Why knowledge of accounting is important to understand how the apparent debt vanishes in the context of securitization.
by Neil Garfield
The big change occurred when the Wall Street securities firms forced securitization practices over the line. Whereas the purpose of securitization had always been to reduce risk, the investment banks meant to eliminate it. The only way you can eliminate the financial loss from a failed asset is if you don’t own it. That is basic accounting, basic law and common sense.
If you don’t own an asset there is no basis in the law that allows you to claim a loss if the asset is somehow damaged (assuming it even exists). If you have no loss then you have no claim and the court ahs no power to grant you any “relief”.
Why knowledge of accounting is important to understand how the apparent debt vanishes in the context of securitization.
Before 1995, all homeowner transactions were subject to the same accounting rules. Accounting consists of making data entries and issuing accurate reports about those data entries. All laws, regulations, and rules about data entries and reports are based upon compliance with Generally Accepted Accounting Principles and practices (GAAP). And all of GAAP is based on double-entry bookkeeping.
Double entry, a fundamental concept underlying present-day bookkeeping and accounting, states that every financial transaction has equal and opposite effects in at least two different accounts. It is used to satisfy the accounting equation: Assets = Liabilities + Equity. With a double-entry system, credits are offset by debits in a general ledger or T-account.
See https://www.investopedia.com/terms/d/double-entry.asp
In legal practices and doctrines, such accounting entries and reports are considered evidence that transactions occurred. And if the entries were made by an employee of the company who personally received shipment or payment, that employee would make data entry of that receipt.
The data is then processed through an accounting department that matches that entry with a different data entry showing how or why that shipment or money was received. In the simple example, if someone receives a payment it will be posted as a data entry of cash received. Accounting would post it as an increase (credit) to the cash account and a decrease (debit) of a prior account established with a product that was sold and converted into an account receivable.
Each data entry has a corresponding entry in some other account. If you paid for something, you would show a debit to cash and a credit to inventory for the product received. The outside auditor (or a court) takes all that as evidence of an event in the real world — unless, on examination, it turns out that the product was never received or that the cash was not used for the purchase of the product, such as in embezzlement.
So in a residential loan transaction, the lender keeps an accounting ledger in which all data entries are compiled. When the lender gives a borrower money, the lender debits a cash account and then credits another asset account to take the place of the cash it used to fund the loan. That other account is generically described as a loan account receivable. In general banking practice, a depository loan account is created in the name of the borrower, and the money proceeds from the loan are deposited into the name of the borrower. The borrower, if he or she was a business, would keep an accounting ledger that showed an increase (credit) to the cash account and an increase in accounts payable under the subcategory of loans payable.
So when the lender comes to court asking for foreclosure, it satisfies the prima facie elements of the claim for foreclosure by saying we loaned money to the defendant, we have the records, the defendant paid us until he didn’t, and we are suffering financial loss or injury arising from the defendant’s failure to pay. That would et them past the pleading stage.
Then at trial, the lender would produce its records custodian who would testify that he/she keeps the records for the lender. At the request of the Attorney for the lender, the custodian would provide the foundation testimony to establish that he has personal knowledge of how the books and records are kept, who receives payments, how they record them, and how the data entries are then recorded into the account ledgers of the lender. If the borrower contested whether payments were accurately entered, the lender would be obligated to produce a witness who actually received or supervised the receipt of payments from the borrower.
And so it was — for centuries.
Starting in 1995, the securitization system based upon “derivatives” (which began in 1983). So securities brokerage firms set about buying loan portfolios, initially, which evolved into borrowing to buy loan portfolios of real loans from real lenders. The first such activities were performed in accordance with the theory and intent of securitization of residential debt. Investors bought pro-rata interests in the portfolios which were managed by master servicers who subcontracted the work to subservicers. it was all perfectly legal but the securities brokerage firms were limited in sales to the dollar value of the loans. That in turn limited the commissions and fees to a percentage of the loan portfolios being traded.
Around the year 2000, everything changed. The securities brokerage firms started executing a plan that would give them multiples of the amounts traded as “loans” instead of percentage commissions. As an analogy, imagine a car salesman suddenly finding a way to get $500,000 for every car he/she sold for $40,000. If his/her commission was 5% the earings would increase from $2,000 to $500,000. And even if his scheme was somewhat illegal or extra-legal he would have enough money to pay off everyone around him to shut up, giving them more money than they had ever seen in their lives.
The rules of accounting and the rules of law are the same. If you don’t own an asset you have no financial loss associated with the loss of the asset. And that is because there is no account that gets debited or credited with any payment or disbursement related to the asset. According to GAAP and the law, if there are payments and disbursements, they are not related to an asset if it is not owned by the party who made or received payment. Without that, the courts are without any authority to hear any dispute relating to the asset. If the party making a claim does not own the asset, it cannot claim a financial injury. And without a present financial injury, there is no claim.
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