By Monique Terrazas
May 2013 – SA Real Estate Investor – Money grows on trees
(This post is old but just as valid today until we End the Fed, which is a non-permanent non-banking debt system, and move to an alternative permanent value-backed real money and real banking system.)
The banking and Financial system globally is under scrutiny as scandal after scandal rocks what we had always assumed was a trustworthy industry, solid as rock. But things have changed. There is little doubt that the irresponsible practice of securitization and inter-bank lending brought about the global credit crunch. After setting in motion the subprime crisis that dumped the global economy into the worst recession in living memory, banks were exposed for manipulating the Libor and Euribor interbank interest rates- providing false figures on key interest rates upon which mortgages and loans are priced – affecting millions of families and hundreds of thousands of companies, large and small, across the globe. As one commentator noted: “This dwarfs by orders of magnitude any financials cam in the history of the markets. In addition, the information age has brought to the man in the street the knowledge that “money” is no longer backed by gold reserves, but fabricated through the fractional reserve banking system. Given how pervasive the financial system is – affecting every aspect of our lives – it has become critical that we move out of our comfort zone where ignorance was bliss. We need to become far more proactive and involved, understanding thoroughly how the system works. This is the only way in which we can shift from being victims of a system we have helped to create through ignorance, complacency and greed, to becoming empowered consumers and users of these systems, understanding the rules so we can play the game or step outside the game for our own collective best interests, and the interests of generations to come.
Understanding the rules
We cannot play on an equal footing in the global financial system if we don’t understand the rules. While learning the rules requires time, effort and dedication, it is absolutely necessary if we are to become empowered players, instead of victims. It is not possible to explain the intricacies of the entire global financial system in one article, but there are a few concepts that, once understood, will help us to understand the basic tenets of the system, notably the fractional reserve banking system and securitization.
The fractional reserve system
In previous articles in REIM, we revealed that banks do not actually lend out money they already possess, but rather “create” the money loaned to borrowers, using the “promise to pay” signed by the borrower. In other words, “money” is created through debt. This is called a ‘fractional reserve’ banking system, and it is used by governments, central banks and financial institutions across the globe. On a national scale, central banks print money that has no intrinsic value, based on a “promise to pay” issued by a government. Because this new “money” has no intrinsic value, it derives its value by literally taking value from the money already in circulation, and this is what is called “inflation”. The money already in circulation is worth ever less to give value to new money that is printed. This practice was taken to extreme in Zimbabwe not so long ago, when the government’s practice of simply printing more money at a rate well in excess of economic growth, sent inflation to levels above 1 000%, rendering the money already in circulation worthless. Of course, today, they do not really actually “print” more money, but simply “create” the money through a “deposit entry”, even though no deposit was made by anyone! The same happens when a borrower approaches a bank for a loan. The bank does not actually have the money it “loans” to the borrower. They simply “create” money, through similar electronic “deposit entries” or “book entries”, simply based on a borrower’s “promise to pay”, with no actual deposit being made by anyone, anywhere. This raises a number of issues, including the legal validity of a “loan” and the legality and the morality of charging interest on such a “loan”. It has been contested in a number of court cases that a “loan” agreement cannot exist legally under these circumstances, because the bank did not “lend” something they had prior title, ownership and rights to. The “money” lent to the borrower did not exist before the borrower signed the all-important “promise to pay”, but was “created” based on the borrower’s “promise to pay”. How can a loan agreement exist when nothing was loaned? This, furthermore, raises issues around the charging of interest. How can the bank charge interest on a “loan” that is not legally valid? If the “money” loaned is “created” out of nothing more than a “promise to pay” – which belongs to the borrower – and the bank does not loan its own money to the borrower, why is interest charged by the bank? “A management fee payable to the bank for managing the system seems more appropriate,” comments Robert Vivian, Professor of Finance and Insurance at the School of Economic and Business Sciences at the University of the Witwatersrand.
Another hot topic over the last few years is the practice of securitization. Banks securitize loans by bundling them together, using a special purpose vehicle (SPV), and selling them to third party investors, who trade them on the capital markets. For example, in the home loan market, the borrowers’ promissory notes are backed by collateral through the mortgage contraction the property. As such, these become “mortgage-backed securities”. The bank approaches another institution that buys and sells mortgage-backed securities. It “sells” the buyer’s mortgage-backed security to this institution for the full amount – the principal and interest – payable by the buyer over the period of the mortgage loan. This is up to three times the amount of the principal debt. Since the bank is paid in advance, it makes a tidy profit without using or risking its own money. However, legally, once a bank securitizes a loan, it loses all rights to it – i.e. the bank is no longer the owner of the debt. Should the borrowers default on their loans, the debt to the SPV and its investors are covered by insurance policies, called “credit default swaps” in the US and other countries. While the use of this insurance has not been confirmed in South Africa, it stands to reason, according to legal experts, that an SPV trading on a stock exchange would be required to have this insurance in place. The South African Securitization Forum has confirmed that the implication of this is that the bank cannot, for example, repossess
the property if the borrower defaults on repayments, because the bank no longer has any rights to the property that is the collateral for a “loan” which has been securitized and now belongs to another entity. Quite simply, there can be no legal case against the defaulting borrower, because all parties have been settled. The bank was settled when the mortgage-backed security was sold, and the investors were settled through an insurance policy. Several recent court rulings in a number of states in the US have, essentially, declared the practice of securitizing home loans illegal, and as a result numerous banks have stopped foreclosure procedures on home-owners who have defaulted on their mortgage repayments. The implications are staggering: four million people in the US have had their homes repossessed illegally and the banks have been forced to pay out $8.5 billion in settlements.
“How can a loan agreement exist when nothing was loaned? And how can the bank charge interest on a “loan” that is not legally valid? ”
The situation in South Africa
How do these practices in the global financial system impact South Africa? South Africa has one of the most advanced financial systems in the world, which is why we survived the global economic crisis better than most developed countries. But this does not mean there is nothing to be concerned about. The fractional reserve system is used extensively in South Africa.
According to Russell Lamberti, writing on Mises.co.za/blog, the blog of the Mises Institute South Africa (www.mises.co.za): “Since 2000 the SARB [South African Reserve Bank] probably printed about R100 billion out of thin air. This allowed the commercial banks to use about R40 billion to fractionally leverage at about 40:1 and create about R1.6trillion in additional money out of thin air (that’s R1,600,000,000,000).” This means that South Africa has quadrupled its money supply in the last decade and, of course, the value of this new money must be derived from the money in circulation, creating inflation.
He adds that: “Since 2000, the US Fed balance sheet grew 370%. Over the same time the SARB balance sheet increased from R76bn to R440bn, about 480%. In other words, since 2000 the SARB balance sheet has grown 1.3 times more than the Fed balance sheet.” The fractional reserve system is also used by our banks to “create” money based on the borrowers’ “promises to pay”, which raises the issues of the legal validity of the loans and legality and morality of charging interest when “nothing” was loaned, because the money “loaned” did not belong to the bank, but was “created” ex nihilo (out of nothing) based solely the borrower’s “promise to pay”.
The Banks Act states that a bank cannot act as an agent or intermediary for a third party, such as a securitization SPV, without the express written consent of the customer. However, according to the South African Banking Association’s website, local banks securitize loans worth about R30 billion a month. The issue here is that is a bank securitizes a loan, it loses all rights to the asset. Tis means the bank cannot, for example, repossess property put up as collateral on a loan which has been securitized, because the bank no longer has any rights to the debt. It could well mean that thousands of homes may have been illegally repossessed by banks in South Africa too. The issue has already been tested in court, and on a number of occasions, it has resulted in a bank abandoning the foreclosure proceedings, because it was no longer the lawful owner of the debt. These practices are also being challenged in the High Court by New ERA (New Economic Rights Alliance), a non-profit organization supported by 150 000 people, which argues that if a loan has been securitized, not only has the borrower’s legal status with the bank changed, but the debt with the bank no longer exists. Their case is supported by extensive evidence and research with specific reference to South African economics and South African law and presented by lawyers acting pro-bono. The banks have emphatically argued that they cannot understand New ERA’s papers and the court ruled that New ERA must amend its papers, “removing all the evidence”. New ERA has said it will file amended documents with renewed ferocity, “to protect millions of South Africans from what we believe are blatant and unscrupulous actions of the banks.”
Follow the case on http://www.newera.org.za. REIM asked the banks and the major role players the following questions about securitization.
1. Can you provide us with an indication of the value of loans securitized and what percentage of these loans are home loans?
2. Does a consumer have the right to know if their loan has been securitized? Or is there a clause in the credit agreement that the client signs that provides the bank with the rights to securitize the loan? If so, can you provide a sample of the wording used? If not, how is the client informed?
3. Can a consumer choose not to have their loan securitized?
4. How can a consumer trace the securitization of his/her loan?
5. How do the banks ensure compliance with the legislation that credit agreements that have been sold or traded are registered with the NCR?
6. How is the legal standing of a South African citizen’s loan affected if the loan has been securitized?
7. How would the debt counseling process be affected by securitization?
The Banking Association of South Africa did not bother to acknowledge or respond to numerous emailed requests for information. The National Credit Regulator (NCR) –legally mandated to protect the interests of South African credit consumers – replied: “The NCR views this matter in an extremely serious light and is giving it the requisite attention. For fear of compromising the project the NCR is not at liberty to discuss any details at this stage”. Frightening. Especially given the fact that the National Credit Act, Sec 69(4) requires that all credit agreements that have been sold or traded(i.e. securitized) are to be registered with the National Credit Regulator.
“If the ownership of the debt shifts, it could mean the banks have no legal status over the debt, because they do not own the debt.”
Humbulani Salani, spokesperson for FNB Legal, simply responded: “We can confirm that currently FNB does not have any home loan securitization outstanding in the market. When securitization transactions were entered into by FNB in the past, it did not breach any law. Securitization is an industry matter. Steven Barker, Standard Bank’s Head of Home Loans, replied: “Only a small portion of Standard Bank’s Home Loans form part of a securitization arrangement. The customer agrees up front that the bank may cede its rights and delegate its obligations under any loan agreement to a third party. Where a loan is securitized there is generally a cession of the rights under the mortgage bond registered at the Deeds Office. The terms and conditions of the loan agreement are not affected by the securitization and a customer is required to repay the loan as set out in the loan agreement. The debt counseling process and any rights under the National Credit Act is not impacted. Further, Standard Bank complies with its reporting requirements under the Act.”
Absa noted that, currently, their total residential mortgage book amounts to approximately R233bn and only about 2% of this has been securitized. “Worth mentioning is that the performance of South African residential mortgaged backed securitization transactions have been superior to those in the US over the last 10 years. This is primarily due to South Africa’s very well-regulated securitization market where transactions are monitored by the SARB, the JSE, international rating agencies and the NCR. Fitch Ratings recently released a report confirming that EMEA (Europe, the Middle East and Africa) residential mortgaged backed securitization transactions (from 2000to 2011) had significantly lower losses than their US counterparts.” With regard to the questions about the consumer’s rights, Absa stated the following: “The customer will receive a letter from Absa to advise the customer [in the event] of the securitization of the loan and thereafter the credit provider’s details are reflected in all communications to the customer. Usually there is an express provision for a credit provider to transfer its rights and obligations. It should be noted that a credit provider has a common law right to transfer rights without consent. The NCA did not remove this right.”
Furthermore, Absa notes that “The consumer remains indebted under the loan, albeit to a different creditor and, save for this the terms and conditions of the loan do not change. The debt counseling process is not affected by securitization and the consumer is still entitled to exercise the rights he/she has in terms of the National Credit Act. ”Deborah Solomon, founder of the DCI, the debt counseling industry portal that has become the springboard to better debt management for thousands of overly indebted consumers, offered a different view. “The NCR is aware of the process called ‘securitization’ and have stated that they are investigating how this fits into the National Credit Act.
We have also brought the matter of securitization to Minister Rob Davies’ attention and will hopefully get some answers from the Minister’s office. We have also requested further information from the NCR regarding the compliance of the banks in terms of registering credit agreements that have been sold or traded with the NCR, but nothing has been forthcoming as yet. In terms of the NCA, the banks must give the debt counselors information as per their request. But the banks all have one ‘template answer’ and obviously feel that they do not have to answer these types of questions. It is another point which we have raised both with the NCR and with the Minister,” says Solomon.
She notes that from a debt counselor’s perspective, securitization has huge implications, as the counselor needs to know who the debt belongs to, to ensure negotiations and payments. “If we do not know who the real owner of the debt is, how can we make a judgment call on the outstanding ownership of the debt?” In terms of the effect of securitization on the debt counseling process, Solomon says that it could mean that a credit agreement is illegal. “If the ownership of the debt shifts, it could mean the banks have no legal status over the debt, because they do not own the debt.
The new holder or owner of the debt would also need to be a registered credit provider in terms of the NCA. Of course, a debt counselor would look at the debt differently if they knew it was securitized and would question the legality of the action on behalf of the consumer.” Solomon further notes that consumers absolutely have the right to know if their loan has been securitized. “If the bank has securitized a debt, made money from your signature without your consent or knowledge, and then try to take legal action against you should you default on the loan, it is 100% your right as a consumer to know this. Maybe this could be the reason why the banks have not embraced the NCA or tried to window dress the debt counseling process, because they know that should the truth be revealed, they could stand to lose more than what they are currently worth.”