Friday was a mixed bag from a sector point of view. Two major sectors were at odds and the market did move much. Tech stocks, which represent almost 20% of the S&P 500’s market cap — more than any other sector — are up; but financials, which represent about 15% of the weight of the S&P 500 — second only to tech — are down. Usually these two sectors have to be doing well for the market to do well. They are simply too big to be ignored.
Today this has flipped. The banks are moving up this morning and tech is very mixed. The banks are again getting the headlines. This time over the foreclosure mess that is stiring Fridays article closed with a message to watch the banks this week. This could be fruitful. Remmember – don’t trade the headlines – trade the reaction to them
In the tech sector some important earnings reports will be out after the close. Apple (AAPL), which is up 11% for the month already will report. Needless to say expectations are high. Bidu (BIDU) will report on the heels of the good report alrerady out from Google (GGOG), and competitors Amazon (AMZN), and eBay (EBAY), will also report. IBM will also report and has had a big run into their earnings.
The following comes from David Kotec of Cumberland Advisors via John Maudlin. David Kotec wrotes:
“Homeowners can only be foreclosed and evicted from their homes by the person or institution who actually has the loan paper…only the note-holder has legal standing to ask a court to foreclose and evict. Not the mortgage, the note, which is the actual IOU that people sign, promising to pay back the mortgage loan
“Before mortgage-backed securities, most mortgage loans were issued by the local savings & loan. So the note usually didn’t go anywhere: it stayed in the offices of the S&L down the street.
“But once mortgage loan securitization happened, things got sloppy…they got sloppy by the very nature of mortgage-backed securities.
“The whole purpose of MBSs was for different investors to have their different risk appetites satiated with different bonds. Some bond customers wanted super-safe bonds with low returns, some others wanted riskier bonds with correspondingly higher rates of return.
“Therefore, as everyone knows, the loans were ‘bundled’ into REMICs (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then “sliced & diced”…split up and put into tranches, according to their likelihood of default, their interest rates, and other characteristics.
“This slicing and dicing created ‘senior tranches,’ where the loans would likely be paid in full, if the past history of mortgage loan statistics was to be believed. And it also created ‘junior tranches,’ where the loans might well default, again according to past history and statistics. (A whole range of tranches was created, of course, but for the purposes of this discussion we can ignore all those countless other variations.)
“These various tranches were sold to different investors, according to their risk appetite. That’s why some of the MBS bonds were rated as safe as Treasury bonds, and others were rated by the ratings agencies as risky as junk bonds.
“But here’s the key issue: When an MBS was first created, all the mortgages were pristine…none had defaulted yet, because they were all brand-new loans. Statistically, some would default and some others would be paid back in full…but which ones specifically would default? No one knew, of course. If I toss a coin 1,000 times, statistically, 500 tosses the coin will land heads…but what will the result be of, say, the 723rd toss? No one knows.
“Same with mortgages.
“So in fact, it wasn’t that the riskier loans were in junior tranches and the safer ones were in senior tranches: rather, all the loans were in the REMIC, and if and when a mortgage in a given bundle of mortgages defaulted, the junior tranche holders would take the losses first, and the senior tranche holder last.
“But who were the owners of the junior-tranche bond and the senior-tranche bonds? Two different people. Therefore, the mortgage note was not actually signed over to the bond holder. In fact, it couldn’t be signed over. Because, again, since no one knew which mortgage would default first, it was impossible to assign a specific mortgage to a specific bond.
“Therefore, how to make sure the safe mortgage loan stayed with the safe MBS tranche, and the risky and/or defaulting mortgage went to the riskier tranche?
“Enter stage right the famed MERS…the Mortgage Electronic Registration System.
“MERS was the repository of these digitized mortgage notes that the banks originated from the actual mortgage loans signed by homebuyers. MERS was jointly owned by Fannie Mae and Freddie Mac (yes, those two again …I know, I know: like the chlamydia and the gonorrhea of the financial world…you cure ’em, but they just keep coming back).
“The purpose of MERS was to help in the securitization process. Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially where the digitized mortgage notes were sliced and diced and rearranged so as to create the mortgage-backed securities. Think of MERS as Dr. Frankenstein’s operating table, where the beast got put together.
“However, legally…and this is the important part…MERS didn’t hold any mortgage notes: the true owner of the mortgage notes should have been the REMICs.
“But the REMICs didn’t own the notes either, because of a fluke of the ratings agencies: the REMICs had to be “bankruptcy remote,” in order to get the precious ratings needed to peddle mortgage-backed Securities to institutional investors.
“So somewhere between the REMICs and MERS, the chain of title was broken.
“Now, what does ‘broken chain of title’ mean? Simple: when a homebuyer signs a mortgage, the key document is the note. As I said before, it’s the actual IOU. In order for the mortgage note to be sold or transferred to someone else (and therefore turned into a mortgage-backed security), this document has to be physically endorsed to the next person. All of these signatures on the note are called the ‘chain of title.’
“You can endorse the note as many times as you please…but you have to have a clear chain of title right on the actual note: I sold the note to Moe, who sold it to Larry, who sold it to Curly, and all our notarized signatures are actually, physically, on the note, one after the other.
To read this complete fascinating article go to: www.frontlinethoughts.com .
So it gets clearer to see now why the ‘robo signers’ headline is such an issue. The banks have been foresclosing on people without a legal right, and people that have bought foreclosed homes may not legally own them. What a tangled web we weave.
To be sure without securitization there will be no morgage market. If there is no mortgage market we will have to go back to ‘It’s a Wonderful Life’ and The Bailey Bank and Loan. This cannot continue. who will want to buy a mortgage without clear title? What title insurance company would back it?
So the banks are again in trouble over the same issue – mortgage back securities – again.
Could this all stop the rally? Always a hard quesiton but it bears watching. Trade the reaction.
Trade with a plan.