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.

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.

High Noon: Banks vs. The Law (Mortgage Foreclosures) – Part 4

We start to get at the root of the problems in the foreclosure crisis with this article from the Washington Post.  Essentially, the big banks decided that in the 1990’s that the existing laws governing real estate transactions and deed recording were inconvenient.  They thought they had a better way.  But rather than pushing for the law to be changed (which they could easily do with their formidable lobbying resources), the banks decided they didn’t have to conform to existing laws.  They decide to create their own (emphasis is mine):

The land title system that went largely unchallenged in the United States for centuries became an obstacle in the 1990s. That’s when financial firms began to ramp up a process called securitization, bundling and selling pools of home loans to sell to investors. Each time the loans were reassigned, the new owner had to record the transfers with local clerks.

Several executives in the mortgage industry came up with a faster, easier approach: MERS. The list of MERS shareholders includes an array of banks, lenders and title companies. Among them: Fannie MaeFreddie MacBank of America, GMAC, Washington Mutual, Wells Fargo and AIG’s United Guaranty Corp.

Here’s how MERS works: When a homeowner closes on a house, the paperwork signed at settlement often appoints MERS as a “nominee” for the lender and for whomever the lender might sell the mortgage to down the road. Each time the loan is sold and resold, MERS tracks the reassignment in its computer system, without generating paperwork.

The company says such an arrangement benefits all parties – consumers, lenders and investors.

But after the MERS computer system went live in 1997, some county recording offices complained that the company was bypassing the legal process and raking in money charging fees that were lower than those charged by municipalities. They were largely ignored.

“It wasn’t like Congress or state legislators did anything,” said Christopher L. Peterson, a law professor at the University of Utah who has consulted in cases against MERS. “The mortgage industry just changed how the land title system worked without getting anyone’s okay.”

MERS has consistently claimed authority to act as a representative, or “nominee,” on behalf of banks and lenders.

But as millions of homes have fallen into foreclosure, Peterson said, “the MERS system doesn’t provide a substitute for all the recordkeeping” that never took place during the boom years. “MERS created the illusion of record keeping when it wasn’t really done.”

To convince courts that they have the right to foreclose on homes, banks and lenders have often found it difficult – when challenged – to provide the paperwork showing they indeed own the loans. Financial firms, which bought mortgages from other companies, have also been challenged in court over whether MERS even had the legal right to reassign the loans.

These problems contributed to the use of flawed and fraudulent paperwork, including backdated assignments and forged documents, that have prompted firms such as Ally Financial, J.P. Morgan Chase and Bank of America to halt foreclosures.

For more on this crisis, which is admittedly rather complex if you’re not a real estate lawyer, see Part 1, Part 2, and Part 3.