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Schneiderman Could Focus on REMICs in Bank Fraud Inquiry

We learned today that one prominent voice would not serve as staff director of the RMBS working group, the investigatory panel looking into securities fraud by the big banks. We don’t know who the working group will ultimately select. But Chris Whalen does give a theory as to how the working group, if Eric Schneiderman gets his way, could proceed. Basically, he thinks Schniederman could get the banks on tax fraud, which is something he’s been hinting at in recent public appearances. Interestingly, Whalen postulates that most of this will come out of the New York AG’s office rather than the working group.

The NY AG inquiry, on the other hand, reportedly focuses on areas such as loan origination and sales, the creation of residential mortgage-backed securities, the change in and perfection of title with respect to mortgages, and the role of the trustees and servicers. Each of these areas of inquiry is separate and apart from the issue of foreclosure abuse. And each carries with it legal and tax consequences that are significantly larger than the $25 billion involved in the foreclosure settlement announced recently […]

But perhaps the biggest surprise coming from the New York AG is going to be his focus on the issues of taxes, something Schneiderman talks about in media interviews but which the financial press largely ignores. The allegations of wrongdoing against Bank of America and Bank of New York with respect to RMBS raise troubling issues for investors, not the least of which is the tax status of what are arguably busted RMBS REMIC trusts.

There is also the issue of the largest banks counting losses from RMBS trusts as expenses, a maneuver admitted already by Countrywide in court proceedings. This admission not only eviscerates any claim of separateness between the sponsor and the RMBS trust, but may also result in huge future tax liabilities for the banks. By pretending that losses to the RMBS trusts were losses of the bank, Countrywide underpaid state and federal taxes for years and arguably committed tax fraud on a systemic basis.

Whalen positions this as similar to how federal prosecutors brought down Al Capone and other mob figures, through violations of the tax code. I’ve described what Schneiderman may be thinking about REMICs here and here. A taste:

REMICs are an acronym for Real Estate Mortgage Investment Conduits. When you’re talking about mortgage pools used in securitization, you’re talking about REMICs. And REMICs have special tax treatment; they are exempt from federal taxes provided they only invest in “qualified mortgages” and other permitted investments. Here’s the important part: under the 1986 Tax Reform Act, the REMIC must receive all of its assets in the trust within 90 days and the assets have to be performing (not in default). Any REMIC violations make the vehicle subject to a penalty tax of 100%, with additional penalties as they apply.

Well, the strong suspicion is that, during the bubble years, the trustees did not properly convey the mortgages to the REMICs. Which makes the whole investment vehicle a massive tax fraud.

As for counting RMBS losses as expenses, that’s a new one on me. But both of them point to liability on tax issues. This would require at least some buy-in from the IRS, however, and according to Yves Smith, they’re just not that interested.

I’ll certainly believe this when I see it. The banks have very good lawyers who know how to wriggle off the hook (check out the possible loophole that could get them out of the FHFA lawsuits). The opposing forces must be as nimble and creative. We’re still waiting to see how that will proceed.

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David Dayen

David Dayen