How to Stop Foreclosures
If I default on my $300,000 mortgage Bank of America will collect approximately $550,000 to $650,000. If my friend defaults on their $500,000 mortgage Goldman Sachs will collect $900,000 to $1.2 million (depending on interest rates, term of the mortgages, and credit ratings).
Why do they collect such a big payout? Because they have insurance on the Mortgage-Backed Securities that hold the mortgages. When an MBS goes into default, the insurance pays. Why do they collect so much more than the face value of the mortgage? Because, over the life of the loan the mortgage would have generated 2 ½ to 3 times the face amount in cash flow, minus discounts; the insurance covers that anticipated cash flow, not the nominal value of the original mortgage.
What is this insurance? Credit Default Swaps are essentially insurance for Mortgage-Backed Securities. If a certain percentage of mortgages held in the MBS go into default then the MBS defaults and the insurance is paid. AIG Financial Products was the largest writer/issuer of CDS contracts. With the government’s backing AIG has paid out tens of billions in claims on CDS contracts.
CDS is not typical insurance; it is almost completely unregulated; an investor can purchase a CDS contract/insurance policy even though they have no insurable interest in the underlying mortgage or even the underlying MBS; if CDS insurance is purchased that covers my mortgage, I do not receive any notification. The homeowner has been unilaterally stripped of their mitigation rights as a party to the contract by the purchase of CDS contract. This, in effect, modifies the original contract without consideration to the homeowner for that modification.
We do not allow doctors to purchase life insurance policies on their patient's lives without the patient’s knowledge and then be in charge of making life and death decisions for the patient’s treatment. I trust my doctor but we all recognize that it is reckless and foolhardy to subject that trust to excessive temptation. We do allow mortgages investors to purchase default insurance policies without the homeowners’ knowledge and, if delinquency occurs, we recklessly tempt these investors to make the decisions on whether the loan will be modified or go into default.
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http://aboutpalmcoast.blogspot.com/2010/02/it-pays-to-default-on-your-mortgageit.html