Damned if you do, damned if you don't. How the "failure" of rating agencies on Wall Street directly impacted homeowners.

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The certificates that are referred to as “mortgage-backed securities” are neither mortgage-backed nor securities. There have been at least dozens of cases in which tax treatment or liability of the trustee for a REMIC trust has been decided and hundreds more where there were settlements without litigation. In every case, it was found that the owners of the certificates had a creditor-debtor relationship with the book runner investment bank that was unsecured. In every case, the court found or the case was settled on the premise that the owners of the certificates had no claim at all against the payments, obligations, notes, or mortgages issued by any homeowner.

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The failure of the government to regulate the issuance of those certificates is traced back to the deregulation of those instruments as being “private contracts,” not to be regulated as securities.

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So the whole notion that the rating agencies failed to properly assess the risk elements contained within the purchase of those certificates is correct but manifestly incomplete. Those certificates were promises to pay issued by Book runners doing business under the name of a nonexistent trust. The promise to pay, in most instances, contained no maturity date as to the principal. The promise to pay, in all instances, was subject to the sole discretion of the book runner.

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The failure of the rating agencies can be traced to corruption. And the specific failure of the rating agencies was the failure to identify the immediate yield spread premium taken by the book runner together with its securitization partners. That premium had a range of 20 to 50% of the amount invested by purchasers of the certificate. A casual review of the “lending” transactions conducted with homeowners reveals that there was no possible way that certificate owners could’ve been paid as stated in the promotional materials and indenture. The payment was ultimately based upon the continued sale of certificates — with more yield spread premiums. So the “failure” of the rating agencies was the failure to call this scheme by its proper name: a PONZI scheme.

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The intermediate securities brokerage houses were borrowing money from their securitization mega counterparts against the sale of the certificates. The certificates promised, on average, around 5% return to investors. The transactions that were actually funded had a stated average of 7 to 9% return (with very little likelihood that it would ever be paid). So the amount that was claimed as a loan was far less than what had been received from investors. Part of this money went into a reserve account from which the book runner, as master service sir, could make “servicer advances.” Do the math. In many cases, if you allocate the money to a specific “loan” transaction the amount of revenue generated was equal to or greater than the amount of “principal” on the “loan.” On average it was less than that — but far more than what was required to be disclosed to the consumer homeowner.

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The only way that yield spread premium could exist is by charging a higher interest rate on the “loan.” The only way the higher interest rate could be charged was by structuring transactions with homeowners that had maximum risk instead of minimum risk. And the only way the book runner could keep paying the certificate holders was if more certificates were sold since actual payments from actual homeowners would never materialize in the amount needed to meet the whimsical promise made by the bookrunner. Knowing that, the bookrunner and securitization counterparts were able to create insurance contracts that insured them instead of investors but still promote the certificates as “insured.”

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To get independent confirmation of what I am saying here, which is above most readers’ understanding, is by tracking the evolution of the definitions used in the TARP program. First, it was to offset losses suffered by the banks from homeowner defaults. Then it was discovered that the banks did not own any loans to homeowners and therefore could not suffer any loss and needed no bailout for such losses. But they were still left with the threat of financial Armageddon that was being pushed by the megabanks — bail us out or else we will freeze all credit markets.

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So then TARP was changed to bail out the banks for losses on the RMBS certificates. That didn’t work either because the banks were selling those certificates, not buying them. SO there was no loss there either. But the threat remained that as Geithner said “The plane was burning, We had to land it.” The megabanks were insistent on the bailout even though none of them had experienced any losses.

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The true nature of the bailout was revealed when the bailout of AIG occurred in the open. It turns out Goldman Sachs had been bailed out of losing a windfall profit it had “earned” by having insurance paid to itself instead of investors or homeowners. The taxpayers were coerced into funding profits. No losses were bailed out because no losses were incurred by the recipients of the bailout.

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So that is why I say the “failure” of the rating agencies is a generous way of portraying what they did. This mess might never have occurred if they were not complicit in the scheme. And that is why I say that the legal doctrine of res ipsa loquitur applies —- in the absence of negligence or other tortious behavior, the thing would not have occurred.

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It is peculiarly irksome for homeowners and their lawyers that there have been so many settlements predicated on the fact that the transactions with homeowners were never conducted, underwritten or executed properly. Those settlements have strictly been with the government or investors. What disturbs homeowners is that those defects are all violations of lending laws for which there are self-executing remedies including rescission. But while the banks are getting paid “bailout” money, the homeowners are being barred by the courts from remedies that were created in order to establish a self-regulation process rather than a gigantic new federal agency that would review, insure and approve all consumer lending transactions.

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The second irksome issue for homeowners is that they know that the parties seeking enforcement against them are doing it for fun and profit — not to repay an existing loan account receivable. Any real analysis by the rating agencies would have revealed the fact that the enforcement of the homeowner’s scheduled payments was completely dependent upon the satisfaction of the condition precedent stated in Article 9 §203 of the UCC — payment for the underlying obligation. But what the Wall Street banks had created was an oxymoron. Anyone who had paid value did not own the obligation, and anyone who received “title” to the underlying obligation did not pay value. It was precisely this structure that enabled the virtual sale of the debt many times over rather than being limited to a single actual sale.

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The problem then is that even if the certificates had been properly sold and properly managed, the homeowner transactions were mere points of reference rather than any enforceable contract that served as “mortgage backing” for the certificates. None of this could have occurred without the rating agencies and the homeowners who were unknowingly drafted into a securities scheme without receiving notice nor any incentive payment — despite statutory requirements to the contrary. Hence the sale of financial products to homeowners produced an inchoate liability for the Wall Street banks. This liability, based upon the stated position of owners of the certificates could vicariously be ascribed to the certificate owners who found themselves in the old position of “damned if you do, damned if you don’t.”

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