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James Sogi

Philosopher, Juris Doctor, surfer, trader, investor, musician, black belt, sailor, semi-centenarian. He lives on the mountain in Kona, Hawaii, with his family.

RMBS, by James Sogi

Hawaii's top mortgage foreclosure lawyer and I were chatting with our new judge about mortgages and foreclosures. He commented that some of the top mortgage holders/servicers are moving to non-judicial foreclosure despite possible challenges. Notably, he observed that many mortgage holders or their servicers s had difficulty properly accounting for and producing ledgers for their mortgage payments and matching them to specific mortgages. The mortgages are packaged and securitized leaving a servicing entity to do the collections and accounts. Cutting costs servicing leads to sloppy work.

In Fabrozzi, Bond Markets, Analysis Strategies,valuation of RMBS and the yield and the option adjusted spread depends in part on the actual experience, and thus the the accounting of the income and the prepayment rates. Actual and expected cash flow may differ, but an additional issue of accounting for actual cash flow for identified securities may be problematical. Certain tranches may also be stuck with credit risk or unintentionally the sloppy accounting issue. Let's say a borrower defaults Normally the mortgage gets foreclosed, and security is. realized. But if the servicer cannot locate the ledger to show the default for that particular mortgagee it cannot prove default, and cannot foreclose. The servicing problem underlies the move to nonjudicial foreclosure. With sloppy accounting, both the security and the value may be called into question in some circumstances. As the need for accurate accounting and servicing is lowered by non judicial foreclosure, the amount spent on servicing will drop more to save costs and boost profits. The deterioration of accounting levels follows Nock's Law of Least Effort. The accounting issue might not be revealed by standard pricing models and is another example of accounting risk discussed before. The modeling of prepayment due to defaults will be affected. These issues do not arise in a rising real estate market, but are unveiled as the market falls. Profits often hide a multitude of sins.

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