I suppose the fact that the New York Fed hosted a meeting last week with a group of solons is a sign that it is finally taking mortgage documentation and resulting foreclosure issues seriously. But the Fed’s spin diverges from the reading I got from attorneys who have a vantage on the process. Per Housing Wire:
But the New York Fed said solutions are on the way. The Uniform Law Commission and the American Law Institute, which facilitated the recent meetings, seek to clarify and update federal and state laws governing the securitization process.
I’m bothered by the dishonest presentation, which a close reading of the related NY Fed document confirms. Let’s start with its opening paragraph:
Problems with mortgage foreclosures have been in the headlines during the past several months. The media attention arises from several concerns. One concern relates to whether lending institutions have followed proper foreclosure procedure. Another reflects a popular misconception among many that a mortgage can become separated from the note it secures. Yet another concern arises out of the complexity of some of the structured transactions involving the mortgages.
This seeks to present the concerns as mere noise in the media, rather than a result of troubling incidents and widespread abuses. In addition, notice the failure to mention the elephant in the room: chain of title issues, which are so widespread that a borrower challenging a foreclosure in a post 2004 securitization has a decent chance of winning if he argues that the trust lacks standing.
The Big Lie here is that the problem lies with “the complexity, and the outdated nature of the relevant law.” The NY Fed argues that the real estate regime was fine when banks held the mortgage to maturity and everything that was important that needed to happen took place in the same local area.
The paper, astonishingly, acts as if the operational requirements of mortgage securitization have led servicers to lose money. The argument made in these two paragraphs is pure fabrication:
The process of selling loans and mortgages requires that there be some method of determining the current owner of each particular loan and mortgage. In fact, that is a necessary component of the foreclosure process. The loan and mortgage owner, or a servicer who is acting as the owner’s agent, must determine whether it is appropriate to exercise foreclosure rights. When a loan and mortgage securing the loan is created, the initial lender will ensure that the mortgage is recorded in the correct real estate records based upon the location of the real property. However, when the loan and mortgage are sold, the manner of transferring the right to realize on the security for the loan does not typically require that an assignment of the mortgage be recorded in the real estate records. In many cases the loan and mortgage will be registered with an entity called MERS, which is a tracking system, so that interests in it can be followed when the loan and mortgage are transferred. In some cases, MERS also is listed as the mortgagee in the mortgage as an agent of the initial lender and all of the initial lender’s subsequent assignees (buyers of the loan and mortgage).
This division and fractionalization whereby there are entities that are owners of the loan and mortgage (or some part of the loan and mortgage), a servicer for the loan and mortgage, and a named mortgagee that is not necessarily the owner of the loan and mortgage has caused significant confusion. Mark Kaufman, Commissioner of the Maryland Office of Financial Regulation (OFR) testified about the remarkable changes in securitization and third-party servicing before a Congressional legislative committee, noting that these developments “forever changed the mortgage landscape.” Today, he said community banks only hold a fraction of mortgage loans in Maryland and account for next to none of the foreclosure complaints received. “The unbundling process may have facilitated the flow of cheap capital, but it has also fragmented roles, distorted market incentives, and severely complicated the task of modifying loans to avoid preventable foreclosures.” Moreover, Kaufman continued, the same economies of scale drove consolidation in the mortgage servicing business line, so that today the top five mortgage servicers are responsible for over 60% of the mortgages serviced. Every one of the five is owned by a major bank holding company. He noted that this concentration not only created an enormous management challenge, but left money losing servicers trapped in too-big-to-fail institutions. As a result, “the invisible hand of the market will not fix this.”
Notice how there is no timeline in this discussion? If you were to read the paper, you’d think banks created this great system called securitization which “enables the initial lender to replenish its supply of capital to make new loans.” But whoops! They somehow didn’t realize there would be a lot of operational demands, and now we have “money losing servicers trapped in too-big-to-fail institutions.” Notice NO OTHER EXPLANATION is offered. The only possible culprit is therefore those pesky but important legal requirements that bit the securitizers in the ass.
Utter hogwash. Securitization has been around since 1970. Private label securitization started to become a meaningful activity in the later 1980s. And most important, the industry managed to satisfy all those operational requirements and servicing was seen as a decent, even attractive business Remember how Bank of America was falling all over itself to buy Countrywide? The prize was Countrywide’s servicing unit.
An aside: that dramatic quote also implies these horrible servicing operations are a serious drain on those fragile too big to fail banks. Yes, they are cash flow negative, but no, they do not pose a threat to their health.
So what happened? Three things. First, the banks created MERS to improve their profits. That took place in the later 1990s but it did not start to be widely used until the early 2000s. Second, starting in the 2002-2003 refi boom, originators and packagers started cutting corners on the carefully crafted procedures for notes (the borrower IOU) to be conveyed to the securitization trust. This change not only ran afoul of some legal requirements but also was a violation of the requirements of the pooling and servicing agreements, the contracts that govern the securitization. Third was the global financial crisis left a record number of foreclosures in its wake, far higher than ever contemplated when these deals were designed. Servicing highly delinquent portfolios is a money-losing proposition.
So the real reason that industry is having trouble with foreclosures and servicers are losing money has absolutely nothing to do with the reasons suggested by the Fed. Two of the three are due to the industry running roughshod over the law. MERS was vetted only on a Federal law level; no review was ever undertaken of whether it would work under the laws of all the states. It was brazenly assumed that if MERS was imposed, the states would roll. That proved to be a tad optimistic. The second reason, the abandonment of established procedures, is fraud pure and simple. The packagers and trustees lied in the PSAs and the ongoing certifications.
And since any fix is going to be prospective rather than retrospective, invoking the losses servicers have now is irrelevant. The “invisible hand” contention is nonsense. If the servicers are losing money on their current pricing, they have to live with that and figure out how to reprice their offerings once their current portfolios run off. Businesses make bad decisions all the time and get in situations where they are losing money on a product or in a certain geography. They don’t go running to some of the best legal minds in the US demanding waivers to fix their business models. Oh, I forgot, we are dealing with banks, who will try any and every trick they can if there is a buck to be made.
There was another worrisome bit, per Housing Wire:
The two organizations also drafted a report to guide judges and lawyers involved in the transactions, and, the central bank said, should make the application of present laws more transparent.
The Housing Wire declaration that “solutions are on the way” is wildly premature. At this stage, the legal heavyweights are simply discussing whether to draft to provisions. Thus the Fed is trying to prod them to do so.
The good news is the lawyers who are watching the state of play seem to think this is more bluster than real. If anything were to happen, it would involve amending the Uniform Commercial Code, which is about as fast-moving a process as drafting and implementing new Basel rules, but with more philosophizing involved (see here for an overview). Moreover, the fact that a change to the UCC is published does not mean states will adopt it. A major revision to Article 2 of the UCC was proposed in 2003 and no state has implemented it.
One DC source indicated this was all theatrics to try to sway state court judges; all stressed that any change would have no impact on the current mess.
I’m nevertheless disturbed by the Fed trying to insert itself in a process in which it has no legitimate role, and as its paper indicates, in which it is willing to misrepresent facts to assist banks. Its concern instead should be for the public and the integrity of the housing market, both of which are victims of securitization industry greed and recklessness. But it will take root and branch reform of the Fed before that could ever happen.