Mortgage Industry Nuclear Bomb
By now you have probably heard about the freezing of foreclosure’s by some of the country’s largest banks while they try to get their houses in order. This is my attempt to provide an idea of why this is huge and could be a watershed event. There are certainly some errors in my description (not being an expert in this area), but the gist should hold true.
First, you need to know that a mortgage is made up of multiple parts including the deed and the note. To securitize the note it would be sold through a number of intermediaries until it arrived in the trust of a mortgage backed security (let’s ignore CDOs and other more complicated instruments for now). The trust of a mortgage backed security defined the rules of what securities are eligible to be in the trust (e.g., x% equity, credit rating > y, not in default, etc).
Now as anyone who has gotten a mortgage knows, it is a paperwork intensive process with needed signatures on lots of pieces to make sure everything is transferred properly. For example, each time the note get’s transferred (originator -> aggregator -> mbs, etc) all the proper parties must sign the note. When the note has no more space to fit these transfer assignments, you can then attach a new sheet a paper (an allonge) to continue the process.
During the mortgage hay day, all this physically signing of things was considered too burdensome so they used an electronic registration system (MERS) to keep track of ownership (this was never blessed by any state law). So much like you could log into a bank and transfer funds, with the electronic system an originator could enter in that they have a new note and sell it to the aggregator without any hard copy recording of the transfer being created. The originator would simply store the original note in their warehouse.
Now let’s fast forward to today, when many of these mortgages are in default and need to be foreclosed on. 23 states have judicial foreclosures, which means you must go through the courts to foreclose on a house. In order to foreclose on a house you need to prove you own the note (i.e., have standing) and you need to notify the homeowner that you are going to foreclose.
The following are some of the shenanigans that have come to light.
- Employees (i.e., robo signers) were signing 50 to 100 affidavits a day stating that they had personal knowledge that the homeowner had been served with notice when in fact they had no such knowledge. It is being discovered that this is an industry wide practice. It has also come to light that proof of service paperwork was being forged on a regular basis.
- Remember how the physical notes were left at the originator and that the law doesn’t recognize the electronic assignment? To overcome this problem, allonges were fabricated showing the necessary backdated transfers. Remember an allonge is only supposed to be used when the note has no more room for transfers and the allonge is supposed to be attached to the note in manner that its separation would physically harm the note. We know these allonges are fabricated because they were neither attached nor was the note’s space for transfers filled.
Furthermore, all this fraud means truly bogus foreclosures are occurring. A man in Florida had his house foreclosed on when he didn’t even have a mortgage! The only reason that could happen was because the bank and law firms were fabricating the necessary documents to foreclose.
Without changes in the law this cannot be easily fixed. First the originator (say Countrywide) may be bankrupt, which means that no assets (of which the note is one), may be transferred out of the company without the court’s approval. Second, even if you pass that hurdle, now that the note is in default, it no longer qualifies to be transferred into the trust of the mortgage backed security. A law that retroactively recognizes the electronic transfers would seem to be the only legal way to solve this problem for lenders.
3. Lender Processing Services acted as a conduit between lender’s and the attorney’s who were processing the foreclosures. It turns out that they set up secret revenue sharing agreements with the law firms they referred cases to (this constitutes the unauthorized practice of law in many states) as well as facilitating the fabrication of many of the above documents. Two multi billion dollar suites have recently been filed trying to achieve class action status against them.
To summarize, rampant fraud has been going on and its ubiquitous nature is just now coming to light. As these facts work their way into the popular media, this could end up being a focusing catalyst for a lot of pent up anger.