President Obama several days ago vetoed a bill that had passed the Senate unanimously and without debate.

What was this bill that won such bipartisan support? It was called “The Interstate Recognition of Notarizations Act of 2010,” and was apparently designed to help banks enforce foreclosures even when their paperwork establishing the “chain of title” was flawed or non-existent.

How did it come to pass that this problem of clear title is so widespread that big mortgage lenders like Bank of America, JPMorgan Chase and GMAC have suspended foreclosures completely in many states (and in the case of BofA, in all states)?

This is more than a minor paperwork glitch. It’s a deep solvency problem.

Here’s one explanation, best followed by studying the graphs in the short video below.

Watch especially the section on “tranches.”

What follows is my hopelessly amateurish attempt to explain the problem. Feel free to correct me.

The magic — the devilishly clever magic — in the construction of the tranches is how each credit-rated tranch (from AAA to BBB-) within a single large pool of subprime mortgage-backed securities is contractually defined by its percentage share of the defaults within the whole pool.

For instance, the BBB- tranch is defined to bear the very first losses within the total pool (up to, say, 8% of the total). These losses are assigned at the time of default to the BBB- tranch. Losses are not considered to occur in the AAA tranch at all until the rate of losses for the whole pool reaches at least 24%. BBB- takes the first losses, but since it has that higher risk, it pays a higher rate of return.

The key to making this all work is to have each mortgage in each mortgage-backed security pool simultaneously exist (or you might say “virtually” exist) in all tranches at once, and only get assigned to a specific tranch at the time of default. To accomplish this, the geniuses on Wall Street played games with the title assignment process. This may be the point at which  lenders and titles began to part ways.

Ellen Brown, in a recent article on the subject (“Foreclosuregate“), concludes:

In an academic paper titled “It Isn’t Working: Time for More Radical Policies,” Prof. Randall Wray and Eric Tygmoine suggest calling a bank holiday. They write:

“We believe that most major banks are insolvent and cannot (and should not) be saved. We suggest that the best approach is something like a banking holiday for the largest banks and shadow banks in which institutions are closed for a relatively brief period. Supervisors move in to assess problems. It is essential that all big banks be examined during the ‘holiday’ to uncover claims on one another. It is highly likely that supervisors will find that several trillions of dollars of bad assets will turn out to be claims big financial institutions have on one another (that is exactly what was found when AIG was examined–which is why the government bail-out of AIG led to side payments to the big banks and shadow banks). There probably are not ‘seven degrees of separation’–by taking over and resolving the biggest 19 banks and netting claims, the collateral damage in the form of losses for other banks and shadow banks will be relatively small.”

What we need to avoid at all costs is “TARP II” another bank bailout by the taxpayers. No bank is too big to fail. The giant banks can be broken up and replaced with a network of publicly-owned banks and community banks, which could do a substantially better job of serving consumers and businesses than Wall Street is doing now.

Here’s the short video explanation of the tranches magic. See if you can follow it: