Monthly Archives: July 2010
Principal Reductions-The Reality
Principal Reductions
Has anyone had a client receive a notice of conditional acceptance for a Principal Reduction from Bank of America? Any other national lenders? They are happening, I have some of them here in my office and I have a strong theory. We have researched a principal reduction negotiation shop with a couple of attorneys and a certified forensic mortgage auditor and a few CPAs that have negotiated 334 principal reductions over 24 months. These guys are under the national radar screen. Many of these principal reductions are 40-60 % of initial face principal value of the note. We have reviewed the principal reductions and the re-casting of these loans. These are real. We are now in partnership with a member of this group. I am extremely excited about this model because it works. Principal reduction has been the golden chalice of the mortgage modification industry. Any professional who is in the good fight against foreclosure fraud and helping distressed homeowners has been searching for the angle we just found. The banks right now are over-run with what physicists call momentum. The momentum to foreclose. The extremely strong, manufactured momentum to foreclose on homes is fueled by the lenders looking for the least resistance/ shortest distance to hitting loss share insurance funds$$. Foreclosure is an absolute loss since none of these homes are worth as much as the homeowner owes. 80% of the loss created by selling the home as REO and subtracting this sale price from the face value of the note creates an absolute loss and is paid by the FDIC or some other government or CDS insurance loss subsidy. You see, accidentally the banks got caught up in their own executives’/controlling shareholders’ hyper-greed. They have used their amazing Washington DC lobby over the last three decades to wrest control of the US financial system so successfully that now chairmans of investment banking firms run the Treasury and the Federal Reserve. The payday for running an Administration is really in the aftermath of the administration’s failure to the US citizens. This is evidenced by the fact that guys from the Clinton & Bush administrations are allowed to purchase failed banks with borrowed money guaranteed to create massive returns by the US Government. Ok, (deep breath) let me reel in my A.D.D. again. These same bankers could have chosen another route. Recasting subprime predatorial notes at 90% NPV also allows the banks to receive subsidies for the losses. It also lets people keep their homes and pay more affordable mortgages and stem the huge flow of inventory or REO onto the market. This is how our partner Principal Reduction Consultants, LLC negotiates reductions for you. Check out this video (below) a video embedded from the FDIC’s website, showing that these agreements were made to let people keep their homes but were bastardized by the foreclosure mills…. Watch it and then visit http://www.PrincipalReductionConsultants.com
securitization audits
Securitization Audits-Questioning Securitization of Mortgages I just watched the latest Michael Moore movie, “Capitalism, a Love Story”. This was my second look. I know a lot of people don’t think much of Michael Moore. I have a great deal of respect for him. I think some of his tactics are shamelessly gimmicky like pretending to make citizens arrests of executives on Wall Street or standing in front of the Citibank building with a money bag and a Brinks truck and demanding the taxpayers money back, but his point is always well made. In this case his point is that Banks have infiltrated and control the highest levels of US government to the detriment of the entire country. He underscores the slick manipulated congressional robbery of the national treasury by $800 billion with absolutely no judicial oversight after Congress first turned the package down as a result of the millions of calls coming in from the people of each congressional district. No one in government can tell you where this money went. No one from the corporate elite will tell you. When I think of how these banks and lending institutions are foreclosing on homes using illegal foreclosure Mills I can’t help but wonder if Moore isn’t entirely correct. This just might be the strongest tell tale sign of the beginning of the end for Capitalism. It seems to be crashing in on itself. Any farmer that kills off his own herd in an orgy of selfish personal gluttony while watching his neighbors starve is not long for the farming business, it would seem to me.
Having said that there are some very strong methodologies being incorporated into the gun lockers of foreclosure prevention attorneys and other related service shops. Securitization Auditing is one of the most powerful tools I’ve seen in the fight to save a home from a foreclosure Mill where the mortgage servicer does not actually have standing or capacity to foreclose on a home because they [or the loan pool Trust] they purport to represent do not properly own the note for which the substitute Trustee (foreclosure Mill) is claiming to represent to the local court. The Securitization Audits unveils this “lack of standing & lack of capacity“. Here are some of the things that one might find out about their note through a Securitization Audit: First a little background on Securitization. For a very long time financial instruments have been getting securitized into entities and sold off to investors in the form of stocks or bonds or some other form of interest in the entity. Sallie Mae was created to securitize student loans and sell investment vehicles to investors based on the long term returns of student loans packaged within student loan backed securities. A Mutual Fund is really nothing more than a fluid managed group of securitized stocks or bonds or treasury bills grouped into an investment company (the vehicle) with a directive to either create income, pursue aggressive equity growth, pursue slow steady equity growth with higher safety, or some combination of these or other investment objectives to which the Mutual Fund hires a (hopefully) competent investment management team to effect. In all of the above cases, the management team is responsible to the investors pursuant to the listed investment objectives which are listed in the prospectus of the mutual fund. Same with ETF’s, bond funds, treasury bill funds. etc. mortgage backed securities are stakes in a separately incorporated entity whose objective is to purchase pools of mortgages and then transfer the income from the streams of revenue from the individual notes (secured by the deeds of Trust) to the owners of the stakes. These became highly popular to Wall Street in 04,05,06 and a veritable ticking time-bomb within our economy because of world wide investor appetite for these seemingly lower risk but higher return securities backed by deeds of Trust on real property in the USA, the strongest economy on the planet.
The brilliant Wall Streeters came up with diabolical methods for creating guaranteed returns through alternative insurances on the loan pools and by tranching the investments in multiple series allowing an investor to “dial in” their particular investment vehicle based on their appetite for risk or aversion to risk . What I mean by tranching is simple and I am not trying to complicate it. The investment bankers, God love ‘em, would create Tranche A shares, Tranche B shares and Tranche C shares in each mortgage Trust. Tranche A is safer and is paid by the more conservative mortgages. Tranche C contains the more risky mortgages. Here’s the kicker, Tranche A investors are not only paid their returns by the Tranche A mortgages, but they are paid also by B & C mortgages in the event of any default within the A Tranche . The A Tranche investors are guaranteed their returns even by the revenue generated from the mortgages purchased by Tranche C investors. So homeowners with higher risk sub prime loans paying their Tranche C mortgages might be paying the mortgages of other homeowners and not their own mortgages. This entire scheme underscores the difference in how the elite control the masses. The elite wealth is not only guaranteed by the investment collateral for investments made by the elite, but also at the detriment to investment collateral backing investments made by the masses. There is no more room in the elite class. The door is now closed, with the exception for the luckiest of blind squirrels who finds a golden nut. First class is full and economy must give up its parachutes to the wealthy in the event that someone in first class forgot to pack a chute. Anyway, back to the reality of Securitization Auditing. Another method these guys came up with to increase the marketability of these mortgage backed securities is the Credit Default Swap- or CDS. The Credit default swap-CDS is a method of guaranteeing returns by having someone buy from your entity the default event. In other words a mortgage default is commoditized as a potential event and entities that had no insurance regulators to regulate their purchase or sale were purchasing or short selling these events. It’s a slick way of rigging the game to make Moodys and S&P give better ratings to a pool because it created the illusion of security and guaranteed return without having any regulatory oversight to look at the underlying financial health of the issuer of the default swap contract, most of these issuers were off shore entities with no assets other than the dollars given to them to issue the default event purchase which of course they pocketed. It was the biggest Wall Street shell game hoax ever perpetrated and allowed scam artists of the highest blue blood breeding to make off with billions while imploding our real Bond guarantee corporations AMBAK, MBIA and absolutely demolishing the foundation of our entire mortgage industry FANNIE MAE & FREDDIEMAC as well as tanking all of the lenders who were caught in the cross fire. It was a rigged musical chairs game. How is it that these bankers, Bank of America, OneWest, Goldman Sachs are making billions and billions right now? How did they dodge the bullet? How is it possible that Bank of America, which cut a deal with the government to purchase Countrywide, the single largest issuer of sub prime mortgages currently in default is making billions each quarter? Simple, many if not most of the mortgages currently in default have already been paid for. The foreclosures taking place on many of these homeowners burdened with a sub prime loan are already paid for by either PMI insurance, Credit default swap-CDSs or TARP. The banks are foreclosing on homes for which the note has already been paid at least in part by insurance. The foreclosure is icing on the cake.
It’s a windfall profit and I would argue that its fraud. Shouldn’t the benefit of a foreclosure inure through subrogation to the entity insuring the default? Shouldn’t a Note that has been paid off (albeit by insurance) mean that the note is paid? No, the elite want it all; they want TARP to buy the troubled assets; they want the insurance money; they want your home, the FDIC Loss Share, the PMI, the default swap cash, and then the icing on the cake, the proceeds from the REO sale of your home. They do want it all. FDIC guarantees through Loss Share Agreement 80 % of any loss OneWest experiences on its IndyMac portfolio, OneWest only paid 70 cents on the dollar for the assets based on the discounted value of the assets at the time of purchase. The loss is calculated from the face value of the notes. It’s an insane deal that OneWest was able to cut with FDIC to the benefit of the elite at the cost of the taxpayer. Guess who owns OneWest? John Paulson, and former executive from Goldman Sachs, George Soros and a bunch of other Goldman Sachs brass. Go figure. Bank of America has the same arrangement with the FDIC and is now sending out principal reduction modification offers to all of its sub prime homeowners as the illegal foreclosure machine shows serious signs of distress . What the hell does all of this have to do with Securitization Audits? OK, I’ve gotten way off track so let my reel in my A.D.D.. A Securitization Audit tracks the ownership of a note as it makes its way from the loan originator into a pool of notes and finally into a Trust which is sold off to the investors. The Securitization Audit looks specifically at endorsements required by the PSA-Pooling and Servicing Agreement which is located within the prospectus of the particular series of mortgage backed securities. It looks to see if the note was properly placed within the Trust pursuant to the PSA. The PSA requires that all of the endorsements, every PSA I’ve read requires that each entity through which the note ownership has traveled endorse the note to the successor owner. A Securitization Audit seeks to find signatures that were notarized after an entity was bankrupt or made by the wrong party or were not made within a time frame required by the PSA or never made at all. A Securitization Audit looks for breaches of the rules outlined by the PSA. Or to find that a note had no signatures and was illegally or never actually placed into the Trust and is therefore potentially owned by a bankrupt entity and not properly or legally transferred to a foreclosing Substitute Trustee because there was never any standing or capacity. A Securitization Audit tests and demands that MERS not be allowed to fraudulently comply with the lenders use of MERS as a method to obfuscate ownership and illegally transfer title by a illegally signed affidavit to a non-party. A Securitization Audit attacks the robo-signer industry. Securitization Audits show the fraudulent vulnerable underbelly of the entire Securitization & mortgage backed security sales and illegal deed enforcement process. It reveals on a one off basis the most vulnerable place to attack and kill this overfed ham-fisting elitist Wall Street behemoth pig. In general these Securitization Audits show on an one-off basis how the US banking regulators screwed up when they deregulated the banking industry. A Securitization Audit is the biggest gun you can arm your attorney with to defend your home against illegal foreclosure. Mers cannot foreclose on your home, they do not own your note. they have no interest in your note, MERS is nothing more than an electronic filing cabinet.
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We are in Virginia, we do Securitization Audits and foreclosure defense in Virginia, Pennsylvania, North Carolina and Florida. We have very strong foreclosure defense attorneys in Virginia, Maryland, DC, Pennsylvania, North carolina, New York, Utah, Oregon, Washington State, California and Florida. 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We can do a securitization audit for any of the following lenders: We have added the loss mitigation contact information for each lender.. Altegra Credit Co. Loan Services Loss Mitigation Department (Home Loan Services) Gary Fedoronko Gary_Fedoronko@HLS.ML.com 412-918-7552 American Home Mortgage Servicing fka Option One Loss Mitigation Department Donald Kelly Donald.Kelly@ ahmsi3@oomc.com 904-996-1748 Ameriquest Mortgage Co. Loss Mitigation Department (Citi Residential Lending) Tess Hoo teresa. hoo@citi.com 714-634-2474 ext 38864 BancorpSouth Loss Mitigation Department Carla Hall carla. hall@bxs.com 662-620-3644 Bank of America Loss Mitigation Department Nick Kieser nicholas.j. kieser@bankofamerica.com 716.635.7112 Cynthia Mech Loss Mitigation Department cynthia. mech@bankofamerica.com 716-635-2760 Boshwit Bros. Mortgage Co. Loss Mitigation Department Andrew Boshwit aboswhit@comcast.net 901-272-0100 Chase Manhattan Mortgage Co. Loss Mitigation Department (Chase Home Finance) No Certain Person 800-446-8939 Chevy Case Bank / B.F. Saul Mortgage Loss Mitigation Department Jeff Huston jrhuston@chevychasebank.net 301-939-4057 Jana Gantt jmgantt@chevychasebank.net 301-939-4054 Cimarron Mortgage Co. Loss Mitigation Department Ronnie Greenhagen ronnieg@ecimarron.com 601-899-1547 (voice) 601-899-1502 (fax) Citifinancial Mortgage Loss Mitigation Department Dianne Whatley dianne. whatley@citigroup.com 972-657-3090
David Stern, Robo-Signors and mass fraudulent foreclosure practices
Is the foreclosure machine going to come to a screetching halt? Have the lenders already been paid for your defaulted subprime mortgage through PMI insurance, TARP, FDIC loss share agreement or another government insurance or subsidy program? Have you been watching as the good guy attorneys in Florida crush deception and fraud being purpetrated upon the Courts? Is the Florida litigation landscape a peek into the future for courtrooms across this Country? We think so. It’s already spreading.
If you want to see what the future of foreclosure litigation looks like check out case number 07013084CI in the sixth Judicial circuit in Pinellas County Florida where Judge Rondolini reverses his own ruling after seeing proof that GMAC manufactured faulty proof of standing to foreclose in order to steamroll a foreclosure on one Miss Debbie Visicaro.
Debbie Visicaro, like many homeowners, at first decided to fight the foreclosure action initially without a lawyer. She didn’t know that the foreclosure law firm employee was signing 2000 affidavits per day. How could she. But Debbie Visicaro finally hired a lawyer, who pointed out the fraudulent evidence to Judge Rondolini in a rehearing who then admitted he made a mistake when he first awarded GMAC a quickie legal win and further admitted that he had probably illegally foreclosed on many homeowners.
When the GMAC lawyer couldn’t explain away the bad evidence — and could only manage a duhhh-hamina-hamina — the judge remarked: “You’re going to have to speak up. I know that when you’re getting pummeled, it’s hard to talk loudly.”
“You know what I’d really like to see?” Rondolino said. “I’d like to see in one of these cases where a defense lawyer cross-examines, takes a deposition of these people, and we can see whether they ought be charged with perjury for all these affidavits.”
Here’s the scoop. GMAC, doing what they do best illegally foreclosed on Debbie Viscaro in January of 2010. Counsel for the defendant, Michael Wasylik, Esq noted a request for rehearing of the case based on an initial motion for Summary Judgement filed by Steven Fraser from the diabolical offices of the largest foreclosure robo-scam firm in Southern Florida, the Law offices of David Stern. Citing a plethora of cases, Mr. Wasylik argued that the initial motion was based on inadmissable evidence (an affidavit from a robo-signor with no knowledge) Judge Anthony Rondolino admitted in this rehearing that he had given “short shrift” to the arguments made in the initial hearing by the defendant and basically foreclosed in a “doing business as usual” manner on the “face of the foreclosure” as most Judges do and as he admitted to having done in this manner as a matter of course. And then in an unprecendented move Judge Rondolini, addressing both attorneys made the following statement.
“I’ve had several events which have occurred [since the initial trial] in cases which cause the Court to have great concern about the validity of the filings in our mortgage foreclosure cases, and that precipitated my reevaluation of the evidentiary considerations. [in the present case]
I’ll give you an example of that. I have one case that was called up for summary judgment hearing and I thought it was going to the the typical granted situation, and then a lawyer for the defendant homeowner showed up. I was beginning to recite to the lawyer what I typically recited, that there were no affidavits in opposition. And then the lawyer said, “well, I thought you might be interested in this,” and handed me some documents which were out of another file in our circuit, and as it turned out, it was the same note and mortgage that was in a separate and independant file.
There was a different plaintiff pursuing a foreclosure proceeding on the same note and mortgage as the one that was being proceeded on here. Both of the cases contained allegations in the initial complaints that the separate plaintiffs were the owners and holders of the note. Both of them had a count to reestablish, and both of had gone so far as to have affidavits filed in support of summary judgment whereby an individual represented to the court in the affidavit that the separate plaintiffs had posessed the note and had lost the note while it was in their possession. Interestingly, both affidavits, although they were different plaintiffs, purported the same facts and they were executed by the same individual in alleged capacity as a director of two separate corporations, one of which was ultimately found to be an assignee of the original note.”
Judge Rondolini went on to state “I really honestly –I dont have any confidence that any of the documents the Courts receiving on these mass foreclosures are valid“
read the entire transcript here Rondolinotranscript
Is everyone getting this? It took a while but the ice is cracking under the weight of massive fraud being committed my substitute trustees and law firms who have been incentivised to shove as many foreclosures through the courts as they can ham fist through. They [the foreclosure law firms like David Stern] are giving uneducated unknowledgable 8.00/hour employees designations as VP’s and officers of mortgage companies, many times having the VP or officer designation of 5 or 20 banks/lenders at a time. The firms are having them sign 2000 and 3000 affidavits per day. Swearing in these lost note affidavits that they have knowledge (as a bank executive) that the note for the property listed on the affidavit is owned by their bank. Fraud Fraud Fraud.
Credit default swaps-article michael greenberger
of
Michael Greenberger
Law School Professor
Financial Crisis Inquiry Commission Hearing
Dirksen Senate Office Building, Room 538
Washington DC
Wednesday, June 30, 2010, 9am EDT
4 The exchange trading requirement of the CEA was so central to that statute‘s policy that it is still a felony to knowingly violate it and substantial fines may be levied upon offending dealers and their employees.
5 The Nature of Futures Contracts. ―The traditional futures contact is an agreement between a seller and a buyer that the seller (called a short) will deliver to the buyer (called a long), at a price agreed to when the contract is first entered, and the buyer will accept and pay for, a specified quantity and grade of an identified commodity in the future.
6 While futures contracts were first developed for the agriculture sector, it expanded into metals and energy products. ―
[T]here has been a continual [further] expansion of the futures and derivatives market [to] [f]inancial futures– on government securities, private debt issues, foreign currencies and stock indexes– an increasingly important part of the commodities world.
‖7 ―Standardization of terms is a key feature of publicly traded futures contracts. Under a futures contract, most customers do not expect to take delivery.…There is an opportunity to offset, and the customer has a right to liquidate rather than take [or make] delivery.‖
8 Only through the use of highly standardized products can the necessary liquidity be developed that allows traders the much needed ability to offset quickly delivery commitments in order to avoid
unwanted delivery obligations.
One more recent accepted method of ―avoiding delivery‖ is to ―cash settle‖ the futures transaction based on the market price of the futures contract, a settlement process which has been deemed by the Commodity Futures Trading Commission(―CFTC‖) to be wholly permissible under the CEA.
9 The Contours of the Exchange Trading Requirement. As would be expected of a market regulation bill that followed in the wake of the Securities Acts of 1933 and 1934, the contours of futures exchange regulation closely mirrored the regulation of the equities markets,i.e., futures contracts were required to be traded on publicly transparent and fully regulated exchanges supported by clearing mechanisms that ensure contractual commitments would be backed by adequate capital. 10
4 7 U.S.C. § 6(a) (2009).
5Id . § 13(b).
6 Phillip Mc Bride Johnson and Thomas Lee Hazen, DERIVATIVES REGULATION, §1.02[3] at 25 (Aspen, 2004)
7Id . § 1.02 [1] at 11.
8Id . at 24-25 n. 97.
9Id .§ 1.03[8] at 146-47.
10 See id.
As an integral part of this regulatory format, futures contracts also had to be cleared,i.e., a well capitalized and regulated intermediary institution was required to stand between the counterparties of a futures contract to ensure that commitments undertaken pursuant to thosecontracts were adequately capitalized through the collection of margin. 11 Any contractual failure was guaranteed by the clearing facility, a financial commitment that served to insure that the clearing facility had a great incentive to strictly enforce the capital adequacy of traders through highly disciplined assessment of the market price of the futures position and immediate collection of initial margin upon executing the futures trade and of variation margin as the contract price moves against a counterparty to the trade. 12 The Development and Characteristics of Swaps. By the 1980‘s, a variant of futures contracts was developed, commonly referred to as ―swaps‖. 13 When first addressing ―swaps‖ contracts, the CFTC defined them as―an agreement between two parties to exchange a series of cash flows measured by different interest rates, exchanges rates, or prices with payment calculated by reference to a principal base (notional amount).‖ 14 Similarly, the International Swaps Derivatives Association (―ISDA‖) defines a ―swap‖ as ―[a] derivative where two counterparties exchange streams of cash flows with each other. These streams are known as the ―legs‖ of the swap and are calculated by reference to a notional amount.‖ 15 A classic example of an interest rate swap transaction is where one party to the agreement exchanges a floating interest rate obligation on an existing loan for a fixed rate obligation to be paid by a swaps dealer or by another counterparty to which the swap has been assigned by the swaps dealer. Usually, the person swapping the floating rate for a fixed rate is expecting (or hedging against the fact) that the fixed rate will be lower than the floating rate. In other words, the loan is usually neither negotiated nor renegotiated under the swap. It is an assumed amount written into the swap, most often reflecting an actual outstanding loan of one of the swaps customers from a creditor or lender upon which a floating rate is being paid to the lender. The fixed interest rate payments paid by the swaps dealer to the borrower would also be specified in the transaction, as would the manner in which the floating rate would be calculated. Thus, rather than buying/selling asing le future rate or price (as would be true in a traditional futures contract), there is a ―swapping‖ of commitments with one party buying the 11 See id. § 1.18. 12 See id. § 1.18. 13S ee DERIVATIVES REGULATION § 102[12A] at 29-30 (Supp. 2010). 14 54 Fed. Reg. 30694 (July 21, 1989). 15 DCG Glossary, International Swaps and Derivatives Association, Inc. website, available at www.isda.org/c_and_a/oper_commit-dcg-glossary.html (last visited June 27, 2010).
16 54 Fed. Reg. 30694 (July 21, 1989).
17Id . (emphasis added).
18Id .
19 DERIVATIVES REGULATION § 1.02[5] at 43.
20 Pub. L. No. 102-546.
21 58 Fed. Reg. 5587 (Jan. 22, 1993) (emphasis added).
Moreover, exempt swaps agreements were not to be ―traded on or through a multilateral transaction execution facility.‖23 In laymen‘s terms, ―a multilateral transaction execution facility‖ consists of one party offering electronically a swaps agreement to many different other parties, rather than merely offering agreements on a bilateral or one-on-one basis. The Standardization of Swaps Through the ISDA Master Agreement. However, even before the 1993 CFTC rule calling for negotiation of each of the material economic terms of swap was promulgated, the International Swaps and Derivatives Association (known then as the International Swaps Dealers Association) in 1992 created a standardized and copyrighted Master Agreement and related schedule to govern the execution of a swap. ISDA ―was chartered in 1985 and today has over 825 member institutions.‖24 The ISDA Master Agreement is 18 pages long with standardized, boilerplate clauses, and each page carries with it a copyright in ISDA‘s name. It includes the fundamental provisions without which the swaps transaction could not be understood. Included among the many contractual points resolved by the ISDA Master Agreement are ―interpretation‖ principles (¶ 1); ―obligations‖, including ―liability‖ (¶2); ―representations‖ (¶3); ―agreements‖ (¶4); ―events of default and termination events‖ (¶5); ―early termination‖ (¶6); ―transfer‖ (¶7); ―contractual currency‖ (¶8); ―remedies‖ (¶9); ―expenses‖ (¶11); ―notice‖ (¶12); ―governing law and jurisdiction‖ (¶13); and forty three ―definitions‖ governing the swaps transactions (¶14). Accompanying the ISDA Master Agreement is a ―Schedule,‖ which is thirteen pages long, derived directly from a standardized ISDA template for that―Schedule,‖ which, in turn, provides a standardized menu of limited choices to further define terms of the ISDA Master Agreement. The ISDA template for the Schedule is itself copyrighted on every page in ISDA‘s name. The ISDA standardized template for the Schedule is dependent upon, and references only, the ISDA Master Agreement. Accompanying the ISDA Schedule is a standardized ISDA Credit Support Annex, which is sixteen pages long and also includes copyrights in ISDA‘s name on every page except those relating to the last of thirteen paragraphs. The first twelve paragraphs within the ISDA Credit Annex are standardized boilerplate written by ISDA. Every page is once again copyrighted in ISDA‘s name. Only the last paragraph concerning ―elections and variables‖ is not standardized.
According to the most recent market survey by [ISDA], the notional value of new transactions reported by ISDA members in interest rate swaps, currency swaps, and interest rate options during the first half of 1997 increased 46% over the previous six- 22 17 C.F.R. § 35.2(b) (2009). 23Id . at § 35.2(d). 24 Eraj Shirvani New Chairman of ISDA, News Release, April 16, 2008, available at http://www.isda.org/.
Also, these OTC derivatives were now, because of the ISDA Master Agreement, so standardized that they could be traded electronically on a multilateral basis, thereby exhibiting all of the trading characteristics of traditional exchange traded standardized futures contracts.26 Because swaps were increasingly standardized and traded multilaterally, however, the market was not within the ―safe harbors‖ exemption from the CEA regulatory requirements and protections of the CEA provided by the 1989 Swaps Policy Statement or the 1993 Swaps exemption.
On May 7, 1998, the CFTC promulgated a ―concept release‖ on ―OTC Derivatives,‖ finding that these standardized products were almost certainly subject to the mandatory exchange trading requirement (and therefore were trading in violation of law) and calling for public
comment on the development of various alternative regulatory features that would create an § 4 (c) exemption from the CEA‘s mandatory exchange trading.27
Any new regulatory system would be applied ―prospectively,‖ with the existing market retroactively sanctioned under the CEA.28 The public was asked to answer a series of questions pertaining to what, if any, of the features of a fully regulated exchange trading requirement should be applied to the swaps market,e.g., reporting and disclosure, capital adequacy, clearing, exchange trading, regulation of intermediaries, self regulation or application of anti-fraud and anti-manipulation principles. The CFTC expressly stated that it had no preconceived notion of the answer to these questions.
26S ee 63 Fed. Reg. 26114 (May 12, 1998).
27Id .
28Id . at 26114.
29I d. at 26114, 26115.
The most prominent scandals deriving from swaps by May 1998 included the1994 bankruptcy of Orange County, the largest municipal default in the Nation‘s history. Orange County was one the country‘s wealthiest and fifth most populous. Having executed many poorly understood interest rate swaps, the county suddenly found itself facing massive debt as interest rates quickly rose. It lost approximately $1.6 billion.30 Merrill Lynch agreed to pay $400 million to Orange County to settle claims involving the derivatives that caused Orange County’s bankruptcy. Also beginning in 1994, two large corporate clients of Bankers Trust, Gibson Greetings and Procter & Gamble, successfully sued it for defrauding them in the sale of complicated unregulated derivatives, thereby causing large customer losses. Central to that litigation success were over 6500 tape recordings of Bankers Trust employees acknowledging to each other that thebank‘s clients did not understand the adverse impact the derivatives transactions would have on them. The SEC and CFTC took cooperative enforcement against Bankers Trust for violating the antifraud provisions of the federal securities and commodities laws in connection with OTC derivatives it marketed.31 The SEC found that Bankers Trust violated various sections of the securities laws, including making false statements or omissions in the sale of securities, supplying materially inaccurate valuations of derivatives transactions, and failing to supervise marketing personnel.32 The CFTC asserted that Bankers Trust, by its conduct, had assumed the role of a commodity trading advisor and had violated the antifraud provisions of the CEA governing such parties‘ activities.33 Opposition to the CFTC Concept Release. The CFTC‘s sister agencies the Treasury, the Fed, and the SEC) within the President‘s Working Group were strongly opposed to the CFTC‘s concept release inquiry.34 In response to a request from the remaining members of the President‘s Working Group on Financial markets issued on the very day the concept release was published, Congress eventually enacted a six month statutory moratorium to the CFTC concept release.35
32Id . at 44. 33Id . at 45-46. 34 Frontline: The Warning (PBS television broadcast Oct. 20, 2009) (transcript available at ttp://www.pbs.org/wgbh/pages/frontline/warning/etc/script.html).
created failure of many of its counterparties which were the hedge fund‘s OTC derivative counterparties and creditors, including some of the world‘s largest financial institutions. So concerned were those financial institutions about the systemic effect of LTCM‘s failure that,
under the auspices of the New York Federal Reserve, on September 23, 1998 (with just about 48 hours of notice about LTCM‘s potential collapse) fourteen of those institutions contributed a total of $3.6 billion to buy out the fund to keep it from failing.3 6
One of the major recommendations of the April 1999 PWG report was that the SEC, the CFTC and the Treasury receive expanded authority to require OTC derivative counterparties to provide credit risk information, recordkeeping and reporting and data on concentrations, trading strategies and risk models, as well as the ability to inspect risk management models.38 Fed Chairman Greenspan declined to endorse this set of recommendations, but deferred to those regulators with supervisory authority.39
management practices, including improved supervision and reporting and market practices pertaining to OTC derivatives. Included within CRMPG‘s recommendations was a commitment to meet informally and periodically with their primary regulator to discuss OTC ―market trends and conditions,‖ including providing reports ―detailing certain large exposure information on a consolidated basis group.‖40
Illustrative of a problem that would reoccur in these markets is an observation about the lack of proper documentation of OTC derivatives transactions. CRMPG states: ―The global financial markets operate through an interconnected series of contracts among market
participants.. ..Although written documents may not be, per se, necessary to establish a contract, they are the best evidence of the terms of a contract and the best way to ensure that parties agree 36 Hedge Funds, Leverage, and the Lessons of Long-Term Capital Management, Report of the President‘s Working Group on Financial Markets (April 1999) 10 -17.
37Id .viii.
38Id .39 -4 0 .
39Id . 39, note 23.
40 ―Improving Counterparty RiskMa na ge men t Practices,‖ Counterparty Risk Management Policy Group, June 1999
A cloud of legal uncertainty has hung over the OTC derivatives markets in the United States in recent years, which, if not addressed, could discourage innovation and growth of these important markets and damage U.S. leadership in these arenas by driving transactions off-shore… .‖
Accordingly, on December 15, 2000, Congress passed and on December 21, 2000, President Clinton signed into law the Commodity Futures Modernization Act of 2000(―C FMA ‖).44 The CFMA removed OTC derivatives transactions, including energy futures transactions, from all requirements of exchange trading and clearing under the CEA so long as the counterparties to the swap were ―eligible contract participants‖. Generally speaking, a counterparty to be an ―eligible contract participant‖ had to have in excess of $10 million in total assets with some limited exceptions allowing lesser amounts in the case of an individual using the swap for risk management purposes.45
The SEC was similarly barred from OTC derivatives oversight except for the limited fraud jurisdiction it maintained over securities-based swaps. During the TARP hearings in September 2008, then-SEC Chairman Christopher Cox warned Congress about the need for―immediate legislative action,‖ because he viewed OTC credit derivatives market as a ―regulatory blackhole.‖47
Recognizing that the deregulation of swaps would remove the Act‘s bar against excessive speculation in regulated exchange traded futures, the CFMA also expressly preempted state gaming and anti-bucket shop laws,48 which would have barred the otherwise unregulated
speculative activity authorized by the CFMA.
Finally, to ensure that not even the CFMA itself could be used as a basis to challenge the legality of a swap, the Act provides that ―[n]o agreement, contract, or transaction between eligible contract participants . . .shall be void, voidable, or unenforceable . . .based solely on the failure . . . to comply with . . .this Act . ..‖49
Deal, as well as a central premise of the common law of contracts,i.e., that illegal contracts are subject to a declaration of unenforceability. In effect, almost no law applied to this market. 46 Unlike financial swaps, which were ―excluded‖ from the exchange trading requirement, including fraud and manipulation prohibitions, energy and metals swaps, while relieved of the exchange trading, continued to be subject to fraud and manipulation prohibitions; they were therefore labeled by the CFMA as ―exempt‖ transactions. Compare § 2(g) (relating to financial swaps) with § 2 (h) relating to energy and metals swaps. See also Charles W. Edwards, James Hamilton and Heather Montgomery, Commodity Futures Modernization Act of 2000: Law and Explanation at 28 (CCH, 2001) (hereinafter ―CFMA Law and Explanation‖) (quoting remarks of Sen. Tom Harkin, 146 Cong. Rec. S11896, December 15, 2000, ―The Act continues the CFTC‘s antifraud and anti-manipulation authority with regard to exempt transaction in energy and metals derivative markets.‖). By exempting metals and energy swaps from exchange trading, Congress disagreed with the unanimous recommendation of the PWG that swaps concerning ―finite‖ supplies not be removed from the exchange trading mandate of the CEA. 47 Robert O‘Harrow, Jr. and Brady Dennis, Downgrades and Downfall, WASH. POST, Dec. 31, 2008, at A1(stating ―‗ The regulatory blackhole for credit-default swaps is one of the most significant issues we are confronting on the current credit crisis,‘ Cox said, ‗it requires immediate legislative action.‘‖). 48 DERIVATIVES REGULATION § 4.04[11] at 975 (referencing 7 U.S.C. §16(e)(2)).
Even those once skeptical of arguments about the dangers of OTC derivatives have joined this chorus. In warning Congress about badly-needed financial regulatory reform efforts when it considered the TARP legislation in Senate hearings before the Senate Banking
Committee in September, 2008, then-SEC Chairman Christopher Cox called the CDS market a ―regulatory blackhole‖ in need of ―immediate legislative action.‖56Former SEC Chairman Arthur Levitt and even former Fed Chair Alan Greenspan—both of whom supported the CFMA 53S ee Remarks of Chairman Gary Gensler, OTC Derivatives Reform, Chatham House, London (March 18, 2010)
Superintendent Eric Dinallo, Review of the Role of Credit Derivatives in the U.S. Economy: Before the H. Comm. on Agriculture, Nov. 20, 2008, available athttp :// www. ins.state .ny.us/speeches/pdf/sp0811 201.pdf (last visited on June 27, 2008).
http://www.washingtonpost.com/wp-dyn/content/article/2008/12/30/AR2008123003431.html.
Geithner also asked the banks―to form a clearing house for trillions of dollars in complicated derivativesc ontracts.‖59 Within a year the banks were able to claim that 94% of the backlog in credit derivatives had been erased.60 However, Geithner‘s call for the development of a clearing mechanism was not adopted prior to the 2008 meltdown.61
obligations (―CDOs‖). As this Commission well knows, these CDOs constituted the pulling together and dissection into ―tranches‖ of huge numbers of MBS, theoretically designed to diversify and offer gradations of risk to those who wished to invest in subprime mortgages.
However, investors became unmoored from the essential risk underlying loans to non-credit worthy individuals by the continuous reframing of the form of risk (e.g., from subprime mortgages to MBS to CDOs); the false assurances given by credit rating agencies that were
misleadingly high evaluations of the CDOs; and, most importantly, by the purported―insur ance ‖ offered on CDOs in the form of CDSs as a seeming safety net to these risky investments.
The lack of recordkeeping and reporting also prevented fraud enforcement– had fraud enforcement itself not been banned for CDS by the CFMA. The lack of reporting also blinded regulators to the scope of the problems caused by underfunded CDS commitments, leaving them guessing as to the reality of the situation and adopting (perhaps correctly) a worst case scenario of defaults and resulting systemic risk. Again, because CDS were deemed neither insurance nor an instrument otherwise regulated by the federal government, issuers were not required to set aside adequate capital reserves to stand behind the guarantee of CDOs.
collapse of a major financial institution would have destabilized the world wide economy. Only the intervention of taxpayers as the lender of last resort, stemmed the onset of a worldwide Depression.
The financial media is filled with reports that the SEC will be bringing further actions similar to the Goldman case premised upon synthetic CDOs; and private parties are readying similar cases pursuant to the private rights of action clauses within the securities law.67
1. Underwriters of CDSs did not have adequate capital to pay off guarantees as housing prices plummeted, thereby defying the supposed ―risk free‖ nature of issuing huge guarantees for the small premiums that were paid.
3. As the housing market worsened, new CDS obligations were unexpectedly triggered, creating heightened uncertainty about the viability of financial institutions who had, or may have had, issued these instruments, thereby leading to the tightening of credit. No institution could be trusted because there was no transparency as to which institutions held toxic CDS.
4.The issuance of ―naked‖ CDS increases exponentially the obligations of the CDS underwriters in that every time a subprime mortgage defaults there is both the real financial loss and the additional exponential loss derived from failed bets.
5. The securitization structure (including CDS) is present not only in the subprime mortgage market, but in the prime mortgage market, as well as in commercial real estate, credit card debt, and auto and student loans. As of this writing, the financial media is filled with concerns that forfeitures in commercial real estate market will worsen sufficiently, thereby triggering CDSs and naked CDSs for which will almost certainly be 70 DERIVATIVES REGULATION § 4.04[11] at 975 (2004) (referencing 7 U.S.C. § 16(e)(2)). 71 New York State Insurance Dept., Recognizing Progress By Federal Government In Developing Oversight Framework For Credit Default Swaps, New York Will Stay Plan To Regulate Some Credit Default Swaps, press release, November 20, 2008 (“Dinallo announced that New York had determined that some credit default swaps were subject to regulation under state insurance law and that the New York State Insurance Department would begin to regulate them on January 1, 2009.”).
destabilization, the remainder of the OTC market has historically led to other destabilizing events in the economy. These include the recent energy and food commodity bubble,75 the near failure of LTCM in 1998, the Bankers Trust scandal and the Orange Country bankruptcy of 1994, and now the causative factor of the European sovereign debt crisis (cross currency swaps masking the full extent of sovereign debt).76 Unregulated OTC Derivatives of All Kinds Cause “Too Big To Fail.” However, even if looking only at the financial crisis which is now the focus of this Commission‘s mandate, the remainder of the unregulated OTC derivatives market was central to the crisis‘ causation. That is because the remainder of the OTC derivative market relates directly to the interconnectedness that made large financial institutions ―too big to fail;‖ and the prevention of a cascading collapse of the financial system therefore required calling upon the American taxpayer to bail out many of those huge financial entities.
The Lehman liquidators are now embarked in a huge battle with Lehman‘s OTC derivative counterparties, claiming that those counterparties have greatly exaggerated the value of amounts owed by Lehman pursuant to those derivatives. The liquidators have just filed a law suit against Nomura, which has filed $1 billion in counterparty claims against the Lehman estate.
―In the ordinary course of business, the costs of AIG‘s inability to meet its derivative obligations would have been borne entirely by AIG‘s shareholders and creditors. But rather than sharing the pain among AIG‘s creditors, the government instead shifted those costs in full onto taxpayers. The result was the government backed up the entire derivatives market, as if high-profit, high-risk trading deserved the same taxpayer backstop as savings deposits and checking accounts. Every counterparty— from pension funds for retired workers and individual insurance policies, to sophisticated investors and other financial institutions— received exactly the same deal: a complete rescue at taxpayer expense.‖82
rather than in a bankruptcy proceeding. However, as Robert Johnson has recently made clear, the unwinding of the obligations of OTC counterparties may, in the absence of OTC derivative reform, be far too complex whether it is done by banking regulators or by a court. Johnson has concluded: ―[W]hen a [too big to fail institution] is in trouble –and there are substantial holdings of complex and opaque derivatives on the balance sheets of all [such] firms– resolution
authorities have difficulty unraveling web of exposures and valuing them properly. . .Unfortunately, it is easy to understand why resolution authorities could be induced to forebear rather than resolve an [too big to fail institution] when they have no clarity about its structure and patterns of exposures. In such a circumstance, it may be easier to incur the risk that the insolvent [firm‘s] balance sheet should continue to deteriorate. . . .‖83 All Swaps Are Masked By Opaque Accounting Principles. A final reason all derivatives–not just credit derivatives– played a role in the onset of the crisis is that they were by virtue of swaps dealer lobbying never properly accounted for on balance sheets. Because of a major lobbying effort by ISDA, ―banks and corporations that trade swaps do not play by the same rules as other individuals and businesses. Banks are permitted to exclude their full exposure to swaps from their financial statements and instead report only the ―fair value‖ changes in those swaps over time. Such reporting is like an individual reporting only the change in their
Thus, prior to the meltdown swaps of all kinds were masked by a double barrier of copacity, i.e., not only were they private and bilateral, but they were even hidden on the balance sheets of those institutions most likely to suffer from their adverse impact. This kind of balance sheet opacity blinded regulators and market observers from the explosive and toxic nature of the contractual obligations embedded in swaps. And, when the crisis became full blown in
September 2008, this opacity led both the extenders of credit and policy makers to fear the worst. As a result bank lending froze up, causing the credit crisis.
By removing the multi-trillion dollar swaps market from the traditional norms of market regulation, a highly speculative derivative bubble was created that was opaque to federal regulators and market observers alike. By removing all forms of ensuring the normal capital adequacy protections of market regulation, the swaps market permitted trillions of dollars of financial commitments to be made with no assurance that those commitments could be fulfilled beyond the highly illusory AAA ratings of the counterparties in question.
Had the norms of market regulation been applicable, these swaps transactions would have been adequately capitalized by traditional clearing norms; and the dangers building up in these markets would otherwise have been observable by the transparency and price discipline that accompanies exchange trading.
While the poorly capitalized underwriting of CDS and naked CDS triggered the meltdown, the crisis was further aggravated by the opaque interconnectedness of large financial institutions emanating from interest rate, currency, foreign exchange and energy swaps.
Because there was no road map outlining interdependency of those financial transactions, the worst was feared in the wake of the Bear Stearns, Lehman, AIG, and Merrill dysfunctions. Institutions became too big to fail because of these uncharted and feared interdependencies; and the fear that unwinding of these institutions (as proven in the Lehman bankruptcy) would be hampered by the lack of reliable pricing of the instruments in question.
The darkness of this huge multi-trillion dollar unregulated market not only caused, but substantially aggravated, the financial crisis. And, the American taxpayer funded the bailouts and rescued the economy from Depression. The banks are now stronger than ever. The taxpayer,
however, is burdened by high unemployment, job insecurity, depleted pensions, and little access to credit. We are depending on this Commission to identify correctly the malpractices to ensure that a fiasco of this nature never happens again.
