Nov 24, 2021
Like everything else, “servicer advances” is a false label. There is no money being advanced. But there is money received by institutional investors who bought certificates under the mistaken belief that they were mortgage-backed securities. They receive that money regardless of whether or not payments are made by homeowners. The test for whether or not they will actually receive the money is whether or not the investment bank is continuing to sell new securities. Like any Ponzi scheme, a basic component is the continual payment of prior investors.
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So you might ask, where does the money come from? And the answer is it comes from the investors. A portion of the proceeds of the sales of certificates is set aside in a reserve fund that is disclosed in the prospectus. It is also disclosed that they may be receiving their scheduled payments from that reserve fund.
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The ability to create the reserve fund comes from the yield spread premium between the sales of certificates to institutional investors and the sales of Financial products to homeowners. I have previously written about how this works. But in summary, here it is.
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Investors pay money to the investment bank for certificates lead promise scheduled payments, without a maturity date. This is based on a formula designed to produce a specific percentage return on investment. Since most of the institutional investors are stable managed funds, they were only seeking an increase in the current rate of return of 10 to 15%. That meant that if they were earning 4%, they only wanted 4 1/2% from the investment bank. The illusion is created by converting the percentages to dollars. That’s where the yield spread premium emerges.
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An institutional investor who pays $1 million for a 4 1/2% return is seeking scheduled payments of $45,000 per year. The investment bank, through intermediaries, is closing deals with homeowners at rates varying from 5% to as much as 10%.
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The yield spread premium results from a question: how much money does the investment bank need to “loan” in order to produce $45,000 per year. The answer, if they are creating the illusion of a loan at 10%, is that they only need to “lend” $450,000. The rest of the money — $550,000 — is a yield spread premium that goes into the pocket of the investment bank.
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Yes, that means they made more money on the transaction than the entire amount received by the homeowner. It also gives them money to establish the reserve account from which to pay the institutional investors from their own funds.
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Neil F Garfield, MBA, JD, 74, is a Florida licensed trial and appellate attorney since 1977. He has received multiple academic and achievement awards in business, accounting and law. He is a former investment banker, securities broker, securities analyst, and financial analyst.
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