naked capitalism

Paul Jackson has posted on a decision by an Alabama trial court involving the so-called New York trust theory that we have discussed at some length on this blog. Given how banks have been taking it on the chin ever since the robo-signing scandal broke, I suppose I’d be inclined to gloat a little, as Jackson does, in response to a verdict in favor of a bank; bank PR has been a particularly tough assignment these past few months.

But Jackson tries to treat this particular lower court decision as an important precedent, when this is anything but. In addition, Jackson evidently is not familiar the normal process of getting new legal arguments accepted in court, or of how decisions in one court are viewed in another. Finally, as I will touch on here and discuss at greater length next week, there are good reasons why it is unlikely courts in other states (or even Federal bankruptcy courts in Alabama) will look to this decision as a precedent.

Because Alabama is widely known to have an anti-consumer state court, a decision in favor of the borrower would be seen as far more surprising, hence noteworthy, than a decision in favor of the bank. Alabama used to be a state where juries in class action suits would give mind-numbing awards to plaintiffs. As a consequence, big corporations have labored mightily and successfully in repopulating the judiciary with more pro-business jurists. I’m told it has the most costly Supreme Court elections in the US. If nothing else, they are considerably more expensive to win than the gubernatorial election.

Second, it is not unusual for new arguments, particularly in unsettled areas of the law, to lose on their debut. Think how long tobacco and asbestos litigation took to start getting traction in courtrooms. Plaintiffs’ lawyers go through a learning process as determine what hurdles they need to overcome to persuade a judge or jury. And we’ve seen a similar process in the foreclosure crisis. Even though borrowers’ attorneys had been devising strategies to contend with robo-signing abuses since at least 2009 (it’s hard to find a start date on the specialists blogs), it was a non-issue until it was validated last fall and led most major servicers to halt foreclosures in some or all states (and even now, it appears that the pace of foreclosures may have slowed appreciably as a result of continuing documentation issues).

I will need to look at the trial transcripts and affidavits more closely, as well as confer with independent experts, but as an initial check, I sent the decision to a couple of attorneys who do not have a dog in this fight. One deemed the decision to be “amazing”, which in context is “amazingly bad”. The other thought the decision to be unlikely to be looked at as a precedent, and was critical of some of the key aspects of the legal reasoning.

US Bank v. Congress Order

This is merely a quick pass but let me flag three troubling issues which call the legal analysis into question. The first is on page nine. The Court sets up a straw man argument, that the borrower asked that New York law be used to determine the matter of ejectment. The borrower never took that position, so the matter was never in dispute. I received this comment by e-mail from a former Federal and state prosecutor:

….the PSA’s choice of law provision should control the threshold fact issue whether or not the promissory note is trust property. This basic fact issue is one that the trustee has agreed should be decided by New York trust law. The trust’s beneficiaries have every expectation when they purchase the trust’s certificates that the trustee will promote a uniform interpretation of the trust’s terms no matter where the forum.

In fact, it was discussed in the hearing at some length that the trustee was unable to establish conclusively which trust held the loan. There were multiple trusts created around that time by the same issuer that could potentially have owned the loan, and the same loan number appeared in two SEC filings (I need to reread the transcript on this issue but I do recall considerable time spent on this matter). Instead, the decision finesses this issue:

[w]hen GMAC referred the note to plaintiff’s attorney, GMAC informed her the Trust was the current holder of the Note.

In reality, the referral came from the default subservicer, Fidelity/LPS, and the subservicer’s identification of the trust is hearsay. How Fidelity/LPS came up with the name of the trust remains a mystery.

Second are the questions raised about a “tah dah” document appearing on the eve of trial (literally Thursday evening before Memorial Day weekend, when the hearing was the following Tuesday, which would normally be considered too close to trial to be permissible to introduce new evidence), namely, an allonge. For those new to the foreclosure mess, what laypeople call a mortgage has two legal elements: a promissory note, which the borrowers signs, and a lien on the property, which is in most states confusingly called the mortgage. In many states, and Alabama is one of them, the note is the critical instrument. You need to have legitimate rights to the note to be able to foreclose; the lien is a mere accessory and follows the note.

Notes are negotiable instruments, meaning to be conveyed from one owner to the next, they need to be signed, just like a check. They can be endorsed in blank (no specific party named, so whoever has possession could claim ownership) or to a specific party. The documents governing securitization, the pooling and servicing agreement, typically required that the note had to have the full chain of endorsement through multiple specific parties before it got to the trust, and this one was no exception.

Under the Uniform Commercial Code, an allonge, which is a separate document attached to a note to permit more signatures to be added, must be “affixed”. The language in the old version of the UCC was “firmly affixed”; most states have now adopted an newer version of the UCC which merely required “affixed.” The reason for concern is tampering. A note has clear monetary value; a note endorsed in blank is a bearer instrument. Notes are (or should be) handled as carefully as checks, particularly since they typically have considerable monetary value. If you could just assert “I have this piece of paper, it shows that check you have really was endorsed to me” you can imagine what mischief would result.

This part of the decision is a stunner:

In this case the allonge was attached by means of a rubber band and the instruments were together in a file folder. The court finds that the allonge in this case was adequately “affixed” to the note and the signature on the allonge a valid endorsement of the note.

To be clear, the note was in the collateral file at the beginning with other documents in between, and the allonge was at the end with a rubber band around the whole file folder, which was not all that skinny. What makes this a matter of concern is the mysterious appearance of this document at the eleventh hour when it was absent from bank’s evidence submission, after it became clear pre-trial, thanks to affidavits submitted by the borrower’s lawyers, that they were going to argue that there was no evidence that the note had been properly conveyed (as in the note lacked the needed signatures).

Now from what I can tell, there are no Alabama court precedents on allonges since the new UCC was put in place. Courts in other states that have adopted the UCC don’t accept the standard asserted by this judge. For instance, Massachusetts requires physical attachment. The Ohio appeals court recently also required attachment and looked to a Texas Supreme Court decision and an Arizona decision, both of which concluded the allonge needed to have been attached (there was discussion in the Texas decision that it was OK to detach the allonge that was known to be previously attached (presumably for purposes like photocopying) as long as there was good reason to believe tight controls had been maintained over the documents. Consider this section (page 20):

In contrast to Watson, no evidence was presented in the case before us to indicate that the allonges were ever attached or affixed to the promissory note. Instead, the allonges have been presented as separate, loose sheets of paper, withno explanation as to how they may have been attached. Compare In re Weisband,(Bkrtcy. D. Ariz., 2010), 427 B.R. 13, 19 (concluding that GMAC was not a “holder”and did not have ability to enforce a note, where GMAC failed to demonstrate that an allonge endorsement to GMAC was affixed to a note. The bankruptcy court noted that the endorsement in question “is on a separate sheet of paper; there was no evidence that it was stapled or otherwise attached to the rest of the Note.”) {¶ 68}

Third is the judge’s arguing for the use of digital signatures, which he acknowledges were evidently Photoshopped to fit on the allonge. Most states require so-called wet-ink signatures; indeed, I had been under the impression that that was close to a universal standard for real property transactions. Real estate transactions were specifically exempted from the Federal laws related to digital signatures for that very reason.

Jackson misses the fact that these fights over new legal issues are not battles but campaigns. And Jackson’s record at calling their outcome is on a par with the National Association of Realtors’ record on housing price forecasts. For instance, in October, he wrote:

The real fact is that the ‘robo-signing’ scandal is a procedural one, albeit one that offends the very nature of due process. That said, until someone can provide consistent and repeated evidence suggesting that the information contained within ‘robo-signed’ affidavits is factually incorrect — not just some of the time, but most of the time — the end result of this mess is nothing more than a very public, brand-damaging, headline-making procedural blip.

Jackson set the standard that one had to reach before anyone should take robo-signing concerns seriously was that the underlying inaccuracies had to be pervasive:

Thus far? Not a whit of credible evidence has been produced suggesting that foreclosure affidavits are factually incorrect on an endemic level. And this, despite a debtor’s counsel that for years has been actively and aggressively sniffing out every possible way it can to forestall foreclosures. If false debt amounts were being pushed by banks onto the courts en masse, and there was any credible evidence to support such a claim, you can bet all the apple pie in America that every single one of us would have heard about it by now — and well before anyone started to complain about the arcane technicalities of which nameless, faceless bank employee was signing a particular document.

As Barry Ritholtz argued pointedly, that’s the wrong standard. The process should be error free. No one should ever be at risk of losing their house to a documentation “mistake”. Real estate was historically deliberate and procedure intensive for a very good reason: these transactions were very important to the parties involved. And judges also taken issue with the idea that the proper submission of affidavits is merely “procedural”; this sort of casualness strikes at the heart of the processes designed to insure that evidence submitted to the court is accurate and reliable.

For instance, we pointed out that the state attorneys general and the Federal regulators did at most a cursory exam of servicers (knowing how hard it is to reconcile servicer records with borrower payments, the review of 2800 loans cannot have involved checking the integrity of servicer record and payment and their use of impermissible pyramiding fees). Thus the only abuses that they’ve apparently looked into are HAMP abuses (the Treasury was somewhat on the case, no doubt due to the ministrations of the Congressional Oversight Panel). So it appears that the authorities are pressing for principal mods at servicer expense (when as we’ve said, investors would be happy to see them go to viable borrowers) that would involve meaningful hard costs to the banks. If these abuses were the nothingburger that Jackson has maintained they are, why is the bank-friendly Administration pushing for these measures?

The problem with Jackson’s reading is he is so deeply invested in defending the securitization industry that it distorts his interpretations. Consider this statement from a recent post:

Believe it or not, mortgage servicing is a noble industry. Or, at least, it’s supposed to be. Even in managing borrower defaults and repossessing property, there is something noble to the work, underneath it all — and it comes from following the law, enforcing contracts, ensuring that our nation’s system of property rights maintains its integrity for all Americans.

In fairness, in the rest of the post, he did discuss how servicing had gone badly awry due to cost cutting pressures (which he blamed on Fannie and Freddie). But consider his assumption: he sees servicers playing a judicial role. That is in fact what has too often happened, and that’s wrong. Real property transactions are governed by the law, and the courts, not the servicers, are the mechanisms for enforcing contracts and upholding property rights. Richard Smith discussed at some length precisely why these procedures have remained the foundation of property rights for over 300 years.

We also have this:

By subverting our nation’s real estate law to favor borrowers who have no intention of fulfilling their debts, we risk undermining everything that establishes private property rights in our country — and perhaps the coup de grâce of it all is that the American public will be cheering when it happens.

Sorry, Paul, the overwhelming majority of borrowers who eventually default struggle to stay current and have every desire to meet their commitments. They don’t want a free house, they want a modification. And while many are hopelessly over their heads, some would be viable on a principal mod that would still put the investors ahead. That’s not my view, that’s the view of Wilbur Ross who has actually tried it.

It’s ironic that Jackson keeps presenting himself as the voice of reason, when in fact his world view is that of a one-sided morality where those with the most money are right. And on top of that he holds himself as a defender of law, yet frequently defends practices that undermine the very foundation of property rights. That stance is, at its core, unreasonable, unfair, and profoundly dangerous.