Here Comes the Big 25% –The Bell Tolls for Thee

This from Karl Denninger (posted in full by Foreclosure Blues here) on the additional investor lawsuits on the horizon:

“You need 25% of the MBS pool to have standing – that’s blocked most of these up until now, and the banks (cleverly) structured most of the notes so that getting to the 25% is tough.  That is, the “Senior” portions of the offering typically encompass about 80% of the total, just enough so that until and unless those people take losses they have a strong DISincentive to participate in a suit.

But if they feel the heat of risk, this all changes immediately, and instead of having 80% of the investors on your side the flip to the other side of the equation becomes equally dramatic and immediate.

That’s all it will take – for the overcollateralization offered by the junior tranches to be exhausted, and the senior portions to start getting whacked on with unrecoverable losses – not “mark-to-market” losses, but permanent impairments due to parts of the pool being found to be contaminated beyond that which overcollateralization can protect against.

With loss severities running around 50%, that won’t be tough to do if 1/3rd or more of the pools are junk – and the testimony from Clayton at the FCIC hearing strongly suggests that to be the case.

The banks appear to have relied on the premise that they could get away with this by structuring securities such that all of the junior tranches could get wiped out and yet it would not produce enough angry noteholders to meet standing requirements.  That’s nice of them, isn’t it?

But greed ultimately will nail these guys, because it also appears they didn’t stop short of the line where the senior holders were “safe.”  That line, once crossed, will immediately lead to essentially all of the noteholders being both willing and able to sue.

What’s worse is that if the holder is a pension fund it has no choice but to sue once value is impaired, because the pension fund manager has no discretion – he is a fiduciary for the pension beneficiaries and can potentially be held personally liable if he does not discharge that duty.

The premise among the market participants that has produced a big shrug in stock prices thus far is that since robbery and fraud has become Wall Street’s “greatest and most profitable product” in the last ten years that they will be able to continue, with help from Washington DC, and avoid the liability for their actions.

I don’t think so – not when the biggest constituency that is getting hosed here are pension funds, including union pension funds. Those folks not only want to sue once they can establish standing and have an unjust loss they have to sue.

I predict some truly ugly surprises in the offing, and soon”‘


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