"Biggest fraud in the history of the capital markets"

Karl Denninger has been covering "Foreclosuregate" for some time now and it appears that his analysis has been spot on with regard to the consequences.

He makes a clear case for this with the following description of how the MBS creation process actually occurred:

No, what happened then (and still does today) is that these MBS are sold first and filled after!

That is, a pension fund calls up Vampire Squid Bank and says "I need $100 million of MBS that pay a 5% coupon."

Vampire Squid Bank takes the $100 million dollars and then proceeds to securitize loans.

But in doing so it took the $100 million on a prospective pooling and servicing agreement in which they agreed to provide loans of a certain credit quality and specification to the buyer.

So it's much worse than "we didn't know." It's "we took the money, then we build the security and didn't look, even though we told you we would."

biggest fraud

Capice?!! The Pension funds, or any other investor (Chinese, European.. etc) placed an order for a MBS structure paying a certain dividend. Then the Investment Bank (Goldman, Bears.. etc) packaged a bunch of mortgage notes together, got them rated by the Rating Agencies, then took that investment rating and obtained insurance from the Mortgage insurers (Ambac sym=ABK, Radian=RDN, PMI=PMI,) and others.

Ambac was the #2 mortgage insurer out there and it has been literally wiped out (put in "run-off" status) by this mortgage fraud. However, on the Sept 29th, they sued Bank of America=BAC for $16 Billion, alleging that 97% of some 6300 mortgages that Ambac analyzed violated origination standards (also known as Representations and Warranties). So, they and the other mortgage insurers (also known as Monolines) have had to pay the mortgage payments to the originators, which then gets paid to the security holders, leaving the banks off the hook for the swindle they perpetrated.

So.. the question is whether Denininger is correct and a Resolution Trust (RTC) structure is going to be required to finally resolve this mess and make those who were victimized (including the mortgage insurers and security holders) whole again. It strikes me that it will require this ultimately. But obviously the banks, and the politicians who receive their campaign donations, are trying to put this off as long as possible.

I have noticed that there is a lot of market activity in the Mortgage Insurer (Monoline) sector over recent days. I'm not sure if the perception is that these companies are finally going to receive their day in court. I definitely believe were victimized by the fraudulent ratings and "representations and warranties" that were presented to them when they insured these MBS entities. I will admit that back in 2008 I lost a lot of money betting on ABK, under this same premise, but that was at much higher stock prices. But I've always felt they had a solid case for denying payment of claims against these fraudulent MBS. The problem was that they needed a legal finding to justify doing so.

The fraud that was perpetrated on the Monolines is, IMO, like a person going to obtain vehicle insurance and lying about all the DUIs and Reckless Driving citations they've received. If you lied when you applied for your insurance, it's a clear cause for denial of claim should you get in an accident. You've lied in your personal "representations and warranties" related to your driving record.

Now supposedly the insurer is supposed to verify your driving record, but in the case of the Mortgage and MBS insurers, they heavily rely upon the Ratings Agencies (RAs) (Moody's, S&P, Fitch.. etc). Well.. the RAs were PAID by the investment banks (IBs), so they obviously didn't scrutinize these securities very closely.. Would have been bad for business if they didn't give the rating the IBs wanted. It was a very incestuous conflict of interest, which has been well covered in the news. But now one has taken the issue this far into the political arena, as we're currently seeing.

NOW, it would appear, that the issue is finally reaching a political head and Obama has "officially" vetoed that sneaky little notarization bill that the bankers wanted so much:

Obama's "pocket" veto with memorandum of disapproval

Obama knows this is a political hot potato. Banks don't vote.. They just pump money into the political system. And those who do vote have a lot of reasons to hate the banks at the moment, especially if they are getting foreclosed on. But they also hate the banks because they were forcing qualified home buyers to compete with sub-prime borrowers and even illegal aliens (it's true!!) to buy a home. Those unqualified borrowers resulted in a tremendous "false" demand that drove home prices up. So now, when the sub-primers default and the illegals bail out back to Mexico (or change their names) those who were qualified homebuyers find the prices on their homes plummeting back to earth.

Now.. I know.. no one forced them to buy that house. They could have continued to rent, as I have opted to do (but I just like my freedom to wander to another location.. ;0). But you know how much pressure husbands are under from their wives.. That damn "nesting instinct" that drives a woman to have a home of their own and few marriages survive defying it.

However, I've talked with a number of folks who have decided to undergo a "strategic default", bank their cash, and attempt to recover at some point in the future.

And as I saw on the Daily Show last night, even the Mortgage Banker's Association in Washington, DC has defaulted on their $79 million loan on their previous building (This is pretty damn funny, but probably not for those are undergoing a foreclosure):

MBA defaults on their offices

Good for the Goose.. Good for the Gander?

Really hard to have much sympathy for a Mortgage Banker when they can't even maintain the payments on their own "home".

Thus, if many Americans happen to have watched that, and start tuning into the Congressional hearings on Foreclosure and Mortgage Fraud next month, they may be even less inclined to continue making payments on a mortgage that is severely under water.

This is going to be interesting to watch.

My question is whether being an investor in the severely beaten down Monoline insurers is the sign of a potential recovery in the sector, or merely a short-term speculation. Some of these companies, if they can get out from under their obligations on these Fraudulent MBS insurance contracts, have a TON OF MONEY stashed away in reserve for paying claims. They could actually surge tremendously over the next year or two, if the courts see things their way, or the Government comes in and performs the "Mother of all RTC" programs.

Scrutinizer