Here is the Answer to Guilt About the "Free House" — the one the banks don't want you thinking about.

Imagine we are in a new era, where disclosure was full and complete to investors and borrowers.

The deal pitched to investors is simple: the investment bank gets your money and uses it to buy debts, notes and mortgages. The purchased loans (including the debts) will be put into a portfolio and the investors grant ownership to a trust with the investors as beneficiaries. [Instead of the investment bank as beneficiary under a secret trust agreement.]

The investment bank promises to use its best efforts,  (1) to pay cash flow to investors equal to a specified interest rate, and (2) multiply the investment through issuance of complex derivatives.

The investment bank shares in the investment through administration fees and sharing in profits from the sale of complex derivative instruments whose value is based upon the certificates purchased by investors.

In the end, the investors receive the stated rate of return on their investment plus a return of 200% in capital gains. The investment bank earns profits in excess of 600% of the investment by investors.

So the investors get back whatever principal is paid on the loans plus 200% of their investment plus interest. Good deal.

Since all of this is disclosed in detail, there is no conceivable problem anyone could have in such an arrangement. Bravo to the investors and investment banks.

The pitch to borrowers is equally simple: the borrower gets a loan in a specified amount at a stated rate of interest subject to specific payment terms. The lender is the trust. In addition the borrower becomes an investor in their own loan in which the investment bank premises to use its best efforts to obtain profits such that borrowers could receive up to 200% of the loan over a period of time.

In the end, the borrowers receive 200% of their loan which is required to be allocated toward payment of interest and principal. The investment bank receives in excess of 600% of the loan amount which is different from the invested amount received from investors.

Since all of this is disclosed in detail, there is no conceivable problem anyone could have in such an arrangement. Bravo to the borrowers and the investment bank.

The entire plan generates 1200% of invested capital and 1600% of loan balances. Everybody pays tax on their gains. The plan is completely legal and doable as long as investors invest and borrowers borrow.

Nobody has a problem with that scenario except the investment banks who want to keep all of the excess gains derived from issuance, sale and trading in complex derivative instruments using money from investors and collateral from borrowers.

Investors get a free investment with profit. The borrowers ultimately get a free house and some profit. The free house doesn’t seem so outlandish, does it?

Everything I have described above is what is happening with three exceptions: there is no disclosure of excess profits from sales and trading in complex derivatives and neither investors nor borrowers share in a business plan that requires their investment of money and collateral. In addition virtually no taxes are paid on the gains. They don’t share because they didn’t know.

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