It is important to note
That according to the draw schedules, posted many times here, that the interest payments were included in the $187 billion. One of the reasons used by Treas and FHFA for the sweep (according to the court docs) was the interest was being paid using part of the borrowed money.
As a mortgage company insider, I watched what I am about to write about happen in real time. It changed my world. I am 62 years old now and will never recover what I once had.
Some questions that will be discussed here.
Where all the money came from for FNMA to pay back the loans?
Why did the market really crash?
How did the hedge funds do it?
Why is Wag The Dog Important here?
Here is the first of the Horsemen of the Apocalypse.
Hedge funds began massively shorting the mortgage industry.
Then there was a new accounting rule that went into effect around '05-'06. It was called "Mark to Market". It was pushed on the accounting standards board by the hedge funds who were hounding everyone looking for a profit for their shorts.
Before that, the "Present Value Of Future Payments" method was being used to value mortgage portfolios. Present value of the payments minus reserves for doubtful accounts. This is how you place a value on an income producing asset that has little or no market.
Mark to market now meant the portfolios had to be valued as if they were for sale at all times even though they were mostly being held to maturity by institutions who were not interested in selling.
Massive shorting followed by Mark to Market is what brought down the mortgage industry. The hedges shorted the entire industry into oblivion.
From this point, it gets a little technical. I will try to make this understandable. It involves a great deal of "Wag The Dog".
Here is how they did it.....
First, all mortgage companies who created and sold portfolios had to guarantee the performance of those portfolios. Using NFI as an example, they would create and sell a portfolio that would yield a specified rate of interest and guarantee no more than a 6% default ratio of the underlying mortgages. Their underwriting was such that the default ratios never exceeded 1%-2% total loans and after sale of the foreclosures netted even or better on the balances.
So, the bottom line is their portfolios performed as agreed or better than agreed.
So, how do you place a value on the vast majority of those portfolios that are not for sale and never will be?
Enter the credit default swap. The CDS was essentially an insurance policy issued by Goldman Sachs and a few others underwritten mainly by AIG and a few others. Mortgages in the Rah Rah real estate market were safe and did not require much, if any reserves.
Here's the second of the Horsemen of the Apocalypse. Credit default swaps were supposed to guarantee the returns on their underlying mortgage portfolios and securities.
So how does shorting make a profit in this environment?
Crappy people buying houses they can't afford. This is the Wag Of The Dog. Pay attention to the media and not to what is really going on in the market.
It goes to the mortgage companies and their guarantees. In those guarantees, one of them, was the guarantee that the mortgage companies would maintain a specific net worth. Here is where shorting took its toll.
After the dot com bust, hedge funds as an industry had over $4 trillion in assets. Roughly the amount of the entire US gov budget that year. That is the kind of ruling class money that makes or breaks entire countries. Add to that naked shorting which leveraged that $4 trillion to many times that amount. Like Buffett, the hedgies had to do something with that money. Pick a country to take down. Which one? Remember. If a hedge fund goes long, they have to go public with paperwork filed with the SEC. They can short 500% of a company naked and keep it a secret what they are doing.
The US mortgage industry was only about $8 trillion and was an easy target.
First, pile on the shorts. Second change the accounting rules in effect for over a 80 years to the new "Mark to Market"
Mortgage companies were being hurt by the shorting. Now things were shaky but not falling off the cliff yet.
Remember the Credit default swaps? They were being sold based upon the value of the underlying mortgage portfolios which were performing as agreed. They took on a completely new significance.
Since there really was no secondary market for mortgage portfolios the price of the credit default swap began to be used to value the underlying portfolios. I guess that is OK if the only people buying them were the investors holding the portfolios. It just meant there was an additional layer of security underwritten by AIG.
In rides the Third of the Horsemen Of the Apocalypse. Goldman and Lehman began selling the CDS paper to anyone who wanted to buy it.
Now, why would a disinterested third party (hedge fund) want to own a CDS? How would they profit from that ownership?
The only way to make a profit is for the underlying portfolio to default.
Kinda like selling a guy down the street a fire policy on your house. He only makes money if your house burns down.
Things are about to get VERY UGLY.
Remember, all of the portfolios and securities in the market, with the very rare exception, were performing as agreed the market is still OK.
Now, when Lehman or Goldman sell a CDS on a portfolio, everything is OK. When they sell the second CDS on the same portfolio, that second one was technically a "Short". Goldman and Lehman sold many CDS policies on each portfolio. Now there are many savvy investors in the market who want and need for the industry to collapse. Kinda like selling everyone in your neighborhood a fire policy on your house.
Is it getting scary yet?
GS and Lehman sold so many CDS policies short that the market for them began to crash. The price dropped from Par to $.20 on the dollar.
With the CDS being used to value the illiquid portfolios, and with Mark To Market being the rule, the accounting value of the portfolios was adjusted to $.20 on the dollar and it didn't matter how well it was performing.
Here rides in the 4th of the Horsemen of the Apocalypse.
Remember the guarantees being made by the mortgage companies when they sold their portfolios? Remember the part about maintaining a required level of net worth? Reserves had to be increased. Reserves were increased by selling stock in the market.
Pay attention. The crash is very near now. Things are speeding up quickly.
Remember the massive shorts already piled on by the hedge funds? Now they start naked shorting because bankruptcy is very near AND THEY ARE NEVER GOING TO HAVE TO COVER. The price of mortgage companies crash. The net worth requirements are no longer able to be met. Technically, the mortgage companies are in default with their agreements.
Now, because of the defaults and the huge cuts in the values of the underlying portfolios, the institutions who originally were never going to sell their paper, demanded that the mortgage companies buy them all back.
Nobody could do that. Mortgage companies don't and never did have that kind of money and never will. GOING TO THE MARKET FOR NEW CAPITAL WAS NO LONGER AN OPTION. The mortgage market collapsed and, with it, the real estate market. Every mortgage company in America filed bankruptcy and the hedge funds never had to cover any of their shorts, naked or otherwise.
The entire industry crashed and burned. Hedge funds and Mark to Market killed them all. Everybody, no exceptions, filed bankruptcy. AIG was down in flames until the hedge funds holding the CDS paper got the government to step in and bail them out. Goldman got to change their status and was able to place its blood funnel directly into the Fed Funds window.
So, why did the hedge funds leave Fannie and Freddie relatively unscathed? Could it be that the penalty for Treason is Death? Could it be that they didn't want to learn Russian?
Who knows?
I do know that the $189 billion was not for losses but to maintain "Net Worth".
I also know that "Mark To Market" has gone the way of the dinosaur since early 2012.
And I also know that the $200+ billion was reserves freed up by the subsequent increase in value of the portfolio now it is again beilg valued at "present value of future payments". The $$ billions paid by the settling banks added to the cash profits of the company don't come anywhere near that $200 billion figure.
I also know that the Crappy Borrower who was maligned in the media as the reason for the crash was just "Wag the Dog"
The question you need answered now is "Where do they go next?".
They now have unbelievable amounts of capital to work with.
Wag The Dog.
