[DEBATE] : Mortgage rate freeze aims to conceal fraud by banks

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Mortgage rate freeze aims to conceal fraud by banks

Submitted by cpowell on 08:44PM ET Sunday, December 9, 2007. Section: 
Daily Dispatches

Interest rate 'freeze': The real story is fraud

By Sean Olender San Francisco Chronicle Sunday, December 9, 2007

http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/12/09/IN5BTNJ2V.DT...

New proposals to ease our great mortgage meltdown keep rolling in. First 
the Treasury Department urged the creation of a new fund that would buy 
risky mortgage bonds as a tactic to hide what those bonds were really 
worth. (Not much.) Then the idea was to use Fannie Mae and Freddie Mac 
to buy the risky loans, even if it was clear that U.S. taxpayers would 
eventually be stuck with the bill. But that plan went south after Fannie 
suffered a new accounting scandal, and Freddie's existing loan losses 
shot up more than expected.

Now, just unveiled Thursday, comes the "freeze," the brainchild of 
Treasury Secretary Henry Paulson. It sounds good: For five years, 
mortgage lenders will freeze interest rates on a limited number of 
"teaser" subprime loans. Other homeowners facing foreclosure will be 
offered assistance from the Federal Housing Administration.

But unfortunately the "freeze" is just another fraud -- and like the 
other bailout proposals, it has nothing to do with U.S. house prices, 
with "working families," keeping people in their homes or any of that 
nonsense.

The sole goal of the freeze is to prevent owners of mortgage-backed 
securities, many of them foreigners, from suing U.S. banks and forcing 
them to buy back worthless mortgage securities at face value -- right 
now almost 10 times their market worth.

The ticking time bomb in the U.S. banking system is not resetting 
subprime mortgage rates. The real problem is the contractual ability of 
investors in mortgage bonds to require banks to buy back the loans at 
face value if there was fraud in the origination process.

And, to be sure, fraud is everywhere. It's in the loan application 
documents, and it's in the appraisals. There are e-mails and memos 
floating around showing that many people in banks, investment banks and 
appraisal companies -- all the way up to senior management -- knew about 
it.

I can hear the hum of shredders working overtime, and maybe that is the 
new "hot" industry to invest in. There are lots of people who would like 
to muzzle subpoena-happy New York Attorney General Andrew Cuomo to buy 
time and make this all go away. Cuomo is just inches from getting what 
he needs to start putting a lot of people in prison. I bet some people 
are trying right now to make him an offer "he can't refuse."

Despite Thursday's ballyhooed new deal with mortgage lenders, does 
anyone really think that it can ultimately stop fraud lawsuits by 
mortgage bond investors, many of them spread out across the globe?

The catastrophic consequences of bond investors forcing originators to 
buy back loans at face value are beyond the current media discussion. 
The loans at issue dwarf the capital available at the largest U.S. banks 
combined, and investor lawsuits would raise stunning liability 
sufficient to cause even the largest U.S. banks to fail, resulting in 
massive taxpayer-funded bailouts of Fannie and Freddie, and even the FDIC.

The problem isn't just subprime loans. It is the entire mortgage market. 
As home prices fall, defaults will rise sharply -- period. And so will 
the patience of mortgage bondholders. Different classes of mortgage 
bonds from various risk pools are owned by different central banks, 
funds, pensions, and investors all over the world. Even your pension or 
401(k) might have some of these bonds in it.

Perhaps some U.S. government department can make veiled threats to 
foreign countries to suggest that they will suffer unpleasant 
consequences if their largest holders (central banks and investment 
funds) don't go along with the plan, but how could it be possible to 
strong-arm everyone?

What would be prudent and logical is for the banks that sold this toxic 
waste to buy it back and for a lot of people to go to prison. If they 
knew about the fraud, they should have to buy the bonds back. The time 
to look into this is before the shredders have worked their magic -- not 
five years from now.

Those selling the "freeze" have suggested that mortgage-backed 
securities investors will benefit because they lose more with rising 
foreclosures. But with fast-depreciating collateral, the last thing 
investors in mortgage bonds ought to do is put off foreclosures. Rate 
freezes are at best a tool for delaying the inevitable foreclosures when 
even the most optimistic forecasters expect home prices to fall. In 
October, Goldman Sachs issued a report forecasting an incredible 35 to 
40 percent drop in California home prices in the coming few years. To 
minimize losses, a mortgage bondholder would obviously be better off 
foreclosing on a home before prices plunge.

The goal of the freeze may be to delay bond investors from suing by 
putting off the big foreclosure wave for several years. But it may also 
be to stop bond investors from suing. If the investors agreed to loan 
modifications with the "real" wage and asset information from 
refinancing borrowers, mortgage originators and bundlers would have an 
excuse once the foreclosure occurred. They could say, "Fraud? What 
fraud? You knew the borrower's real income and asset information later 
when he refinanced!"

The key is to refinance borrowers whose current loans involved fraud in 
the origination process. And I assure you that it was a minority of 
borrowers whose loans did NOT involve fraud.

The government is trying to accomplish wide-scale refinancing by 
tricking bond investors, or by tricking U.S. taxpayers. Guess who will 
foot the bill now that the FHA is entering the fray?

Ultimately, the people in these secret Paulson meetings were probably 
less worried about saving the mortgage market than with saving 
themselves. Some might be looking at prison time.

As chief of Goldman Sachs, Paulson was involved, to degrees as yet 
unrevealed, in the mortgage securitization process during the halcyon 
days of mortgage fraud from 2004 to 2006.

Paulson became the U.S. Treasury secretary on July 10, 2006, after the 
extent of the debacle was coming into focus for those in the know. 
Goldman Sachs achieved recent accolades in the markets for having bet 
heavily against the housing market, while Citigroup, Morgan Stanley, 
Bear Sterns, Merrill Lynch, and others got hammered for failing to time 
the end of the credit bubble.

Goldman Sachs is the only major investment bank in the United States 
that has emerged as yet unscathed from this debacle. The success of its 
strategy must have resulted from fairly substantial bets against 
housing, mortgage banking, and related industries, which also means that 
Goldman Sachs saw this coming at the same time they were bundling and 
selling these loans.

If a mortgage bond investor sues Goldman Sachs to force the institution 
to buy back loans, could Paulson be forced to testify as to whether 
Goldman Sachs knew or had reason to know about fraud in the origination 
process of the loans it was bundling?

It is truly amazing that right now everyone in the country is deferring 
to Paulson and the heads of Countrywide, JPMorgan, Bank of America, and 
others as the best group to work out a solution to this problem. No one 
is talking about the fact that these people created the problem and 
profited to the tune of hundreds of billions of dollars from it.

I suspect that such a group first sat down and tried to figure out how 
to protect their financial interests and avoid criminal liability. And 
then when they agreed on the plan, they decided to sell it as "helping 
working families stay in their homes." That's why these meetings were 
secret, and reporters and the public weren't invited.

The next time Paulson is before the Senate Finance Committee, instead of 
asking, "How much money do you think we should give your banking 
buddies?," I'd like to see New York Sen. Chuck Schumer ask him what he 
knew about this staggering fraud at the time he was chief of Goldman Sachs.

The Goldman report in October suggests that rampant investor demand is 
to blame for origination fraud -- even though these investors were 
misled by high credit ratings from bond rating agencies being paid 
billions by the U.S. investment banks, like Goldman, that were selling 
the bundled mortgages.

This logic is like saying shoppers seeking bargain-priced soup encourage 
the grocery store owner to steal it. I mean, we're talking about 
criminal fraud here. We are on the cusp of a mammoth financial crisis, 
and the Federal Reserve and the U.S. Treasury are trying to limit the 
liability of their banking friends under the guise of trying to help 
borrowers. At stake is nothing short of the continued existence of the 
U.S. banking system.

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Sean Olender is a lawyer in San Mateo, California.

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