MERS: The Mirror Crack'd

Land Registration is sometimes a complex business. This is because law in English speaking countries (in general) allows a range of equitable and legal instruments to coexist; in a sense the mirror that land registration holds to reality is double-glazed and somewhat misted.

However, a growing number of state legislatures are now finding that the mirror is very badly cracked. The story is complex, (and explained well here) but it boils down to this. Because of securitization and financial innovation--that whole vast world of credit default swaps, bistro products, mezzanine risk, cds squared and cds cubed--mortgage companies and banks developed a huge volume of business. To avoid inefficiency, and state and county taxes, they created a very strange front company to technically own all mortgages in America, Mortgage Electronic Registration Systems.

This company could not under state laws nor under existing federal law own mortgages properly, because front companies with unpaid directors and vice presidents created to disguise ownership or avoid county fees are not meant to be acceptable. MERS was, however, tolerated. Successive regulators, Congresses and Departments of Justice ignored it. Now it is coming unstuck, leaving the vast majority of mortgages in America--and therefore the western economy--in legal limbo, and raising a serious problem for those who wish to foreclose.

Because the collapse of such a company into legal recrimination would affect the rich and powerful, rather than the little person, America's leaders and bankers are concerned at this development. Pressure is far too great from the states for the matter to be avoided, and that pressure has an obvious and clear safety valve in the courts. America's age of narcissism, with all its associated credit, may end, appropriately, with m'learned friends. As a general rule, the rich and powerful when significantly damaged exact a fairly bad revenge on human communities, since great wealth is not always earned honestly. In my experience, ethics and gold go together like moral philosophy and wolves.

In some ways, the MERS debacle deserves to be called a 'Reagan legacy'. Such was the indifference, bordering on contempt, for ethics and steady growth of that administration (led, as it were, by a charming but delusional liar) that the lesson taken from the savings and loan crisis which was kicked off by events on Reagan's watch was that small, serious banks should not be such ever again. Instead, they would become agents of growth and buccaneering adventure--I'm tempted to say, 'a thousand points of light' in deference to Peggy Noonan's work for Bush Senior--and part of the securitisation boom, which would prevent them from being collapsed by fleeter junk bond companies ever again. Into arcadia they did go--and look at the skulls they found there....

This is not going to be pretty, and I have no doubt that every effort is going to be made to look at that mirror on the wall and pretend that what it says has nothing of the truth about it at all.


Toni said…
Hmm, I have mixed thoughts concerning the whole "derivatives are evil" issue. I worked on the embryonic CDO market, but had been involved in credit derivatives for some time. I championed credit derivatives for a long time as I thought they were a superb instrument, if properly used, for diversifying risk. It was a fruitless task for a long while and in my case at least came out of my first job in the city which was the whole Brady bond plan for dealing with the defaulted syndicated loans to the emerging markets. I went away for a while and am not quite sure exactly what happened but suddenly the credit default swap market started gaining real momentum. In retrospect, it was probably the implementation of Basel II rules which meant we were not so much trading assets as trading appetite for risk to a certain company or market sector. Very soon we had a liquid market but what we needed was a customer base. The CDO market was perfect because in a low yield environment, investors were hunting for yield. It is worth remembering in the year 2000 holding a hundred million yens worth of Japanese Government Bonds would provide you with enough interest income to buy two cups of coffee in the Starbucks in Shinjuku. Pension funds and insurance companies needed investment income, but because of their tiresome rules they could only invest in assets that met a certain criteria. Once the rating agencies provided us with an investment grade rating we had it all, the supply, the product and the customers. The profits generated were incredible. Overnight regular bond trading was a joke.
Martin Meenagh said…
I don't think derivatives are evil; they were a sensible way to release capital from the gaps between illiquid trades and to buy time when the feds invented them in 1975, and fairly ok when superpowered in the late nineties. It's human folly, maybe overtrading, and bank behaviour, and the decline of real industry, real productivity, real education and real critical, long-term intelligence that has undone things. We supped off the derivative coke of the markets whilst dulling everyone else with taxes and regulations, and ignored the stagflation, oil crisis, and deficits which had caused what now seems to just be the 'warning crisis' of the seventies. This process was accompanied by a vast redistribution of wealth to subsidised global companies and an upper strata of rich; globalisation meant that the west developed its own third world. The other people who have done well are the South Americans and Africans and Asians, and good luck to them. Maybe Europe and America have just been on borrowed time for a long time.

Do you think that the safest thing to do was to let the market regulate itself, and use monetary and fiscal policy just to build up a proper economy that employed people to make things whilst regulating access to credit and mortgages? My prejudices direct me to that--leave the markets as a jurassic park jungle, toss an occasional cow in for the dinosaurs, and get on with life. I guess that would never work since we'd all develop mad corporate and municipal bonds markets and sell off building societies and so on because the energies of such a turbo charged market could not be contained.

I increasingly like the idea of very low but targeted regulations and very low, flat taxes with no loopholes. That's a pipe dream though.

Many thanks for the comment Toni, made me think.
Martin Meenagh said…
I mean the financial markets, by the way.
Toni said…
I have to defer to your knowledge as you are obviously better informed than I am. I was, however at ground zero for the CDO explosion and can assure regulation wasn't a problem we were highly regulated, the whole market was, which partly explains the complicated structure of most CDO's. A convenient tax haven was essential. The Caymans being first choice as you can get a business and account set up there in a matter of hours. The regulators and rating agencies had plenty of time to view what was being done - we also had a major accountancy firm overseeing the process on a consultancy basis, but my opinion was that external regulators were simply overawed by the cash flows involved. Also the team of four that structured our paper, which I wasn't a part of, much to my annoyance, were employed as a sort of in-house private consultancy and were assigned bonuses separately from the rest of the bank. The rewards for them were quite staggering, with nearly £30m being share between them in the first year alone. As something of a credit specialist I recall a meeting when the first issue was being prepared. The rating agencies had a fairly stringent set of criteria for a portfolio of securities or reference assets as we called them and this meant only buying a certain amount of bonds in any 1 company and a certain amount in any industry. I did point out buying 2 billion of assets in the time frame would be at best difficult and they said we will just use credit default swaps. The implications of this were that we no longer owned a portfolio of real assets but a portfolio of derivative contracts.
Martin Meenagh said…
I'd actually defer to you since the issues were meat and drink on your watch. I just find myself wondering where the situation arose--was it an emergent quality of a new technology like derivatives, added to new communications and transactions across frontiers that made the long boom possible? What you wrote made me think of the South Sea crisis. Shares were new then; the Southern trades seemed exotic, and yet accessible because of the new newspapers and their wide reach; politicians either didn't understand it or didn't care because they gained money and kudos from letting it go on. Intellectuals in the eighteenth century let themselves feel that they were living through an age of enlightenment--and then of course the first of many crashes came.

People forget. My prejudice is for stable, ordered society with rules, proper jobs and savings, and for financial markets to be free places but neither so central nor accessible that their energies wreck the economy.

The world in 2010 increasingly is like a Rashomon remake. Everyone sees the same facts and sees something different, and everyone may be a little right. I do think enormous rewards and the celebration of unrestrained greed store up trouble though. I also think that the market's obvious success encouraged the worst side of the political-media class and the wannabes, each of whom competed to be more indebted, cutting edge and laissez faire about everything than the other. People need limits and a sense of propriety in public matters....

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