by Calculated Risk on 12/01/2007 02:35:00 PM

On Thursday, Brian provided a spreadsheet of the assets included in the E*Trade portfolio sale. He estimated the deal was for 27 cents on the dollar, and we were definitely surprised by the implied size of the haircuts for the prime first lien portion of the portfolio.

Here is more from Reuters: E*Trade firesale seen hurting Wall St portfolios (hat tip Alan)

UPDATE: I've received several emails pointing out that Bhatia is probably wrong.
Analysts are suggesting the sale valued the portfolio ranging from 11 cents to 27 cents on the dollar:

Citigroup investment bank analyst Prashant Bhatia said E*Trade actually received 11 cents on the dollar for its portfolio, if you factor in that the brokerage received $800 million in cash minus 85 million shares it issued. He said that implies Citadel's received stock compensation worth about $450 million, leaving E*Trade with only $350 million for its $3.1 billion portfolio.

And everyone was surprised by the price considering the assets in the portfolio:

Goldman Sachs analysts said they were surprised by the size of the discount on the E*Trade portfolio because 73 percent of the assets were backed by prime mortgages, or loans to people with solid credit.

It is worth emphasizing that a large portion of the assets were backed by prime - not subprime - mortgages. And many of the prime loans were first liens with decent average FICO scores (average 725) and LTV (71%).

by Anonymous on 12/01/2007 11:30:00 AM

Another item sure to get some attention--or maybe not, since it kind of complicates the narrative of "predatory servicers." From the Wall Street Journal:

Law firms handling thousands of foreclosure cases on behalf of mortgage lenders and servicers are drawing criticism from judges, who say roughshod filing practices are trampling borrowers' rights.

Lawyers operating so-called foreclosure mills often are paid based on the volume of cases they complete. Banks and mortgage servicers often contract with such firms to handle foreclosures; the pay in Ohio, for example, is around $1,000 a case.

Um, is the pay based on volume, or is it just $1,000 a pop regardless of how many you do? My impression here is that it's the latter, and the problem is that this is a flat fee, not depending on how complex an individual suit is or--to the current point--how much time and effort might be needed just to assemble the documents and verify the liens in the land records to produce the original filing. It therefore becomes a matter of firms relying on volume because margins are skinny, and of treating every filing as a "no brainer" from the beginning. It's annoying when regular old newspapers don't get basic business practices. It's appalling when the WSJ doesn't.

Anyway, to continue:

The firms are typically small but may handle thousands of cases a year. Using computer software, they plug in variables such as a borrower's name, address and mortgage amount to generate a suit. Firms compete for business in part based on how quickly they can foreclose.

Um, no. They compete for business based on how quickly they can begin foreclosure proceedings. That's the problem here: a sloppy filing up front gets you onto the court's docket faster, but as we've seen, it tends to drag out the process and make foreclosures longer at the end of the day. And this description of the process ignores what's wrong with just "plugging in variables": we skipped the step of doing a search of the land records to verify that the last recorded assignment puts the foreclosing entity into current first-lien-holder status. And the step of going back to the servicer or trustee or whoever requested the foreclosure in the first place and reporting that an assignment needs to be recorded before the FC complaint can be filed.

"In general, most of the firms that practice this kind of law do a very good job," said Peter Mehler, a Cleveland-area lawyer who handles foreclosures on behalf of mortgage servicers. But in the "gold rush" to get a piece of the growing business, some firms "have cut corners."

Lately, judges are faulting law firms for what has become a common practice: filing a foreclosure suit, in states that require them, without showing proof that the plaintiff actually holds the mortgage and has the right to foreclose. (Such plaintiffs are often banks that act as trustees for investors of securities backed by mortgages.) The situation occurs in part because mortgage documents and the contracts between borrowers and lenders may change hands multiple times and may not be assigned to the plaintiffs at the time the suits are filed.

What this has really got to do with loans changing hands "multiple times" isn't very clear. If a loan changed hands exactly once, and no assignment was recorded in the land records exactly once, you'd have exactly the same problem. Of course the odds of having a missing assignment or a gap in the assignment chain go up when there are multiple assignments. But in that case, the problem is often not that the plaintiff--the last party in the chain--doesn't have an assignment. It's that the party who assigned to the plaintiff didn't have an assignment from the party who assigned to it, or something like that.

Why be so obsessed with the details here? Because way too many people have taken that unfortunate phrasing of the problem to mean that securities are purchasing delinquent loans just for the purpose of foreclosing. The WSJ, intentionally or not, falls into this kind of language:

This month, a state judge in Cincinnati dismissed a foreclosure lawsuit brought by Wells Fargo Bank because the bank filed the suit before it had acquired the mortgage. In dismissing the case, the judge sent a warning letter to the bank's law firm, John D. Clunk Co. LPA, in Hudson, Ohio. Judge Steven E. Martin wrote that it was "troubling" that the plaintiff "and its counsel filed the lawsuit with no basis whatsoever" and that firm must not do so again.

The law firm didn't respond to requests for comment. Wells Fargo declined to comment.

"Before it had aquired the mortgage" makes people think that Wells filed to foreclose a loan before it ever owned that loan, as if Wells saw, say, a bad loan at Podunk National and decided to buy it just for the pleasure of foreclosing it, but somehow managed to file first and buy later.

There is exactly zero reason to believe that this is what happened. Wells "acquired" the loan (or some security acquired the loan and Wells became the master servicer or trustee or something) back when the loan was fresh and new. What someone failed to do was to record the evidence of transfer of the beneficial interest in the collateral (known as an "assignment of mortgage") in the land records before the day the FC was filed.

It is quite common practice in the industry, as I have explained before, to execute assignments in "recordable form" when a loan is sold, and for the buyer or the buyer's custodian to take physical custody of that assignment, but to refrain from actually sending it to the county recorder of deeds for recordation in the land records unless and until it becomes necessary to foreclose. I know of no judicial opinion yet that has ever implied that the failure to record a document voids the loan sale; in fact, Judge Kathleen O'Malley's Order of November 14,* one of the several dismissals for inadequate documentation (along with Boyko's and Rose's) making the rounds, explicitly states that

The Court is only concerned with the date on which the documents were executed, not the dates on which they were recorded (if recorded) with the county recorder’s office.

The trouble with valid, executed, but unrecorded assignments is that even if a foreclosure attorney ran a records search before filing, in order to verify current lienholder, the assignment would not appear in the land records. It really is incumbent on the trustee or servicer to provide the original assignment for recordation, since the trustee or servicer is the one who has custody of it (or can get it from the custodian) and therefore the only one who can reliably vouch for its existence.

There are exellent reasons to record that old assignment first, then file your FC complaint. But as far as I can tell, judges aren't even asking for recorded assignments; they're just asking for valid assignments. What seems to have happened in at least one case--the Deutsche Bank case that Boyko went ballistic over--was that plaintiff's attorney, not having the real original assignments handy, simply executed new ones, after the fact. That's pretty amazing practice for an officer of the court, and His Honor reacted exactly the way one ought to. But it does not mean that the original assignments do not exist. Absence of evidence is not evidence of absence. Forging a new assignment because you can do that in twenty minutes, while just breaking down and requesting the originals from the custodian might take several days, is bad lawyering. It is not evidence that anyone is buying deliquent loans in order to foreclose them.

What reputable banks like Wells Fargo are learning here, I think, is a painful lesson in reputation risk. Wells hired some cheap corner-cutting law firm to handle its foreclosures (as did Deutsche Bank), and as a result, its name is now all over the press in association with practices that can be made to sound exceptionally sinister. Remember Boyko's "priceless" comment? Well, I'm here to suggest that Wells Fargo's good name is worth a whole lot more to it than $1,000. Legally, plaintiff is responsible for the actions of plaintiff's counsel.

Here, by the way, is the relevant part of Judge Thomas Rose's order** involving a number of foreclosure filings by several different trustees:

To date, twenty-six (26) of the twenty-seven (27) foreclosure actions based upon diversity jurisdiction pending before this Court were filed by the same attorney. One of the twenty-six (26) foreclosure actions was filed in compliance with General Order 07-03. The remainder were not.2 Also, many of these foreclosure complaints are notated on the docket to indicate that they are not in compliance. Finally, the attorney who has filed the twenty-six (26) foreclosure complaints has informed the Court on the record that he knows and can comply with the filing requirements found in General Order 07-03.

Therefore, since the attorney who has filed twenty-six (26) of the twenty-seven (27) foreclosure actions based upon diversity jurisdiction that are currently before this Court is well aware of the requirements of General Order 07-03 and can comply with the General Order’s filing requirements, failure in the future by this attorney to comply with the filing requirements of General Order 07-03 may only be considered to be willful. Also, due to the extensive discussions and argument that has taken place, failure to comply with the requirements of the General Order beyond the filing requirements by this attorney may also be considered to be willful.

A willful failure to comply with General Order 07-03 in the future by the attorney who filed the twenty-six foreclosure actions now pending may result in immediate dismissal of the foreclosure action. Further, the attorney who filed the twenty-seventh foreclosure action is hereby put on notice that failure to comply with General Order 07-03 in the future may result in immediate dismissal of the foreclosure action.

My boldface, there: it seems clear to me that this is an admission that the assignments really do exist, and can, in fact, really be produced. But what, we ask, has relying on this attorney done for the reputation of the lienholders? The story wasn't reported as "some worthless lawyer screwed up"; it was reported as Deutsche Bank and Wells Fargo and HSBC et al. screwed up. If you don't want your name in the headlines like that, hire a better lawyer. And pay for it. Oh, wait . . .

Allow me to close by observing that Curly and Larry (if not Moe) have lent some weight to a proposal that would basically mean servicers shoving through across-the-board modifications to "freeze" interest rates. I'm not here to argue the wisdom of rate freezes in this post. I am here to point out that a modification of mortgage is a legal document that has to be recorded in the land records in which the original mortgage was filed. If the modification is being executed by a servicer or trustee on behalf of the noteholder, then any intervening assignments up to the one to the modifying party need to be recorded first, so that the recordation of the modification is valid. Also, modification agreements are complicated documents; you want to be very careful with their wording, so that you are sure you are modifying only certain specified terms of the original mortgage and note. More than a few sloppy servicers have been haunted by a bad modification agreement that inadvertently waived rights or terms that servicer needed to keep.

So it really just sounds like a fantastic idea to push through a major effort to execute modifications really fast and cheaply, doesn't it? Frankly, the whole idea gives me goosebumps.

-------------------

*UNITED STATES DISTRICT COURT, NORTHERN DISTRICT OF OHIO, EASTERN DIVISION, In Re Foreclosure Actions 1:07cv1007 et al., November 14, 2007. No, I didn't go to law school and learn how to cite court orders in proper format. So sue me if you can find a decent lawyer.

**UNITED STATES DISTRICT COURT, SOUTHERN DISTRICT OF OHIO, WESTERN DIVISION AT DAYTON, IN RE FORECLOSURE CASES 3:07CV043 et al., November 15, 2007.

by Calculated Risk on 11/30/2007 07:56:00 PM

From David Evans at Bloomberg: Florida Schools Struggle to Pay Teachers Amid Freeze (hat tip Saboor)

School districts, counties and cities across Florida sought to raise cash after being denied access to their deposits in a $15 billion state-run investment fund.

The Jefferson County school district was forced to take out a short-term loan to cover payroll for the 220 teachers and other employees in the system after $2.7 million it held in the pool was frozen yesterday. At least five other districts also obtained last-minute loans, said Wayne Blanton, executive director of the Florida School Boards Association.

``The unthinkable and the unimaginable have just happened here in Florida,'' said Hal Wilson, chief financial officer of the Jefferson County school district, located 30 miles (48 kilometers) east of the state capital Tallahassee. ``What we just experienced here is a classic run-on-the bank meltdown.''

This is the same school disctrict mentioned in David Evans piece on Nov 15th: Public School Funds Hit by SIV Debts Hidden in Investment Pools

Hal Wilson smiles at the blue numbers on his desktop screen. His money is yielding 5.77 percent. For the chief financial officer of Florida's Jefferson County school board, that means the $2.7 million of taxpayer funds he's placed in the state's Local Government Investment Pool is earning more on this October day than it would get in a money market fund.

And Wilson says he knows the Florida officials who manage the funds of the 1,559-student district have invested them wisely.

``We're such a small school district,'' Wilson, 55, says. ``We don't have the time or staff for professional money management. They have lots of investment advisers. It's risk free and easy.''

From "risk free and easy" to "classic run-on-the bank meltdown" in less than two months weeks.

by Calculated Risk on 11/30/2007 04:57:00 PM

From William Poole, President, St. Louis Fed: Market Bailouts and the "Fed Put". In this speech, Poole addresses the "Bernanke Put" and the possible moral hazard created by the Fed. Poole defends the Fed and the recent rate cuts. Here is his conclusion:

Federal Reserve policy that yields greater stability has not and will not protect from loss those who invest in failed strategies, financial or otherwise. Investors and entrepreneurs have as much incentive as they ever had to manage risk appropriately. What they do not have to deal with is macroeconomic risk of the magnitude experienced all too often in the past.

In the present situation, many investors in subprime paper will take heavy losses and there is no monetary policy that could avoid those losses. Clearly, recent Fed policy actions have not protected investors in subprime paper. The policy objective is not to prevent losses but to restore normal market processes. The issue is not whether subprime paper will trade at 70 cents on the dollar, or 30 cents, but that the paper in fact can trade at some market price determined by usual market processes. Since August, such paper has traded hardly at all. An active financial market is central to the process of economic growth and it is that growth, not prices in financial markets per se, that the Fed cares about.

One of the most reliable and predictable features of the Fed’s monetary policy is action to prevent systemic financial collapse. If this regularity of policy is what is meant by the “Fed put,” then so be it, but the term seems to me to be extremely misleading. The Fed does not have the desire or tools to prevent widespread losses in a particular sector but should not sit by while a financial upset becomes a financial calamity affecting the entire economy. Whether further cuts in the fed funds rate target will alleviate financial turmoil, or risk adding to it, is always an appropriate topic for the FOMC to discuss. But one thing should be clear: The Fed does not have the power to keep the stock market at the “proper” level, both because what is proper is never clear and because the Fed does not have policy instruments it can adjust to have predictable effects on stock prices.

From time to time, to be sure, Fed action to stabilize the economy—to cushion recession or deal with a systemic financial crisis—will have the effect of pushing up stock prices. That effect is part of the transmission mechanism through which monetary policy affects the economy. However, it is a fundamental misreading of monetary policy to believe that the stock market per se is an objective of policy. It is also a mistake to believe that a policy action that is desirable to help stabilize the economy should not be taken because it will also tend to increase stock prices. It makes no sense to let the economy suffer from continuing declines in stock prices for the purpose of “teaching stock market speculators a lesson.” “Teaching a lesson” is eerily reminiscent of Mellon’s liquidationist view. Nor should the central bank attempt to protect investors from their unwise decisions. Doing so would only divert policy from its central responsibility to maintain price stability and high employment.

The Fed would create moral hazard if it were to attempt to pump up the stock market whenever it fell regardless of whether or not such policy actions served the fundamental objectives of monetary policy. I have observed no evidence to suggest that the Fed has pursued such a course. To the extent that financial markets are more stable because market participants expect the Fed to be successful in achieving its policy objectives, then that is a desirable and expected outcome of good monetary policy. There is no moral hazard when largely predictable policy responses to new information have effects on financial markets.

That the monetary policy principles I have discussed here are unclear to many in the financial markets is unfortunate. Macroeconomic stabilization does not raise moral hazard issues because a stable economy provides no guarantee that individual firms and households will be protected from failure. Improved public understanding of this point will not only help the Fed to do its job more effectively but also will help private sector firms to understand better how to manage risk.

by Calculated Risk on 11/30/2007 04:31:00 PM

UPDATE: Here is the Bloomberg story: Moody's Says Citigroup SIV Debt Ratings Under Threat (hat tip CBam)

From Reuters: Moody's cuts or may cut over $100 billion of SIV debt

Moody's pointed to continued decline in the value of the investments made by structured investment vehicles, or SIVs, in downgrading or issuing warnings for about $116 billion of their debt.

"The situation has not yet stabilized and further rating actions could follow," Moody's said in a news release.
...
Given the continued decline in SIV asset values, Moody's said it is now expanding its review, which is not complete, to include the senior debt of some vehicles.

From Moody's (no link)

London, 30 November 2007 -- Moody's Investors Service announced today that it has completed part of its review of the SIV sector. This review was prompted by the continued market value declines of asset portfolios. Moody's confirmed, downgraded, or placed on review for possible downgrade, the ratings of 79 debt programmes (with a total nominal amount of approximately US$130 billion). This action affects 20 SIVs as described below.

Moody's has completed its review of capital notes started on November 7th. The significant additional deterioration in market value of assets across the SIV sector observed since November 7th has resulted in the expansion of Moody's original review to include the senior debt ratings of some vehicles. Moody's will continue to closely monitor SIV ratings, taking actions on individual vehicles as warranted.

In its monitoring of SIV ratings, Moody's pays particular attention to the evolving liquidity situation of each vehicle, changes in portfolio market value, and the vehicle's prospects for restructuring.

Rationale for Rating Actions

In recent weeks, Moody's has observed material declines in market value across most asset classes in SIV portfolios. These asset classes include Financial Institutions, which represent, on average, 38% of SIV portfolios, ABS 16%, CDOs 12% (including CDOs of ABS 1.4%). Financial Institutions debt suffered an average price decline of 1.6% from October 19th to November 23rd, ABS 0.7%, CDOs (excluding CDOs of ABS) 0.5%, and CDOs of ABS 22%. Furthermore, the continued inability to issue or roll Asset Backed Commercial Paper (ABCP) or Medium Term Notes (MTNs) causes mark-to-market losses to be realised when assets are liquidated to meet maturing ABCP and MTNs.

In this latest review, Moody's employed its updated methodology as announced on September 5th. The methodology update reflects the unprecedented volatility in the market value of the securities held by SIVs. For each SIV, Moody's models expected loss using a stressed volatility for the distribution of market asset prices based primarily on declines observed since July 2007. With this stress, only those tranches of the ABCP and MTNs issued that can sustain an additional price decline of two times the decline observed in this period will retain Aaa/Prime-1 ratings.

For example, if the net asset value of a SIV (measured as the difference between portfolio market value and the notional value of senior liabilities, expressed as a percentage of paid-in capital) was par in July and declined 30% to a current value of 70%, Moody's assumes that the probability of a deterioration in net asset value by an additional 60% of par to levels below 10% is negligible and is therefore consistent with a Aaa probability of default. Moody's analysis therefore assumes that all asset prices may move in a highly correlated manner. In addition, in Moody's stress analysis of the senior debt, Moody's reduced its estimate of current net asset value of all SIVs by 10-15 percentage points to reflect uncertainty in the ability to execute trades at current market quotes given continued NAV declines.

In modelling both senior and capital notes, Moody's extended its analysis by including the potential benefits of refinancing maturing senior debt using repurchase agreements. Moody's assumes that a vehicle that is able to replace maturing senior funding by repo funding continues to do so until an optimal level of repos is attained; the vehicle then enters into wind-down mode and, for the purpose of our analysis, liquidates its assets at distressed levels in order to satisfy noteholders.

Conclusions and Outlook

Moody's has taken rating actions as a result of deteriorating credit and other market conditions. It appears that the situation has not yet stabilised and further rating actions could follow. As with previous actions, the rating actions Moody's has taken today are not a result of any credit problems in the assets held by SIVs, but rather a reflection of the continued deterioration in market value of SIV portfolios combined with the sector's inability to refinance maturing liabilities.