Always Be Foreclosing

Maybe you've heard it called the "foreclosure mess." Or, from those who can somehow still affix the suffix with a straight face, maybe it was "foreclosure-gate." And then there are the few hand-wringing bloggers, finding both "mess" and "gate" too trivial, who warn that we are already confronting with all-to-familiar obliviousness the beginnings of a full-blown "Foreclosure Crisis." But I suspect that the majority of people are calling it nothing at all, having never heard of any of this.

So much the better, according to the editorial board of the Wall Street Journal. As they see things all this hysteria--the foreclosure moratorium, the fighting words from the politicians, the bloggers, always hysteria from the bloggers--is all over a legal glitch. A minor, albeit oft-repeated, technical error. Nothing to get all riled up and frothy about, Comrade.

Talk about a financial scandal. A consumer borrows money to buy a house, doesn't make the mortgage payments, and then loses the house in foreclosure—only to learn that the wrong guy at the bank signed the foreclosure paperwork. Can you imagine? The affidavit was supposed to be signed by the nameless, faceless employee in the back office who reviewed the file, not the other nameless, faceless employee who sits in the front.

The result is the same, but politicians understand the pain that results when the anonymous paper pusher who kicks you out of your home is not the anonymous paper pusher who is supposed to kick you out of your home. Welcome to Washington's financial crisis of the week. (WSJ)

Totez. Leave it to the libs to make such a big deal out of something as trivial as property rights and contract law.

Here's the story:

Remember the housing crisis? Remember all of those complicated financial arrangements that bankers devised to make lending absurd sums of money to Guatemalan cleaning ladies a riskless proposition? The details don't really matter--only this general point: the dizzying tangle of unnecessary complexity that now connects a single mortgage payer to a single beneficiary of that payment is sufficiently labyrinthine to make even Jareth the Goblin King, codpiece and all, feel a little inferior.


Now with so many borrowers unable or otherwise unwilling to pay their mortgage debt, their homes (the collateral on those loans) are being seized by debt servicers (located either in the bank or outsourced to Knee-Breakers Corp.) and sold off, the proceeds going, minus fees, to investors. Hence, the Gregorian knot of mortgage payments is traced backwards to its source where it is unceremoniously cut.*

But now that process has stalled and most fingers initially pointed at "robo-signers." When a servicer forecloses upon a home, it must provide to the court (in states where foreclosures are passed through the court) a number of necessary documents--most notably, the actual mortgage note (the IOU)--along with a sworn affidavit that says something like, yes, it would seem that we actually have the right to take this person's house away.

But, alas, it was discovered that employees within a number of banks (GMAC, JP Morgan Chase, and Bank of America most notably) were processing these files at a rate of about a case per minute. That's a case examined and deemed to be in order, another foreclosure approved by the bank, every sixty seconds.

Now, here's the debate:

Is the problem simply that that the robo-pens are flying a little too quick for regulatory comfort, that the underpaid schlub in the front office was signing at the dotted line instead of the underpaid schlub working in the back? Is it, to paraphrase the Wall Street Journal editorial, that the servicers aren't certifying their right to foreclose on a property in exactly the proper way? Or is it that, in a number of cases, the servicers just don't have the right to foreclose, period?

Maybe, as many are suggesting, the servicers don't have all the necessary documentation. As the New York Times reported on October 2nd, one of the countries largest title insurers has suspended insuring sales on homes foreclosed by either JP Morgan Chase or GMAC until "the objectionable issues have been resolved." An explanation:

In every sale, a title insurance company insures that the title is free –and clear —that the prospective buyer is in fact buying a properly vetted house, with its title issues all in order. Title insurance companies stopped providing their service [to servicers trying to sell foreclosed-upon properties] because—of course—they didn’t want to expose themselves to the risk that the chain of title had been broken, and that the bank had illegally foreclosed on the previous owner. (The Big Picture)

In other words, these independent private insurers are refusing to sign-off on what the minute-men robots had. And while it's impossible to know exactly what those "objectionable issues" are (the author of the blurb above seems certain, but who knows?), they're obviously serious enough to raise questions over the legality of a given foreclosure.

Recall the housing boom. The business model of most mortgage originators (initial lenders) was originate-to-sell: lend money, sell the debt to a big bank on Wall Street, repeat. This process was, it goes without saying, under-regulated and the poor standards employed by the originators are evidenced by the last three years of financial history. Further up that food chain, mortgages notes (the IOUs) were often traded 18 separate times while claims on their payments were sliced and diced and repackaged down to the cent. Given all that, it certainly seems possible that some of those notes were misplaced--or at the very least, transferred from one party to the next incompletely or improperly. To avoid this, most banks began submitting these notes to a central registry, MERS. But it turns out that the folks at MERS sucked just as bad at their jobs as everyone else in the industry. A worrying statistic:

A 2008 study by the University of Iowa showed that mortgage servicers, most often than not, were neglectful in their storage of original documents that will support foreclosure. The study showed that out of the 1,700 cases of bankruptcy due to home foreclosures, 40 percent have missing original mortgage notes and other required documents. (Real Estate Pro Articles)

Now understand that within the under-regulated complex of industries called Modern Finance, the debt servicing sector stands out as one of its least regulated cogs. With little supervision, the incentives facing servicers are largely skewed towards foreclosure. An example: when homeowners stop making their payments, all existing financial arrangements pertaining to that debt enter a kind of legal limbo. Investors owning securities backed by the mortgages are entitled to their monthly payments and property taxes and insurance must be paid on the property after the first 90 days of delinquency. The servicer must cover these costs until the property is sold. Furthermore, most servicers are paid additional fixed fees to cover default and foreclosure expenses. With so many reasons to foreclose, it would thus appear that the assembly-lines lenders like Countrywide adopted during the housing boom are being re-assembled--in reverse.

And with the attempt to constantly churn out as many foreclosures as possible, like the attempt three years ago to constantly churn out as many mortgages as possible, comes the predictable fraud. Meet the new crisis, same as the old crisis:

Last year, the Department of Housing and Urban Development (HUD) received nearly 2,500 complaints about servicers, a 379 percent increase over 2007. In the first 10 months of 2009, consumers filed about 1,000 legal complaints against 10 of the largest servicers for illegal foreclosures and other predatory practices...A federal class-action suit against Ocwen asserts that it has hiked mortgage payments without fair notice, forced borrowers to buy unnecessary insurance, and intentionally processed payments late. (Mother Jones)

Unmentioned here (and on the editorial pages of the Wall Street Journal and on CNBC) is the wide-spread assertion that, in the absence of valid documentation, many servicers working on behalf of banks or bank-managed trusts simply filled in the blanks. As in, they would just make shit up. Exhibits 1, 2, and 3.

So here's the up-shot:

There has been a systemic breakdown in the national foreclosure process. What some are still trying to call a series of technical errors in actuality represents the untethering of an entire subsection of American Finance from the rule of law and property rights. Blatant fraud aside, many foreclosures seem be taking place based not on legal contract, but on the word of the servicer and the complacency and legal ignorance of the borrower. Shoddy paperwork becomes much more than just shoddy paper work when you are discussing the institution of property rights as it pertains to a 2.6 trillion dollar industry. State attorney generals and major investors are only waking up to that fact now. That is the crisis.

On one end of the broken chain of title sits a class-action law suit waiting to happen in every former homeowner who might have reason to believe that a single detail on their mortgage note was violated, plus a growing army of angry borrowers grinding the foreclosure process to a halt.

On the other end of the chain, sit the investors. Imagine this: back in '05 or '06' or '07, an investor buys a financial product offering a certain amount of cash, sliced off from a thousand different mortgage payments from a thousand different counties around the country. With the meltdown, most of those mortgage payments stopped coming. Now, as the investor waits for foreclosure to squeeze the last dollars out from a disappointing stream of payments, that investor learns that the trust that sold him the security never legally owned the underlying mortgage notes. Hell, maybe those notes were sold simultaneously to three separate banks! So now the investor, and every one of his/her counterparts, wants the principle investment back--right now and with interest too.

So what does the trustee say? We can't be entirely sure in all cases, but the blog Rortybomb gives the following real-world example of a contract between the original underwriting of a pool of mortgages (in this case Goldman Sachs) and the company that bought the pool to slice and dice for investors (in this case Deutsche Bank):

In connection with the transfer and assignment of each Mortgage Loan, the Depositor has delivered or caused to be delivered to the Trustee for the benefit of the Certificateholders the following documents or instruments with respect to each Mortgage Loan so assigned:

(i) the original Mortgage Note (except for up to 0.01% of the Mortgage Notes for which there is a lost note affidavit and the copy of the Mortgage Note) bearing all intervening endorsements showing a complete chain of endorsement from the originator to the last endorsee...In the event, with respect to any Mortgage Loan, that such original or copy of any document submitted for recordation to the appropriate public recording office is not so delivered to the Trustee within 180 days of the applicable Original Purchase Date as specified in the Purchase Agreement, the Trustee shall notify the Depositor and the Depositor shall take or cause to be taken such remedial actions under the Purchase Agreement as may be permitted to be taken thereunder, including without limitation, if applicable, the repurchase by the Responsible Party of such Mortgage Loan. (Rortybomb; emphasis his)

Get that? If any more than one in ten-thousand of the underlying mortgages notes is missing or improperly endorsed, the second bank can force the first to buy everything back. And the originator can't go back and fill in the blanks now, assuming it would be able to do so, because it had 180 days after the purchase date to do that. So all those banks with all those toxic assets sitting on their balance sheets? They might soon find themselves having to make bit more room.

This isn't solely a theoretical possibility. Just before writing this, I found this via Ezra Klein:

The Federal Reserve Bank of New York has joined a group of investors demanding that Bank of America buy back billions of dollars worth of mortgage securities that are plagued with shoddy documentation and lending standards, according to people familiar with the matter...If Bank of America refuses to comply, these investors could end up suing, a person familiar with the matter said.(Washington Post)

And never fear an insufficient number of reasons to feel fear, Felix Salmon has identified a related clusterfuck-in-the-making. This one involves investment banks potentially withholding material information from investors to whom they were selling these mortgage backed monstrosities. Which aside from not being a very gentlemanly thing to do constitutes insider trading and could serve as a solid basis for litigation--either from the SEC or any number of pissed-off investors. Or both. Oy.

With the sins of the mid-oughts potentially coming back to wreak havoc upon the balance sheets of the big banks, a number of people are predicting another full-fledged financial crisis. And this time around, it's hard to imagine any policy maker with the stomach for TARP II. For no particular reason though, I doubt things will get that apocalyptic. Maybe I'm just having a hard time imagining the big banks not finding a way to legally or politically slither out of another existential crisis. What I don't doubt is that with major financial interests opposing the banks on the so-called "buy-side," this problem isn't going away anytime soon. A month or two or three from now, if we're calling it anything, I'm guessing that we will no longer be calling this the Foreclosure Mess (or gate or crisis), but something more along the lines of Pissed-Off Investor-Gate or the There Aren't Enough Lawyers in Hell to Deal with All These Lawsuits Crisis.

But down at the ground level, I suspect that maybe a few high profile cases will bring down a particularly flagrant servicer or two--and with it, the entire foreclosure fraud issue as a publicly recognized scandal. Unless the poor paperwork was so bad as to actually invalidate existing debt (which is not going to happen and if it did would open a whole other can of worms), I have a hard time believing that the servicing and foreclosure system will suffer much more than a few aftershocks. Without regulation, the sector will remain in the shadows. And all those deadbeat defaulters that nobody cares about, without the indignation of a defrauded mutual fund or national government to back them up, will remain deadbeat defaulters, even when they aren't. In the meantime, let's all pray to Saint Elizabeth Warren.

*It is worth mentioning that in all the chatter about fraud and abuse, few are questioning the economic logic of foreclosing at all. Rortybomb has a great post on this.