“The Big Fail” – a legal black hole in the economy

Adam Levitin explains why the legal problems at the heart of the real estate crisis may end up making the last three years look like a speed bump.

The problem is that our banks turned themselves into designers of loans that they then were supposed to have sold off in packages to outside investors. Now that that homeowners are failing to pay their mortgages it turns out the banks may not have ever really transferred the mortgages as they promised.

So who is going to have to cover the losses now?

Here is one tantalizing clip:

The banks are in serious trouble if there are widespread securitization fails. If the loans weren’t transferred to the securitization trusts, then they are on bank balance sheets, which means that (1) the losses on the loans are the banks (to be sorted out with the investors), and (2) the banks need to be holding capital against the loans that haven’t gone into foreclosure.  Depending on the scale of the problem, the banks might not have enough capital to cover the securitization fails….

The Big Fail – Credit Slips