ForeclosureThe Congressional Oversight Panel created in the wake of TARP to oversee and monitor the Treasury Department has just issued a devastatingly clear report about the mortgage mess and its legal implications, which are ugly.

The report hedges and doesn't pick between the financial industry's view that the foreclosure documentation problem is limited and easily fixed and the worst-case scenario that robo-signing and the like are symptoms of fundamental problems with mortgage securitizations that could push the big banks back into bailout land -- or the financial system back over the brink.

However, the panel does recommend further stress-testing the banks, which shows that it thinks the worst-case scenario isn't so far-fetched. Moreover, a close look suggests that the financial industry's view borders on the delusional, and the worst case might even be likely.

Two Grounds for Suing Banks

The worst-case scenario has several components. First is that the big banks are forced to pay investors for all those lousy mortgage-backed securities. As the report notes:
"one investor action alone could seek to force Bank of America to repurchase and absorb partial losses on up to $47 billion in troubled loans. . .Bank of America currently has $230 billion in shareholders‟ equity, so. . .[i]t is possible that widespread challenges along these lines could pose risks to the very financial stability that the Troubled Asset Relief Program was designed to protect."
The investors could have two core grounds for suing. First and fundamentally, sloppy paperwork may mean the securities aren't backed by the mortgages after all because the trust issuing the securities doesn't own the mortgages. Secondly, the banks may have lied to the investors about the quality of the mortgages in the securities to a significant degree. In either case the investors can sue or demand that the securities be bought back.

If the mortgages weren't transferred properly during the securitization process, another set of terrible consequences results from the fact that the owners of the loans aren't the trusts that people think own the loans. As the report explains:
"Borrowers may be unable to determine whether they are sending their monthly payments to the right people. Judges may block any effort to foreclose, even in cases where borrowers have failed to make regular payments. Multiple banks may attempt to foreclose upon the same property. Borrowers who have already suffered foreclosure may seek to regain title to their homes and force any new owners to move out. Would-be buyers and sellers could find themselves in limbo, unable to know with any certainty whether they can safely buy or sell a home. If such problems were to arise on a large scale, the housing market could experience even greater disruptions than have already occurred, resulting in significant harm to major financial institutions. For example, if a Wall Street bank were to discover that, due to shoddily executed paperwork, it still owns millions of defaulted mortgages that it thought it sold off years ago, it could face billions of dollars in unexpected losses."
A related problem is that the loan servicers that are doing mortgage modifications with homeowners may not have the right to do modifications. Similarly, an entity without the right to foreclose also doesn't have the right to modify a loan.

A Broken Paper Trail

To understand how likely the worst-case scenario is, take a look at what would have to go wrong with documentation during the securitization process, and consider it in light of robo-signing and all the other paperwork problems. Although the details may differ with each set of securities, the basic issue is this: to get the notes and mortgages into the trust in a way that kept them there -- even if the mortgage originator or the sponsor went bankrupt (as many originators did) -- they had to be transferred at least twice before entering the trust.

The best way of proving those transfers would be having each one recorded on the note that the mortgage is attached to. And indeed, the contracts that governed how the mortgages got into the trust (the "pooling and servicing" agreements) generally required a chain of endorsements on the note.

How likely is it that an industry that invented an electronic database -- MERS -- specifically to avoid a paper recording of individual transfers of mortgages at land-record offices around the country stayed on top of properly endorsing the notes of each mortgage? How likely is it when you consider all of the "lost note" affidavits foreclosers are submitting to the courts? How likely when you add in the fraudulent assignments of mortgage that have defunct entities transferring the mortgage and note? Or what about notes that didn't have endorsements suddenly having them?

And if the mortgages and notes weren't given to the trust according to the pooling and servicing agreement, is there an easy fix to put the notes in now, in the same way banks claim they can fix their fraudulent foreclosure filings merely by resubmitting papers? No, because the agreements prevent the trusts from getting notes and mortgages after the fact to preserve the special tax-free status the securities are entitled to.

A Fundamental Screw-Up?

Similarly, the agreements prohibit giving the trust any loan that's in default, which many now are. So, if the banks in those freewheeling mortgage securitization days of 2005-2007 didn't do their paperwork properly, title to all those securitized mortgages could be clouded, screwing up American real estate in fundamental ways. And investors could launch crippling efforts to sue the bankers or force them to repurchase the tainted securities.

The panel's report suggests that fraud cases might be hard to win both because it could be hard for investors to prove that fraud caused their losses (as opposed to the market's crash more generally) or because making out a common-law fraud case is just plain hard.

But at least one common-law fraud case based on the rating agencies' fanciful triple-A ratings of these securities has been going forward, and I'm not sure why suing the banks should be harder. According to the panel report, sponsors of the securities may have known that many of the mortgages didn't meet the standards they were supposed to, and the sponsors demonstrated that knowledge by using the information to buy the mortgages more cheaply, without disclosing that material information to the purchasers of the securities. If true, that seems to meet common-law fraud's tough "intent" requirements.

In short, common sense suggests that robo-signing is just the most visible artifact of a mortgage banking culture that appears to have had little respect for following the letter and spirit of the law. If that disregard extended to "law" as spelled out in the key securitization agreements, we can expect to watch the worst-case scenario slowly play out. Investigations, lawsuits and wary courts will force the industry to come clean.

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16 Comments

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dlee4144

I didn't make my mortgage payment for about 5 months. Not because I couldn't- I sent a check each month, but the company first told me to send it to a different address. I did, it was never cashed- that was for two months. Then I got a letter from a company I had never heard of saying the loan had been transferred to them and wanting those two months payments. I didn't know if it was a scam, so I didn't send anybody anything for a couple of months. Then I had my lawyer check out the situation and he said to send the money to the second company, but I didn't owe them for the two months prior to getting their letter- and charging me 1/2 a month's mortgage payment for that information. Now, the calls I am getting from collectors demanding those two months payments are at least keeping the person making the calls employed, so I guess some good came out of it. But, it's almost to the point where it would make sense to stop making your payments and daring them to prove you owe them anything.

November 23 2010 at 1:50 PM Report abuse rate up rate down Reply
mballgoldservice

None of these companies can produce the original notes as they were all scaned and then distroyed.

November 18 2010 at 3:35 PM Report abuse rate up rate down Reply
rodericklavallee

I commend you for delving into this murky ugly mess that seems to defy the light, attention and clarity of 'the rest of the story" Your article is well constructed and understandable. I hope it angers and worries a huge audience that will rally and join the cause of right and help for millions of mortgage victims In my humble opinion, I think you and your colleagues are the only possible way to bring attention, visability and then hopefully resolution of this man made disaster of greed and cupidity brought to us by the keepers of our financial well being as individuals and as a nation

November 18 2010 at 11:20 AM Report abuse +3 rate up rate down Reply
jkennedy806

Is this the end-result of bailing out these fraudsters, with TARP. I hope that now after the Ethics committee is done with Rangel (Ways and Means committee) the Ehics committee can concentrate on a few other scandals. I am going to find out who owns my mortgage? Is it Fannie Mae, is it Norwest, is it Wells Fargo, is it Edward JOnes, Is it someone else. I don't know. Why would I pay my monthly mortgage if I don't know if I am going to be ultimately credited for payment. And by who? I haven't seen a mortgage statement in 12 months from any bank, how can I make a payment if I don't have a statement/paystub? What's going to happen is the banks are going to be on the hook PERIOD and they need to be. Ultimately, each and every mortgage even the ones not in foreclosure will be reviewed. The paperwork has to be addressed, in order for transparency, accountability and consurmer confidence to return. The big banks created this mess, and the big banks need to fix it. NO MORE MERS, NO MORE SWAPPING mortgages or anything else. Go back to regulations until this mess is straightened out.

November 18 2010 at 10:12 AM Report abuse rate up rate down Reply
1 reply to jkennedy806's comment
cyberfreddie

Please use a paragraph-you comments get lost in a mass of print.

November 18 2010 at 3:48 PM Report abuse rate up rate down Reply
marine1942

Hold it !!! This oversight committee is investigating the way it does business ??

November 18 2010 at 8:11 AM Report abuse +2 rate up rate down Reply
edbobbymarc

This entire robo signer "scandal" is purely a diversion. This way, the govt gets people to go back to focusing their anger at the big bad banks instead of realizing why the rate of forecloser is astronomical -- THE ECONOMY! Banks don't easiy foreclose. The vast majority of these people have not paid their mortgages in well over a year. Tell me again why they have the right to sue the banks? Paperwork missing signatures -or any documents- didn't impact their financial ability to make their mortgage payments. Yet they want their houses back on a technicality? Here is what's coming. Banks won't be able to foreclose despite no payments. Without consequences, people who were struggling to make the mortgage payments will stop.Which makes fools out of the people who saved, didn't get in over their heads and pay on time! (In no way am I including people who lost their jobs. Many are truly struggling - I get that) Which brings us back to THE ECONOMY!

November 18 2010 at 2:29 AM Report abuse +2 rate up rate down Reply
pmurph2000

These mortgages are probably all owned the the Chinese. Wouldn't surprise me if the Fed worked out a deal: You take our property since we can never repay our debt anyway. In a few years we will all be sending rent checks to China!(or their office building right down the street. Speaking of, when will the Commercial real estate meltdown hit???

November 17 2010 at 11:09 PM Report abuse +4 rate up rate down Reply
fred

Why is it people were indicted for fraud in the S&L scandals of the '90's, but NO ONE is indicted for the largest fraud of the derivatives scandal of home mortgages? It's amazing to me that everyone blames everyone else on the mess, yet all from bottom to top are responsible (those who borrowed when they shouldn't have to those who lied shuffling the papers and all in between). Regardless of which deck of this cruise ship you're on, everyone who collectively partied as a group now have to pay, like it or not. I just think it's sad that the bottom deck is paying WAY more than the top.

November 17 2010 at 9:50 PM Report abuse +8 rate up rate down Reply
nconstinc

I need $50,000.00 to get out of forclosure. People I know are not that much more in debt with theirs. I want to pay but lost my job. Instead of giving billions to no where, give every American 50K to help get out of debt and stop their forclosures. I cant get ahaed, necause of it, but I copuld maintain it if I got help. And Im not asking for free, loan it to me with no interest, I dont want a hand out, just a litle help.

November 17 2010 at 7:01 PM Report abuse +3 rate up rate down Reply
1 reply to nconstinc's comment
jkennedy806

No you don't, go to a bankruptcy attorney and get cram down, you probably have an underwater home, a mortgage that has been sold over and over again. Do you know if you have a Freedie Mac or a Fannie ? If you do, your bank does not own the loan -- and needs permission from the Fed government a.k.s. the crooks Barney Frank and Chris Dodd. Go to the deed office and see who is on your note, then if it doesn't match the financial institution and there is no paperwork your mortgage was a toxic dervative, been bundled and has been sold to who knows who?? Then find out if the who know who paid the deed filing fees. There is a little law that states that if a mortgage/note was assummed or acquired it must be re-filed in the deed office with all fees paid. This is my scenario. stoped the foreclosure cause the bankster trying to foreclose didn't do the paperwork correctly.

November 18 2010 at 10:26 AM Report abuse rate up rate down Reply
somerscollc

Thank you Barney Frank and Chris Dodd for this mess!1 They both should be in Jail!!

November 17 2010 at 6:22 PM Report abuse +8 rate up rate down Reply