naked capitalism

Some readers may have been unhappy with my failure to comment on a Washington Post article late last week about a push by the mortgage registry service, MERS, to “legalize” its activities. Even though the article indicates that dollars are being thrown at lobbyists to sell the MERS version of reality in DC, their approach seemed to be so unlikely to have much impact as to not merit comment. It described MERS lobbying efforts thus far ($1 million since 2008, which I believe is tantamount to couch lint by DC standards, although they have apparently ratcheted up spending of late). The surprising part is the focus of the efforts:

The industry is seeking legislation that would effectively affirm MERS’s legality and block any bill that would call into question what MERS does.

The latter bit, trying to block anti-MERS legislation, does have a shred of logic, given that the electronic database is coming under unfavorable scrutiny. Not only has Marcy Kaptur proposed legislation that would bar Fannie and Freddie from buying mortgages registered in MERS, but even Republican senator Richard Shelby, who once owned a title insurer, roughed up MERS president R.K. Arnold in hearings earlier this week.

But the idea of passing a Federal statue to solve MERS’ growing state-level problems is a huge stretch. As the latest report of the Congressional Oversight Panel noted,

In the absence of more guidance from state courts, it is difficult to ascertain the impact of the use of MERS on the foreclosure process. The uncertainty is compounded by the fact that the issue is rooted in state law and lies in the hands of 50 states judges and legislatures.

We’ve been told that Constitutional scholars have said that repeated Supreme Court decisions have found real estate transactions to be beyond the reach of Commerce clause, and hence not subject to Federal intervention. So the idea that MERS can be legitimated by Congress appears far-fetched.

But what are the problems with MERS? The focus so far has been on its questionable legal standing, but its operational failings are every bit as serious.

Although critics have provided a number of arguments against MERS, the most fundamental relate to MERS’ claim that it acts as mortgagee of record. While the language it uses to register mortgages in the name of MERS in local courthouses says it is both the nominee for the mortgagee and the mortgagee (a legal impossibility), in depositions its executives have repeatedly said that MERS is the mortgagee (see here and here for examples).

In 45 states, that position would seem to be a non-starter. In those states, the note (the borrower IOU) is the critical document; in these states, the mortgage is a mere “accessory” to the note and has no independent force. Indeed, in these states, you cannot be a mortgagee unless you are also the creditor. But in depositions, MERS has repeatedly acknowledged that it does not lend money and does not collect interest payments. But MERS effectively takes the position that you can separate the mortgage from the note and reunite them, a position that was rejected in an 1873 (no typo) Supreme Court decision, Carpenter v. Longan (Carpenter v. Longan, 83 U.S. 271, 21 L.Ed. 313 [1873])):

.The note and mortgage are inseparable; the former as essential, the latter as an incident. An assignment of the note carries the mortgage with it, while an assignment of the latter alone is a nullity.

Case law in virtually every state follows Carpenter.

But aside from this rather large legal elephant in the room, MERS also suffers from very serious operational shortcomings. MERS, which is the mortgage and servicing rights database, has no employees; its parent, MERSCORP, has roughly 50 employees.

MERS instead relies on “certifying officers”, a bogus arrangement in which employees of “MERS members”, which for the most part are mortgage servicers and foreclosure mills, temporarily act on behalf of MERS. As Christopher Peterson describes it:

As a practical matter, the incoherence of MERS’ legal position is exacerbated by a corporate structure that is so unorthodox as to arguably be considered fraudulent….MERSCORP simply farms out the MERS, Inc. identity to employees of mortgage servicers, originators, debt collectors, and foreclosure law firms. Instead, MERS invites financial companies to enter names of their own employees into a MERS webpage which then automatically regurgitates boilerplate “corporate resolutions” that purport to name the employees of other companies as “certifying officers” of MERS. These certifying officers also take job titles from MERS stylizing themselves as either assistant secretaries or vice presidents of the MERS, rather than the company that actually employs them. These employees of the servicers, debt collectors, and law firms sign documents pretending to be vice presidents or assistant secretaries of MERS, Inc. even though neither MERSCORP, Inc. nor MERS, Inc. pays any compensation or provides benefits to them… MERS even sells its corporate seal to non-employees on its internet web page for $25.00 each.

Per Senate testimony by MERSCORP president R.K. Arnold last week, MERS has over 20,000 signing officers. There is ample evidence its controls over them lie somewhere between deficient and non-existent.

Let us start with the fact that the MERS end uses are under no obligation to update the MERS database. MERS officers admit that the data is only as good as what their users provide. MERS certifying officers have testified that the signing authority agreement specifically states that all parties agree that MERS is not responsible for the accuracy of any information provided by member. And there appears to be little within the system procedures to assure data integrity.

We asked our Richard Smith, who is a capital markets IT professional and has considerable experience in databases, to review key sections of a deposition of R.K. Arnold that dug a bit into operational matters. His excerpts deposition and commentary

1. The “handshake”
==================

This is a matching and confirmation process:

So whenever a transfer occurs of any
10 interest, be it beneficial interest in the
11 promissory note or be it servicing
12 interest, those you expect to be entered on
13 the MERS system?
14 A. It’s not so much that we expect it. We
15 operate a system that offers that
16 capability. So it’s always the parties
17 that transact by an electronic handshake.
18 Q. An electronic handshake. That’s an
19 interesting term. What exactly does that
20 mean?
21 A. One company goes in and stages it
22 electronically and it waits in a status
23 until another company comes in and confirms
it.
2 Q. And is that typically done through the
3 process of an upload or like a batch file?
4 A. Preferably.
5 Q. And y’all have internal coding that tells
6 you what each of those types of –
7 handshakes was your term — what each of
8 those are; right?
9 A. Yes.
10 Q. And so if you have those codes, you know
11 exactly what was changed hands and at what
12 point in time according to those parties;
13 right?
14 A. Yes. And that’s what makes the system
15 instantaneous.
16 Q. Correct. But the system relies upon the
17 actual execution of the underlying
18 agreements and documents?
19 A. Yes.
20 Q. So while your system may indicate the
21 intent to undertake a certain act, it is
22 not proof that that act actually was
23 undertaken, is it?
Page 180
1 MR. BROCHIN: Object to the form.
2 A. As far as its evidentiary nature, you know,
3 I — that would depend on whatever the
4 circumstances were. But it’s not intended
5 to reflect the actual transaction. It’s
6 not the transaction. It’s tracking that
7 transaction.
8 Q. Sure. It is, in fact, a memorialization of
9 the underlying paper that is allegedly in
10 existence between the parties?
11 MR. BROCHIN: Object to the form.
12 A. You know, the — basically it’s a — we
13 operate a system that lets the members
14 through electronic handshakes tell us who
15 we’re working for. And that’s the extent
16 of it. So we serve in the land records for
17 the members, and then the system tells us
18 who we’re serving for.

I agree about the laxity: 1) if there is collusion outside the system, just about any set of transfers could be input and confirmed by two parties. Where is the dual-keying and management supervision? This ends up at the accountability question, below. 2) There’s no indication of any reconciliation process, ie daily checking for transfers that don’t match and sorting out who made a mistake. It beggars belief that there wouldn’t be confirmation failures, with human beings on either side of the transaction.

Combine 1 & 2 and it’s easy to see how the physical legal reality and the electronic record might not agree. As the lawyer keeps emphasizing in his questions, there is nothing here which would make a chain of transfers evidentiary of anything, if it’s the paperwork that actually counts legally. It does seem to be just a (potentially shaky) electronic copy of the physical docs.

Other observations: the guy being interrogated seems like a low level operator who doesn’t necessarily understand the system too well (*update* after closer reading FUCK ME, he’s the CEO).

Authentication
==============

Q. And it says that — with respect to those
Page 192
1 issues, once a person is certified by MERS
2 as a certifying officer, does MERS ever
3 undertake any action to verify that those
4 persons are actually corporate officers of
5 the company, that they have certified
6 themselves to be so?
7 A. Well, first off, it has not always been a
8 requirement that they would be officers of
9 the member.
10 Q. Right. And so you’ve certified whomever
11 they’ve asked; right?
12 A. Yes.
13 Q. And irrespective of how many persons there
14 were; right?
15 A. It — the bigger the company, the more
16 certifying officers they’re probably going
17 to want to have.
18 Q. Especially nowadays; right?
19 MR. BROCHIN: Object to the form
20 of the question, if that’s a
21 question.
22 Q. A lot more foreclosures going on today than
23 lately; right?
…
Q. Again, when did you implement this
8 requirement that these persons with signing
9 authority be officers of the corporation?
10 A. Within the last couple of years.
11 Q. Is it your contention that anyone who is
12 signing as a certifying officer who is not
13 an officer of the corporation is not
14 validly acting on behalf of MERS?
15 MR. BROCHIN: Object to the form
16 of the question.
17 A. No, I wouldn’t agree with that.
18 Q. Do you have any idea how many people are
19 certified as certifying officers of MERS in
20 the country today?
21 A. Me personally? Me personally?
22 Q. Through you personally or through your
23 company, what you know as CEO of MERS.
Page 194
1 A. Well, you say any idea.
2 Q. I mean, ballpark?
3 A. We’ve got a very good idea.
4 Q. Do you know exactly how many?
5 A. We — we have every name.
6 Q. Okay. And do you track every transaction
7 that they undertake in MERS’ name?
8 MR. BROCHIN: Object to the form
9 of the question.
10 A. No.
11 Q. Do you have any idea how many transactions
12 are conducted daily by persons who are
13 identified as certifying officers of MERS?
14 A. I don’t understand the question, any idea.
15 Q. Do you keep any record of the number of
16 transactions undertaken by persons who are
17 designated as certifying officers of MERS
18 on a daily basis in this country?
19 A. There is certain things that the system is
20 required to be updated to reflect, so, yes.
21 Q. What are those things?
22 A. When a loan is paid off, when a foreclosure
23 begins.

So – authentication is essentially non-existent. Look, they only introduced their ridiculous porous authentication process a couple of years ago. This is a real collusion enabler. Not saying there has been any, just that there’s absolutely nothing here that tends to promote integrity between MERS’ account of the txns and the actual transactions. See also pp 201-204, 234.

Access Control
==============
Would like to know if there are ‘super users’ who can tinker behind the
scenes. There seem to be seven distinct user authorizations but no detail on
what they are.

Accountability
==============

With authentication that poor, you don’t have accountability, even if you do have some kind of audit trail. Which *might* exist:

11 Q. (Mr. Wooten continuing:) Mr. Arnold, we
12 looked at several reports generated as part
13 of this discovery. And specifically to
14 those issues, is there any method that
15 you’re aware of whereby a user of the MERS
16 system could go back and alter any of those
17 transactions that have been entered or
18 registered on the system, change any of the
19 terms or the timing or anything like that?
20 A. No.
21 Q. Is that a — is there some sort of audit of
22 the technology to assure that that can’t
23 take place or some sort of firewall? How
1 does that occur? Do you know?
2 A. You just wouldn’t be able to go in and
3 change anything that had been done. You’d
4 have to update it.
5 Q. So if — is there a way to make an entry
6 which would allege that the prior entry was
7 an error and it be replaced on your system?
8 A. You could correct a prior entry with a new
9 entry.
10 Q. Would the old entry be deleted if you
11 correct it?
12 A. No.
13 Q. So even if, say, somebody decided that they
14 didn’t like the timing of some of these
15 transfers in one of these reports, even if
16 they tried to go back and change the dates
17 with a correction, it would still show the
18 previous entries?

This certainly looks as if it’s meant to be an audit trail.

Yves here. Based on my reading of other depositions (another of Arnold, one of Richard Hultman, I’d not place much stock in what passes for audit in MERS-land. MERS keeps track of who is a certifying officer, but its records do not capture what actions have been taken by a particular certifying officer, which is a serious impediment to any sort of accountability. In addition, even though MERSCORP claims to conduct audits and quality reviews, it appears to have at most 16 people devoted to this activity. Given the weakness of the procedures and management information systems, it is very doubtful that so few people can provide effective oversight to over 20,000 people who can and do act on behalf of MERS. And why should MERS bother with supervision? MERS’ agreement with each and every certifying officer disclaims any responsibility for the accuracy of the information.

And without even looking for it, I’ve come across evidence of gross failings of MERS’ operational integrity. In the one consumer foreclosure case I’ve sat in on, the attorney for the foreclosure mill was put on the stand and said that she had transferred a note from an originator, which at the time of the assignment, was bankrupt. That entity had no way of authorizing this action, since it no longer had any employees or officers. Any approval would have had to come from the bankruptcy trustee, who would not have been a MERS member. The fact that this assignment was made on a routine basis calls into question whether this electronic handshake can possibly be an effective safeguard.

In addition, by happenstance, Lisa Epstein of Foreclosure Hamlet sent me a document which shows that one Linda Green, who executed mortgage assignments on behalf of MERS, in fact had no authority to do so in certain cases. While MERS says it has since tightened up its procedures for obtaining authorizations for its certifying officers, it is not clear whether this unauthorized action took place before or after the policy change. Even if it occurred before the new requirements were in place, it is not clear that these measures are adequate, given that the robo signing abuses demonstrate that servicers and foreclosure mills do not have strong operational controls either.

In Congressional testimony last week, R.K. Arnold asserted that MERS is well positioned to be the recording system of the future and can solving some of the problems in foreclosures. Not only does this view seem delusional, particularly given his failure to address any of the concerns raised about MERS.

Many Wall Street types who complain that the problem with the mortgage market, and the explanation for all of these robo-signing issues, is that the mortgage system is antiquated and paper intensive and needs to be modernized.

The system that RK Arnold presides over is far worse than the county recording system – it is not transparent to outsiders, the way the county recording system is, and no one has any global responsibility for it. It makes Facebook’s privacy controls look sophisticated, by comparison. It is the exact opposite of what should replace a complex, supposedly antiquated system.

If the mortgage market were to be modernized, it would be a real database, with extensive control points and would be centralized and accessible to the servicer, homeowners, prospective homeowners, and investors.

MERS is such a loosely run operation, independent of its questionable legal standing, that it would need to be rebuilt from the ground up to have the integrity and the transparency that its constituents deserve. MERS’ failings prove that if the 50 states were to embrace the idea of a centralized mortgage registry, it would be better to replace MERS than to attempt to reform it.