The Financial Tsunami
Part 1: Deutsche Bank's painful lesson
F. William Engdahl
www.engdahl.oilgeopolitics.net/
Nov 26, 2007
Even experienced banker friends tell me that they think the worst
of the US banking troubles are over and that things are slowly
getting back to normal. What is lacking in their rosy optimism
is the realization of the scale of the ongoing deterioration
in credit markets globally, centered in the American asset-backed
securities market, and especially in the market for CDOs - Collateralized
Debt Obligations and CMOs - Collateralized Mortgage Obligations.
By now every serious reader has heard the term "It's a crisis
in Sub-Prime US home mortgage debt." What almost no one
I know understands is that the Sub-Prime problem is but the tip
of a colossal iceberg that is in a slow meltdown. I offer one
recent example to illustrate my point that the "Financial
Tsunami" is only beginning.
Deutsche Bank got a hard shock
a few days ago when a judge in the state of Ohio in the USA made
a ruling that the bank had no legal right to foreclose on 14
homes whose owners had failed to keep current in their monthly
mortgage payments. Now this might sound like small beer for Deutsche
Bank, one of the world's largest banks with over ¤1.1
trillion (Billionen) in assets worldwide. As Hilmar Kopper used
to say, "peanuts." It's not at all peanuts, however,
for the Anglo-Saxon banking world and its European allies like
Deutsche Bank, BNP Paribas, Barclays Bank, HSBC or others. Why?
A US Federal Judge, C.A. Boyko
in Federal District Court in Cleveland Ohio ruled to dismiss
a claim by Deutsche Bank National Trust Company. DB's US subsidiary
was seeking to take possession of 14 homes from Cleveland residents
living in them, in order to claim the assets.
Here comes the hair in the
soup. The Judge asked DB to show documents proving legal title
to the 14 homes. DB could not. All DB attorneys could show was
a document showing only an "intent to convey the rights
in the mortgages." They could not produce the actual mortgage,
the heart of Western property rights since the Magna Charta of
not longer.
Again why could Deutsche Bank
not show the 14 mortgages on the 14 homes? Because they live
in the exotic new world of "global securitization",
where banks like DB or Citigroup buy tens of thousands of mortgages
from small local lending banks, "bundle" them into
Jumbo new securities which then are rated by Moody's or Standard
& Poors or Fitch, and sell them as bonds to pension funds
or other banks or private investors who naively believed they
were buying bonds rated AAA, the highest, and never realized
that their "bundle" of say 1,000 different home mortgages,
contained maybe 20% or 200 mortgages rated "sub-prime,"
i.e. of dubious credit quality.
Indeed the profits being earned
in the past seven years by the world's largest financial players
from Goldman Sachs to Morgan Stanley to HSBC, Chase, and yes,
Deutsche Bank, were so staggering, few bothered to open the risk
models used by the professionals who bundled the mortgages. Certainly
not the Big Three rating companies who had a criminal conflict
of interest in giving top debt ratings. That changed abruptly
last August and since then the major banks have issued one after
another report of disastrous "sub-prime" losses.
A new unexpected factor
The Ohio ruling that dismissed
DB's claim to foreclose and take back the 14 homes for non-payment,
is far more than bad luck for the bank of Josef Ackermann. It
is an earth-shaking precedent for all banks holding what they
had thought were collateral in form of real estate property.
How this? Because of the complex
structure of asset-backed securities and the widely dispersed
ownership of mortgage securities (not actual mortgages but the
securities based on same) no one is yet able to identify who
precisely holds the physical mortgage document. Oops! A tiny
legal detail our Wall Street Rocket Scientist derivatives experts
ignored when they were bundling and issuing hundreds of billions
of dollars worth of CMOs in the past six or seven years. As
of January 2007 some $6.5 trillion of securitized mortgage debt
was outstanding in the United States. That's a lot by any measure!
In the Ohio case Deutsche Bank
is acting as "Trustee" for "securitization pools"
or groups of disparate investors who may reside anywhere. But
the Trustee never got the legal document known as the mortgage.
Judge Boyko ordered DB to prove they were the owners of the mortgages
or notes and they could not. DB could only argue that the banks
had foreclosed on such cases for years without challenge. The
Judge then declared that the banks "seem to adopt the attitude
that since they have been doing this for so long, unchallenged,
this practice equates with legal compliance. Finally put to the
test," the Judge concluded, "their weak legal arguments
compel the court to stop them at the gate." Deutsche Bank
has refused comment.
What next?
As news of this legal precedent
spreads across the USA like a California brushfire, hundreds
of thousands of struggling homeowners who took the bait in times
of historically low interest rates to buy a home with often,
no money paid down, and the first 2 years with extremely low
interest rate in what are known as "interest only"
Adjustable Rate Mortgages (ARMs), now face exploding mortgage
monthly payments at just the point the US economy is sinking
into severe recession. (I regret the plethora of abbreviations
used here but it is the fault of Wall Street bankers not this
author).
The peak period of the US real
estate bubble which began in about 2002 when Alan Greenspan began
the most aggressive series of rate cuts in Federal Reserve history
was 2005-2006. Greenspan's intent, as he admitted at the time,
was to replace the Dot.com internet stock bubble with a real
estate home investment and lending bubble. He argued that was
the only way to keep the US economy from deep recession. In retrospect
a recession in 2002 would have been far milder and less damaging
than what we now face.
Of course, Greenspan has since
safely retired, written his memoirs and handed the control (and
blame) of the mess over to a young ex-Princeton professor, Ben
Bernanke. As a Princeton graduate, I can say I would never trust
monetary policy for the world's most powerful central bank in
the hands of a Princeton economics professor. Keep them in their
ivy-covered towers.
Now the last phase of every
speculative bubble is the one where the animal juices get the
most excited. This has been the case with every major speculative
bubble since the Holland Tulip speculation of the 1630's to the
South Sea Bubble of 1720 to the 1929 Wall Street crash. It was
true as well with the US 2002-2007 Real Estate bubble. In the
last two years of the boom in selling real estate loans, banks
were convinced they could resell the mortgage loans to a Wall
Street financial house who would bundle it with thousands of
good better and worse quality mortgage loans and resell them
as Collateralized Mortgage Obligation bonds. In the flush of
greed, banks became increasingly reckless of the credit worthiness
of the prospective home owners. In many cases they did not even
bother to check if the person was employed. Who cares? It will
be resold and securitized and the risk of mortgage default was
historically low.
That was in 2005. The most
Sub-prime mortgages written with Adjustable Rate Mortgage contracts
were written between 2005-2006, the last and most furious phase
of the US bubble. Now a whole new wave of mortgage defaults is
about to explode onto the scene beginning January 2008. Between
December 2007 and July 1, 2008 more than $690 Billion in mortgages
will face an interest rate jump according to the contract terms
of the ARMs written two years before. That means market interest
rates for those mortgages will explode monthly payments just
as recession drives incomes down. Hundreds of thousands of homeowners
will be forced to do the last resort of any homeowner: stop monthly
mortgage payments.
Here is where the Ohio court
decision guarantees that the next phase of the US mortgage crisis
will assume Tsunami dimension. If the Ohio Deutsche Bank precedent
holds in the appeal to the Supreme Court, millions of homes will
be in default but the banks prevented from seizing them as collateral
assets to resell. Robert Shiller of Yale, the controversial and
often correct author of the book, Irrational Exuberance,
predicting the 2001-2 Dot.com stock crash, estimates US
housing prices could fall as much as 50% in some areas given
how home prices have diverged relative to rents.
 The $690 billion worth of "interest
only" ARMs due for interest rate hike between now and July
2008 are by and large not Sub-prime but a little higher quality,
but only just. There are a total of $1.4 trillion in "interest
only" ARMs according to the US research firm, First American
Loan Performance. A recent study calculates that, as these ARMs
face staggering higher interest costs in the next 9 months, more
than $325 billion of the loans will default leaving 1 million
property owners in technical mortgage default. But if banks are
unable to reclaim the homes as assets to offset the non-performing
mortgages, the US banking system and a chunk of the global banking
system faces a financial gridlock that will make events to date
truly "peanuts" by comparison. We will discuss the
global geo-political implications of this in our next report,
The Financial Tsunami: Part 2.
end
F. William Engdahl
 F. William Engdahl
is the author of Seeds
of Destruction:
The Hidden Agenda of Genetic Manipulation. Publication Launch:
23 November 2007.
Pre-publication
price US$14.00 [list $24.95] until 15 Dec. (click
here to order at $US14).
He also authored
'A
Century of War:
Anglo-American Oil Politics,' Pluto Press Ltd.
He may be contacted
at his website, www.engdahl.oilgeopolitics.net.
321gold Ltd
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