Judge Rules Against Deutsche Bank on Foreclosures, May Lead to Amnesty

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We are dancing on the thin line between uncertainty and risk. Risk is quantifiable. If you can slap a number on it, a probability, then you can hedge against an unexpected outcome.

But you can’t hedge against what you don’t know. Uncertainty is fundamentally different from risk, as Nassim Taleb so elegantly points out in The Black Swan. Against, uncertainty there is no real strategy but alertness.

Yet the market went into October with its eyes wide shut, willfully ignorant of the vast landscape of uncertainty in front of it. How bad is the subprime problem? Who owns the loans? How does the global financial system unwind such tremendous leverage without affecting asset values?

In any event, we have asked these questions before, only to point out that no one knows the answers. They will not be known for a while. If you can’t trade an asset like a CDO because there’s no price, does that mean the asset has no value? If that’s the case, the write-offs in the financial sector could be much larger than the US$300-$500 billion we’ve been advised to prepare for.

We’ve been assuming the schemers and designers of CDOs were clever and crafty. But maybe they were idiots. Or maybe the unforeseen consequences of securitisation and “risk disaggregation” are coming home to roost. Bankers can’t foreclose on bad mortgage loans because they can’t prove they actually own the loans.

Our friend Lila Rajiva, co-author with Bill Bonner of “Mobs, Markets, and Messiahs” pointed us to a New York Times article that uncovers what could be a big trend. The Times reports that, “A federal judge in Ohio has ruled against a longstanding foreclosure practice, potentially creating an obstacle for lenders trying to reclaim properties from troubled borrowers and raising questions about the legal standing of investors in mortgage securities pools.”

“Judge Christopher A. Boyko of Federal District Court in Cleveland dismissed 14 foreclosure cases brought on behalf of mortgage investors, ruling that they had failed to prove that they owned the properties they were trying to seize.” Deutsche Bank (NYSE:DB) was unable to prove to Judge Boyko’s satisfaction that it owned the properties in question, and thus could not foreclose on them.

Blame the pooling and securitisation of mortgages for this one. The advantage of the process in a bull market is that risky loans are sprinkled into tranches with higher-quality assets. This was supposed to make the chance of default less threatening to bondholders, who were being paid a yield above 10-year Treasuries anyway.

Now, where are the actual mortgage notes? They are probably sitting in some box in a warehouse gathering dust. It puts the whole foreclosure crisis in an interesting new perspective. If no one really owned the risk of the bad loan—and can’t prove it—maybe they don’t own the home either, in which case we could see an amnesty for bad loans.

At some point, all the losses—both for borrowers and lenders—are going to be ‘socialised,’ i.e. foisted off on American taxpayers. We’re just not sure what the mechanism is going to be. For some reason it brings to mind a scene in the Harry Potter books where Dumbledore is forced to drink a well-full of poison in order to reach a treasured item at the bottom. The poison nearly kills him. But someone had to do it. Ben Bernanke’s beard is shorter than Dumbledore’s…but he sure could use some magic right now.

Dan Denning
The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Comments

  1. “We’ve been assuming the schemers and designers of CDOs were clever and crafty. But maybe they were idiots.”

    psychology of greed – all that and more?

    Reply
  2. So my question is what the heck does Mr. Denning know about American Mortgages…. He is an Aussie (God love him) but gathers his information based on conjecture and Internet blogs…. Excuse me, ask someone here what it is like to go through a foreclosure….

    Ray Sabb
    Managing Editor
    MainAttraction.net

    Ray Sabb
    June 7, 2010
    Reply

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