Meet Our Short Sale Nemesis: the Shadowy "The Investor"

The Investor. Just the name strikes fear into the heart of even the most stalwart short sale agent. The Investor. That guy or gal who can tank the deal you have slaved over for many months with a wave of his/her hand. Who IS this person? I sort of picture the Wizard of Oz: "Who are you?", he bellows. The trembling negotiator steps hesitantly forward. "Please, sir, I would like to present an offer on this property..." "Silence!!! The great and powerful The Investor knows why you have come. Leave and do not return until you bring me a better price, a promissory note from the seller, and a reduction in the real estate agents' commission!"

But somewhere, hidden behind that curtain, is a guy or gal just trying to do a job. So who are they actually? Let's back up a bit and revisit what happened to the bulk of home loans originated at the height of the market. 

As home loans became more "creative" (read: "nonconforming") and the quality deteriorated, most were sold to large Wall Street investment banks. Once there, they were packaged into bundles (securitized) and sold to investors as mortgage bonds known as mortgage-backed securities (MBSs). Now it would be logical to presume that each individual MBS bond contained a discrete subset of the purchased mortgages, but that isn't how it worked. Rather, the mortgages were dumped into big piles. Then the risk and reward of each pile was divided into layers called tranches (French for "slice"). Interest on the MBSs in the safest tranche was paid first each month as the payments rolled in, but at the lowest interest rate. The riskiest tranche bondholders were paid last, at the highest rate, but were the first to miss payments if the homeowners in the pool started to default. About 80% of the MBSs were triple-A rated; only the very riskiest were rated lower. However each tranche that was created from that pile of mortgages contained the same mortgages; the reason the lower tranches received low ratings was because they assumed the greatest risk of nonpayment, not because they contained riskier mortgages. And there is no 1:1 correlation between mortgages and note holders. 

It gets worse. Some of the tranches sold better than others; many purchasers of these sort of securities such as pension funds are limited by their charters to purchasing triple-A rated securities.  So the unsold MBSs in the lower rated tranches from multiple pools were dumped into another big pile and turned into collateralized debt obligations, or CDOs, made up of MBSs rather than actual mortgages. New tranches were created, wherein previously poorly rated MBSs were doused with Eau de BS and reincarnated as investment grade securities. Once again, about 80% of them were rated triple-A, compliments of asleep-at-the-switch rating agencies. Various other creative and almost incomprehensible permutations such as synthetic CDOs and CDO-squareds were concocted by those wizards of Wall Street, but I think you get the picture.

So...you've probably noticed that we are getting an increasingly larger disconnect between an individual mortgage and the actual investors in the note. How could all of the end investors be consulted every time an individual mortgagor wished to modify his loan or short sell his property? Clearly, that would be impossible. Instead, each time a security was created, a pooling and servicing agreement (PSA) was created as well, complete with a trustee (actually several) to oversee its terms. One of those trustees is our infamous The Investor. In theory, he exists to protect the interests of the actual end investors. But many cynics believe that the interests that are being protected are those of the loan servicers, whose payday increases dramatically when servicing a loan in default. Foreclosure defense attorneys complain bitterly that, with the exception of Fannie and Freddie loans, it is almost impossible to discover the identity of the true investor(s). Loan servicing companies blithely blame "The Investor" for their refusal to agree to loan modifications and/or short sales, and, with no access to the PSA, it is difficult to refute.  Fannie Mae has recently released guidelines suggesting that they will not tolerate a lot of foot dragging and delay from servicers, but for the huge quantity of loans packaged as described above, The Investor remains a man of mystery, as do those he purports to serve.

Photo credits:

• Layer Cake by Jonny Hunter
• Wizard of Oz by Mononukleoza
• Batman by Joe Shlabotnik

All from Flickr via Creative Commons License  

Recommended reading. For those of you that are interested in this stuff, the following books provide a fascinating and more in-depth look at the financial meltdown and mortgage securitization:

1. Gasparino, Charles: The Sellout. HarperCollins Publishers, NY, 2009. 
2. Lewis, Michael: The Big Short. W. W. Norton & Company, NY, 2010.