(PSA=Pooling and Servicing Agreements)

Josh Rosner, a well respected bank analyst (he describes himself as "a recovering GSE analyst") is circulating a client note and it takes the foreclosure crisis very seriously. The critical part is his discussion of the conveyance chain. As we indicated before, the minimum chain for a recent mortgage securitization is is A (originator) => B (sponsor) => C (custodian) => D (trust). Older deals might only have three parties, but recent vintage typically had at least four, and some as many as seven or eight.

The reason for doing this is bankruptcy remoteness. You as the buyer of a mortgage backed security want certainty in what you purchased. If an originator goes bust (as ironically many did), you don't want the creditors to say, "They were already toast by the time they set up that MBS, so the sale of the loans was a fraudulent conveyance, we are gonna take the loans back."

The way to prevent that was to introduce intermediary parties between the originator and the trust. Each party had to be independent (which meant fit the legal definition of independence; the intermediary parties and even many originators were dependent on financing called warehouse lines from the investment bank packager/distributors). The note (the borrower IOU) had to be endorsed (like a check) to the next party in the chain, who then endorsed it over to the party after that, with the last party being the trust.

Rosner's remarks are consistent with our prior posts, and he adds a couple of important additional observations: We have a larger and more significant concern, which, if proved out, could call into
question the validity of nearly all securitizations and raise material questions about
whether "true sale" was achieved.  

   Nearly all Pooling and Servicing Agreements require that "On the Closing Date, the Purchaser will assign to the Trustee pursuant to the Pooling and Servicing Agreement all of its right, title and interest in and to the Mortgage Loans and its rights under this Agreement (to the extent set forth in Section 15), and the Trustee shall succeed to such right, title and interest in and to the Mortgage Loans and the Purchaser's rights under this Agreement (to the extent set forth in Section 15)". Also, an Assignment of Mortgage must accompany each note and this almost never happen.

    We believe nearly every single loan transferred was transferred to the Trust in "blank" name. That is to say the actual loans were apparently not, as of either the cut-off or closing dates, assigned to the Trust as required by the PSA.

    Rather than continue to fight for the "put-back" of individual loans the investors may be able to sue for and argue that the "true sale" was never achieved. To think of it simply, if you go to sell your car and you endorse your title but neither you nor the party you are selling it to sign their name who owns the car? It appears you likely still do.

    While there may be a view that the government can intervene it appears that the private contract spelling out the terms was violated at the transfer point. The Trustee, who has responsibility to make sure all loans were properly assigned to the trust, may have liability. So too might the lawyers who issued the legal opinions.

Obama might try to help Wall Street, but, in the end, it could well be the sharks turning on one another that ends the fiasco. It might not be a good time to have been one of the institutions that provided "warehouse lines" of credit to the various "mortgage brokers" who originated the loans under the "originate to sell" model, especially if your institution was also involved in servicing the mortgages and is securitizing them. Given how things were going in 2004 it seems unlikely that anyone in any particular chain was truly independent. It's getting interestinger and interestinger.

As the Dutch said while fighting the Spanish: "It is not necessary to have hope in order to persevere."