Engdahl: FInancial Tsunami – Part 1


Richard Moore


The Financial Tsunami: Sub-Prime Mortgage Debt is but the Tip of the Iceberg

By F. William Engdahl

Global Research, November 23, 2007

Part 1: Deutsche Bank¹s painful lesson

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 
CDO¹s‹Collateralized Debt Obligations and CMO¹s‹Collateralized Mortgage 
Obligations. By now every serious reader has heard the term ³It¹s a crisis in 
Sub-Prime US home mortgage debt.² 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 ³Financial 
Tsunami² 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 
world¹s largest banks with over ¤1.1 trillion (Billionen) in assets worldwide. 
As Hilmar Kopper used to say, ³peanuts.² It¹s 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. DB¹s 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 ³intent to convey the rights in the mortgages.² 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 ³global securitization², where banks like 
DB or Citigroup buy tens of thousands of mortgages from small local lending 
banks, ³bundle² them into Jumbo new securities which then are rated by Moody¹s 
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 ³bundle² of say 1,000 different 
home mortgages, contained maybe 20% or 200 mortgages rated ³sub-prime,² i.e. of 
dubious credit quality.

Indeed the profits being earned in the past seven years by the world¹s 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 ³sub-prime² losses.

A new unexpected factor

The Ohio ruling that dismissed DB¹s 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 CMO¹s 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. That¹s a lot by any measure!

In the Ohio case Deutsche Bank is acting as ³Trustee² for ³securitization pools²
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 ³seem 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,² the Judge concluded, ³their weak 
legal arguments compel the court to stop them at the gate.² 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 ³interest only² 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. Greenspan¹s 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 world¹s 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 1630¹s 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 ³interest only² 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 ³interest only² 
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 ³peanuts² by 
comparison. We will discuss the global geo-political implications of this in our
next report, The Financial Tsunami: Part 2.

F. William Engdahl is the author of A Century of War: Anglo-American Oil 
Politics and the New World Order. He is a Research Associate of the Centre for 
Research on Globalization (CRG).  His most recent book, which has just been 
released by Global Research is Seeds of Destruction, The Hidden Agenda of 
Genetic Manipulation.

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  © Copyright F. William Engdahl, Global Research, 2007
© Copyright 2005-2007 GlobalResearch.ca

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