OK I’m upping the ante here with some techno-speak. But I’ll try to make it as simple as possible.
YIELD is the percentage or dollar return on investment. For example,
- if you buy a bond for $1,000 and the interest rate is 5%, the yield is 5%.
- You are expecting to receive $50 per year in interest, which is your yield, assuming the bond is repaid in full when it is due.
- Another example is if you buy the same bond for $900.
- The interest rate is still 5% which means it still pays $50 per
year in interest. But instead of investing $1,000, you have invested
$900 and you are still getting $50 per year in interest.
- Your yield has increased because $50 is more than 5% of $900.
- In fact, it is a yield of 5.55% (yield base). You compute it by
dividing the dollar amount of the interest paid ($50) by the dollar
amount of the investment ($900). $50/$900=5.55%.
- But you are also getting repaid the full $1,000 when the bond comes
due so adding to the money you get in interest is the gain you made on
the bond (assuming you hold it to maturity). That difference in our
example is $100, which is the difference between $900 and $1,000.
- If the bond is a ten year bond, for simplicity sake we will divide
the extra $100 you are going to make by 10 years which means you will
be getting an extra $10 per year.
- If you divide that extra $10 by your investment of $900 you are
getting an average annual gain of 1.1%. Adding the base yield of 5.5%
to the extra yield on gain of 1.1%, you get a total yield of 6.6%.
- The difference between the interest rate on the bond (5%) and the
real yield to you as the investor (6.6%) is 1.6%, which could be
expressed as a yield spread.
YIELD SPREAD can be expressed in either principal dollar terms or in
interest rate. In the above example the dollar value of the yield
spread is $100, being the difference between the par value of the bond
(the amount that you hope will be repaid in full) and the amount you
For decades there has been an illegal trick played between
originating lenders using yield spread that resutled in an additional
commission or kickback paid to the mortgage broker, commonly referred
to as a yield spread premium. This occurs when the broker, with full
consent of the “lender” steers the homeowner into a loan product that
is more expensive than the one the homeowner would get from another
more honest broker and lender.
- So for example, if you qualify for a 5% (interest) thirty year
fixed loan, but the broker convinces you that a different loan is the
only one you can qualify for or that the different loan is “better”
than the other one, we shall say in our example that he steers you into
a loan for 7%.
- The yield spread is 2% which may not sound like much, but it means everything to your loan broker and originating lender.
- The kickback to the broker is often several hundred or evens
several thousand dollars — which is the very thing consumers were
intended to be protected against in TILA (Truth in Lending Act).
- By not disclosing the yield spread premium he deprived you of the
knowledge that you get get better terms elsewhere and he didn’t bother
tell you that instead of working for you he was working for himself.
- Sometimes this is discovered right on the HUD statement disguised
amongst the myriad of numbers that you didn’t understand when you
signed the closing papers. They were required by federal law to
disclose this to you and they are required to send you back the money
that was paid as the kickback and for a variety of reasons it is
grounds to rescind the transaction, making the Deed of Trust or
mortgage unenforceable or void.
- The kickback is called a yield spread premium in the language of
the industry. On this phase of the transaction we’ll call it Yield
Spread Premium #1 or YSP1.
Now we get to the securitization part of the “loan.” If
you will go back to the beginning of this article you will see that the
investor was seeking and expecting $50 per year in interest. Buying the
deal for $1,000 gives the investor the 5% YIELD he was seeking.
What Wall Street did was work backwards from the $50,
and asked the following stupid and illegal question: What is the least
amount of money we could fund in mortgages and still show the $50 in
income? Answer: Anything we can get homeowners to sign.
- In our simple example, if they get a homeowner to sign a note
calling for 10% interest, then all Wall Street needs to come up with is
$500. Because 10% of $500 is $50 and $50 is what the investor was
- Wall Street sells the bond for $1,000 and funds $500 leaving
themselves with a YIELD SPREAD PREMIUM of 5%+ or a value of $500, which
is just as illegal as the kickbacks described above. We will call this
YIELD SPREAD PREMIUM #2.
- They take $50 out of this $500 YIELD SPREAD PREMIUM and put into a
reserve fund so they can pay the interest whether the homeowner pays or
not. That is why they don’t want homeowners and investors to get
together, because they will discover that the investor was paid the
first year out of the reserve and payments from homeowners and then
stopped receiving payment even though there was continued revenue.
- But Wall Street also had another problem. Since they had siphoned
off $450 and probably sent most of it off-shore in an off balance sheet
transaction (to a Structured Investment vehicle [SIV]). the time would
eventually come when the investor would want his $1,000 repaid in full
just like they said it would. That would leave them $450 short and
possibly criminally liable for taking $1,000 to fund a $500 mortgage.
- So you can see that if the homeowner pays every cent owed, this is
bad news to the people on Wall Street. They would be required to give
the investor $1,000 when all they received from the homeowner was $500.
Therefore they had to make certain that they (a) had a method of
covering the difference that would give them “cover” when demand was
made for the $1,000 and (b) a method of triggering that coverage.
- They also needed to make it as difficult as possible for investors
to get together to fire the agent of the partnership (SPV) formed to
issue the bonds they bought, which they did in the express terms of the
bond indenture. So logistically they needed to keep investors away from
investors and to keep investors away from borrowers so that none of
them could compare notes.
- To cover the money they took from the investor they purchased
insurance contracts (credit default swaps is one form). They wrote the
terms themselves so that when a certain percentage of the pool failed
they could declare it a failure and stop paying the ivnestors anything.
The failure of the pool would trigger the insurance contracts.
- Under normal circumstances if you buy a car, you can insure it once
and if it is wrecked you get the money for it. Imagine if you could buy
insurance on it thirty times over at discounted rates. So you smash the
car up and instead of receiving $30,000 for the car you receive
$900,000. That is what Wall Street did with your mortgage. This was not
risk taking much less excessive risk taking. It was fraud.
- So IF THE LOAN FAILED or was declared a failure as being part of a pool that went into failure, the insurance paid off.
- Hence the only way they could cover themselves for taking $1,000 on
a $500 loan was by making absolutely certain the loan would fail.
- It wasn’t enough to use predatory loan tactics to trick people into
loans that resulted in resets that were higher than their annual
income. Wall Street still had the problem of people somehow making the
payments anyway or getting bailed out by parents or even the government.
- They had to make sure the homeowner didn’t want the loan anymore
and the only way to do that was to make certain that the homeowner
would end up in a position wherein far more was owed on the loan than
the house ever was worth and far more than it would ever be worth in
the foreseeable future.
- They had to make sure that the federal government didn’t step in
and help the homeowners, so they created a scheme wherein the federal
government used all its resources to bail out Wall Street which had
created the myth of losses on loan defaults for notes and mortgages
they never owned. It would then become politically and economically
impossible for the government to bail out the homeowners.
- This is why principal reduction is off the table. If these loans
become performing again, insurance might not be triggered and the
investors might demand the full $1,000. With insurance on the $500 loan
they stand to collect $15,000. without it, they stand to lose $1000.
There is no middle ground.
- So they needed a method to get the “market” to rise in values as
much as possible to levels they were sure would be unsustainable. That
was easy. They blacklisted the appraisers who wanted to practice
honestly and paid appraisers, mortgage brokers and “originating
lenders” (often owned by Wall Street firms) 3-10 times their normal
fees to get these loans closed. They created “lenders” that were not
banks or funding the loans that had no assets and then bankrupted them.
- With the demand for the AAA rated and insured MBS at an all-time
high the demand went out to mortgage brokers not to bring them a
certain number of mortgages but to bring in a certain dollar amount of
obligations because Wall Street had already sold the bonds “forward”
(meaning they didn’t have the underlying loans yet).
- With demand for loans exceeding the supply of houses, they
successfully created the “market”conditions to inflate the market
values on a broad scale thus giving them plausible deniability as to
the appraisal fraud on any one particular house.
Whether you call it appraisal fraud or simply an undisclosed yield
spread premium, the result is the same. That money is due back to the
homeowner and there is a liability to the investors that they don’t
know about. Why are the fund managers so timid about pressing the
claims? Perhaps because they were not fooled.
Filed under: CDO, CORRUPTION, Eviction, GTC | Honor, Investor, Mortgage, bubble, currency, foreclosure, securities fraud | Tagged: appraisal fraud, bailout, credit default swaps, insurance, pool, SIV, TILA, yield, yield spread, yield spread premium