naked capitalism

A story by Ellen Brown gives a good summary of how the widespread use of a national electronic mortgage registry called MERS, designed to save mortgage securitizers the cost and bother of recording mortgages at the local courthouse, is backfiring spectacularly.

Although in a industry as large and diverse as the mortgage industry, one has to generalize with caution. Nevertheless, early in this century, the mortgage securitization industry took the view that recording mortgage at the local courthouse was a tad barbaric, and sought to streamline the process via the use of a national electronic mortgage registry called MERS.

There were two wee problems with this idea:

1. Real estate is governed by state law. A “mortgage” really consists of two elements, the note (the IOU) and the mortgage (in some states, called a deed of trust), which is the lien. In 45 of 50 states, the note is the critical instrument; the mortgage is a mere “accessory”. You need to demonstrate that you are the owner of the note (the “real party of interest”) in order to foreclose.

2. Many of the securitizers got very sloppy with the transfer of the note to the securitization entity, a trust. Theyv’e tried to rely on MERS to prove ownership, or worse to foreclose in the name of MERS. A rising tide of state court decisions is nixing this approach.

The article muffs some details. It isn’t all 62 million HOMES (as the title suggests) that could be difficult to foreclose upon if challenged. MERS may have 62 million MORTGAGES, but this appears to include some second liens, and some of those are in the five states where MERS is hunky dory. And not all states have MERS-unfavorable rulings on the books. But judges in some states are looking to decisions in other, so the fact that quite a few states have important decisions against MERS will make it easier for judges in other states to take that position.

The finesse that MERS has tried to use, when challenged, is that it is a nominee. But in most states, the real party in interest has to be the plaintiff, a mere nominee can’t take legal action without the real party in interest (in this case, the note owner) also joining the action. Moreover, a nominee is a party authorized to act on behalf of another party. But there is no evidence, no paper trail to demonstrate that MERS is authorized to act on behalf of the trust, nothing contemplated in the pooling and servicing agreement that governs the securitization, no fees paid by the trustee to MERS, no agreement, etc.

The article cites a recent case in California which accepts MERS’s contention that it is a nominee, but finds that is insufficient for MERS to foreclose:

The latest of these court decisions came down in California on May 20, 2010, in a bankruptcy case called In re Walker, Case no. 10-21656-E–11. The court held that MERS could not foreclose because it was a mere nominee; and that as a result, plaintiff Citibank could not collect on its claim. The judge opined:

Since no evidence of MERS’ ownership of the underlying note has been offered, and other courts have concluded that MERS does not own the underlying notes, this court is convinced that MERS had no interest it could transfer to Citibank. Since MERS did not own the underlying note, it could not transfer the beneficial interest of the Deed of Trust to another. Any attempt to transfer the beneficial interest of a trust deed without ownership of the underlying note is void under California law.

In support, the judge cited In Re Vargas (California Bankruptcy Court); Landmark v. Kesler (Kansas Supreme Court); LaSalle Bank v. Lamy (a New York case); and In Re Foreclosure Cases (the “Boyko” decision from Ohio Federal Court). (For more on these earlier cases, see here, here and here.) The court concluded:

Since the claimant, Citibank, has not established that it is the owner of the promissory note secured by the trust deed, Citibank is unable to assert a claim for payment in this case.

The broad impact the case could have on California foreclosures is suggested by attorney Jeff Barnes, who writes:

This opinion . . . serves as a legal basis to challenge any foreclosure in California based on a MERS assignment; to seek to void any MERS assignment of the Deed of Trust or the note to a third party for purposes of foreclosure; and should be sufficient for a borrower to not only obtain a TRO [temporary restraining order] against a Trustee’s Sale, but also a Preliminary Injunction barring any sale pending any litigation filed by the borrower challenging a foreclosure based on a MERS assignment.

While not binding on courts in other jurisdictions, the ruling could serve as persuasive precedent there as well, because the court cited non-bankruptcy cases related to the lack of authority of MERS, and because the opinion is consistent with prior rulings in Idaho and Nevada Bankruptcy courts on the same issue.

Earlier cases focused on the inability of MERS to produce a promissory note or assignment establishing that it was entitled to relief, but most courts have considered this a mere procedural defect and continue to look the other way on MERS’ technical lack of standing to sue. The more recent cases, however, are looking at something more serious. If MERS is not the title holder of properties held in its name, the chain of title has been broken, and no one may have standing to sue. In MERS v. Nebraska Department of Banking and Finance, MERS insisted that it had no actionable interest in title, and the court agreed.

Yves here. Some of the earlier decisions have actually been pretty tough too. In Kesler, the Kansas Supreme Court ruled:

The relationship that MERS has to Sovereign [the creditor] is more akin to a straw man than to a party possessing all the rights given a buyer….in the event that a mortgage loan somehow separates interests of the note and the deed of trust, with the deed of trust lying with some independent entity, the mortgage may become unenforceable.

The reason some foreclosures have been performed in the name of MERS is a combination of laziness plus inability to prove, or in some cases, even determine, which trust (the foreclosure should be filed in the name of the owner, which would be the securitization entity, a specific trust) owns the note. Judges, when the foreclosure is challenged, have tended to dismiss the foreclosure without prejudice, meaning if someone can show that they own the note, they can then foreclose (no one is disputing that the borrower owes someone money; the question is whether the party in court is the right one. This isn’t an idle concern. There are cases where the same note has been sold into more than one trust, exposing the borrower to the risk that it could be hit multiple times for the same debt if the courts get cavalier about foreclosure).

Why are judges getting bolder? After all, as some readers will inevitably protest, the result looks inequitable, some people get to live in free houses.

First, comparatively few people contest foreclosures. If you can’t afford the house, why fight to keep it? The vast majority are victims of servicing errors they can’t get resolved, or people who have filed Chapter 13 bankruptcies, where the lender is trying to pierce the bankruptcy stay and seize the house. There are far more people getting “free” houses because they have stopped paying their mortgage but the bank has not foreclosed on them.

Second, at least in some jurisdictions, judges may be of the view that banks are foreclosing (and clogging up their courts) rather than work with borrowers (for most other legal matters, judges like to see that the parties have made a good faith effort to resolve their dispute before going to court). There is evidence to support that; foreclosure rates are lower on bank-owned mortgages (where there are incentives to reduce losses and take half a loaf by doing a mod) than on securitized mortgages (where the servicer is paid to foreclose and is not paid to mod, except when bribed to do so by special Treasury programs). Normally, you’d expect judges to favor banks over deadbeats, so the fact that that increasing numbers are deciding against them says they are troubled by the legal issues (abuse of process) and/or the lack of good faith dealing (efforts to remedy the situation by taking a meaningful haircut, as opposed to a mere catch up plan, which includes paying back late fees, usually charged in violation of Federal law so as to produce more compounding of fees).

These cases are on the verge of a tipping point, where the focus shifts from what these decisions mean to borrowers, to what they mean for investors. The officialdom seems to fantasize that somehow, the private securitization market will come to life, but someone needs to deal with this dead body in the room before than can happen.