Thursday, November 15, 2007


Two interesting stories resulting from the credit crunch

Both have roots in securitized mortgages and they illustrated the far reaching problems caused by lax lending standards during the housing bubble.

One hidden problem that has the potential to be very bad for our financial system is the fact that supposedly safe investments sometimes hold small amounts of CDOs in order to goose up their return.

Based on information on GE Asset Management's Website, the enhanced cash fund has about 27% of its assets in home-equity asset-backed securities, 23% in residential mortgage securities and the rest in a mix of securities, including credit-card securities and corporate bonds. This information is as of June 30. [Emphasis added.]

Well maybe not small amounts. I would like to point out that they called these cash funds in this quote and the title of the article calls them bond funds. There is a big difference between the two in that investors expect to have no risk of losing their investment in a cash fund. In fact, the returns on this fund seem to indicate that they were considered a low risk profile.

The 4% loss suffered by outside investors is sizable relative to the added returns that the fund generated relative to short-term investments. The one-year return on the fund through June 30 was 5.49%, versus one-month Libor of 5.39%.

A 4% loss in a fund that only returned 0.10% over cash is huge. I don't know what past returns have been but even if they were 1.0% over Libor, which I strongly doubt, that would take 4 years to break even.

I know the amounts of money seem small but they show that the street was willing to trust that mortgage backed securities and other CDOs had a return and risk which could be readily understood. Also, these MBS securities will keep popping up for a long time producing losses in unexpected places. Uncertainty is the enemy of stability.

The second story concerns a judges decision to force mortgage security holders to produce paper work which unequivocally proves that they own the mortgages they are trying to foreclose on. Mortgages can and have been divided up into all sorts of securities. Interest only payments, principle only, dividing up the mortgage based on the timing of the payments, risk level of the borrowers, and so on and so forth which leaves the question of who really holds the mortgage. Apparently the mortgage securization industry has not been entirely legally correct when it comes to who is the owner.

On Oct. 10, Judge Boyko, 53, ordered the lenders’ representative to file copies of loan assignments showing that the lender was indeed the owner of the note and mortgage on each property when the foreclosure was filed. But lawyers for Deutsche Bank supplied documents showing only an intent to convey the rights in the mortgages rather than proof of ownership as of the foreclosure date.

Saying that Deutsche Bank’s arguments of legal standing fell woefully short, the judge wrote: “The institutions seem to adopt the attitude that since they have been doing this for so long, unchallenged, this practice equates with legal compliance. Finally put to the test, their weak legal arguments compel the court to stop them at the gate.”

This is just a paperwork issue that will be corrected very soon I imagine by the lawyers working for the various owners of these bits of mortgages. What it shows is that in the rush to securitize mortgages some "I"s weren't dotted and "T"s not crossed. Sloppy work, lack of due dilligence, failure to consider risk all in the rush to profit. All fine with me as long as the risk takers are the ones to suffer the consequences. IOW, know what's in your cash fund.

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