The Trillion Dollar Fraud

The above title is used by John R. Talbott for a May, 2010 article at Talbott describes the transfer of $1.2 trillion in assets from banks onto the Fed balance sheet, about $1 trillion of this in MBSs (mortgage backed securities). The actual value of these securities is unknown because there is no accounting surveillance.

The Settlement 

Today (January 3, 2011) it was announced that Bank of America has reached a settlement with Fannie Mae and Freddie Mac to pay them $2.8 billion compensation for the bank having sold the GSEs (Government Sponsored Enterprises) bad mortgages.  In the GEI News Blog editorial notes it was pointed out that the actual eventual losses on these bad mortgages are unknown and may be many times the $2.8 billion settlement amount.  This action may well be the start of a process that will be a backdoor bailout, transferring many billions (or even hundreds of billions) of bank losses to the federal government.  Just such a process was described by Talbott last year and will be described below. 

Total Exposure is Unknown

Without an accounting there is no way to know if any of these MBS assets are as toxic as the synthetic CDOs that went into the Abacus 2007-AC1 securities offering by Goldman Sachs (GS) that quickly lost all value and are the subject of the civil case SEC vs. Goldman Sachs. William K. Black has testified that, as a class, the so-called “liar loan” sub prime mortgage issuance has resulted in losses between 50% and 85%.

How much of the MBS related securities acquired by the Fed have resulted in (as yet unrecognized) losses of more than 50%? How many toxic assets were acquired at nominal value when they contained large current and future unrealized losses? How many other assets were acquired above true value?

Money Laundering and Backdoor Bailouts

Talbott describes the motivation of the Fed to engage in such questionable operations – namely, banks would have collapsed into bankruptcy without the deception. Talbott goes on to describe how Fannie and Freddie can be used in the future as a mechanism for the Fed (with government complicity) to transfer the bad assets to the taxpayers. Since the GOEs (government owned enterprises) are off balance sheet to the federal debt, the deception can be hidden from less discerning observers.

I have previously reported on the process by which worthless junk, such as the Abacus 2007 AC-1 securities mentioned above, was magically transformed into AAA rated securities which quickly became worthless as the housing bubble started to collapse.

Bad Forestry Practices

About two years ago I wrote that I feared the path chosen by the Bush administration (which has been continued by the Obama administration) was aimed at saving some diseased trees at the risk of the health of the rest of the forest. I still think that metaphor is appropriate.

If you have disease in some trees in the forest, you have a choice: (1) remove the diseased trees so that the disease can not spread; or (2) treat the diseased trees and hope the disease does not spread. We have chosen (2). It appears the disease may still be spreading.

Bank of America is Still in the Forest

Bank of America is still far from out of the woods.  The $2.8 billion settlement covers only mortgages produced by Countrywide up to 2008 for Freddie Mac and is less specific for Fannie Mae.  Other government claims may still be made.  And others besides the government may also make claims.  One estimated is that MBS (mortgage backed securities) insurers may have claims in the $10 – $20 billion range.  And of course we have the potential for claims from other banks, pension funds and others.  The putback process for BAC is just beginning. 

Notes about John R. Talbott: He is a former executive in the investment banking arm of Goldman Sachs. See my article for the difference between bankers and traders. Talbott has also been an international economic consultant, a visiting scholar at UCLA’s Anderson School of Management, a contributor to several leading newspapers and a commentator on many news and financial media outlets.

Talbott has authored several noteworthy books. My favorites are:

  • “The Coming Crash in the Housing Market” (2003)
  • “Sell Now! The End of the Housing Bubble” (2006)
  • “The 86 Biggest Lies on Wall Street” (2009)

He is currently working to eliminate the power of corporate and banking lobbyists in Washington. I have corresponded with him on that topic over the past year and plan to support his efforts.

Added Note:  Part of this article was written May 10, 2010.

Related Articles

Just What is the MBS Outback Exposure for Banks  by John Lounsbury

The Great Debate©:  Will Housing be a Drag on the Economy in 2011?  Part1  by John Lounsbury

The Great Debate©:  Will Housing be a Drag on the Economy in 2011?  Part 2  by John Lounsbury

21% Decline Forecast for December 2010 Existing Home Sales  by Steven Hansen

New Home Sales Remain At Historic Lows by Steven Hansen

The Great Debate©:  Residential Construction is Dead – Or Is It?  by William C. Wheaton and Gleb Nechayev

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