The battle lines are forming.
In the last two years, local attorneys working for the small minority of borrowers who contest foreclosures have reported a wide range of what in spin doctor land would be called irregularities. These reports were so widespread and consistent as to suggest that malfeasance was endemic, but without corroborating evidence that these abuses were happening on an institutionalized basis, it was easy to dismiss them as anecdotal.
The admission by GMAC that it produced improper affidavits, followed by suspension of foreclosures by GMAC, Chase, and Bank of America in 23 judicial foreclosures states, is the tip of the iceberg of widespread foreclosure abuses. Yet comparatively few members of the media have asked the right question: why would servicers and law firms engage in fraudulent activity on such a widespread basis?
The ugly answer, as we have detailed long form in earlier posts (see here and here for more detail) is just as the front end of the mortgage securitization pipeline broke down, with originators increasingly simply pumping any deal through in the interest of pulling out fees, the same behavior spread to the back end.
Evidence is mounting that the various parties responsible for getting the notes (the borrower IOU into the securitization trust, failed to perform a series of tasks that were clearly set forth in the governing contract, the pooling and servicing agreement. These procedures were designed to thread a path through a complex thicket of multiple legal considerations (state real estate statutes, federal securities law, trust law, IRS provisions, to name a few). The failure to do it right means any retrospective fixes run afoul of multiple boundary conditions. Thus to industry participants, fraud, bizarrely, looks to be less bad than admitting to their colossal failures to respect contractual obligations and legal requirements.
We are seeing more recognition of the consequences of this clusterfuck, which in more polite company might be called, “My dog ate your mortgage.”
While commentators so far have focused on the implications for borrowers, the real bagholders are mortgage securities investors. As the Wall Street Journal notes:
For mortgage investors, the recent suspension of foreclosures could potentially cause further losses in the already-battered $2.8 trillion market for residential mortgage-backed securities…..
While it is unclear whether the delays will have a deep impact on the market for bonds, the changes are already creating some unexpected outcomes, say investors.
When houses that have been packaged into a mortgage bond are liquidated at a foreclosure sale—the very end of the foreclosure process—the holders of the junior, or riskiest debt, would be the first investors to take losses. But if a foreclosure is delayed, the servicer must typically keep advancing payments that will go to all bondholders, including the junior debt holders, even though the home loan itself is producing no revenue stream.
The latest events thus set up an odd circumstance where junior bondholders—typically at the bottom of the credit structure—could actually end up better off than they expected. Senior bondholders, typically at the top, could end up worse off.
This is the first time we’ve seen a reference to the role servicer advances play, an issue we highlighted last week. And the story also mentions potential servicer liability:
Typically, mortgage servicers enter into contracts called pooling and servicing agreements with bondholders that spell out the servicers’ obligations to manage the loans in the best interests of the investors. These agreements provide that the servicers be reimbursed by funds in the trust for all costs related to litigation and extra processing of foreclosures, provided they follow standard industry practices….
But the problems could be magnified if the reviews uncover a lack of proper documentation or other substantive problems rather than simple procedural errors.
With the stakes so high for the various parties to securitizations, the first line of defense of the incumbents is to try to minimize the problem. But the fact that more extreme measures are being readied suggests they are coming to understand that this cesspool might be plenty deep.
One sighting (hat tip 4ClosureFraud) is the effort by the Ohio Secretary of State to enlist support against a proposed measure to allow for electronic notarizations. The Secretary hints strongly that this measure being put forward is directly related to the revelation of affidavit improprieties, which further suggests that the banks might regard this as a remedy for this particular, um, lapse:
H.R. 3808 is known as the “Interstate Recognition of Notarizations Act.” It passed the House under a suspension of the rules in April 2010. It requires federal and state courts to recognize any notarization that is lawful in the state where the notary is licensed. Now, in one day, it passed in the Senate.
When I learned of it last Thursday, it sounded innocuous to me, but then I started looking at the timing of the bill. GMAC, owned by Ally, had just suspended its foreclosure actions in 23 states, including Ohio. I had already referred Chase Home Finance, LLC, on August 23, 2010, to the U.S. Department of Justice, asking it to review and investigate Chase’s document notarization practices in home foreclosures (18,000 documents per month were being notarized by 8 people, along with other irregularities). I license notaries in the State of Ohio. Even though I don’t have the power under state law to investigate or prosecute, I couldn’t stand idly by without acting. That’s why I’m asking you to email or call the President at 202-456-1111 to ask him not to sign the bill.
Last Wednesday, the day before I announced the DOJ referral, JPMorgan Chase announced it was having third party counsel review its document procedures for foreclosures. Just two days before, the U.S. Senate had rushed through H.R. 3808. Something didn’t seem right. Since then others agree with me.
Yves here. This development reveals how this battle is likely to play out. Now that judges in some states are starting to take these dubious, potentially fraudulent measures seriously, the next line of attack is to get the more bought and paid for Federal government to intercede on behalf of the banks. As the e-mail by the Ohio Secretary shows, this is a state versus Federal rights issue. And the problem is that these solutions will be depicted as “efficient,” just as securitizations and other “innovations” were.
And while efficiency in theory is a good thing, it must always be kept secondary to the overall integrity of the system, otherwise, you run the risk of breakdown. Using dubious arguments to overturn well settled law to get the banking industry out of a monster mess it created is a Faustian bargain. It makes it abundantly clear what is really at stake here, which is the rule of law. Banks that were quick to defend unjustifiable pay deals by invoking “sanctity of contract” have no inhibition about ignoring their own contracts to pad their bottom line, and ultimately, the wallets of top executives.
Rather than deal with the considerable consequences of these abuses, the banks are prepared to bulldoze well settled state laws to give them an easy way out. And I’m not basing my view on this story alone; I had a conversation yesterday with a Congressional staffer who matter-of-factly said (but with little understanding of the underlying issues) that Congress would intervene on behalf of the industry, via its authority over national banks.
The result is that we institutionalize kleptocracy while keeping largely gutted forms of due process as theater. The powers that be hope that the broad public will remain unaware of what is really at work.
However, the battle is not yet lost. Elizabeth Warren has said she will stand up for consumers and is a vocal advocate of contracts as a mechanism for protecting the interests of American families. This issue could serve as an opportunity for her to demonstrate that her appointment as de facto head of the new financial services consumer protection agency is not mere Obama Administration window dressing (or more accurately, that her appointment was a PR ploy, but Warren is able nevertheless to turn it to her advantage).
In addition, an increasing number of Congressmen, as least at this juncture, are lining up in this fight in favor of borrowers and against well funded business interests who provide hefty campaign donations is a hopeful sign. It may be that there is enough left of what passes for propriety in this country that even the Congress can’t be rolled so easily on this one. Per the Washington Post:
House Speaker Nancy Pelosi, Rep. Zoe Lofgren and other California Democrats are calling for a federal investigation into the processing of thousands of foreclosures by some of the nation’s largest mortgage lenders.
In a letter to Attorney General Eric Holder, Federal Reserve Board Chairman Ben Bernanke and U.S. Comptroller John Dugan, the lawmakers said recent reports that Bank of America, J.P. Morgan Chase and Ally Financial may have improperly approved thousands of foreclosures “amplify our concerns that systemic problems exist.”
Banks “have repeatedly misled and obstructed homeowners from receiving the help Congress and the Administration have sought to provide,” they wrote. “The excuses we have heard from financial institutions are simply not credible three years into the crisis.”
Sen. Robert Menendez (D-N.J.) this week called for the Government Accountability Office to investigate “the role of all government entities – including federal regulators, involved in overseeing mortgage servicing companies and affiliated banks – and identify any regulatory problems that may have permitted this misconduct to occur without detection until now.”
Note that these Congressmen are not aiming at the narrow issue that gave this story prominence, the robo signers, but the broader patterns of abuses. Let’s hope they have the resolve to make an investigation a serious undertaking, rather than a mere photo op.