THE MIDDLE GAME QUAGMIRE
After a bad opening, there is hope for the middle game. After a bad middle game, there is hope for the endgame. But once you are in the endgame, the moment of truth has arrived. - Edmar Mednis (Grandmaster)
I have one central thought of where this fraudclosure fiasco could lead, and this is why everyone should watch very carefully how the various players move their pieces in this subprime middle game.
Up until now, the banks have been making sweeping statements that this all reflects a "technical" glitch in foreclosure processes.
Well, having a posse of State AGs band together to commence a joint investigation is no longer a minor "technical" glitch. Allegations of masses of forged signatures, falsified or fabricated notarized documents, back dating etc., if true, collectively amount to an institutional pattern of criminal behavior. Having the Justice Department announce it is opening a preliminary investigation raises the stakes even higher.
Being forced to suspend all foreclosures has obvious "material" economic consequences to the CDO note holders.
But having title companies pull out of the residential real estate market because they no longer trust the veracity of bank provided documents presages claims by mortgagors who lost their properties as well as the subsequent purchasers of same. The only way to conclusively cure that kind of problem is to get waivers, and releases from the various claimants wherever they may be or pass retroactive curative laws or laws doing things like creating a bailout fund to indemnify those who are injured (yikes!). You cannot simply say this is immaterial, sprinkle in the word MERS and hope this will all go away.
The CDO note holders will have potential claims stemming from the interruption of non-performing loan processing. Think breaches of the trust servicing agreements and allegations of "gross negligence or willful misconduct", the latter being magical legal hurdle in these types of agreements. However, the much more troubling aspect, is the growing realization that the various pools of securitized mortgages may never have been properly assigned, transferred and recorded at inception. If this turns out to be the case, game over--the noteholders will have to be made whole (here we will be expanding into the universe of securities "underwriter" liability).
How these problems are all handled in public disclosure documents is another key area to watch. The standard for "materiality" is whether a reasonably prudent investor would consider an item of disclosure important in making an investment decision. What would you say is important?
Remember that RICO is what brought down Drexel. RICO claims can be brought by the state or by private parties. Private RICO actions have apparently already been filed by certain litigants. This is a securities and white collar crime litigators wet dream.
Over and above the criminal and civil liability issues, are the regulatory and reputational risks. The damage to the reputation of a bank caught defrauding its customers is serious indeed. However, think of all the regulatory detonators that can be potentially triggered by all of this.
The list goes on and on.
What this means is that Jamie Dimon and his 2Big2Fail CEO brethren can no longer pretend that this is just a minor technical hiccup. These developments constitute material risk factors threatening the very 2Big2Fail existence of their banks. That's not hyperbole.
They cannot pretend not to know what happened. They no longer have the luxury of taking the high road. It is now clearly their fiduciary duty to find out what happened and to take whatever corrective measures are necessary to protect the shareholders.
Any fatal mistakes at this point are more than likely to constitute "good cause" for termination. Moreover, as we all know and Messrs Nixon and Clinton will attest, it is often how one behaves in the post facto spin and damage control operation that can lead to ultimate ruin.
They are all spending their Columbus Day weekend lawyering up.
Someone is going to suggest a forensic/legal examination of the documentation. This will take months and months, particularly if they have to look at fraudclosures already processed.
The good news? Here is a new job class created under Obama, Mortgage Fraud Forensics Specialist. This is not something an accountant is trained to do. This is a legal exercise. Unemployed real estate lawyers take heart. Work is on the way.
The end game may not be here quite yet, but it is approaching very soon, because they will all have to start thinking seriously about how to re-mark these toxic loan portfolios given the stark new market and legal reality.
So where is this great game leading? Talk of a TARP II rescue would lead to torches, pitchforks and political suicide in Tea Party America.
No, this could very well lead to a 2Big2Fail checkmate. We shall see...
[I recommend you read the other ZH posts on this subject as well as other excellent Blogs like Yves Smith's Naked Capitalism. The above is my humble attempt to distill my view of the current state of play for the reader. No one should under estimate the magnitude of this emerging crisis. Particularly, Team 0. File this post under: "A Momentary Lapse of Banzai7 Seriousness"]