Why are many of the big Wall Street banks imposing a freeze on foreclosures when the average number of days to foreclose on a property, according to Lender Processing Services, is at an all-time high of 478 days?
The answer is that we have entered Part II of the subprime crisis, which also can be characterized as big banks behaving badly yet again. The subprime crisis was most notorious for the so-called no-doc and NINJA mortgages, in which "no-doc" stood for "no documentation required" and NINJA stood for borrowers with "no income, no job or assets." In other words, it was a "paperwork problem." "Nothing to see here, folks; move on," we were told.
The big mortgage lenders, such as Bank of America, Countrywide, Wachovia and Washington Mutual, then sold these mortgages to Wall Street investment banks, including Goldman Sachs, Morgan Stanley and Merrill Lynch, which sliced and diced them into collateralized debt obligations (CDOs). The ratings agencies blessed most of these CDOs with triple-A ratings, after which the soon-to-be-junk securities were foisted off onto unsuspecting investors around the world. Then the subprime borrowers often failed to make even a single payment on their mortgages, sending the values of the CDOs plummeting into junk status and worse.
In the financial carnage that ensued, Countrywide, Wachovia, Washington Mutual and Merrill Lynch failed, only to be folded into other Wall Street titans such as Bank of America and J.P. Morgan Chase, which then were bailed out by capital injections from the taxpayer-funded TARP. Goldman Sachs and Morgan Stanley survived, but only after being rescued by the Federal Reserve, which under cover of night granted them access to its discount window by converting them into bank-holding companies. That is old news - the story of the subprime crisis, which is over and done. Or is it?
In recent weeks, several major mortgage lenders have 'fessed up that they have discovered pervasive "paperwork problems" in their legal actions to foreclose upon delinquent borrowers. First, it was GMAC, but then Bank of America and J.P. Morgan Chase followed suit; others likely will follow. But what do the big banks really mean by "paperwork problems"? We have learned of so-called "robo-signers," employees of these banks who filed affidavits with the courts handling the millions of foreclosure actions, swearing that they had read the loan files and knew that the information in these files was true. Then later, when deposed in person, these same employees testified that, actually, they had not read the loan files and had no idea whether or not the information in the files was accurate. What information was inaccurate? Such small details as, "Does the bank legally own the mortgage note."
"Paperwork problem" is a misnomer; what we have here is perjury problem. Bank employees have sworn before the courts across this land to facts that were not true. Not once, not 10 times, but tens of thousands of times. And they are only the ones who have 'fessed up. According to RealtyTrac, more than 6 million homes have been seized by lenders during the past three years.
Didn't we impeach a sitting president a decade ago for lying to a court about a much lesser matter? And why are these big-bank employees lying about these foreclosure actions? The answer lies in the subprime securitization gold rush that took place between 2004 and 2007. In their rush to move mortgages from origination to securitization (garbage to gold, the ultimate financial alchemy), the big banks created a "virtual" system for tracking who owned the mortgage notes. This virtual system, known as MERS (Mortgage Electronic Registration Systems), was founded back in 1997 to bring our nation's "archaic" land-title recording system into the 21st century. This system registered MERS as the "nominal" owner of the mortgage and supposedly let the real owners trade the associated promissory notes among themselves without having to worry about niceties of the land-title system, such as the need to prepare and record assignments when trading residential and commercial mortgages. Without MERS, the securitization machine would not have been quite as profitable. MERS boldly advertised that it would enable lenders to "save" by avoiding the filing fees (typically $25 to $50) required by counties across the country when ownership of real property is transferred. It now appears that lenders such as Countrywide and Washington Mutual took advantage of these savings by using MERS to track changes in ownership but failed to prepare and file affidavits of ownership with county courts, as required by law in all 50 states and the District of Columbia.
Enter the Statute of Frauds. The Statute of Frauds refers to an English common law established back in 1677 to protect poor landowners from expropriation by the nobles. It simply requires that all contracts conveying an interest in real estate be in writing, with "wet signatures" by both buyer and seller, as well as by a witness, typically a notary public. What we are learning is that many lenders relied upon MERS alone to track ownership of the promissory notes they sold. In order to save 50 bucks on filing fees, they failed to comply with state laws requiring a paper affidavit of ownership signed by both parties and notarized by a witness. With no "skin in the game," why should they have worried? Now that Countrywide, Wachovia, Washington Mutual and Merrill have failed, we know why: They didn't expect to be around for the carnage we face. Unfortunately for Bank of America and J.P. Morgan Chase, those two megabanks ended up acquiring the legal carcasses of the failed mortgage lenders and now are saddled with the paperwork/perjury problems the defunct lenders created.
As long as poor and ignorant borrowers simply handed over the keys to their foreclosed properties, there was no problem. But a few such delinquent homeowners had the temerity to hire lawyers and contest the foreclosure actions of MERS and the big-bank servicers. When they were represented by competent legal counsel, a startling trend began to emerge. When lenders were challenged to prove that they actually owned the note, many withdrew, or sought to amend, their foreclosure actions. A few bold defense attorneys were able to depose a few of the lenders' employees, each of whom had signed, as we now know, thousands of affidavits before the courts that the lenders owned the notes (i.e., the promissory notes associated with the mortgage liens). Only then did the robo-signer scandal emerge.
Now the Wall Street banks are desperately trying to sell their egregious actions to the public as a paperwork problem. Don't buy their snake oil; this is really a perjury problem. Yes, in most cases, the borrowers have failed to live up to their contractual obligations to repay mortgage loans and are subject to foreclosure proceedings. However, that does not deny those borrowers of the right to due process or relieve the lenders of their legal obligation to prove that they followed the rules and hold legal title to the notes underlying the mortgages. In the rush to securitization gold, many mortgage lenders broke the rules, just as they broke the financial system and brought about what is now known as the Great Recession. By their perjurious conduct, the Wall Street banks have violated the trust of the court system and should be held accountable. As more and more judges are deciding, the best sanction is to dismiss their foreclosure actions with prejudice, effectively rendering their perjured affidavits of ownership worthless.
The fallout from this perjury problem goes far beyond the 2 million homeowners currently in the foreclosure process and even beyond the additional 2.4 million borrowers who are seriously delinquent on their mortgages but not yet in the foreclosure process. The actions of these lenders have cast a cloud on the title of more than 60 million mortgages registered in MERS virtual registry. Did the lenders properly assign ownership as they traded the notes underlying these mortgages? In many cases, we now know that they did not. How pervasive is the problem? No one knows yet. What we do know is that this is going to be an expensive problem to fix, requiring a detailed review of each and every document related to these 60 million mortgages.
For those with dirty titles, the owners will be forced to file a quiet-title action with the courts to clean up the chain of title. Who is going to pay for these reviews and actions? Most likely, you and I will pay. In order to sell your house in the future, you are going to have to establish clean title. Even though Bank of America and GMAC have announced they are ready to resume foreclosures, this problem is not going away anytime soon. It will likely bedevil the courts for much, if not most, of the coming decade.
Rebel A. Cole is professor of finance and real estate at DePaul University.
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