HEAD TO HEAD: ANONYMOUS VS. GARFIELD

Nov 15, 2010

Anonymous is in regular type, Garfield is in bold.

Dear Anonymous:

Think some of the confusion here is in the concept of funding of the loans.   As I have said before (and I know Neil does not like) investors do not directly fund individual mortgage loans. They indirectly fund the securitization of a “POOL” of securitized receivables.    Thereafter, the pools are combined with other pools and multiple tranches, thus, forming CDOs – which are derived from the securities – which are derived from the receivables – which are derived from individual loans. There is no funding by investors for individual loans – and, therefore, investors can never be considered your “creditor” or “lender.” It’s not that I don’t like it. I know perfectly well that investors do not fund individual loans. My point is that all evidence I have is that the first monetary transaction is between the investor and the investment banker who underwrites the issuance of the MBS. That transaction is in contemplation and expectation that the money will be used to fund loans, although the borrowers are not yet known. All evidence I have shows that the LAST transaction involving money is in the funding of the borrower’s loan. Under the single transaction rule the test is simple: would the investor have advanced money to the investment banker if there wasn’t going to be loans to homeowners? The answer is no obviously as you can read from any prospectus or PSA. Would the borrower have taken a loan without the presence of the investor’s money? The answer is no if you exclude the small percentage of people who were in traditional loan situations. Therefore it is a single transaction — or so I say. There wouldn’t have been a borrower without an investor and vica versa. The creditor, under the law, is the party to whom the obligation is owed. At the beginning of the borrower’s transaction there is only one source of funds — the investor’s money which is sitting in a pool. If the investor is NOT the creditor, then nobody is. A creditor is a party who has given consideration for the benefit of the customer or borrower. If they hadn’t tried to securitize the receivables, then you would be arguably right. There would then be no easy evidence to show that it was a table-funded loan, since the originator could take the position that it is in fact the lender and where it gets its money is nobody’s business. But they DID try to securitize the loan thus disclosing the existence of the investors and the method by which the money was acquired. Thus you have a disclosed principal acting through purportedly authorized agents acting within the scope and course of their authority which is why the investment banks say they are not the ones who bear the risk of the failure of the loans or the pools. It is under the pretender lender arguments that the only possible conclusion left is that investors de facto funded the loans through agents. The fact that they violated the securitization documents by not actually transferring the loans is a problem between investors and the investment banks. SO my position is that either there is NO creditor, which could be true but unacceptable to most judges, or the creditor is the investor.

Overcollateralization is not the “yield spread premium.”   YSP is the “bonus” paid to mortgage brokers to deliver higher interest rate loans to the purchasing bank. YSP is not defined by the recipient of the remuneration. It is defined by the manner in which it was calculated and why. The fact that the investment bank is not a mortgage broker licensed as such doesn’t mean it wasn’t acting as such. Overcollateralization is only evidence of the tier 2 YSP — the difference between the money that was advanced by the investors and the actual money used to fund mortgages.

Overcollateralization is when the face value of the underlying loan PORTFOLIO (Pool) is larger than the security it backs.    Banks were able to overcollaterize due to credit enhancement in the pool tranche structure.   That is, they were able to sell the securities for less than the value of the pool of receivables the bank owned because the risk to security investors of default was supposedly mitigated by a trance structure in which the higher risk (lower tier) tranches protected the lower risk (higher tier ) tranches.   Further, the risk was supposedly mitigated by combining many pools and tranches into CDOs. By not removing loans from pools – when the loan was actually not securitized into that pool or sold upon default- allowed for multiple inclusion of individual loans in separate pools. This would be a true statement if you were reading the securitization documents. It is not a true statement because the underwriters did not follow the restrictions, terms and conditions of the securitization documents.

You have to go the TILA and definitions of Creditor (and the TILA Amendment in May 2009) to understand who is considered a lender/creditor to an individual loan borrower. Not really. Creditor is defined under the Bankruptcy code and many civil codes including the UCC.

How the creditor/lender pools loans to pass through income streams is bank’s business – but those derivative securities investors are never individually funding any loan – those derivative investors are only interested in a pool -in which your loan may or may not be very fractionally represented. Not true even according to the securitization documents. Regardless of whether you go by the securitization documents or just track the obligation without the documents, the answer is that the investors’ interest in the pool is derived from the supposed value of the loans in that pool. As it turned out there were no loans in the pool in most cases. And any attempt to put defaulted loans into the pool would violate many restrictions in the enabling documents for the pool.

Overcollateraliztion was to supposed to protect CDO investors from loans that went into default. Thus, providing enough money to cover those defaults.   The derivative securities, therefore, could be purchased for much less than the face value of the “pool” and multiple “pools”.   But, the defaults came so fast that the the pool and pool’s value collapsed – causing the CDO’s value to fall to zero. If I understand what you are saying here I agree.

Individual loans were funded by warehouse lines of credit that the purchasing banks provided to originators.   This is the missing link in chain of securitization that is never disclosed – making any conveyance of individual loans to any trust – false.   That is, the banks purchased the individual loans before they securitize their “pools” of receivables.   Only who funds individual loan is relevant to the borrower according to TILA. This lies at the heart of our disagreement. The banks never, or almost never, originated, much less bought existing loans before they actually sold the MBS> It was exactly the reverse.