AGORACOM Small-cap Investor Relations Blog

As I write, DEC Gold is up $25 to $1,372.  Most commentators are discussing the usual suspects, which can be summarized as follows:

• Weakening $USD
• Anticipation of QE2
• Erosion of confidence in $US (and all fiat currencies)
• etc., etc.

However, I strongly believe a big reason behind gold’s recent surge has been the very issue I raised on October 5th in my article:  Checkmate – US Real Estate On The Verge Of Imploding, Pushing Gold Closer To $2,200.

If you are not fully up to date on this issue, then you need to read the article and get up to speed now.   Specifically, I stated:

Well, we are about to learn that markets can only be artificially maintained for so long. Eventually, they break free and revert to their true pricing levels. US Real estate is about to go through a mean dose of reversion, while simultaneously providing gold with additional fuel for $2,200.

Since then, in just a matter of a week, the problem has escalated to the point of this headline earlier today: Attorneys General in 49 States Join Foreclosure Probe. Highlights of the story include:

• The states will conduct a coordinated inquiry into whether banks and loan servicers used false documents and signatures to justify hundreds of thousands of foreclosures

• States including California and Colorado asked lenders to stop foreclosures.
• The attorney general of Ohio last week sued Ally Financial Inc., claiming fraud in foreclosure practices.
• In December, a GMAC employee said in a deposition in a foreclosure case in West Palm Beach, Florida, that his team of 13 people signed about 10,000 documents a month without verifying them.
• Bank of America Corp., the largest U.S. lender, extended a freeze on foreclosures to all 50 states Oct. 8 as concern spread among federal and state officials that homes were being seized based on faulty data.

HOW BAD IS THIS AND WHAT DOES IT MEAN?

I can go on and on – but the most important question that should be on your mind is “What are the potential economic and market implications of this?”. The answer can be summarized in the following statement by Georgetown Law Prof Adam Levitin:

The mortgage is still owed but there’s going to be a problem figuring out who actually holds the mortgage, and they would be the ones bringing the foreclosure.

You have a trust that has been getting payments from borrowers for years that it has no right to receive. So you might see borrowers suing the trusts saying give me my money back, you’re stealing my money.

You’re going to then have trusts that don’t have any assets that have been issuing securities that say they’re backed by a whole bunch of assets, and you’re going to have investors suing the trustees for failing to inspect the collateral files, which the trustees say they’re going to do, and

You’re going to have trustees suing the securitization sponsors for violating their representations and warrantees about what they were transferring.

If this were to come to pass — and plaintiffs lawyers will certainly be eager to show that their clients were paying the wrong mortgage holders — the value of all instruments (including the performing ones) could plummet.

BANKS COULD GET CRUSHED AS THIS MAY BE “TOO BIG TO SAVE”

In short, the whole system could freeze overnight.  I’m not so sure it hasn’t already frozen.  With the exception of brand new homes, who would risky buying a re-sale home now?  Title Insurance companies have already stopped insuring re-sales of foreclosed homes – but how long will it be until that is extended to all homes that:

• Were bought out of foreclosure in the past 5 years
• Whose mortgage may be in good standing (or slightly delinquent) but is “Title Undefined”

The big losers will be the banks and Wall Street because:

• They are not receiving any payments
• They will be sued by customers that purchased Mortgage Backed Securities that failed to properly have mortgages attached to them
• Underwriters face the threat of making CDO investors whole (Trillions of dollars)
• If fraud is proven, mortgage originators could be help liable.  They may be long gone but the securitizers (Wall Street) are not.

Given the fact we are talking about Trillions of dollars, the banks and Wall street firms can potentially go from “Too Big To Fail” to a problem that is “Too Big To Save”.  Major US banks could literally be shut down overnight, with shareholders losing every penny and bond holders forced to take a major hair cut.

Yep, it could get that bad.  Even it was 1/2 as bad, the inevitable outcome is another economic crisis of epic proportions that pushes investors away from the $USD and into gold.

Stay tuned.

Regards,
George