Before we get to the meat of the post, I have a fun project for readers. Just as “whocoulddanode” has become inextricably linked to the excuses for the failure to see the housing crisis coming, we need a new tag phase for the hopeless tangled mess that the folks who screwed up mortgage securitizations have foisted on Americans. Conceptually, FUBAR (Fucked Up Beyond All Recognition) is accurate, but it is pretty antique as far as slang goes, so we need a new term. Ideas encouraged.
But to give readers the latest report of modern FUBAR, mortgage edition, let us continue with the sorry saga of “Where’s My Note?” For the benefit of newbies, what everyone calls a mortgage actually has two components: the note, which is the borrower IOU, and the mortgage (in some states, it’s called a deed of trust) which is the lien on the property. In 45 states, the mortgage is a mere accessory to the note; you must be the real party of interest in the note in order to foreclose.
The pooling and servicing agreement, which governs who does what when in a mortgage securitization, requires the note to be endorsed (just like a check, signed by one party over to the next), showing the full chain of title, and the minimum conveyance chain is A (originator) => B (sponsor) => C (depositor) => D (trust). The endorsements also have to be wet ink; no electronic signatures permitted.
I’ve had a lot of anecdotal evidence to support the idea that these procedures, which were created in the early days of mortgage securitizations, were simply not observed on a widespread, if not a universal basis. My sense is that the breakdown in practice was well underway by 2004, but it may have taken place earlier. For instance, a group of over 100 lawyers in a loose network around Max Garndner, a North Carolina bankruptcy lawyer who has taken a serious interest in this area, now has a standing joke that the first one that finds a deal where the note was correctly endorsed must bronze it and hang it on their wall. In other words, in none of the cases this large group has seen were the notes transferred to the trust properly.
I’ve been reluctant to take as strong a stand as their collective experience suggests, but independent evidence confirms their report. One little stunner came courtesy Alan Grayson’s office. In 2009, the Florida Bankers Association wrote a letter to the Florida Supreme Court objecting to some proposed rule changes for foreclosure cases. The full text of the letter is here. The critical section:
The reason “many firms file lost note counts as a standard alternative pleading in the complaint” is because the physical document was deliberately eliminated to avoid confusion immediately upon its conversion to an electronic file. See State Street Bank and Trust Company v. Lord, 851 So. 2d 790 (Fla. 4th DCA 2003). Electronic storage is almost universally acknowledged as safer, more efficient and less expensive than maintaining the originals in hard copy, which bears the concomitant costs of physical indexing, archiving and maintaining security. It is a standard in the industry and becoming the benchmark of modern efficiency across the spectrum of commerce—including the court system.
This is highly entertaining, because the excuse is “oh we destroyed the note, so our standard practice is to use a lost note affidavit.” If this was really as widespread as the Florida Bankers Association suggests, they are in a whole heap of trouble, because in most (if not all) jurisdictions, original notes with proper wet ink endorsements are required. And in states that are serious about proper procedure (South Carolina, for instance), judges are not going to have much sympathy with the use of a lost note affidavit when the note was destroyed.
But while it is clear the notes weren’t handled properly, I’m not certain that this electronic scanning story is accurate either (meaning it isn’t standard practice in mortgage land). In plenty of cases, plaintiffs come up with collateral files with hard copies of documents in them, albeit including suspiciously helpful ones that appear miraculously at the last minute.
At least in private label deals (meaning non Freddie and Fannie), it appears instead that the notes are back with the originator, never endorsed as required in the pooling and servicing agreement, and are transferred out when needed. We provided a report that suggests all the notes from Countrywide deals are still with Countrywide, even though it securitized 96% of the mortgages it originated. We got even stronger confirmation over the weekend.
One of my colleagues had a long conversation with the CEO of a major subprime lender that was later acquired by a larger bank that was a major residential mortgage player. This buddy went through his explanation of why he thought mortgage trusts were in trouble if more people wised up to how they had messed up with making sure they got the note. The former CEO was initially resistant, arguing that they had gotten opinions from top law firms. My contact was very familiar with those opinions, and told him how qualified they were, and did not cover the little problem of not complying with the terms of the pooling and servicing agreement. He also rebutted other objections of the CEO. They guy then laughed nervously and said, “Well, if you’re right, we’re fucked. We never transferred the paper. No one in the industry transferred the paper.”
This creates a lot of problems. If the originator is bankrupt (New Century, IndyMac), the bankruptcy trustee is supposed to approve any assets leaving the BK’d estate. I’m told bankruptcy judges who have been asked were not happy to hear this sort of thing might be taking place, which strongly suggests this activity is going on without the requisite approvals. And who from the BK’d entity can endorse it over? It doesn’t have any more officers or employees. Similarly, a lot of the intermediary entities (the B and C in the A-B-C-D chain earlier) are long dead. How do you obtain their endorsements?
Now you understand why everyone is resorting to fabricated documents and bogus affidavits. There is no simple way to fix this mess. The cure for the mortgage documents puts the loan out of eligibility for the trust. In order to cure, on a current basis, they have to argue that the loan goes retroactively back into the trust. This is the cure that the banks have been unwilling to do, because it is a big problem for the MBS.
The former subprime lender CEO still refused this to consider this a problem: “Oh, Congress will pass a law.” My colleague pointed out that this was a state law matter, Congress had no authority, and even the Supine Court was unlikely to intervene in well settled real estate law. The arguments from the CEO were distressingly familiar, bank industry incumbents seem to resort to the same script: any borrower friendly solution will wreck the economy, the banks will have to get another bailout to get themselves out of this mess.
So here we are back to 2007-8. If you and I make a serious mistake at our jobs, we get fired, and if we make a really serious error, our company could perish. But when bankers screw up, and leave a lot of collateral damage in their wake, they are confident that their sugar daddies in DC will clean up the mess for them.
And the worse is they might even be correct if we let them get away with it this time.