High Noon: Banks vs. The Law – Part 8

It’s happening fast and furious now.  It’s starting to feel like late summer 2008 IMHO.  All 50 state Attorneys General are now involved in a joint investigation.  JP Morgan Chase drops it’s use of MERS (see Part 4). And Citi circulates a research note from a Professor that suggests the problems are much deeper than the banks have admitted to.  Again we go to Yves Smith of Naked Capitalism to report the latest:

From the Associated Press:

JPMorgan Chase’s CEO says the bank has stopped using the electronic mortgage tracking system used by major financial institutions.

Lawyers have argued in court proceedings that the system is unable to accurately prove ownership of mortgages.

JPMorgan Chase & Co. and other banks have suspended some foreclosures following allegations of paperwork problems in thousands of cases.

The trigger may have been the publication of a simply devastating analysis at the end of September, “Two Faces: Demystifying the Mortgage Electronic Registration System’s Land Title Theory” by Christopher L. Peterson. Even though I have read the critical MERS unfavorable opinions, this is the first time I am aware of that someone has looked at the operation of MERS from a broader legal perspective. It finds fundamental flaws in virtually every aspect of its operation. To give a partial list: the language used by MERS in its registry at local courthouses is contradictory (it claims to be both the owner of the mortgage and as well as a nominee; legally, a single party can’t play two roles simultaneously), rendering it unenforcable; MERS has employees of servicers and law firms become “MERS vice presidents” or secretaries when fit none of the criteria that fit those roles, and also have clear conflicts of interest given that they are also full time employees of other organizations; MERS record keeping has the hallmarks of being poorly controlled (there have been cases of mortgages basically being stolen from other MERS members; some contacts have suggested that a single MERS member can assign a mortgage, meaning checks are weak; MERS members are not required to update records). And most important, every state supreme court that has looked at the role of MERS has ruled against it.

As much as I have heard the case against MERS in bits and pieces, and regarding it as very problematic, seeing it assembled in one place (with solid references to judicial decisions) makes for a overwhelming case. The best resolution the author can come up with is that lenders with MERS registered mortgages would be granted an equitable mortgage as a substitute for the flawed MERS registered mortgages:

While awarding equitable mortgages is surely a better approach for financiers and their investors than simply invalidating liens, it would not solve all their problems. Replacing legal mortgages with equitable mortgages would give borrowers significant leverage. Historically, state law has not uniformly treated equitable mortgagees vis-à-vis other competing creditors. Generally, the holder of an equitable mortgage had priority against judgment creditors. But, it is likely that an equitable mortgage could be avoided in bankruptcy. Moreover, it is likely that financiers would have less luck seeking deficiency judgments when foreclosing on equitable mortgages.

High Noon: Banks vs. The Law (Mortgage Foreclosures) – Part 7

I know the story is getting old. This is my 7th post on the subject, but it is snowballing and casting a huge shadow on the economy.  The potential exists to freeze mortgage/housing markets for a few years, run up legal costs into the hundreds of millions, if not billions of dollars, and even, potentially to topple some major banks.  Again I turn to Yves Smith at Naked Capitalism to tell the tale:

Astonishingly, despite mounting evidence that the lapses in industry conduct were egregious and widespread (the failure to adhere to their own contracts; the widespread use of fabricated documents), the industry is trying to keep the focus very narrow and pretend the only thing at issue is the, um, improper affidavits, and surely that will be fixed shortly, really there is nothing wrong with the underlying process. The abject failure to convey notes says otherwise, as does more and more evidence of people losing their homes due to servicing errors or other abuses.

Before readers start arguing that these problems are small and therefore inconsequential, consider Barry Rithotz’s remarks:

There are multiple failsafes and checkpoints along the way to insure that this system has zero errors. Indeed, one can argue that the entire system of property rights and contract law has been established over the past two centuries to ensure that this process is error free. There are multiple checks, fail-safes, rechecks, verifications, affirmations, reviews, and attestations that make sure the process does not fail.

It is a legal impossibility for someone without a mortgage to be foreclosed upon. It is a legal impossibility for the wrong house to be foreclosed upon, It is a legal impossibility for the wrong bank to sue for foreclosure.

And yet, all of those things have occurred. The only way these errors could have occurred is if several people involved in the process committed criminal fraud. This is not a case of “Well, something slipped through the cracks.” In order for the process to fail, many people along the chain must commit fraud.

That it is being done for expediency and to save a few dollars on the process is why the full criminal prosecution must occur..

In another widely-circulated sighting, Georgetown professor
Adam Levitin provided a prognosis that some sites touted as a surprisingly dour forecast. I was actually found his remarks to be pretty moderate; I’ve been told by litigants who have sought his input that his private views are more pointed (although it is possible they cherry picked his views). From the Citigroup report (hat tip Karl Denninger):

Levitin articulated three possible outcomes to the aforementioned issues and assigned an equal likelihood to each. In his best case scenario, these issues are deemed merely technical in nature and are successfully resolved but it takes at least year to do so and all foreclosures are delayed by at least a year. Levitin disputed the claim by banks that these issues can be resolved in a month or so and attributed the banks’ claims to “legal posturing.” In the medium case scenario, litigation ensues and it takes years to sort out these matters. In the worst case scenario, the aforementioned issues become a “systemic problem” which causes the mortgage market to grind to a halt as title insurers refuse to insure mortgages involving existing homes

I see the odds that the problems are “merely technical” as zero. Levitin hedged his bets on how widespread the problems are with the conveyance of the notes. The reports I am getting are providing more and more confirmation for the notion that the notes were seldom, if ever, conveyed correctly from 2005 onward. And if that is the case, the problems are not technical but fundamental.

It would be better if I were wrong, but brace yourself for a rocky ride.

A rocky ride indeed.  There is more at stake here than just the money and homes of the foreclosed.  Also at stake is the core legal system of contracts and real estate property rights.  This system was evolved over hundreds of years.  It has held up well.  Until multiple players in the banking industry decided they need not play according to the law and could write their own rules for their own profit.

Check out Part 1Part 2Part 3Part 4, Part 5 and Part 6 of my posts on this topic.


High Noon: Banks vs. The Law (Mortgage Foreclosures) – Part 6

Felix Salmon starts to bring out why the foreclosure mess is much bigger, and potentially much messier, than the banks or politicians are letting onto now. In The enormous mortgage-bond scandal:

You thought the foreclosure mess was bad? You’re right about that. But it gets so much worse once you start adding in a whole bunch of parallel messes in the world of mortgage bonds. For instance, as Tracy Alloway says, mortgage-bond documentation generally says that if more than a minuscule proportion of notes in a mortgage pool weren’t properly transferred, then the trustee for the bondholders can force the investment bank who put the deal together to repurchase the mortgages. And it’s looking very much as though none of the notes were properly transferred.

But that’s not even the biggest potential problem facing the investment banks who put these deals together. It also turns out that there’s a pretty strong case that they lied to the investors in many if not most of these deals.

mentioned this back in September, and I’ve been doing a bit more digging since then. And I’m increasingly convinced that the risk to investment banks isn’t only one of dodgy paperwork; there’s also a serious risk of massive lawsuits from the SEC or other prosecutors, as well as suits from individual mortgage investors.

The key firm here is Clayton Holdings, a company which was hired by various investment banks — Goldman Sachs, Bear Stearns, Citigroup, Merrill Lynch, Lehman Brothers, Morgan Stanley, Deutsche Bank, everyone — to taste-test the mortgage pools they were buying from originators…

The banks, yes, the too-big-to-fail banks, the usual suspects, the ones we bailed out just 2 years ago, could easily be in deeper trouble this time.  The trusts that handled and sold the MBS bonds, the trusts where the banks dumped the mortgages may not have actually (as in legally) ever have been in possession of the mortage notes.  That means the banks committed fraud on investors when they sold the MBS bonds.  Who were those investors? Just about everybody: pension funds, foreign banks, state and local governments, your 401(k) or IRA.  How much is potentially at risk?  Try in the TRillions of dollars invested in this MBS bond market.  That’s a lot of uncertainty and potential loss. It’s beyond the scale of the Lehman and AIG failure two years ago.

Check out Part 1, Part 2, Part 3, Part 4, and Part 5 of my posts on this topic.

The Economy: Back to the Future, only Worse

Regular readers and my students in class can probably detect a distinct pessimism in my comments on the U.S. economic prospects.  They are right.  I am pessimistic. Not necessarily because things have to be gloomy (they don’t – there are alternative policies), but because I just don’t see the politics allowing such policies.  Instead, we are going back to the future.   Or, rather our future is looking a lot like the recent past, only worse.

In the decade (really 2-3 decades) prior to the Great Recession beginning in 2007 and the Wall Street implosion of 2008, the U.S. was moving along toward an oligarchy.  Increasing inequality of income and increasing political power and economic power for a narrow elite of truly over-the-top rich led by FIRE, the Financial-Insurance-Real Estate sector (Wall Street).  Of course this trend was aided and abetted by too many in the economics profession who not only forgot the lessons of the past, but also reanimated economic dead ideas (see Zombie Economics).   I thought (hoped) that with the crash of 2008 and the severity of the Great Recession, that change might arrive.  Well, we didn’t get change and now there’s not much hope, either.

The New York Times has an article about why, despite being technically “over”, the Great Recession still stings.  Here are a few excerpts that nail my concerns fairly well (red emphasis is mine, as are the comments in brackets and italic):

…an enormous oversupply of houses and office buildings and crippling debt. The decision last week by leading mortgage lenders to freeze foreclosures, and calls for a national moratorium, could cast a long shadow of uncertainty over banks and the housing market. [this could be worse than the Lehman/AIG failure] Put simply, the national economy has fallen so far that it could take years to climb back.

The math yields somber conclusions, with implications not just for this autumn’s elections but also — barring a policy surprise or economic upturn — for 2012 as well:

¶At the current rate of job creation, the nation would need nine more years to recapture the jobs lost during the recession. And that doesn’t even account for five million or six million jobs needed in that time to keep pace with an expanding population. [we are looking at a lost generation of potential workers] Even top Obama officials concede the unemployment rate could climb higher still.

¶Median house prices have dropped 20 percent since 2005. Given an inflation rate of about 2 percent — a common forecast — it would take 13 years for housing prices to climb back to their peak, [house prices are more likely to decline further first] according to Allen L. Sinai, chief global economist at the consulting firm Decision Economics.

¶Commercial vacancies are soaring, and it could take a decade to absorb the excess in many of the largest cities. The vacancy rate, as of the end of June, stands at 21.4 percent in Phoenix, 19.7 percent in Las Vegas, 18.3 in Dallas/Fort Worth and 17.3 percent in Atlanta, in each case higher than last year, according to the data firm CoStar Group.

Demand is inert. Consumer confidence has tumbled as many are afraid or unable to spend. Families are still paying off — or walking away from — debt. Mark Zandi, chief economist of Moody’s Analytics, estimates it will be the end of 2011 before the amount of income that households pay in interest recedes to levels seen before the run-up. Credit card delinquencies are rising.

“No wonder Americans are pessimistic and unhappy,” said Mr. Sinai. “The only way we are going to get in gear is to face up to the reality that we are entering a period of austerity.”

This dreary accounting should not suggest a nation without strengths. Unemployment rates have come down from their peaks in swaths of the United States, from Vermont to Minnesota to Wisconsin. Port traffic has increased, and employers have created an average of 68,111 jobs a month this year.

After plummeting in 2009, the stock market has spiraled up, buoying retirement accounts and perhaps the spirits of middle-class Americans. As a measure of economic health, though, that gain is overstated. Robert Reich, the former labor secretary, notes that the most profitable companies in the domestic stock indexes generate about 40 percent of their revenue from abroad.

Few doubt the American economy remains capable of electrifying growth, but few expect that any time soon. “We still have a lot of strengths, from a culture of entrepreneurship and venture capitalism, to flexible labor markets and attracting immigrants,” said Barry Eichengreen, an economist at the University of California, Berkeley. “But we’re going to be living with the overhang of our financial and debt problems for a long, long time to come.”

New shocks could push the nation into another recession or deflation. “We are in a situation where our vulnerability to any new problem is great,” said Carmen M. Reinhart, a professor of economics at the University of Maryland.

It’s that “vulnerability to any new problem” that bothers me most.   We have a growing foreclosure fraud crisis that could become a big bank failure problem.  We have a Eurozone so committed to austerity and protecting German banks that it is willing to sacrifice GDP and millions of jobs in the process. The banks, despite their record profits of the last 15 months aren’t really all that healthy.  We just allowed them to extend and pretend that many of the loans on their books are good, when they most likely won’t be.

I don’t need to watch the annual October crop of fright movies to get scared.  I just read the economic news. What I see happening is that we are re-building the debt-based, banks-are-king system we had before the crash, but only bigger.  Instead of recovery, we have return.

Nobel Memorial Prize Winners: Mortensen, Diamond, and Pissarides

The 2010 winners of the Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel (often incorrectly called the Nobel Prize for Economics) are Peter Diamond, Dale Mortensen, and Christopher Pissarides.  They did work on search models, labor markets, and unemployment.  In particular, their work helps explain why even when there are more job openings than workers, there may still be measurable unemployment called frictional unemployment.  For a good summary of their work and insights, see the New York Times (free registration may be required) at The Work Behind the Nobel Prize By EDWARD L. GLAESER.

So what do these folks suggest for today’s economy where we have very high unemployment that has not come down at all since it went up over 18 months ago?  Let’s go to the New York Times in a different article (emphasis is mine):

The work is especially relevant today, as policy makers try to understand and combat the causes of stubbornly high unemployment in countries like the United States.

In a phone interview, Professor Diamond, 70, said that one of the implications of his work was that more fiscal and monetary stimulus was probably necessary to speed up job growth.

“The slower it happens, the more workers lose their skills and stop searching, and so the process goes more poorly after that,” Professor Diamond said.

President Obama nominated Professor Diamond in April for a Fed board position, where he would serve under his former student, Ben S. Bernanke, the Fed chairman. But in August, under an obscure procedural rule, the Senate sent Mr. Diamond’s nomination back to the White House before starting its summer recess, and a senator questioned his experience.

President Obama renominated Professor Diamond for the Fed position on Sept. 13. A hearing on his confirmation is still to come.

Note too that one of these prize winners, Peter Diamond, has been nominated to join The Federal Reserve bank board of governors.  But, Republicans in the Senate, led by Senator Shelby of Alabama, have stopped the nomination claiming that Peter Diamond is “unqualified”.  Res ipsa loquitur


High Noon: Banks vs. The Law (Mortgage Foreclosures) – Part 5

Ok, continuing the series on the mortgage foreclosure crisis here. For background on the legal side of the problem see Part 1 and for a humorous look by Jon Stewart at the crisis see Part 2.  For a clue to how the problems may be far more serious than the mere “paperwork glitches” that the banks PR machines suggest, see Part 3.  Yves Smith explains the crisis in a video in Part 4.

The widespread practice of banks using “lost note affidavits” may well be a cover-up for a much more serious problem.  Rather than simply needing to attest to the borrower’s indebtedness and default status, these affidavits may be used to cover-up the fact that the notes (mortages) were never properly, legally conveyed to the new mortgage owners, the MBS Trusts.  If the notes were never properly conveyed to the trusts, then the trusts don’t own the mortage an have no right to foreclose.  Even more so, it means that in the past the banks foreclosed and sold homes they had no legal right to foreclose or sell.  Thousands of homeowners may have been deprived of legal due process and had their homes taken by corporate entities that had no legal right to do it and did it by committing fraud on the courts.

Today Yves Smith at Naked Capitalism reports on some potential costs and consequences of the crisis (note: the red bold emphasis is mine, not Yves’):

As readers no doubt know, we’ve indicated from early on in the foreclosure crisis that problems with foreclosures of mortgages held by securitizations went well beyond the now well known “robo signer” issue. The most difficult to resolve and apparently widespread problem is the failure to convey the note (the borrower IOU) properly to the trust (the legal entity that holds the notes on behalf of the investors) as specified in the pooling and servicing agreement.

Kate Berry of American Banker reports that the banks that are reviewing their internal processes are looking beyond the robo signers’ verification (or more accurately, failure to verify) borrowers’ indebtedness. One area of vulnerability being highlighted is the use of “lost note” affidavits. We had flagged this earlier as a possible way the banks could be finessing their failure to convey the notes correctly to the trust. In particular, the Florida Bankers’ Association made a very odd, indeed implausible claim, suggesting that borrower notes were routinely destroyed because they had been scanned electronically. Tom Adams, a securitization expert, and I both found that farfetched; it would be like burning down a warehouse full of cash (although we have learned that one defunct subprime originator did appear to have destroyed some notes, but the lawyers we have spoken to about this are of the view that this is not a common activity).

So why would the Florida Bankers’ Association claim that banks had engaged in a hugely irresponsible activity? Perhaps to provide legal cover for the use of lost note affidavits to cover for the fact that the note had not been conveyed properly; claim it’s lost rather than use the other apparently common route for finessing the problem: fabricating documents that show that the note was signed by all the relevant parties in the proper manner, which includes on a timely basis.

From American Banker (and note the section we boldfaced):

Servicers are looking more broadly at all other documents involved in foreclosures, including “lost-note” affidavits and mortgage assignments, to ensure the chain of title actually lets them foreclose on a borrower in default.

The resulting delays will hamper the filing of new foreclosures — not just those already begun — as judges take a tougher stance on documents being used to verify that loan information is correct, and that the servicer has the right to foreclose in the first place.

“The courts are going to be much more skeptical,” said Mark Ireland, a supervising attorney in the Foreclosure Relief Law Project, a unit of the nonprofit Housing Preservation Project in St. Paul. “It would be silly to show up in court with a lost-note affidavit when there is widespread evidence of an industry practice that calls into question the affidavits.”

Mortgage servicers have filed thousands of lost-note affidavits, which must be signed in the presence of a notary, claiming that the original promissory note on a property has been lost.

Whether such documents will now hold any weight in court is unknown and probably will be decided case-by-case, further delaying foreclosures, lawyers said…..

Some states have a one-year redemption period during which a foreclosed-on borrower “can say the foreclosure was not done properly and the servicer has to start all over again,” Ireland said. “This is a legal grenade.”

Patricia McCoy, a law professor at the University of Connecticut, said judges may ask to see a photocopy of the underlying mortgage note or they may go further and ask for the actual note itself….

Problems with foreclosure documents have led Ally Financial Inc.’s GMAC Mortgage and JPMorgan Chase & Co. to suspend foreclosures in 23 states, and Bank of America Corp. has suspended foreclosures in all 50 states. Goldman Sachs Group Inc.’s Litton Loan Servicing LP has also suspended some foreclosures, and PNC Financial Services Group Inc. is reviewing its processes.

Derrick Gruner, a partner overseeing the banking and lending group at the Pinkert law firm in Miami, said a wide range of documents — affidavits of indebtedness, lost-note affidavits, postdated mortgage assignments — were “being robo-signed,” a term used to describe employees who rubber-stamp documents without verifying the information in them or signing them in the presence of a notary….

(Citigroup Inc. said Tuesday that it had stopped initiating foreclosures through a Florida law firm, the law offices of David J. Stern, which is being investigated by the Florida attorney general.)

A few analysts have tried to quantify the magnitude of the problem. Paul Miller, an analyst at FBR Group Inc., said foreclosure delays will cost at least $6 billion, or roughly $1,000 per loan for every month that a foreclosure is delayed.

Laurie Goodman, a senior managing director at Amherst Securities Group LP, has estimated that $154 billion of nonperforming loans are affected by the current moratoriums….

A crucial problem, she wrote, is the way that servicers chose to cut costs by using Merscorp Inc., the Vienna, Va., company that runs the mortgage industry’s electronic loan registry system. The system let mortgage lenders reassign loans on the registry but not through county recorders.

The paperwork needed to transfer ownership and maintain a legal chain of ownership “was often neglected by sellers-servicers,” she wrote. “Servicers cannot prove to the courts that they have a valid ownership and right to foreclose,” Goodman wrote, “and the appropriate affidavits are being contested in court. To clean up the matter, servicers may need to redocument the transfers and refile the appropriate assignments, presumably at a large cost to the servicers and investors.”

The consequences for the banks, and therefore the economy, could be enormous.