EDM and others seem to have overlooked or to be unaware of the impact of loan servicing agreements on failed primary lenders (1). Companies like Countrywide and Indy Mac (Indy Mac spun off from Countrywide as a REIT and subprime lender (2), then got into consumer banking) made money on the front end through loan origination fees (points) and associated add-ons to the buyers (i.e., the borrowers) (3), then shifted the loan risk to the secondary market by bundling the loans for securitization (4). These bundled loan sales invariably contained language that guaranteed a revenue stream to the originator of the loans (5) (i.e., Countrywide and Indy Mac) through a loan servicing contract. As long as the loans were outstanding, the servicing companies took a piece of the cash flow. It became a low risk, fee-for-service business, until all the loans started to default. As EDM says, "investigation continues..." but now the FBI is involved in that investigation. (6) It will be interesting to see how all this plays out on the criminal angle.
(1) EDM is not unaware of anything relevant except where we go on from here. The stock market is adjusting for an "over-bought" situation; most consumer products, especially housing, have been "over-bought" of late due to the easy financing of consumer lust to satisfy excessive "wants" rather than basic "needs."
(2) Back in a more commercially prudent time frame, when I was in the construction mortgage business (as the attorney who prepared the documents, but well aware of consumer finance), brokering mortgages was simply an outsourcing of manpower and a division of labor and had nothing to do with sub-prime lending.
(3) Points and loan service fees are endemic to the separation of available money sources from the matchmakers of the mortgage loan deal. When I bought my first real estate (a $26,500 two family in 1972) the closing costs were $7.00 to record the deed and mortgage; title insurance was paid by the seller. The loan was made in-house at the bank at a given rate of interest for a stated term which determined the monthly payment.
If my bank packaged my loan and sold it, I would never have known because the loan service agreement would have (A) provided that the bank kept part of the interest earned, and (B) the bank would have been compensated by a loan service fee to process payments and keep up with the paperwork. Meanwhile, the buyer of the packaged loan(s) had a pure investment security at a given bargained-for rate of return, minus a fee for handling.
(4) The financial world was at peace...and there was no shifting the risk because loans were essentially packaged and sold with "recourse," the composition of the loan package being such that one bad apple did not spoil the bushel. Given the low level of risk, I believe there as insurance, for which a cost was assessed, somewhat like banks being charged a premium for FDIC insurance on savings accounts. When mortgage loans were originated by banks the responsibility bad loans was "in house," and the culpable loan originator was an employee.
Separate the loan originator from the money and one would think the money lenders would be more careful. The idea of a "credit swap" between players at risk made sense; sort of like an bunch of apple sellers spreading the risk over a massive number of bushels so that one out-of-the-ordinary bad bushel did not severely impact any one seller.
(5) Then non-banks (Countrywide,
et al) started grabbing a share of the action, which on the surface seemed to benefit consumers in the context of the American fixation with deregulated "competition." At first the mortgage brokers broadened the possibilities for home buyers who disdained doing business with the stuffy old banks and loan officers who asked tough questions. Getting a mortgage was like going to McDonalds, fast food, fast money, no questions about trans-fats or points or loan origination fees or closing costs or true rate of interest; satisfy the "want" appetite--instant gratification, no consideration of consequences.
(6) As to "...how this plays out from the criminal angle," check out "Willy & Ethel" in the comics today:
Willy says,"I told a bookie that old ten-dollar watch of mine is worth a hundred dollars and to bet it all on a horse."
Ethel says, "What if the horse loses? Won't he find out the watch is only worth ten dollars and want the other ninety?"
Willy's retort, as he opens a can of beer: "He's not worried...if I don't pay him the government will...it's complicated, but that's the way things work now..."
From the criminal angle, bookie bets are not legally enforceable, but the derivatives, called "credit default swaps," which became legal after congress and then president Bill Clinton repealed the "Anti-Bucket-Shop-law of 1907," are now legally binding bets that congress and the president are honoring by throwing massive amounts of money into the "Bucket Shops," whose side bets far exceeded the actual mortgages outstanding. In other words, bad loan insurance failed for two reasons: (1) The premiums and/or reserves for bad debts were insufficient; and (2) the insurance was being sold to persons without an insurable interest, mere bystanders who placed massive numbers of bets with Willy's bookie that loans would fail.
This bail-out is like if a state legalized and licensed casinos, which then became so large in relation to the state itself that the failure of the gambling establishments would severely impact the state's economy. What to do? Guaranteed the casinos' betting losses? A bankrupt casino can't pay the gamblers who made irrational bets, and by doing so, through pure luck of the draw, "broke the bank." You gotta read Ben Stein to truly understand the source and magnitude of the problem. His article "Why I'm Still Buying" is required reading at:
http://finance.yahoo.con/expert/article/yourlife/115733#As a former bank auditor and a former mortgage company attorney, I am just now starting to fully comprehend the details of the problem. Somewhere there is one simple answer to where this all went wrong. If financial institutions had not been nit-picked by regulations forcing loans of a quality that would otherwise have been avoided...if non-bank mortgage brokers (not subject to banking regulations) had not gained a foothold...if packaged loans were sold with recourse...if credit default swaps ("insurance") had not got out of hand by repeal of the "bucket Shop Law"...and if the bets on defaults had not taken on a life of their own, independent of insurable interest...
Well, then there wouldn't be today's opportunity to buy the Dow, formerly above 14,000, and now at below 8,500. My posts on this thread have given me an opportunity to gather my thoughts in a sometimes hostile environment. There is a wealth of information on the Internet if one can only separate the wheat from the chaff. I believe we may be at a point where opportunity knocks. By low, sell high, and if it don't go up...don't buy. EDM
