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When mortgages are "securitized" by the banks that originate them ("sponsors"), such as Bank of America -- whom we're slowly learning, this weekend, due to developments in a New Jersey bankruptcy hearing last week, may have actually and completely fallen into the insolvency abyss -- they're subject to a "pooling and servicing agreement." In lay-speak, these "pools" and/or "bundles of mortgages," serve as the basis for what is known as "mortgage-backed securities," or more correctly, "mortgage-backed securitizations" (i.e.: "MBS," and/or "RMBS," which are the initials for "residential mortgage-backed securitizations"). These MBS/RMBS are then sold off by special purpose vehicles/special purpose entities ("SPE's," "SPV's"), licensed bond traders/trading firms, and investment trusts (entities that actually create the mortgage-backed securities and then sell them to others) to investors. (Diarist's Note: This is the "Cliff Notes" version, and technically speaking, it's not 100% accurate, since it's considerably more complex than this.)

This process occurs via private (as described above) and public institutions, by way of the government's "GSE's" (government-sponsored enterprises), such as Fannie Mae, Freddie Mac, and others. (Again, there's a bit more to it than that, but this is the extremely abbreviated description. Click on the links in this paragraph and the paragraph above for more detail.)

Unless you've been living in a cave over the past 36 months, you're aware of our country's "mortgage meltdown," wherein many hundreds of billions (actually, it's trillions) of dollars in mortgages--particularly the subprime subset of those mortgages--have diminished in value to just pennies on the dollars they were worth just three years ago.

As myself and many others have been reporting it over the past few years (it'll be three years here on DKos, approx three weeks from now, since I posted THIS on December 13, 2007), and more recently, on the "consumer side" of the matter over the past couple of months, the rule of law, as its relates to mortgage foreclosures, has been documented to have been ignored (in fact, outright misrepresented to the courts) by many banks, particularly with regard to banks that have claimed in foreclosure proceedings that they hold the physical mortgage/title/deed to a property, when in fact they do not.  (Therefore, in many states, they've created a situation where lenders have perjured themselves in front of judges reviewing foreclosure cases, by misrepresenting same.)  

And, while there are now, literally, thousands (if not tens or hundreds of thousands) of documented instances where these types of transgressions have occurred between the banking community, the courts and the public, thus capturing the lion's share of MSM coverage on the matter--as myself and many others, led by Naked Capitalism Publisher Yves Smith, have noted over the past couple of months--it is on the investor-side of the issue where the banks have the greatest exposure to actual losses.

On Friday, American Banker Magazine posted this article: "Countrywide Routinely Failed to Send Key Docs to MBS Trustees, B of A Employee Says," as noted by University of Oregon Professor of Economics Mark Thoma in a post at his Economist's View blog on Saturday.

In that piece, American Banker sought to downplay the importance of the article as it related to the ongoing solvency of nothing less than our country's largest bank, Bank of America...

"Countrywide Routinely Failed to Send Key Docs to MBS Trustees"
Mark Thoma
Professor of Economics, University of Oregon
Economist's View
Saturday, November 20, 2010

Kate Berry of American Banker reports that B of A may have run into some new trouble regarding documentation that "could complicate attempts by the company to foreclose on soured loans" (via email from David Cay Johnston):

Countrywide Routinely Failed to Send Key Docs to MBS Trustees, B of A Employee Says, by Kate Berry, American Banker: Countrywide, the mortgage giant that's now part of Bank of America Corp., routinely didn't bother to transfer essential documents for loans sold to investors, an employee testified.

The testimony -- which a New Jersey bankruptcy judge cited in dismissing a B of A claim against a debtor -- could complicate attempts by the company to foreclose on soured loans that Countrywide originated...

As Naked Capitalism's Yves Smith has brought it to our attention, this afternoon, the possibility now clearly exists -- in fact I would go as far as to say, "much moreso that this IS the case than not" --  that almost all (96%) of Bank of America's Countrywide Financial unit's subprime mortgages, starting around 2004-5 onward, may very well be subject to "putbacks" (wherein the sponsoring bank is forced to buy these mortgages back at 100 cents on the dollar, give or take/face value, with interest, even though many of them are only worth a fraction of that, today) by the SPE's/SPV's/mortgage-investment trusts that hold them, effectively making Bank of America even more grossly insolvent...perhaps (and this is my "editorial license," however Yves definitely takes us there in her post this afternoon) to the point of no-return.

Here's what Professor Adam Levitin, one of the country's foremost experts on mortgage securitization law, said in his testimony before the House Financial Services Committee last week as he described described what the implications would be if it is proven that the notes and mortgages were not properly transferred to the trusts:

If the notes and mortgages were not properly transferred to the trusts, then the mortgage-backed securities that the investors' purchased were in fact non-mortgage-backed securities. In such a case, investors would have a claim for the rescission of the MBS, meaning that the securitization would be unwound, with investors receiving back their original payments at par (possibly with interest at the judgment rate). Rescission would mean that the securitization sponsor would have the notes and mortgages on its books, meaning that the losses on the loans would be the securitization sponsor's, not the MBS investors, and that the securitization sponsor would have to have risk-weighted capital for the mortgages. If this problem exists on a wide-scale, there is not the capital in the financial system to pay for the rescission claims; the rescission claims would be in the trillions of dollars, making the major banking institutions in the United States would be insolvent.

Bold type is diarist's emphasis.

As Yves Smith pointed out in a post on Naked Capitalism, from this afternoon: "Countrywide Admits to Not Conveying Notes to Mortgage Securitization Trusts."

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(Diarist's Note: Diarist has received formal authorization from Naked Capitalism Publisher Yves Smith to reprint her blog's posts in their entirety for the benefit of the DKos community.)

Countrywide Admits to Not Conveying Notes to Mortgage Securitization Trusts
Yves Smith
Naked Capitalism
Sunday, November 21, 2010   3:08PM

Testimony in a New Jersey bankruptcy court case provides proof of the scenario we've depicted on this blog since September, namely, that subprime originators, starting sometime in the 2004-2005 timeframe, if not earlier, stopped conveying note (the borrower IOU) to mortgage securitization trust as stipulated in the pooling and servicing agreement. Professor Adam Levitin in his testimony before the House Financial Services Committee last week described what the implications would be:

If mortgages were not properly transferred in the securitization process, then mortgage-backed securities would in fact not be backed by any mortgages whatsoever. The chain of title concerns stem from transactions that make assumptions about the resolution of unsettled law. If those legal issues are resolved differently, then there would be a failure of the transfer of mortgages into securitization trusts, which would cloud title to nearly every property in the United States and would create contract rescission/putback liabilities in the trillions of dollars, greatly exceeding the capital of the US's major financial institutions....

Recently, arguments have been raised in foreclosure litigation about whether the notes and mortgages were in fact properly transferred to the securitization trusts. This is a critical issue because the trust has standing to foreclose if, and only if it is the mortgagee. If the notes and mortgages were not transferred to the trust, then the trust lacks standing to foreclose...

As we indicated back in September, it appeared that Countrywide, and likely many other subprime orignators quit conveying the notes to the securitization trusts sometime in the 2004-2005 time frame. Yet bizarrely, they did not change the pooling and servicing agreements to reflect what appears to be a change in industry practice. Our evidence of this change was strictly anecdotal; this bankruptcy court filing, posted at StopForeclosureFraud provides the first bit of concrete proof. The key section:

As to the location of the note, Ms. DeMartini testified that to her
knowledge, the original note never left the possession of Countrywide, and that
the original note appears to have been transferred to Countrywide's foreclosure
unit, as evidenced by internal FedEx tracking numbers. She also confirmed
that the new allonge had not been attached or otherwise affIXed to the note.
She testified further that it was customary for Countrywide to maintain possession of
the original note and related loan documents.

This is significant for two reasons: first, it points to pattern and practice, and not a mere isolated lapse. Second, Countrywide, the largest subprime originator, reported in SEC filings that it securitized 96% of the loans it originated. So this activity cannot be defended by arguing that Countrywide retained notes because it was not on-selling them; the overwhelming majority of its mortgage notes clearly were intended to go to RMBS trusts, but it appears industry participants came to see it as too much bother to adhere to the commitments in their contracts.

As one hedge fund investor noted, "Whenever we've gotten into situations on the short side, no matter how bad we think it is, it always proven to be worse." The mortgage securitization mess looks to be adhering to this script.

Bold type is diarist's emphasis.
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Now, if you're an investor in an MBS, and the contractual agreements between your MBS pool and the sponsor (in this case, Bank of America/Countrywide) indicates that you're entitled to a 100% refund on your fraudulently represented security, as opposed to taking a hit for hundreds of thousands or many millions (or tens of millions) of dollars, yourself,  are you going to eat the loss or make the sponsor pay you (as you're entitled to it under U.S. securities law) for the fraudulently conveyed securitized mortgages?

You have three seconds to provide an answer, and the first two seconds don't count!

Reiterating, this means that--barring a miracle--Bank of America is pretty much in a position wherein they'll have to pony up the cash equivalent of 100% of the original face value (give or take), on mortgage paper now worth a small fraction of that, for roughly 96% of all of the subprime mortgages that their Countrywide Financial unit has originated since, roughly speaking, 2005.

What does this tell you about the future of America's largest bank?

Hint #1: Published yesterday online,  with the story actually making the rounds in Sunday's print edition of the NY Times, we have Gretchen Morgenson, in: "Trying to Put a Price on Bank Errors," putting a $52 billion price tag on the cost of mortgage putbacks, as far as the big banks are concerned. But, that was WITHOUT any knowledge/mention of this latest "problem" for Bank of America/Countrywide.

Hint #2: This story really hasn't gone viral yet. Yves Smith, whose been ahead of the curve (receiving kudos from the likes of the Columbia Journalism Review, and others) on this for months now,  is the first person to put the pieces together, this afternoon.

Just in case you're wondering about "the pieces" of the puzzle falling together (or completely falling apart, depending upon which side of the table you're on: Main Street or Wall Street) here...consider the stories behind these links:

From the Wall Street Journal: "Fed Orders Another Round of Stress Tests," Wall Street Journal Online, November 18, 2010

From Zero Hedge: "Why Pimco's Purchase Of Another $30 Billion In MBS (Much Of It On Margin) May Be Very Bad News For Bank Of America (And Taxpayers)," November 19, 2010

"Why Pimco's Purchase Of Another $30 Billion In MBS (Much Of It On Margin) May Be Very Bad News For Bank Of America (And Taxpayers)"
Submitted by Tyler Durden on 11/19/2010 13:23 -0500

Bill Gross continues to telegraph that an MBS monetization announcement is just a heart beat away. Either that, or the firm is now fully convinced it will be able to putback every single MBS in its book (and then some) to some soon to be sad shell of a bank (read- Bank of America and/or Wells Fargo). In October, Pimco's Total Return Fund saw its margin cash jump by the most since February 2009: the time when the full QE1 was announced: at $28.1 billion in margin cash, the firm increased it dry leverage powder from $7.6 billion to $28 billion. And where did this money go? Virtually all of its went in Mortgage Backed Securities, which stood at $100 billion as of October 31. This is a $50 billion increase in the past two months, and brings the total to the highest since February 2009, again - just before the Fed started monetizing UST and MBS/Agency debt in earnest. And even as the firm was lifting every MBS offer, it dumped Treasurys: it only had $71.7 billion at the end of Ocotber, down from $83.2 billion a month earlier, and making MBS the top TRF holding (first time since July 2009). As Gross never does anything without a reason (and fundamentals are never a "reason" for the Fashion Island denizens) there are only two possible explanations: either Gross knows that the Fed will have no option but to promptly shift from monetizing MBS in addition of USTs (now that rates have once again started leaking wider), a topic we have covered repeatedly in the past, of the firm is convinced it will be successful in getting the BofA's to accept all of its putback demands, and possibly more. As both outcomes will result in a material profit on all recent purchases, the bottom line is that taxpayers (either via QE or via TARP2) are about to make the GEM (Gross-El Erian-McCulley) even more valuable...

Oh, and by the way, it is said by many that Bill Gross and his founding partner, Mohammed El Erian (these are the guys that termed the phrase, "the new normal"), due to the fact that they run PIMCO, the world's biggest bond fund, are privy to more inside info on the Fed and the Treasury Department than just about ANYONE outside of our government. But, like any savvy business operation, one can never have enough inside, they went out and hired former TARP chief Neil Kashkari, as well.

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Here's a question for you, from the headline of my post on October 13th: "Guess who's going to pay the bill for the foreclosure crisis?"

And,  here are a few more diary links for background on much of what I covered, above:

Stiglitz: "Corruption, American-style." (Where's Liz Warren?) 11/9/10

"The Mortgage Insurance Scam: Dems Paying For GOP's Sins" 11/1/10

"NYT Lead: 'Battle Lines Forming in Clash Over Foreclosures'" 10/21/10

"Mtge. Fraud Bill Escalates As Stiglitz "Bashes" Bernanke's QE" 10/19/10

"Has The Mortgage/ Foreclosure Fraud Crisis Gone Surreal?" 10/18/10

"Is Wall St. Imploding, Again? Krugman: It's 'very, very bad.'" 10/15/10

One more link, from Yves NYT op-ed, on October 31st:  "How The Banks Put The Economy Underwater," Yves Smith, NY Times (op-ed)

Originally posted to on Sun Nov 21, 2010 at 08:52 PM PST.

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