Chris Kuflik - ScotiaMcLeod Montreal

In September Ben Bernanke discussed “potential negative shocks” as the rationale for an unusual pre-announcement that the US Fed stood ready to execute another massive round of quantitative easing dubbed QE2. The timing of the announcement was suspect, to say the least. There is a potentially large storm brewing in the US financial system that I hope can be avoided.

Market participants at the time took Mr. Bernanke’s statement to mean that the Fed would embark on QE2 to stimulate growth in a sluggish US economy. Markets rallied sharply with the belief that the Feds would backstop the US economy with QE2. There is currently a bigger problem which has been largely ignored, that could emerge from the US housing market. In the last week, several large financial institutions have temporarily suspended mortgage foreclosures which were the result of "robo-signing" of housing-related documents. Thousands of lawsuits are being filed. States attorney generals are banding together to investigate, sue, and more than likely charge big banks, Freddie and Fannie, and mortgage servicers with fraud.

The largest banks in America, Freddie and Fannie created a company called MERS (Mortgage Electronic Registration Services).  The purpose of MERS was to establish an electronic means of moving mortgages easily from one bank or lender to another so they could be traded in and out of securities pools of mortgage-backed securities. It seems that MERS, a “nominee” owner of the mortgage, was also created to avoid paying recording fees. In the US, when an individual or company purchases a property, they receive title to that property. If there is a mortgage on that property, the lender is named on the title as possessing an encumbrance on the property - namely the mortgage. Every time a mortgage is traded from one lender or pool of mortgage backed securities to another, a new title has to be recorded naming the new mortgage holder on the title. Each time the title changes owner a "recording fee" is supposed to be paid to the local government where the property is located. Hundreds of millions of title changes were executed electronically without paying recording fees. The financial institutions used people who weren't actually mortgage holder representatives to sign off on foreclosure documents.

There is also a question about the legality of having documents signed by people who were acting on behalf of a “nominee” who isn't a rightful lender or owner of any real mortgage and therefore could not institute foreclosure proceedings. In addition, the financial institutions could be sued for criminal intent to defraud governments out of recording fees by States attorney generals. The Federal Reserve is afraid that the fallout from this debacle could panic financial markets and sink the economy.

There are many problems which could arise should this mess not be solved quickly. Among them:

1) Purchasers of foreclosed properties may sue as to the validity of the titles that they hold

2) Those who were foreclosed could sue to get their property back

3) If homes can't be foreclosed, due to the moratoriums put in place, inventories will build. US housing prices could crash again when this inventory hits the market.

4) Local cash strapped governments could, and probably will, sue banks for potentially hundreds of billions of dollars of recording fees they did not receive.

5) Criminal fines could add hundreds of billions of dollars more to the banks liabilities.

US banks still own most of their mortgage related assets. Currently, these assets are buried, with the consent of the Fed and Treasury waiting for an economic recovery and low rates to let borrowers re-finance and pay them back. What happens if there's widespread panic that this new round of mortgage-related stress won't be fixed quickly? Banks would be forced to raise capital, increase loan loss provisions once again and could restrict the availability of credit.

Is this going to happen? I certainly hope that this doesn’t come to fruition. My intent is not to alarm, but to make you aware of the possibility that there is a potentially large storm cloud on the horizon which could derail the fragile global economic recovery. Does this mean that we should sell and move to cash? Not at this time, but to help mitigate this risk, we will employ tighter stop losses than normal…just in case it becomes a large problem.  

Please feel free to call us to discuss your personal situation. In addition, please feel free to share this article with someone you feel would benefit from its contents.

Chris Kuflik

Associate Director, Wealth Management

Wealth Advisor

514-287-2931

This e-mail address is being protected from spam bots, you need JavaScript enabled to view it  

Visit our website at www.chriskwealth.com

^® Registered trademark of The Bank of Nova Scotia, used by ScotiaMcLeod under license. ScotiaMcLeod is a division of Scotia Capital Inc. Scotia Capital Inc. is a member of the Canadian Investor Protection Fund.

This publication is intended only to convey information. It is not to be construed as an investment guide or as an offer or solicitation of an offer to buy or sell any of the securities mentioned in it. The author is an employee of ScotiaMcLeod, a division of Scotia Capital Inc. ("SCI"), but the data selection, analysis and views expressed herein are solely those of the author and not those of SCI. The author has taken all usual and reasonable precautions to determine that the information contained in this publication has been obtained from sources believed to be reliable and that the procedures used to summarize and analyze such information are based on approved practices and principles in the investment industry. However, the market forces underlying investment value are subject to sudden and dramatic changes and data availability varies from one moment to the next. Consequently, neither the author nor SCI can make any warranty as to the accuracy or completeness of information, analysis or views contained in this publication or their usefulness or suitability in any particular circumstance. You should not undertake any investment or portfolio assessment or other transaction on the basis of this publication, but should first consult your investment advisor, who can assess all relevant particulars of any proposed investment or transaction. SCI and the author accept no liability of whatsoever kind for any damages or losses incurred by you as a result of reliance upon or use of this publication in contravention of this notice.