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The Bank Job, Massachusetts Massacre

The US stock markets dropped precipitously around 11 am when the Massachusetts Supreme court delivered a ruling that will have long lasting implications for the banking sector and the US economy.

Dubbed the “Ibanez Case”, it pitted US Bancorpand Wells Fargo against two homeowners. In a nutshell, US Bancorp and Wells Fargo foreclosed on and sold homes that they did not legally have the right to sell…obviously a big no-no!

The case originally was filed because of a dispute about whether advertising in a state-wide newspaper met the requirement for notice, as opposed to placing an ad in a local paper. During this process the Judge realized that the banks may not have owned the properties in the first place.

The problem lies in the way mortgages were transferred during the securitization process. In order to save time and process more securitizations, mortgages were transferred with a blank endorsement. When transferred, the mortgage was signed “Endorsed to _____”.

As the mortgage passed through roughly eight different entities on its way toward its final resting place in a sub-prime MBS pool, the blank endorsement made it easy to transfer but impossible to prove who actually owned the loan at any given time. Herein lies the problem, if a bank cannot prove that it owns the loan, then it cannot foreclose and the entire foreclosure process halts.

The Massachusetts court case addressed this very problem and by ruling to void the foreclosures it has opened a giant can of worms.

The Massachusetts Supreme Court ruled that neither US Bancorp nor Wells Fargo could prove they owned the property due to the blank endorsement. Which of course means the banks did not have any right to foreclose and sell the properties in question.

In my view, this is more than just two homes in Massachusetts; this calls into question the entire originate-to-distribute model and every loan that has gone through this process. Additionally, this opens the door for more put-backs and thus more charges to the banks earnings.

It is likely that every mortgage going through foreclosure will now need to be examined to determine who actually owns the property and those homeowners who have already lost their home have a means to seek damages. In practice, it means the banks will be less willing to lend since they do not have clarity on this issue. In turn, this will be a drag on an already fragile economy.

The Massachusetts ruling was the catalyst for us to take our modest profits in bank stocks and establish a short position in the Financial ETF . In our view, this is a big problem that cannot be fixed by printing more money or an improving employment picture.

-- BK

If you watch Fast regularly you know Brian Kelly as BK or Beeksee but he's more than just a CNBC contributor with a catchy name. Brian Kelly is founder of Kanundrum Capital, a registered investment advisor managing portfolios for high net worth individuals, entrepreneurs, trusts, executives
and estates.

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Looking for trades? On Fast at 5 the traders discussed this story as well as how to trade in its wake.

Brian Kelly got out of his positions in JPMorgan and Wells Fargo and he shorted a small position in the XLF.

Guy Adami reminds the desk that he’s been cautious of banks because of headline risk such as this. “However banks didn’t get as crushed as much as I thought they would have,” he says. “That either says every dip is a buy or (not all investors understand these developments) and we’re at the start of something.”

Tim Seymour thinks banks have already put more than enough provisions aside to weather whatever storm these developments present. “I think the market oversold the BKX on the news,” he says.
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Trader disclosure: On January 7th, 2010, the following stocks and commodities mentioned or intended to be mentioned on CNBC’s "Fast Money" were owned by the "Fast Money" traders; Seymour owns (AA); Seymour owns (AAPL); Seymour owns (BAC); Seymour owns (DRYS); Seymour owns (F); Seymour owns (FXI); Seymour is short (MOS); Seymour is short (POT);
Adami owns (AGU); Adami owns (C); Adami owns (GS); Adami owns (INTC); Adami owns (MSFT); Adami owns (NUE); Adami owns (BTU); Adami's wife works at (MRK); Terranova owns (GM); Terranova owns (C); Terranova owns (VRTS); Terranova owns (UPL); Terranova owns (PEP); Terranova owns (OXY); Terranova owns (GS); Terranova owns (LTD); Terranova owns (GLD) puts; Terranova owns (SLV) puts; Terranova owns (FCX) puts

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