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Ostriches Don't Make Good Witnesses

In Sunday's New York Times, Gretchen Morgenson, a journalist who has developed a specialized focus in the mortgage industry, opined that responsibility for the mortgage meltdown hasn't been assigned to all culpable parties.

She's right, of course. There's little doubt that securitizations deserve healthy examination in light of the monumental mortgage collapse. They are the primary way that the market rolled out so many loans in such short time. But the party she directs her attention to -- trustees of securitizations --  don't deserve first blame.

Securitizations are complex and involve many parties that are paid by a trust for the life of the securitization. The servicer, master servicer, trustee andcredit risk manager (which I introduced to securitizations in 2001 with my former company, The Murrayhill Company) are all named when the securitization is issued.

Ms. Morgenson offers examples of law suits painting trustees as joint venture partners with lenders, to build the argument that trustees baer responsibility for the creation of bad loans in securities. It's an interesting point, but not a convincing one.

I've always been mystified by the term "trustee," which implies an entity with a fiduciary responsibility to protect another. For securitizations, the inference is that a trustee is responsible for protecting the financial interests of an investor. But that's not how it works.

Trustees, in fact, are hired into securitizations with no knowledge or say in what loans will be put into the trust. Believe me, when a securitization is coming together, the trustee is the last party anyone would consult about what goes in it.

Once the securitization is complete, the trustee must reverse engineer it to decipher the payout instructions. The trustee figures out who gets paid, how much and in what order, as well as who gets the first dollar of loss. From then on, the trustee accepts data and cash collected from borrower payments provided by the master servicer, runs them through computer models and sends payments to investors according to the payout instructions of the securitization.

In the mortgage industry, one thing you can count on is errors. When an error is made, like a loss of, say, $90,000 being posted against a loan that should have taken a $9,000 loss, you might imagine an investor saying, "I'll call the trustee and get that corrected." But the trustee's position is that they are simply making payments based on data they get from a master servicer. If pressed (or threatened with litigation), the trustee may take up the matter with the servicer or master servicer. But only with great reluctance.

The trustee is just a cash-and-reports processor hired to do a specific job on a securitization and nothing more. It's not part of a joint venture. And it's certainly not responsible for the issuing of individual loans.

We should connect the dots in the mortgage crisis and make changes that prevent another meltdown. (I founded Allonhill to fix problems in due diligence and credit risk management that contributed to the pie-eating contest that secondary markets became.)  Loans were made that shouldn't have been. People took out loans that they knew they shouldn't have taken. Of all of the parties to the mortgage process, I cannot think of any who is entirely blameless.

But trustees are perhaps the last to deserve the blame, by their own limited role.