naked capitalism

As we’ve discussed the “where’s the note?” problem of mortgage securitizations, some readers who are old enough to have sold a home more than once have said that while they’d gotten a cancelled mortgage note back on their first sale, on a more recent one, they hadn’t. They were concerned, and as this post will show, they are right to be.

By way of background, the popular press has done the public a disservice by talking about “mortgages”. A “mortgage” consists of two instruments: a promissory note, which is a IOU, and a lien against the property, which is referred to as a mortgage (in non-judicial foreclosure states, they are typically called a deed of trust and confer somewhat different rights, but we’ll put that aside for purposes of this discussion).

What appears to be happening on all too often in Florida is that when borrowers signed warranty deeds in lieu of foreclosure when they can no longer keep these homes, they often get only a satisfaction of mortgage, not a cancelled note. This is not what is supposed to happen. When a borrower deeds his property to the bank, the objective of the exercise is to cancel the debt. If the note has not been extinguished, it is referred to as a “zombie note”. As the Fort Myers News-Press reported last year:

Carol Kaplan, a spokeswoman for the Washington-based American Bankers Association, said leaving the note off the satisfaction of mortgage is “not a practice we’ve ever heard of.”

Turns out that’s a bit disingenuous. The article quoted Jack Williams, resident scholar at the American Bankruptcy Institute and a bankruptcy professor at Georgia State University:

“We saw something very similar to this in the debacle in the ’80s, people buying notes from the government and suing,” Williams said. “I won’t rule out that could happen again. They sold the note to collection agencies and law firms and places like that.”

In the real estate meltdown of the ’80s, he said, it was the Resolution Trust Corp., set up by the federal government to liquidate mortgage loans and other real estate assets held by failed savings and loan associations.

“Let me tell you, people made millions of dollars suing homeowners back in the day,” Williams said.

Some of the debt was in the form of deficiency notes: court judgments saying a certain amount was owed even after the property was sold at public auction.

But in other cases, Williams said, it was the note, straight up.

Even though the lawyers who’ve taken note of this practice are in Florida, the ground zero fo the foreclosure crisis, it is important to stress that anything that is happening in one state on a meaningful basis in securitized mortgages is very likely to be happening elsewhere. The securitizations were set up to be widely dispersed geographically and the servicers have set up their procedures to be as standardized as possible even with the differences in real estate law across states. If borrowers aren’t getting notes back in Florida, it’s quite probable that that is occurring in other states.

Xiomara Cruz, a Coral Springs attorney who has taken an interest in this topic, sent a warning to fellow lawyers:

I have seen in dozens if not hundreds of foreclosure suits allegedly “settled” for properties in Florida, MOST only include language satisfying the mortgage BUT DO NOT INCLUDE SPECIFIC CANCELLATION/SATISFACTION of the promissory Note. So that in essence your client just got a Release of Mortgage and nothing else.

I hate these tactics being used against consumers, the recording system and the judiciary. It is wrong. Regular people are being conned. Judges are being conned. Even many lawyers are being conned. The words “mortgage loan” and “mortgage” are being used by Fannie, Freddie, all Servicers, Banks as if they were interchangeable with ‘debt’ and ‘NOTE’ when the foreclosure mills walk into court or settle for their ‘clients’. Yet, when you ask the mills or the banks, servicers, Fannie, Freddie to put their money where their mouth is, all of a sudden its “we only made an agreement to settle the foreclosure suit, we dismissed with prejudice, we filed a satisfaction of mortgage, we can’t back to sue you” That is serious BOLOGNA and I don’t mean the capital city of Emilia-Romagna!

The very inherent INTENT of every borrower entering into a settlement is to cancel the debt, otherwise what good is to settle to give back the collateral willingly? Filing the satisfaction of mortgage only helps the banks, servicers, and Fannie/Freddie obtain clear title so they can sell it and make more money after already getting fat with interest for years, servicing fees, selling ‘beneficial rights’ to receive monthly payments, but not selling the actual underlying note. This situation gets horribly worse because if the note is left outstanding, it can be used upon by anyone else who obtains that note in the flow of commerce. A suit on the note is left open.

And she reports in a later message to me that servicers and even judges don’t take well to being pushed on this issue:

When this happened to my client, he immediately raised the flag requesting specific performance in the underlying foreclosure suit. However, the bank voluntarily dismissed the foreclosure action with prejudice while the motion for specific performance was pending hearing (which had already been set) and the judge ceded to the bank’s voluntary dismissal. He then hired me specifically after a year of calling everyone from members of congress to the OCC to the AG to obtain the cancelled note back because no one would give it him back to him marked cancelled. The bank and Fannie stated through their attorneys, over and over in every instance before our suit, that they never promised him anything else but a dismissal of the foreclosure suit and a satisfaction of mortgage, and he got a dismissal with prejudice. Long story short, its still there, the circuit judge dismissed all counts of the unfair consumer practices, unfair debt collection practices, with prejudice and although he really wanted to couldn’t dismiss with prejudice the breach of contract, specific performance counts but dismissed them without prejudice and with leave to amend “because he didn’t like some of the WHEREFORE clauses”.

This story borders of Kafkaesque. Yet Cruz is not being unreasonable. 25 years ago, an attorney who did not demand the cancelled note in satisfaction of a mortgage would have been considered grossly negligent. And the risk is not theoretical. Professor Williams described how people were defrauded in the wake of the S&L crisis when notes that should have been cancelled got into the wrong hands. April Charney had just seen a case on a 2008 foreclosure where the ex parte order returned the original note to the plaintiff/servicer. The hapless borrower is now being sued by the private mortgage insurer. PMI was typically used to insure the LTV over 80% on high LTV loans. In in the subprime market, lenders bought mortgage insurance on loans and paid the premiums themselves (via the trust) rather than have the premiums paid by the borrower, as is the more traditional structure.

Tom Adams suggested that this issue probably arose when the insurer would have had no direct relationship with the borrower but would have been at risk to the loan defaulting. But regardless, this is an ugly business, and serves as a reminder to homeowners: if your friendly servicer asks you to deviate from a long-established practice, your assumption should be that it is for a very good reason, and that reason is for their benefit, not yours.