Foreclosure-Gate: Adam Levitin - Dire Implications of “Securitization Fail”

11-23-2010 • creditslips.org/

Banks (Securitization Sponsors) The banks are in serious trouble if there are widespread securitization fails. If the loans weren't transferred to the securitization trusts, then they are on bank balance sheets, which means that (1) the losses on the loans are the banks (to be sorted out with the investors), and (2) the banks need to be holding capital against the loans that haven't gone into foreclosure. Depending on the scale of the problem, the banks might not have enough capital to cover the securitization fails, which means we're in Dodd-Frank resolution territory. Investors If the notes weren't properly transferred to the trusts, then investors have the mother of all putback claims. Investors probably also have claims against securitization trustees and against the law firms that did diligence on the securitization deals. (Note that these same firms are the ones lining up to swear that there isn't a problem....). Of course, the danger for investors is that there is a huge problem, and the banks lack the money to fix it. Let's be clear that investor interests here are split. AAA investors who are still well in the money would prefer to simply be paid out on their RMBS at 100 cents on the dollar than mess with putbacks. But mezzanine (like CDOs) and junior investors have a lot of potential upside here. Monolines This could be very awkward for the monolines. Generally they promise timely payment of principal and interest to investors. If that coverage obligation continues while the monolines make rescission claims, they might have to pay out of pocket first and then look to the banks for recovery. If so, they would be in a heck of a liquidity pickle. Homeowners Chain of title doesn't affect whether homeowners are in default on their loans. The loans' validity is not in question because of chain of title. But chain of title does affect who has the right to foreclose. At the very least, if there is a chain of title problem, it means lots of foreclosures cannot properly proceed because of lack of standing. On the other hand, if the loans weren't actually securitized, they are on banks' books, which might, just might, facilitate workouts. More generally, if there is a widespread securitization fail, it means that there will have to be a legislative solution to the problem, which might facilitate real loan modifications.