On Jan. 23, U.S. Department of Housing and Urban Development Secretary Shaun L.S. Donovan met in Chicago with several Democratic state attorneys general (AGs) in an attempt to strong-arm them into signing up for an administration-backed agreement to settle the “robo-signing” scandal. Wall Street would pay what sounds like a large fine ($25 billion), and in exchange, the state AGs would relieve the bankers of all legal liabilities related to the fraudulent mortgage-lending practices that led directly to the 2008 financial meltdown and a 30 percent drop in U.S. home prices.
Sadly, this is nothing more than another bank bailout, in addition to the $700 billion Troubled Asset Relief Program (TARP); the $7 trillion in loans to the banks from the Federal Reserve; and the Fed’s zero-interest-rate policy, which allows banks to borrow from the Fed at zero percent while investing in U.S. Treasury bonds at 4 percent.
The fraudulent practices of the mortgage servicers have injected an untold number of forged documents into the legal system, jeopardizing the clean titles to millions of homes around the country. The costs of cleaning up this legal mess will most likely be in the hundreds of billions of dollars, yet this settlement would let Wall Street settle up with the state AGs for just $25 billion. Worse yet, most of this money would come from the pockets of investors who now own the mortgages, not from the perpetrators of fraud, and the rest would come out of the pockets of bank shareholders rather than from the miscreants who perpetrated the fraud.
Let us all agree that when a homeowner defaults on his mortgage, someone has the right to foreclose. The question is - who? In order to protect peasants from expropriation of their land by nobles, English common law, back in 1677, established the Statute of Frauds, which requires that all legal contracts involving land be in writing with “wet” (original) signatures. Real property law in most states follows the Statute of Frauds in setting forth legal requirements for a lender to establish before the court that it has the legal right to foreclose and take the property of a borrower.
Herein lies the problem. In their rush to securitize poorly underwritten mortgages and foist them upon unsuspecting investors around the world, bankers decided that they did not have to play by the (legal) rules. They did not create and/or keep the original documents needed to prove to the property courts that a lender has the legal right to foreclose. The bankers didn’t care - because they no longer owned the mortgages; they only serviced the mortgages for investors to whom they had sold the mortgage-backed securities (MBS).
“No-doc” loans became “no-doc” foreclosures because servicers found it much cheaper to foreclose with forged documents than to restructure a mortgage, even when the restructuring was in the best interests of the investor who owned the mortgage. Losses on foreclosed properties go to the investors; the bank servicers get paid no matter how severe the losses.
When a few borrowers challenged “no-doc” foreclosures, the bankers responded by “re-creating” the originals - i.e., by forging and backdating signatures and notarizations and then committing perjury about their actions before the property courts. Borrowers (and the media) responded, in turn, by calling attention to the perjury and forgery problems Wall Street prefers to peddle as “paperwork” problems.
Why does this matter so much? Because of what economists call “externalities.” What happens to the homeowner who is going into foreclosure affects each and every one of us. If there is one foreclosure in your neighborhood, the value of your house will fall by 1 percent; if there are five foreclosures in your neighborhood, the value of your house will fall not by 5 percent but by 10 percent; and if there are 10 foreclosures in your neighborhood, you might not be able sell your house at any price. Why?
When a delinquent homeowner vacates a house, too often it is vandalized by criminals who steal anything that can be sold for value, such as aluminum siding, copper pipes and appliances such as heat pumps. This makes it impossible for the lender to sell the foreclosed house without investing tens of thousands of dollars in repairs, which lenders often are unwilling to do. Hence, the property becomes a haven for criminals in search of a private place to do their business. Many others are sold at discount prices, lowering comparables for the whole neighborhood.
Therefore, it is critically important that the state AGs and property courts around the country maintain the rule of law. If a bank has the legal right to foreclose, it must follow the law by producing in court the legal documents required to back its claim. If the bank cannot produce those documents, it must take the expensive legal steps to re-establish its legal rights; it cannot be allowed simply to forge copies of the original documents that it failed to maintain. Such forgeries have clouded the titles to millions of foreclosed properties and will cloud the titles to the 4 million properties that are headed into foreclosure. The costs of cleaning up the millions of titles to foreclosed homes, by themselves, will far exceed the proposed $25 billion settlement.
Instead of giving a free pass to the Wall Street banker who created the housing crisis, the state AGs should instead prosecute every instance of fraud, forgery and perjury within their jurisdiction. Flip the little fish into testifying against the big fish; then hit the big fish with jail time. Don’t leave bank shareholders holding the bag for the criminality of the Wall Street bankers who created the financial crisis. Now is the time for accountability, not for another big-bank bailout.
Rebel A. Cole is professor of finance and real estate at DePaul University.