The Credit Mess part deux

Laupahoehoe Cove

Oh this mortgage mess has reared its ugly head again, and, once again, our grandstanding political body is missing the real mark.

What no one has focused on is the term that was used many times in the last 2 years. That is “Lax Underwriting Standards” What does that mean in reality?

Minimally, it means that the standard by which the banks evaluated a borrower’s creditworthiness was lowered as a matter of corporate policy. Terms like “no doc” and “stated income loans” became a large proportion of total loan originations in 2005, 2006 and 2007. Basically borrowers were told what income level was needed to qualify for the loan, and in turn, the borrower stated what their income was with no verification on the part of the bank. In this case the term “Due Diligence” requires that the bank actually believe what the borrowers said their stated income was, since these loans were sold to third parties to be packaged into mortgage-backed securities, then sold to investors. The ultimate investors as, it turns out, were you and I. Other banks, insurance companies, pension and retirement funds, mutual funds, money market funds and individual investors bought these securities based on the stamp of AAA approval by the debt rating agencies (Moodys & S&P).

If you had the pleasure of watching some of the grilling of the Treasury Department, Federal Reserve, broker dealer and investment bank professionals over the last 18 months, it is evident that they all knew that what used to go for underwriting and due diligence standards were wholly ignored, because the fees generated by the originators of these loans were too good to pass up. In fact, the mortgage brokerage industry has no regulatory body overseeing them whatsoever (even today).

If a borrower embellishes (kind) his (or her) stated income in order to qualify for the house that they just “have to” own, that is fraud. If you tell me that none of these investment banks knew that this was going on, and there are not a thousand emails all over the place stating that knowledge, I would not believe you. The knowledge that you are placing loans based on fraud into a mortgage backed security that is ultimately sold to everyone from “widows and orphans” to sophisticated investors is complicity to fraud. Which mortgage pools (bunches of individual mortgages) do you think the people shorting these mortgage pool derivatives wanted in the securities? You guessed it, the ones that were most likely based on fraud. The ones that nobody knew about! I think not.

All of the investment banks knew about this and just looked the other way. It will ultimately cost them billions of more dollars in class action suits, fines, penalties and restitutions, all while neither admitting nor denying they did it.

Posted in: Investment Outlook

About Michael D. Cohn

Mr. Cohn has been an investment management and trading professional for over 25 years. His career started in 1985 at Bear Stearns & Co. in New York City. His experience there included Treasury bond trading, mortgage backed securities trading and underwriting, risk arbitrage, and OTC trading.

He has been a member of both the New York and American Stock Exchanges. From 1995 to 2003 he was the President and Managing Partner of Raymar Capital LLC. a stock and option specialist firm on the American Stock Exchange.

Currently Mr. Cohn is the Founder and President of Atlantis Asset Management. He manages portfolios for individuals and a variety of public and private entities. His specialty is using innovative risk management strategies to preserve wealth, and create high income growth oriented portfolios with lowered market risk. He has extensive experience using alternative investing strategies to balance overall portfolio risk.

He is published and quoted regularly in magazines, on investment websites, and writes articles for highly respected wealth management publications.