New Year's Day 2022
Day 2 of the Newsletter.
Thank you very much to those that signed up for subscriptions Friday and yesterday.1 Please share this Newsletter with those that you think might be interested in the subject matter
Over the last ten years, my usual practice is to sit down and assess what took place during the past year and then set forth a business plan for the coming new year.
This year is a little different because I started planning for 2022 roughly about June of 2021. I started planning early, as it was obvious to see the handwriting on the wall for what is coming. Thus, unlike past years, I had a little extra time this year on New Year’s Day 2022.
So yesterday, my better half (and yes that means that I clearly agree that I am the ‘worse” half) and I took part in a “polar bear plunge”, named “Freezin’ for a Reason”, in Newport RI, to support two sick children’s wishes. The good news is that we lucked out with the weather, where the temperature was 50 degrees F.. However, the bad news was that the surf temperature at Newport R.I.’s Easton’s Beach yesterday was still a “blistering” 46.7 degrees F.. Wow, that was an eye-opener!
Now that I am finally thawed out from my swim in the 46.7 degrees Atlantic ocean, I thought that I would continue to set down some additional thoughts for today’s Newsletter. Underlined words or sentences below are links for further information.
The Ugly Truth About The Genesis of “Securitization”
The few people that understand the term “securitization” of mortgages know this to mean that their mortgage (more specifically the payment stream from the Note) is sold after its “origination” into the “secondary mortgage market.
In fact, it is widely believed that the concept of “securitization” began in 16th Century England.
The South Sea Company (officially The Governor and Company of the merchants of Great Britain, trading to the South Seas and other parts of America, and for the encouragement of the Fishery) was a British joint-stock company founded in January 1711, created as a public-private partnership to consolidate and reduce the cost of the national debt. The South Sea Company underwrote the British National Debt which stood at roughly $30 Million Pounds, in return for the promise of the British Government to pay 5% interest.
In order to help the South Sea Company to generate income, in 1713 the British Government granted the South Sea Company a monopoly (the Asiento de Negros) to supply African slaves to the islands in the "South Seas" and South America, [generally the portion of the Pacific Ocean south of the equator]
When the South Sea Company was created, Britain was involved in the War of the Spanish Succession and Spain and Portugal controlled most of South America. Thus, there was never any realistic prospect that the South Sea Company trade would ever take place.
In fact, history reveals that the South Sea Company never realized any significant profit from its monopoly. However, despite having no real profits, due to wild speculation, the South Sea Company stock still rose greatly in value as it expanded its operations dealing in government debt.
The creators of this “scheme to defraud” the citizens of Britain, engaged in widespread “insider trading” though utilizing advanced knowledge of the timing of consolidations of the national debt to make very large profits from purchasing debt. Politicians were also heavily involved in the South Sea Company scheme as well, where bribes were accepted to support Acts of Parliament necessary for the scheme to continue.
The expectation of profits from trade with South America was “talked up” to encourage the public to purchase shares in the South Sea Company, but the bubble prices reached far beyond what the actual profits of the business (namely the slave trade) could justify.
The demand for shares peaked in 1720 before suddenly collapsing to a little above its original offering price. The notorious bubble was created, which ruined thousands of investors, became known as the South Sea Bubble.
Many investors were ruined by the share-price collapse, and as a result, the British national economy diminished substantially. 2
After the spectacular crash of the South Sea Company shares (“South Sea Bubble”), the debt securities market lied dormant for some 200 years.
Then came the 1970’s and the United States’ sponsorship and involvement with the “secondary mortgage market”. “Governmental National Mortgage Association (“Ginnie Mae”). Hey what’s old is new, so let’s roll out something everyone knew would eventually lead to disaster
Today’s securitization of mortgages could not exist without the Government National Mortgage Association (Ginnie Mae), which guaranteed the first mortgage pass-through securities. See the written testimony of Ted Tozer, describing the history of Ginnie Mae at a Hearing before the House Committee on Financial Services Subcommittee on Insurance, Housing and Community Opportunity Thursday, September 8, 2011.
Interestingly, like the South Sea Company, Mr. Tozer identifies that Ginnie Mae operates as a “public-private partnership”.
Prior to Ginnie Mae, if investors wanted to purchase an interest in loans in the secondary market, they had to do so on an individual basis. Since loans were not securitized, very few investors were interested in buying them.
Government-backed pass-throughs became a revelation to secondary mortgage traders. They were then viewed as safe investments. Ginnie Mae was soon followed by two other government-sponsored corporations, Fannie Mae and Freddie Mac.
However, the distinction between Ginnie Mae and Fannie Mae, Freddie Mac, is that Ginnie Mae is a government entity, while Fannie and Freddie are “Government Sponsored Entities” (“GSE’s”)
Fannie Mae fueled the fire when it issued the first collateralized mortgage obligations (CMOs) in 1983. Congress doubled down on CMOs when it created the Real Estate Mortgage Investment Conduit (REMIC) to facilitate the issuance of CMOs.
A collateralized mortgage obligation (CMO) refers to a type of mortgage-backed security that contains a pool of mortgages bundled together and sold as an investment. A CMO involves pooling mortgages into a special purpose entity, from which different tranches of the securities are then sold to investors. Organized by maturity and level of risk, CMOs receive cash flows as borrowers repay the mortgages that act as collateral on these securities. In turn, CMOs distribute principal and interest payments to their investors based on predetermined rules and agreements [pooling and servicing agreements, and related documents].
By 2000, the trade in mortgage-backed securities has become a $6 trillion market. It bore a great deal of the blame for triggering the 2008-2009 financial crisis when many of those underlying mortgages went into default. After about five years in no man's land, the market for mortgage-backed securities came roaring back. By 2018, the total was close to $10 trillion.
Indeed like echoes from the past that were first heard in the South Sea Company bubble, back in 1720, speculation began to run wild during the decade of the 2000’s. This speculation was driven predominately by financial institutions that chose not to review the history of the South Sea Company bubble, as well as the real estate and title insurance industry.
Traditionally a “bank” could only loan out a percentage of its depository receipts it held on its customer passbook savings accounts. With the dawn of mortgage “securitization”, banks and financial institutions quickly became unshackled from such restrictions.
Indeed, the “bank” suddenly became merely a conduit to procure “payment streams” to be sold into the “secondary mortgage market. The benefit of this process meant that the bank would sell the right to a 30-year mortgage payment stream at a discount and also remove the risk of default from the borrower. Better yet, most times the “bank” would undertake a “warehouse line of credit” from banks such as the Royal Bank of Canada (“RBC”) to initially find the loans. When the loans were “sold” to the “secondary mortgage market”, these funds would then be used to repay the warehouse line of credit, as well as adding the rest to “the bottom line”.
Thus, unlike traditional bank “lending”, the originating bank had no worry about the loan eventually defaulting, because it was “quickly sold off”. This is part of the reason that underwiring standards went out the window. Even though the agreements for mortgage securitization (pooling and servicing agreements) specifically dictated adherence to credit score and income requirements, those requirements were overlooked in the mad dash to procure an even greater amount of loan originations to feed the voracious appetite of institutional investors caught up in the speculation created in the secondary mortgage market. Everybody looked the other way, that is until the music stopped and the finger-pointing began.
With Fannie and Freddie’s involvement, the banks could quickly off-load default risk, and at the same time retain the “mortgage servicing rights” to those sold mortgages. Mortgage Servicing Rights (“MSR’s”) are a cash cow for financial entities. Generally, there are different types of “mortgage servicers, A “Master Servicer” [entity with the main responsibility for collecting payments and overseeing the loan administration for the securitized trust, and a server and/or “sub servicer”, who is hired by the Master Servicer to carry out these functions, including “default servicing” and to conduct the foreclosure process.
Like the 1720 South Sea bubble, speculation in the housing market was driven by the real estate and title industry publications and advertisements to caution that, “you don’t want to miss the boat on this fantastic investment opportunity, because real estate prices are skyrocketing”.
Indeed, real estate prices were rising, however, they were only rising on pure speculation that prices would continue to rise indefinitely. Common sense would warn that prices cannot continue to rise forever, because at a certain level it becomes completely unaffordable. That is precisely what set the house of cards tumbling in 2008. The shell game had been exposed.
The U.S. Government stepped in to “bailout” these companies because they were determined to be “too big to fail”. However, the U.S. Government was selective in which companies would be “saved”, and which companies would be liquidated.
History reveals that companies like Goldman Sachs and JPMorgan Chase Bank, escaped relatively unscathed from the debacle.
A close review reveals why. In 2008, many former employees of Goldman Sachs and JPMorgan Chase had moved on to take strategic positions within the U.S. Government. A key player for JPMorgan Chase is the high-powered law firm of Sullivan and Cromwell. Sullivan and Cromwell has had many of its partners take roles in the U.S. Government.
Founded in 1879, Sullivan & Cromwell was the firm John Pierpoint Morgan himself turned to when creating U.S. Steel Company. Sullivan & Cromwell’s client list back then included one of the more notorious robber barons of the day, E. H. Harriman, whom President Teddy Roosevelt dubbed an “enemy of the Republic.” One Sullivan & Cromwell partner, John Foster Dulles, a future secretary of state, helped negotiate the Treaty of Versailles after World War I. Another, his brother Allen Dulles, would go on to lead the CIA. After the 1929 crash, John Foster Dulles tried convincing federal officials that there was no need to write new laws restricting businesses, according to “A Law Unto Itself,” a 1988 history of Sullivan & Cromwell written by Frank Ipsivs.
When John Foster Dulles failed to convince federal officials that there was no need for restrictive business laws, another partner at Sullivan & Cromwell helped to write both the Securities Act of 1933 and the Securities Exchange Act of 1934. Talk about the Fox in the henhouse.
Indeed, Sullivan Cromwell’s reach is current and ongoing. For instance, Brent McIntosh former partner at Sullivan Cromwell was appointed by President Trump to be General Counsel for the U.S. Treasury. He then was named Under Secretary for International Affairs. After President Biden was elected, McIntosh thereafter bounced around to various conservative think tanks such as the Alexander Hamiton Society. Another Sullivan and Cromwell alum, Jay Clayton, was appointed by President Trump as the head of the Securities and Exchange Commission and later almost became the top prosecutor for the Southern District of New York. Don’t worry, poor old Jay Clayton just scored a new position with Fireblocks, a $2 billion Israeli-based crypto custodian.
Thus, like the South Sea bubble, there was [and still is] governmental entanglement and quasi-governmental assistance in the coverup of what took place during the decade of 2000, and also to mitigate damage to those companies that were the actual cause of the disaster. This entanglement continues today. Like George Carlin said long ago, “It’s a Big Club folks, and you and I are not in it”, see video here [caution graphic language]
There is less than one handful of individuals that were ever brought to justice for what they unleashed during the runup to 2008, (and continue to unleash) upon America.
Why was there never any accountability? The answer is obvious, you and I are merely pieces on a chessboard to be moved around for the benefit of large financial institutions. Something about not being in that Big Club I guess.
Today’s Warning Signs That Eeerily Resemble 2007
Like the runup to 2008, one does not have to search too far to see that the Real Estate market has been white-hot.
The same forces that drove the market up over a decade ago are back at it today. Indeed, Quicken’s “Rocket Mortgage boasts, “push a button get a mortgage”, see one of their ads here
Like 1720, ads like this fueled speculation. The Quicken’s Rocket Mortgage ads started running in 2016, so they are well-seasoned in the minds of the public at this point. Housing prices have hit all-time highs, and the demand for homes is ferocious.
Just like in 1720, and 2007, it is obvious that a bubble has once again formed in the housing market.
This time we have an additional layer of uncertainty to factor in, the COVID-19 pandemic, and the “great resignation”.
When the pandemic hit, businesses collapsed, and so did workers’ income. With regard to the mortgage market, the U.S. Government sought to keep the ship afloat by offering stimulus payouts and worked with mortgage servicers/securitized trusts to offer payment forebearance programs in the hope that things would be rectified so that people could go back to their formal live of paying their bills. The federal government under President Biden then issued a National Moratorium on evictions for federally back loans, which ended last October (2021).3
There will most likely be a crushing wave of foreclosures and evictions during 2022.
When all collapses again this time who will come to the rescue to provide the bailout? The U.S. Government? Think again. That train left the station 13 years ago, and the U.S. is currently $28.91 Trillion in debt as of November 2021. Further, the Biden administration seeks to spend trillions more on infrastructure and social programs.
There will be no “bailout” this time.
What then of the collateral damage (no pun intended) that will come in the form of mass foreclosures and evictions. Don’t worry, I’m sure that a former Sullivan and Cromwell lawyer will come out of the woodwork to “save” us.
The collapse is coming, make no mistake about it.
Including the best doubles partner during my time at Newport Jai Alai.
Such mandate was determined to be unconstitutional and repealed when the Biden administration sought to extend the moratorium.