What Is Securitization and Why Is It Fraudulent? Part 1

By now you have heard in the news about robo-signing, MERS, etc. and how the economy was brought down by Mortgage Backed Securities. But what, specifically, does that mean and how does it affect us as homeowners and real estate investors? As can be expected, the greatest financial fraud every pulled over in the history of the world began with taking away responsibility from banks and brokers…

When a broker purchases a stock or bond with your money, it’s standard practice to buy the stock in the name of the brokerage. This was all well and good when the owners and partners of the brokerage were personally liable for all of the consequences of an investment. After brokerages were allowed to incorporate and become “legal persons,” the owners of the brokerage houses were shielded from all of the legal and financial responsibilities for the consequences of their investments. This took away all of the personal risk they incurred by making wild bets on exotic investments with their clients’ money. After all, it was just the company that would get in trouble, not the individual brokers or owners of the company!

This left the commercial and investment banks free to concoct the securitization scheme.

The way a bond is supposed to work is that an investor purchases a bond from a trust. The trust then was to use this money to purchase mortgages or originate their own. The trust then uses the money made off of these mortgages to pay off the bonds to their investors.

That’s how it is supposed to work.

In the case of Mortgage Backed Securities (i.e. bonds issued by trusts that consisted solely of mortgages), the money the investor paid to purchase the bond was never given to the trust. The trust was a legal fiction. The investor’s money never was paid into the trust, so the trust never had any money to purchase or originate ANY loans. Instead of being deposited into the trust that was going to purchase or originate loans with which to repay the investors, the money was commingled with other investors funds in undifferentiated accounts. The bank basically put the investor’s money into their checking account. A note was made that said the investor purchased a bond, but the trust NEVER received the money and a bond was never issued. In many cases the trust never existed at the time of investment, but legally that doesn’t even matter because the trust never had any money and never purchased or originated any loans!

In these cases, the investor’s money was sent by a broker to the closing agent for the mortgage (usually a title agent), who also received closing papers from a “lender.” The catch is that the entire lending side of the transaction was completely fictitious. The “lender” never existed, and the trust that the lender was acting on behalf of never had any money to lend!

From the new homeowner’s (borrower’s) perspective, this loan is considered predatory because the Federal Truth in Lending Act states that the borrower is required to be given information about the identity of the lender and all fees, commissions, and other compensation paid to all parties.

From the investor’s perspective, this is a dangerous activity because, in most cases, the prospectus from your investment states that you can be paid your interest and principal out of your own investment! You might recognize this as the sign of a PONZI scheme. Well, so do the feds, as this is the type of activity they look for and label as a red flag of fraud in their investigations!

This is where it gets tricky. The banks used aggregators to bundle up a huge number of loans created with fictitious trusts. They included a certain number of risky loans in order to increase the value of the packages (higher interest rates increase the value of the bundles). Then the brokerage house sold this bundle to itself at this inflated value and counted it as a profit from proprietary trading. They used investors’ money to line their pockets while they purchased overly risky securities from themselves at an inflated price with the knowledge that, if they went bad, their insurance would pay them off!

In next month’s article I will explain what this means for the title on the home for which a mortgage was taken out and what it means for homeowners and real estate investors.

Fortunately, with all of the fraud the banks committed being discovered and exposed; we investors now have a way to get the banks to negotiate on our terms. By investigating the specific circumstances behind underwater homeowners’ loans, we are exposing unbelievable and blatant fraud that can be used as leverage against the banks in order to negotiate huge discounts on note purchases. This allows investors to free homeowners from the burden of dumping money into an underwater home while also doing some incredibly profitable deals with multiple possible exit strategies.

If you would like more information on this awesome strategy, give my office a call at 706-485-0162!