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'This is the biggest fraud in the history of the capital markets'

newjanpic.jpgJanet Tavakoli is the founder and president of Tavakoli Structured Finance Inc. She sounded some of the earliest warnings on the structured finance market, leading the University of Chicago to profile her as a "Structured Success," and Business Week to call her "The Cassandra of Credit Derivatives." We spoke this afternoon about the turmoil in the housing market, and an edited transcript of our conversation follows.

Ezra Klein: What’s happening here? Why are we suddenly faced with a crisis that wasn’t apparent two weeks ago?

Janet Tavakoli: This is the biggest fraud in the history of the capital markets. And it’s not something that happened last week. It happened when these loans were originated, in some cases years ago. Loans have representations and warranties that have to be met. In the past, you had a certain period of time, 60 to 90 days, where you sort through these loans and, if they’re bad, you kick them back. If the documentation wasn’t correct, you’d kick it back. If you found the incomes of the buyers had been overstated, or the houses had been appraised at twice their worth, you’d kick it back. But that didn’t happen here. And it turned out there were loan files that were missing required documentation. Part of putting the deal together is that the securitization professional, and in this case that’s banks like Goldman Sachs and JP Morgan, has to watch for this stuff. It’s called perfecting the security interest, and it’s not optional.

EK: And how much danger are the banks themselves in?

JT: When we had the financial crisis, the first thing the banks did was run to Congress and ask for accounting relief. They asked to be able to avoid pricing this stuff at the price where people would buy them. So no one can tell you the size of the hole in these balance sheets. We’ve thrown a lot of money at it. TARP was just the tip of the iceberg. We’ve given them guarantees on debts, low-cost funding from the Fed. But a lot of these mortgages just cannot be saved. Had we acknowledged this problem in 2005, we could’ve cleaned it up for a few hundred billion dollars. But we didn’t. Banks were lying and committing fraud, and our regulators were covering them and so a bad problem has become a hellacious one.

EK: My understanding is that this now pits the banks against the investors they sold these products too. The investors are going to court to argue that the products were flawed and the banks need to take them back.

JT: Many investors now are waking up to the fact that they were defrauded. Even sophisticated investors. If you did your due diligence but material information was withheld, you can recover. It’ll be a case-by-by-case basis.

EK: Given that our financial system is still fragile, isn’t that a disaster for the economy? Will credit freeze again?

JT: I disagree. In order to make the financial system healthy, we need to recognize the extent of our losses and begin facing the fraud. Then the market will be trustworthy again and people will start to participate.

EK: It sounds almost like you’re saying we still need to go through the end of our financial crisis.

JT: Yes, but I wouldn’t say crisis. This can be done with a resolution trust corporation, the way we cleaned up the S&Ls. The system got back on its feet faster because we grappled with the problems. The shareholders would be wiped out and the debt holders would have to take a discount on their debt and they’d get a debt-for-equity swap. Instead we poured TARP money into a pit and meanwhile the banks are paying huge bonuses to some people who should be made accountable for fraud. The financial crisis was a product of our irrational reaction, which protected crony capitalism rather than capitalism. In capitalism, the shareholders who took the risk would be wiped out and the debt holders would take a discount but banking would go on.

By Ezra Klein  | October 8, 2010; 1:27 PM ET
Categories:  Housing Crisis, Interviews  
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Next: Krugman vs. me


She's a very smart lady, and everything she's saying is absolutely right. I just don't know if Finreg has put the mechanisms in place to deal with it. It should have, but I have this horrible feeling that it didn't.

Posted by: bgmma50 | October 8, 2010 1:39 PM | Report abuse

I agree she's smart and right, but smart, right, people have been saying this for 3 years, yet all we get are willfull ignorance and half measures. The hope that stuff swept under the rug will just disappear. Or, ideally, that some new bubble can come along and replace the old one.
We will not get past this until the real, multi-trillion dollar problem is worked out of the system, globally.

Posted by: Rockfish66 | October 8, 2010 1:52 PM | Report abuse

Ezra, I realize you are not a real estate lawyer and foreclosure expert but there are points that need to be remembered:

1- throughout the history of the invention of who owns things, real property has been treated specially; it has had a sacrosanct spot in the annals of ownership; for example the Statue of Frauds mandates that all contracts involving real property be in writing; Registry of Deeds were created in all counties in the land in order to process this necessity of writing and as a means of making sure that real property was handled properly- in writing; there are countless other examples;

2- adherence to contract law and the rule of contract is vital to the free flow of property (real and personal) in our society; the creation of the Uniform Commercial Code is an example of the recognition that contracts need be adhered to and executed properly;

3- a mortgage is a real contract about real property (yes, I know obvious, but needs stating) and the reason mortgage contracts are so long and contain so many clauses is to specify the rights of all parties under all existing law; it binds BOTH parties- the lender and the lendee;

4- in order to ensure that only the true holder of the note can kick a person off their real property, a paper trail is specified and required; everyone needs to know who owns the debt so that some other entity cannot claim ownership of the debt;

5- when the ownership trail of the true holder of the note is broken, chaos ensues because ONLY the holder of the note can exercise his/her foreclosure rights; so if no one know who owns the note, NO ONE has the legal right to foreclose to re-claim the real property

6- THAT is the true problem here; if these notes are not done properly or lost or not transferred properly vis-a-vis NY law (I use NY laws because most of the trusts wherein the notes were to be allegedly transferred stated NY law governs), then poof- the right to re-claim is- well, you can figure out what that means....

7- it may seem 'unfair' that the banks lose the right to foreclose when the mortgagor cannot/does not pay but that is the risk inherent in creating a contract; you have to play by the rules or really, the meaning of contract is gone-poof... ; who would make a contract if only one party had to play by the rules? If I screw up and don't pay my mortgage or something happens, the banks will foreclose. But if the banks do not follow the law/rules and cannot foreclose- whose fault is that?

A final note is that it is my guess that unless ones mortgage stayed with the group that made the loan, the transfer of the note was never done properly and any foreclosure done was illegal. It amazes me that any title company would certify title on a recently foreclosed property.

There is no way to fix this without abrogating millions of contracts.

Posted by: bokun59 | October 8, 2010 2:00 PM | Report abuse

Rockfish66, the only thing that gives me hope is that Congress is now too afraid to try a TARP type bailout again.

TARP was entirely the wrong approach to the problem, leaving the bank's equity holders, bondholders, and creditors (including employees who were "owed" huge bonuses) intact while the taxpayers bailed them out. (and don't even get me started on the TARP money that went to investment banks, auto companies and foreign banks)

Paulson, Geithner, Frank, et. al. have claimed that they didn't have the authority to put the TARP recipients into receivership, and wipe out their shareholders, bondholders, and creditors before investing taxpayer money. I never bought that, actually, because as you say, Bush 1 did it during the savings and loan crisis. However, the American public will not tolerate another TARP, and so this time I'm hoping the problem will be dealt with as it should have been 2 years ago.

At any rate, I'd be bailing out of band stocks and bank bonds and mortgage backed securities right now.

Posted by: bgmma50 | October 8, 2010 2:08 PM | Report abuse

bokun59, I doubt very much that the lenders will lose the right to foreclose altogether. But they do have an overwhelming, time-consuming, and very expensive task of remedying faulty or omitted or fraudulent paperwork. The fact remains, however, that the debtors have also defaulted on their obligations, and will not be allowed to just keep the collateral forever.

More than likely, this will facilitate negotiated resolutions and short sales, and reduce the number of outright foreclosures.

Posted by: bgmma50 | October 8, 2010 2:15 PM | Report abuse

Good piece Ezra. This whole thing is fraud, a f'ing joke.

Posted by: marteen | October 8, 2010 2:42 PM | Report abuse

I don't suppose we could jam the Administration into hiring this lady to clean up the fraud?

Oh, I forgot. Republicans wouldn't let them.

Posted by: janinsanfran | October 8, 2010 3:23 PM | Report abuse

Excellent piece. Right on the mark as usual. Too bad we have a government filled with cowards, greed and corruption. Our financial industry is still wrongly based on incentives that allow outrageous risk with no accountability for the principles making those calls. Indeed derivatives are still going strong. Record bonuses continue for the guys that almost shut down the whole show. It used to be that you got fired for screwing the company into the ground. Now you get a prize at taxpayer expense. Instead of making the bankers take their medicine the "change" president's treasury and congress prefers to just sweep it all under the rug hoping that throwing our grandchildren's debt at the problem will fix it. The only thing we've done is encourage more of the same moral hazard at the top levels. We've left the wound to fester and rot beneath the surface and eventually we'll have to cut the leg off rather than exposing it to fresh air and clean sunlight to let it heal properly. I personally think this is the biggest reason for the weak recovery. Most of us know things aren't better or any more secure than 2 years ago. Most of us know the people in charge are still not making the best decisions for the country or the economy. Hence its hold tight to my money and wait until it all shakes out before jumping in the water again.

Posted by: motodude | October 8, 2010 4:40 PM | Report abuse

One has to understand something about executive performance. It's not company performance; it's whether the executive is receiving more compensation this year than last year. If yes, they he's successful. That is the only metric the vast majority of executives care about.

IMO. It should be SOP from here and forever after that any company getting bailed out from failure by the government should have as a necessary condition that all bonuses be suspended and compensation be reduced until the taxpayer is repaid. I'd leave some flexibility to negotiate based on specific conditions.

Re: "It used to be that you got fired for screwing the company into the ground." - Posted by: motodude

Forgot about the taxpayer. Look at the careers of Carly Fiorina and Bob Nardelli and see what you get when you're fired in the private sector.

Posted by: James10 | October 8, 2010 5:20 PM | Report abuse

Great interview. My comments could be lengthy but I'll keep it as short as possible.

Fraud vitiates everything it touches.

The alleged "contract" was conceived in fraud from the beginning(fraud in the inducement). There is a SCOTUS decision from 1872, Carpenter v. Longan that states quite clearly once the deed of trust/mortgage is separated from the promissory note the deed of trust/mortgage becomes invalid. It was intentional from the inception that the DoT and PN be separated, it had to in order to be securitized. Once the PN was taken out of the original grantor deed/mortgage and placed into the securitization trust the original grantor deed/mortgage became extinguished.

I'll say it again. When the loan was securitized, purchased by the securitized trust through the investor(s), at that juncture, the grantor deed of trust which is the original one that started everything was EXTINGUISHED because it was satisfied!

It was satisfied at that juncture and in actuality the trustee in question, the one who is trying to foreclose, because pursuant to title 12 226.39 a(1) says servicers can't foreclose, is the trustee of the securitized trust, not the original deed of trust.

However to hide what they are doing they are reaching out and grabbing onto the the original DoT which is actually empty.

(See the Trust Indenture Act of 1939, reaffirmed in 2009, mortgages/ Deeds of trust are trust instruments and fall under trust law)

The majority of the foundational documents they use to record in the public record are fraudulent. The PSA on securitized loans, the assignments taking place in the public record do not match up with the PSA or the note itself has not been transfered properly in accordance with the PSA's terms and conditions. This is a big problem with chain of title. This means the foreclosing entity can not foreclose and subsequently no one can foreclose.

Posted by: jasonrapp | October 8, 2010 10:05 PM | Report abuse

Wow, is Ezra Klein growing up? I thought sure he was explaining just months ago how the Bush/Obama TARP/Bailouts were just simply the only choices we had! Hey, how about that? No? They're bad, now, Ezra? Awww, honey, you just keep swimming with the flow so you can pretend to know something about economics. How cute. Any look into Klein's background will show you he has NO experience in economics (try wiki, etc.). He is a well-connected little dufus that should stick to writing articles on cooking, metrosexuals, and how much he likes shopping.

Posted by: shred11 | October 9, 2010 12:11 PM | Report abuse

Wow, is Ezra Klein growing up? I thought sure he was explaining just months ago how the Bush/Obama TARP/Bailouts were just simply the only choices we had! Hey, how about that? No? They're bad, now, Ezra? Awww, honey, you just keep swimming with the flow so you can pretend to know something about economics. How cute. Any look into Klein's background will show you he has NO experience in economics (try wiki, etc.). He is a well-connected little dufus that should stick to writing articles on cooking, metrosexuals, and how much he likes shopping.

Posted by: shred11 | October 9, 2010 12:12 PM | Report abuse

If you commit fraud and get away with millions in profits and zero chance of ever seeing jail time, then any self-respecting "free market Capitalist" is going to commit fraud.

And nobody in America seems to be addressing that problem. Where are the criminal charges?

Posted by: Bullsmith1 | October 9, 2010 1:51 PM | Report abuse

Trust me on this: The banks will get this law changed. They almost succeeded last week with that notary provision that Obama vetoed. They'll keep trying, and they'll succeed. If you don't like the rule of law, buy the legislature.

Posted by: MagicDog1 | October 9, 2010 2:50 PM | Report abuse

Many people are missing the point. This is not simply about foreclosures. If a bank (servicer) cannot prove standing to do a foreclosure they also cannot prove standing to accept payoff of the loan because they cannot provide a valid mortgage satisfaction at the time of sale or refinance. This situation could potentially make any home purchased or refinanced in the last 10 years or more unsaleable because no title company would issue insurance with a potential unpaid lien. Depending on the ultimate extent of this problem, a large percentage of residential properties could have title defects that will be very costly to remedy. Every home owner needs to be concerned about this situation whether they are facing foreclosure or not. And one thing we can count on is there will be many sharks out to acquire cheap loan paper where they can file suit and make ownership claims for years to come. I'm afraid the title industry has just been stood on it's head and many many responsible homeowners are going to find themselves in a nightmare.

Posted by: chucko2 | October 9, 2010 4:06 PM | Report abuse

beautiful mind.
christopher story,who was recently horizontalized
as he used to say, named some humongous financial
_________ in his news reports. both are worthy of our critical investigation and action until justice is done..

Posted by: casey78071 | October 9, 2010 6:24 PM | Report abuse

William K. Black has also been on this for some time. See the classic interview with Bill Moyers. According to Black, this was "control fraud," that is, CEO's using their companies to commit fraud. They should go straight to the pokey, just like the S&L bandits, where there were around 1000 convictions.

Posted by: tjfxh | October 9, 2010 6:51 PM | Report abuse

Why don't you ask Janet why she is a johnny come lately? I emailed her about this on going fraud on April 23 2010 according to my records. She still hasn't touched the MERS issue which is the root cause of the affidavit fraud.

Posted by: indio007 | October 10, 2010 9:24 PM | Report abuse

It is heart-breaking to know the hurt in this country, as everyone is so eloquently expresses their knowledge about the financial situation in the housing market. We've been dealing with this kind abuse from the banks for more than 10 years.(me and mine) Nobody would listen to us then and nobody is listening now. Everybody is talking about it and doing nothing. Everybody is talking about foreclosures. These servicing companies should be treated like the thieves that they are, stealing money from senior citizens. This is no different from someone on the street robbing us, in both cases they take your money. We've had to dip in our retirement to keep a roof over our heads. Paying bogus fees that they make up. In some cases they don't make up anything they just give you a total and tell you to pay it. I've heard this story from several seniors. I'm waiting on the day when I see my servicing company be held accountable. Say what you want to about subprime mortgages. We were in a prime mortgage when we got this subprime loan. We were scammed into this predatory loan. We felt pressured at the closing, though we knew they were doing something wrong. We had no legal rep. there. We've tried to get out of the loan several times, but our credit, like so many others, is ruined.We been passed around to several others over the years. Same story. Being foreclosed on is not the worst that can happen. We needed a foreclosure to blow these people out the water. Now are really going to doooo...anything about it? Or, are we going to continue to talk? We are to pray for our enemies, and I pray that hearts of these people change. But I say walk the walk and not just talk the talk. They are getting away!!!! If we knew years ago that this was happening why is it just becoming this known? When it affects the right people it suddenly begins to matter! When crosses certain barriers it must be bad. Everyone's money spends the same. Every homeless person has no home. Every fraud that is committed is a crime against whom ever it is committed. What is it going to take, people getting evicted from the White House?

Posted by: andrsmorris | October 12, 2010 3:49 PM | Report abuse

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