do not exist then the issued “notes” are null and void. If the notes/CDOs are void then no “bets” ie CDS/synthethic CDOs could be placed on their “performance;” ie the CDS constructed on nonexistent CDOs ought be voided and no payouts should have been made by the “losers” and the “winners” like Paulson simply get their “premiums” returned.
No doubt “traders” will contend that none of the “paperwork” matters; it was the market “performance;” but in reality this is little different from a nonexistent corporation issuing certificates purporting to be securities that can not convey an ownership interest as the entity does not exist and neither do the “securities” as they are pieces of paper of no legal import.
Paulson might start worrying about his billions if all these “technicalities” add up to the “paperwork” being reduced to useless pieces of paper of no legal consequence and all those CDS “losers” get a do-over.
Which circle of Hell does that fall into?
Probably the 8th, where goeth the fraudulent, pimps, seducers, flatterers, corrupt politicians, falsifiers, alchemists and thieves.
I think Dante was a bit rough on the alchemists though, unless they’re packagers of securitized loans. ho ho.
And it seems that Mr. Paulson was a bit light on the due dilly. So, if these reports are true, he’s sending a professional whiner around DC hoping to scare up some sympathy? Just goes to show you that luck = skill when it comes to investing. Another nail in the coffin of the “talent myth”. ha ha ha. Finance is such a riot of sweaty palms and panicked fools.
actually Mr. Paulson would probably only be in the third circle — the gluttons.
The entourage that surrounds and enables him might be in the 8th.
I was shocked to see that I’d also be in hell, in the 4th circle no less, for miserliness. I thought that was a virtue! Holy Shit, man. Glad I’m a nice Protestant boy and a cheap Scott by ancestry. So maybe I’ll sidestep that Italian version of Hades.
I guess if Mr. Paulson is Jewish (I have no idea) he might not go to Dante’s hell either, but there probably is a realm in some hell somewhere for unrestrained speculators whose profit is someone else’s loss. And the souls who profited from others’ misery in this realm, like businessmen who run brothels with child prostitutes. They’d be there too.
You know, if these guys have speculated against the RMBS market and fall flat on their faces whilst doing so, it couldn’t happen to a more deserving bunch. Seriously: guys like this throwing temper tantrums is a clear and present sign that they are in the process of falling flat on their faces, that they can see it coming, and that there is not a single thing they can do about it. President Obama did a pocket veto on their pet legislation to take away the problem: probably the shining point of his administration.
Gonna be a hell of a haircut to settle this mess.
Like I said, couldn’t have happened to a more deserving bunch. Karma, baby, karma…
Is it possible that the overall foreclosure mess will result in a two-tiered real estate market, in which non-REO homes will elevate in value or at least be seen to be more attractive to potential buyers?
That BS/Paulson dustup produced some interesting if not downright intriguing quotes in the press at the time, June 2007.
“The real question is, Are there appropriate firewalls between trading desks and captive servicing businesses,” said Josh Rosner, a managing director at Graham Fisher & Co., an investment research firm in New York. “If there are not, it would appear to pose real ethical and possibly legal risks in pitting the fiduciary responsibilities of those banks against those investors they have an obligation to.”
http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aKNi7PlPCy_g&refer=home
“None of the servicing decisions we make are driven by any activity or outstanding positions” in the credit-default swap market, Thomas Marano, head of Bear Stearns’ mortgage business, said in an e-mailed statement.
http://www.bloomberg.com/apps/news?pid=newsarchive&refer=home&sid=a9LOhnBS.L5c
Bullpucky on Mr. Marano’s all too vehement statement. It wasn’t until September 2008 that Bear Stearns and EMC Mortgage agreed to Pay $28 Million to settle FTC charges of unlawful mortgage servicing and debt collection practices.
http://www.ftc.gov/opa/2008/09/emc.shtm
By then EMC had been engaging in mortgage servicing fraud since late 1980’s, making this FTC wrist slap and EMC’s trivial cost of doing business settlement 20 years overdue. FTC settlements didn’t stop servicing fraud on the part of EMC or other servicers named in similar settlements.
While Paulson’s minion may indeed have grave concerns over validity of the trusts being questioned, it’s the malevolent servicing activity behind Paulson’s and other’s bets that bears seriously looking into. It is beyond coincidence that investment banks zealously sought to acquire (read “control”) servicers during the period from 2005 to late 2007. Known servicing fraud was the unspoken guarantee that CDOs would tank. While they hoped robo signers “work product” would readily paper over this ugly aspect of their rigged casino, recent revelations have them running scared, as well it should because when all the dots are connected, it will take insider trading to a level never before known on this planet. There were no firewalls. Sevicers were key to rigging the bets.
BTW, are we forgetting that John Paulson is part of the consortium that owns OneWest Bank, currently trampling homeowners’ rights at every opportunity?
Thank you Michael. Interesting that it only took 36 comments before someone addressed the issues raised in Yves’ post.
Does anyone believe that Bear Stearns was actually in the business of buying defaulted mortgages at par?! Or that their servicer (which is a low margin business, obviously) would buy defaulted mortgages at par so that Bear Stearns could continue to stuff mortgage paper into the market?
All this post proves is that there were a number of traders on the BEST Desk who were stupid. Wow, that’s newsworthy.
I’d like to correct an error in one of the comments here. The trusts did not issue “notes”, they issued “bonds” secured by the home mortgages. If the home mortgages were never properly placed in the trust (to do that you have to execute something called an Allonge to transfer the note, and an assignment to the trust to transfer the mortgage) then yes, the bonds are technically unsecured. However, MERS or the loan servicer would likely get a court order allowing them to transfer the proceeds from sale of foreclosed homes to those bondholders anyway -it’s not as if there is some other entity out there trying to grab the proceeds when a foreclosed home is sold.
My bet as to where this ends up: Congress passes a bill that allows some period of time for transfers to go into those trusts, despite the passage of the deadlines (the trust docs usually required the notes and mortgages to be transferred within x days of creation of the trust). The law will likely also override the state laws about assignments of mortgages so that those assignments continue to be done within MERS, as opposed to people actually filing the assignments of mortgages down at the courthouses and paying the requiredd recording fees.
They’ll come up with some cutesy name like the “Home Mortgage Stability Act.” And it will be loaded with little giveaways based on what the lobbyists/campaign contributors ask for.
I presume a federal law like this would override the New York trust law, and would also address any pesky IRS issues.
What legal interest or standing do MERS or the loan servicer have? The Catch-22 in all this is whoever holds the title, and that is very unclear, has no legal interest and the bondholders, or rather downstream holders of securities, have no title so hence have no standing.
Dear Texas Reader:
The trusts can really only issue trust certificates that evidence an obligation of the trust pursuant to the trust instrument (what they are called is really just a marketing gimmick).
If a trust is not properly perfected (that is state law was not complied with in the formation of the trust or there are issues due to the imperfect funding of the trust under the terms of state law) then it does not exist or at best it is an “empty” trust which is little different from no trust. What is missing is that it is in the interest of the holders of the trust certificates cum “bondholders” to have the trust unwound and to secure the return of their proceeds from those parties responsible for creating the trust (and that would extend to everyone involved in the process).
The point here is that trust law is a sticky wicket and there are hoops for compliance. Miss a hoop and there is no trust. If there is no trust there are no “bonds” or “notes.”
Now it may be that Congress determines it will undermine hundreds of years of trust law and property law to save its financial backers; but the chaos will be something to behold.
My first reaction was “Wow! I’m surprised that this dude didn’t cash out the billions he made on his short bet and go relax or something!” And then I was all like, “Well, I guess if you have the personality type to make billions on a short bet, you’re not gonna take your winnings and go relax!”