A Web of Financial Fraud and Criminality: America's Shadow Banking System
By Ellen Brown
URL of this article: www.globalresearch.ca/index.php?context=va&aid=28878
Global Research, January 26, 2012
The Wall Street Journal reported on January 19th
that the Obama Administration was pushing heavily to get the 50 state
attorneys general to agree to a settlement with five major banks in the
“robo-signing” scandal. The scandal involves employees signing names
not their own, under titles they did not really have, attesting to the
veracity of documents they had not really reviewed. Investigation
reveals that it did not just happen occasionally but was an
industry-wide practice, dating back to the late 1990s; and that it may
have clouded the titles of millions of homes. If the settlement is
agreed to, it will let Wall Street bankers off the hook for crimes that
would land the rest of us in jail – fraud, forgery, securities
violations and tax evasion.
To the President’s credit, however, he seems to have shifted his position on the settlement in response to protests before his State of the Union address. In his speech on January 24th,
President Obama did not mention the settlement but announced instead
that he would be creating a mortgage crisis unit to investigate
wrongdoing related to real estate lending. “This
new unit will hold accountable those who broke the law, speed
assistance to homeowners, and help turn the page on an era of
recklessness that hurt so many Americans,” he said.
The Deeper Question Is Why
Whether
massive robo-signing occurred is no longer in issue. The question that
needs to be investigated is why it was being done. The alleged
justification—that the bankers were so busy that they cut corners—hardly
seems credible given the extent of the practice.
The
robo-signing largely involved assignments of mortgage notes to mortgage
servicers or trusts representing the investors who put up the loan
money. Assignment was necessary to give the trusts legal title to the
loans. But assignment was delayed until it was necessary to foreclose
on the homes, when it had to be done through the forgery and fraud of
robo-signing. Why had it been delayed? Why did the banks not assign
the mortgages to the trusts when and as required by law?
Here is a working hypothesis, suggested by
Martin Andelman: securitized mortgages are the “pawns” used in the pawn
shop known as the “repo market.” “Repos” are overnight sales and
repurchases of collateral. Yale economist Gary Gorton explains
that repos are the “deposit insurance” for the shadow banking system,
which is now larger than the conventional banking system and is
necessary for the conventional system to operate. The problem is that
repos require “sales,” which means the mortgage notes have to remain
free to be bought and sold. The mortgages are left unendorsed so they
can be used in this repo market.
The Evolution of the Shadow Banking System
Gorton
observes that there is a massive and growing demand for banking by
large institutional investors – pension funds, mutual funds, hedge
funds, sovereign wealth funds – which have millions of dollars to park
somewhere between investments. But FDIC insurance covers only up to
$250,000. FDIC insurance was resisted in the 1930s by bankers and
government officials and was pushed through as a populist movement: the
people demanded it. What they got was enough insurance to cover the
deposits of individuals and no more. Today, the large institutional
investors want similar coverage. They want an investment that is
secure, that provides them with a little interest, and that is liquid
like a traditional deposit account, allowing quick withdrawal.
The
shadow banking system evolved in response to this need, operating
largely through the repo market. “Repos” are sales and repurchases of
highly liquid collateral, typically Treasury debt or mortgage-backed
securities—the securitized units into which American real estate has
been ground up and packaged, sausage-fashion. The collateral is bought
by a “special purpose vehicle” (SPV), which acts as the shadow bank. The
investors put their money in the SPV and keep the securities, which
substitute for FDIC insurance in a traditional bank. (If the SPV fails
to pay up, the investors can foreclose on the securities.) To satisfy
the demand for liquidity, the repos are one-day or short-term deals,
continually rolled over until the money is withdrawn. This money is used
by the banks for other lending, investing or speculating. Gorton writes:
This
banking system (the “shadow” or “parallel” banking system)—repo based
on securitization—is a genuine banking system, as large as the
traditional, regulated banking system. It is of critical importance to
the economy because it is the funding basis for the traditional banking
system. Without it, traditional banks will not lend and credit, which is
essential for job creation, will not be created.
All Behind the Curtain of MERS
The
housing shell game was made possible because it was all concealed
behind an electronic smokescreen called MERS (an acronym for Mortgage
Electronic Registration Systems, Inc.). MERS allowed houses to be
shuffled around among multiple, rapidly changing owners while
circumventing local recording laws. Title
would be recorded in the name of MERS as a place holder for the
investors, and MERS would foreclose on behalf of the investors.
Payments would be received by the mortgage servicer, which was typically
the bank that signed the mortgage with the homeowner. The homeowner
usually thinks the servicer is the lender, but in fact it is an
amorphous group of investors.
This all worked until courts started questioning
whether MERS, which admitted that it was a mere conduit without title,
had standing to foreclose. Courts have increasingly held that it does
not.
Making
matters worse for the servicing banks, Fannie Mae sent out a memo
telling servicers that in order to be reimbursed under HAMP—a government
loan modification program designed to help at-risk homeowners meet
their mortgage payments—the servicers would have to produce the
paperwork showing the loan had been assigned to the trust.
The
hasty solution was a rash of assignments signed by an army of
“robosigners,” to be filed in the public records. But the documents are
patent forgeries, making a shambles of county title records.
Complicating
all this are tax issues. Since 1986, mortgage-backed securities have
been issued to investors through SPVs called REMICs (Real Estate
Mortgage Investment Conduits). REMICs are designed as tax shelters; but
to qualify for that status, they must be “static.” Mortgages can’t be
transferred in and out once the closing date has occurred. The REMIC
Pooling and Servicing Agreement typically states that any transfer
significantly after the closing date is invalid. Yet the newly
robo-signed documents, which are required to begin foreclosure
proceedings, are almost always executed long after the trust’s closing
date. The whole business is quite complicated, but
the bottom line is that title has been clouded not only by MERS but
because the trusts purporting to foreclose do not own the properties by
the terms of their own documents.
John
O’Brien, Register of Deeds for the Southern Essex District of
Massachusetts, calls it a “criminal enterprise.” On January 18th, he called for a full scale criminal investigation,
including a grand jury to look into the evidence. He sent to
Massachusetts Attorney General Martha Coakley, U.S. Attorney General
Eric Holder and U.S. Attorney Carmen Ortiz over 30,000 documents
recorded in the Salem Registry that he says are fraudulent.
From Lending Machines to Borrowing Machines
The
bankers have engaged in what amounts to a massive fraud, not
necessarily because they started out with criminal intent, but because
they have been required to in order to come up with the collateral (in
this case real estate) to back their loans. It is the way our system is
set up: the banks are not really creating credit and advancing it to
us, counting on our future productivity to pay it off, the way they once
did under the deceptive but functional façade of fractional reserve
lending. Instead, they are vacuuming up our money and lending it back
to us at higher rates.
“Instead
of lending into the economy,” says British money reformer Ann Pettifor,
“bankers are borrowing from the real economy.” She wrote in the Huffington Post in October 2010:
[T]he
crazy facts are these: bankers now borrow from their customers and from
taxpayers. They are effectively draining funds from household bank
accounts, small businesses, corporations, government Treasuries and from
e.g. the Federal Reserve. They do so by charging high rates of interest
and fees; by demanding early repayment of loans; by illegally
foreclosing on homeowners, and by appropriating, and then speculating with trillions of dollars of taxpayer-backed resources.
Not
only has the system destroyed county title records, but it is highly
vulnerable to bank runs and systemic collapse. In the shadow banking
system, as in the old fractional reserve banking system, the collateral
is being double-counted: it is owed to the borrowers and the depositors
at the same time. This allows for expansion of the money supply, but
bank runs can occur when the borrowers and the depositors demand their
money at the same time. And unlike the conventional banking system, the
shadow banking system is largely unregulated. It doesn’t have the
backup of FDIC insurance to prevent bank runs.
That is what happened in September 2008 following the bankruptcy of Lehman Brothers, a major investment bank. Gary Gorton explains that it was a run on the shadow banking system that caused the credit collapse that followed. Investors rushed to pull their money out overnight. LIBOR—the London interbank lending rate for short-term loans—shot up to around 5%. Since the cost of borrowing the money to cover loans was too high for banks to turn a profit, lending abruptly came to a halt.
That is what happened in September 2008 following the bankruptcy of Lehman Brothers, a major investment bank. Gary Gorton explains that it was a run on the shadow banking system that caused the credit collapse that followed. Investors rushed to pull their money out overnight. LIBOR—the London interbank lending rate for short-term loans—shot up to around 5%. Since the cost of borrowing the money to cover loans was too high for banks to turn a profit, lending abruptly came to a halt.
Fixing the System
The question is how to eliminate this systemic risk. As noted by The Business Insider:
Regulate
shadow banking more tightly, and you probably have to also provide
government backstops. Shudder. Try to shut the thing down or restrict it
and you suck credit out of the system, credit which much of the
non-financial “'real” economy uses and needs.
Interestingly, countries with strong public sector banking systems largely escaped the 2008 credit crisis. These include the BRIC countries—Brazil
Russia, India, and China—which contain 40% of the global population and
are today’s fastest growing economies. They escaped because their
public sector banks do not need to rely on repos and securitizations to
back their loans. The banks are owned and operated by the ultimate
guarantor—the government itself. The public sector banking model
deserves further study.
Whatever
the solution, a system that requires the slicing and dicing of
mortgages behind an electronic smokescreen so they can be bought and
sold as collateral for the pawn shop of the repo market is obviously
fraught with perils and is unsustainable. Please contact your state
attorney general and urge him or her not to go through with the
robo-signing settlement, which will be granting immunity for crimes that
are not yet fully known. Phone numbers are here.
The surface of this great shadowy second banking system has barely been
scratched. It needs a very thorough investigation.
Ellen Brown is an attorney and president of the Public Banking Institute, http://PublicBankingInstitute.org. In Web of Debt,
her latest of eleven books, she shows how a private cartel has usurped
the power to create money from the people themselves, and how we the
people can get it back. Her websites are http://WebofDebt.com and http://EllenBrown.com.
