Is it possible for the US Government to choose to forgive mortgage debt? Sounds outrageous? Read on for the legal theory behind this claim and let me know what you think? I thought it was little esoteric as well, but as I looked deeper... Well, I'll let you be the judge.

A lot of attention accrued to Representative Grayson's calling out of foreclosure fraud, and for good reason. The story is absolutely amazing, and kudos to a member of congress that defends his constituency.

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It's not as if other entities have failed to take notice. ZeroHedge has its usual witty commentary regarding the possibility of foreclosure transactions potentially being unwound due to fraudulent foreclosure activity. The NYT ran an article stating that Fitch will look into lowering the credit rating of companies that participated in the submission of inappropriate foreclosure paperwork, which apparently seems to include an awful lot of companies. It goes on to state (as excerpted by Zerohedge):

Fitch Ratings said that Wednesday it was asking mortgage companies about their internal processes for executing foreclosure affidavits. If it finds the processes lacking, Fitch will consider downgrading the company’s rating.

The agency also said if the issue is widespread, the resulting delays and extra costs to foreclose could increase losses related to residential mortgage-backed securities.

Here's the twist. A lawyer who happens to have followed my writings over the years has suggested that most are missing the big picture in focusing on fraudulent foreclosure documents. He contends (and I'm paraphrasing here, these are not my words, per se) "that since the U.S. has ownership interest in many (if not most) delinquent and distressed mortgages, this fact will be counted as policy in litigation. As a consequence it matters A LOT if you can say that your client has a Fifth Amendment Due Process right (or third party beneficiary Federal common law right) to a HAMP modification which is in FACT a minimization of the risk of default (not that flaky 31% number) BECAUSE, among other things, the U.S. has no economic incentive to foreclose". Now, I am no lawyer and thus the legal issues are beyond my domain, but I must admit I found the theory interesting. So, I've decided to crowdsource this one in anticipation that some of the more astute legal minds can shed some light on the validity of the theory. I'll supply the financial stuff in this post, and I'll rely on the legal eagles to peer review the theory.

Back in September of 2007 when I was preparing to launch a hedge fund, I came up with this interesting name for a blog. It was BoomBustBlog. What made it interesting is that I can literally blog ad infinitum on the synthetically crafted booms and busts of the global economy, for the method of shepherding the economy in this day and age is actually predicated on the existence and/or creation of Booms and Busts. Of course, from my common sense perspective, one would think that the job of a central banker would be to ameliorate the effects of, and in time eliminate booms and busts... Apparently, that doesn't appear to be the flavor du jour. As a matter of fact, it appears as if central bankers are doing the exact opposite. Of course, attempting to cure a bust with a boom, or worse yet attempting to prevent a boom from busting with another boom is a recipe for disaster, and worse yet the probability of success is close to nil, yet central bankers try anyway. This leads to overt and explicit policy errors, which leads to outsized profit opportunities to those who pay attention. Enter "The Great Global Macro Experiment, Revisited", from which I will excerpt below. Please keep in mind that this article was written in October of 2008, and turned out to be quite prescient, I will annotate in bold parentheticals the portions of particularly prescient relevance. The original macro experiment piece was posted on my blog in September of 2007... For those that are interested, I plan on discussing this topic live on Bloomberg TV today: “Street Smart” with Matt Miller & Carol Massar at 3:30 pm.

Last week, I made clear to my readers and subscribers that the bank malaise is not over, despite what may appear to be encouraging moves by the executive staff. Housing prices are still on their way down, save temporary blips from government bubble blowing and the outright concealment of non-performing assets by banks, see Anecdotal Evidence That Banks Are Hiding Depressed High End Real Estate. Now, many may see this as consipiracty theory, which is why I always included hard analysis behind my posts. After a Careful Review of JP Morgan’s Earnings Release, I Must Ask – “What the Hell Are Those Boys Over at JP Morgan Thinking????”

The boys over there at the "Morgan' appear to be partying like it was 1999, releasing all types of reserves and provisions (which coincidentally padded a very weak earnings quarter) as if I didn't make it "Very Clear In March, US Housing Has a Way to Fall":

We believe Reggie Middleton and his team at the BoomBust bests ALL of Wall Street's sell side research: Did Reggie Middleton, a Blogger at BoomBustBlog, Best Wall Streets Best of the Best?

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Personally, I consider the European bank stress tests to be a farce; an attempt to Bamboozle, Hoodwink and Dis-inform any who would be naive enough to drink the Kool-Aid - not to dissimilar from the US bank stress tests (see You’ve Been Bamboozled, Hoodwinked and Lied To! Here’s the Proof). CNBC reports that "NO" default scenarios will be played out, which I find to be rather unrealistic since the reasons why the banks are enjoying restricted access to the capital markets is the fear of default! Think long and hard about this...

You are showing signs of HIV, and nobody wants to come near you, make love to you or lend long term to you due to the symptoms of this most unpleasant and deadly disease despite the many proclamations you have made to the contrary. You decide to set the record straight by visiting a prominent doctor to diagnose your issues and placate your associates. The doctor comes up with a prognosis, but simultaneously declares that:

• AIDS (the syndrome), and death have not and will not be considered because the doctor will not let any of his patients catch AIDS or die! Whaaatt!!!??? Does the doctor really have that much control over who catches diseases and who dies? [Analogous to refusing to even consider the potential for default on sovereign debt, as if no European country has ever defaulted before - many have, and many probably will in the future as well). This analogy actually serves us quite well for the ECB has very limited control over who gets sick and how the contagions (both financial and economic) are transmitted (see below).
• The patient will be assumed to operate between 96% and 57.8% efficiency. This is, of course, a problem if the patient truly is terminally ill, for his health should receive significantly more of a.... Well, a haircut.
• Only the patient's mucous membranes and other very short-lived tissue will be considered for examination, for the patience plans on keeping other body parts for the long term, hence they should not be affected by fluctuations by any potential illness. Yes, I know this statement doesn't make any damn sense, but then again neither does the ECB excluding hold to maturity and portfolio inventory from the stress tests either. It really doesn't matter how long you plan on holding said items, if they are permanently impaired in value, then they are permanently impaired, Right???!!! I know, we won't even consider a default scenario, but since countries do default.. If a default occurs, or more realistically a restructuring, then wouldn't longer term inventory be impaired - Permanently???!!! In the post A Comparison of Our Greek Bond Restructuring Analysis to that of Argentina I demonstrated how much damage was done to the Argentinian bond holders after their restructuring. Too bad the Argentinian investors didn't have the all-powerful ECB there to declare that restructuring and default are not part of the rules, hence not allowed. The following is the price of the bond that went under restructuring and was exchanged for the Par
  

JPM is leaving no stone unturned to prop up the operational performance and give out green signals, even if it involves the most unsustainable measures. While in 1Q10, trading income came to the rescue of the sagging core operations, in 2Q10, it was management’s over-exuberance (defying logic and rationality, to some extent) resulting in drastic reduction in loan loss provisioning and beefing up the bottom line. Although the credit quality has shown slight improvement (thanks to the enormous fiscal and monetary stimulus), it does not completely warrant for JPM’ unhealthy and hasty decision to substantially pare its loss provisions. I know many financial pundits second guess management as arm chair coaches, but when management error is egregious, well let’s let the numbers speak through graphics….

As Excerpted from As I Made Very Clear In March, US Housing Has a Way to Fall:

Trust me, the collateral behind many more mortgages will continue to depreciate materially as government giveaways and bubble blowing for housing fade!

In a nutshell, a cursory glance of JP Morgan's recent earnings announcement is middling, and that's putting it optimistically. Revenue and profits have fallen nearly across the board, and the earnings beat is a result of moving capital from reserves to the earnings column. Even this may be suspect, for while credit metric trends appear to be improving (largely a result of massive government stimulus), the core, underlying cause of this malaise looks to be on the move downward again. See As I Made Very Clear In March, US Housing Has a Way to Fall.

I will be coming out with a detailed review of JPM's results shortly. In the meantime and in between time, refresh your collective memories with past analysis and opinion:

An Unbiased Review of JP Morgan’s Q1 2010 Results Yields Less Roses Than the Maintream Media Presents

An Independent Look into JP Morgan (subscription content free preview!)

The JP Morgan Professional Level Forensic Report (subscription only)

The JP Morgan Retail Level Forensic Report (subscription only)

If a Bubble Bubble Bursts Off Balance Sheet, Will Anyone Be There to Hear It?: Pt 2 – JP Morgan

Is JP Morgan Taking Realistic Marks On Its WaMu Portfolio Purchase? Doubtful!

Anecdotal observations from the JP Morgan Q2-09 conference call

Reggie Middleton on JP Morgan’s Q309 results

Reggie Middleton on JP Morgan’s “Blowout” Q4-09 Results

I wanted to share a series of negative news flow relating to the weakness in the core businesses of the investment banks owing to increased volatility in the capital markets over the last few months. This ebb from the sell side trails the opinion of BoomBustBlog research which forwarned of the same very early in the first quarter as well as last quarter of 2009l The news flow points out that the upcoming results of GS, MS and JPM might be disappointing or below expectations - as if we already didn't know this.

• According to some of the recent MSM articles, the recent surge in volatility has led to record low activity in the underwriting and M&A activity.

Global M&A value for the first half of 2010 grew 3% to $1.18 trillion, compared with $1.15 trillion a year earlier, according to Dealogic's figures. But while values were up against the year-earlier period, the $552.7 billion in value generated in the second quarter was down almost 7% compared with the first quarter of the year - WSJ.com.

Wall Street investment banks sold $1.36 trillion of stocks and bonds in the second quarter, down 33% from the second quarter of 2009 and the lowest quarterly total since the fourth quarter of 2008, according to Dealogic.

• Also, the capital markets volatility will have severe implications for the trading revenues of investment banks like GS and MS which derive substantial portions of their revenues from trading activities. Analysts have been downgrading earnings estimates for these banks and GS’s earnings have been particularly slashed since it generates nearly 60-70% of total revenues from trading.

Barclays Capital analyst, Roger Freeman, cut earnings estimates for Goldman Sachs Group (GS) and Morgan Stanley (MS) on June 23, 2010. Freeman slashed his second-quarter profit forecast for Goldman by nearly 64% to $1.95 a share from $5.35 a share. Freeman is expecting 40% lower trading revenues in FICC and equity segments in 2Q10 against 1Q10. His estimate for Morgan Stanley dropped 29% to 55 cents a share from 77 cents a share - WSJ.com.

Bank of America analyst, Guy Moszkowski, also slashed earnings estimates for GS and MS. He revised GS’ 2Q10 earnings estimates to $1.76 per share, 51% lower than the previous estimate of $3.57. The new estimates reflect a 45% decline in equity trading revenue and 40% drop in fixed-income trading revenue compared with the first quarter. MS’s 2Q10 EPS estimate was cut 35%, to 58 cents a share from 89 cents. The estimate on JPMorgan Chase & Co. was trimmed to 70 cents a share from 77 cents, and Citigroup Inc. was lowered to 2 cents a share from 4 cents - Businessweek.

I would also like to add that the recent volatility and market decline has also impacted the AUM of asset managers and there has been downward price revision by analysts. The assets under management of BEN declined 5% (m-o-m) in May, 2010 and the June figures are not yet out. Consequently, the target price estimates have been lowered by many analysts. In June, FBR Capital lowered its target for BEN to $105 from $118 and Barclays capital lowered its target for BEN to $125 from $133. Analyst at Goldman Sachs have also made significant downward revisions in this sector.

Now, the news flow in light of applied BoomBustBlog research:

The Asset Manager Trade is Printing Money Almost as Fast as Ben Bernanke