naked capitalism

By Richard Alford, a former economist at the New York Fed. Since them, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side.

A number of economists, economic policymakers, regulators, and central bankers have attempted to explain away their failure to both foresee and mitigate the current financial crisis by asserting that no one saw it coming. The inference is that they cannot be held accountable for something so unusual, so extraordinary, and so unforecastable that that no one saw it coming. Robert Shiller, in a November 1, 2008 NYT OP-ED, noted the following example:

Alan Greenspan, the former Federal Reserve chairman, acknowledged in a Congressional hearing last month that he had made an “error” in assuming that the markets would properly regulate themselves, and added that he had no idea a financial disaster was in the making. What’s more, he said the Fed’s own computer models and economic experts simply “did not forecast” the current financial crisis.

However, the Fed and other policymaking agencies cannot honestly claim that no one saw it coming. There is ample evidence that:

• Economist and commentators “saw it coming”; and

• Economists and others repeatedly brought their observations to the attention of the authorities including the Fed, but were ignored.

In fact, the Fed increasingly exhibited a willingness ignoring critics and criticism. The existence of this pattern at the Fed can be illustrated by looking at two presentations by Kohn. The first is from 2003 and the second is from 2005. But first, a return to Shiller’s OP-ED piece:

Mr. Greenspan’s comments may have left the impression that no one in the world could have predicted the crisis. Yet it is clear that well before home prices started falling in 2006, lots of people were worried about the housing boom and its potential for creating economic disaster. It’s just that the Fed did not take them very seriously.

Schiller blamed self-censorship and group think. Shiller reports that while he was a member of the economic advisory panel of FRBNY, he felt the need to use self-restraint and stated that he only gently warned about bubbles in the housing markets.

It is one thing for someone to practice self-censorship. It is another thing all together for an institution charged with a public responsibility to allow and foster an atmosphere in which someone well respected enough to be asked to sit on an advisory board feels as though he or she must temper their statements or pull punches. What was the role of the advisory board, if the members did not feel free to raise and discuss competing views or alternative policy paths? In the context of the dynamics of globalization and financial innovation, why was conformity to a static consensus tolerated and even encouraged?

Furthermore, while the Fed had a responsibility to promote economic and financial stability, Shiller did not. Once well respected economists and analysts highlighted the possible risks the Fed had an obligation to assess those risks. Shiller also reported that the group-think that ignored signs of the impending financial crisis extended well beyond the halls of the Fed:

I gave talks in 2005 at both the Office the Comptroller of the Currency and at the Federal Deposit Insurance Corporation. I argued that we were in the middle of a dangerous housing bubble. I urged these mortgage regulators to impose suitability requirements on mortgage lenders, to assure that the loans were appropriate for the people taking them.

The reaction to this suggestion was roughly this: yes, some staff members had expressed such concerns, and yes, officials knew about the possibility that there was a bubble, but they weren’t taking any of us seriously.

Returning to the Fed, a speech by Kohn in February 2003 indicates that while Shiller was self-censoring, other commentators had been pointed enough in expressing their concerns to merit a response:

In particular, a number of commentators have raised the specter that imbalances are being created in the markets for consumer durable goods and houses–unsustainably high prices or activity–that will produce macroeconomic strains when, inevitably, they correct. These concerns obviously echo those expressed by some observers that monetary policy allowed run-ups in equity prices and capital spending in the 1990s that ultimately proved to be destabilizing.

In a footnote, Kohn went on to say:

Another possibility is that the buildup of debt associated with the strength in household investment will feedback adversely on financial conditions, especially as the boom unwinds. Such consequences could occur even in the absence of a “bubble” in housing prices if households were overextended and lenders had not taken adequate precautions against even a measured drop in collateral values… Moreover, loan-to-value ratios on mortgages have been about flat, leaving ample cushion for moderate housing price declines, should they occur. These observations suggest that widespread credit difficulties with important macroeconomic effects are unlikely when interest rates rise.

Kohn not only acknowledged the existence of the commentators and their concerns and took them seriously enough to present evidence that he thought should lay to rest those concerns to rest. He also suggests that the likely short-lived nature of the interest rate -driven increases in housing prices and real estate investment implied that any resulting macroeconomic or financial problem would be of a manageable scale:

Judging from this analysis, and bearing in mind its inherently tentative–if not speculative–character, it seems likely that as the economy strengthens and interest rates rise in response, household investment and prices are likely to soften some relative to recent trends, but not to break precipitously. Houses and cars would not be providing the impetus to economic activity they often have in past recoveries…

At the Jackson Hole Conference of 2005, a speech by Rajan, the then Chief Economist at the International Monetary Fund, “Has Financial Development Made the World Riskier?” and a response by Kohn allows us to get a read on Fed policymakers reactions to warnings about possible economic or financial dislocations two years later. In the opening paragraphs, Rajan argued that the transformation of the financial sector had made it more efficient, but at the expense of increased risk:

The expansion in a variety of intermediates and financial transactions has major benefits,…However, it has potential downsides, which I will explore ..

… the incentive structures of investment mangers today differs from the incentive structures of bank managers in the past in two important ways. First,… managers have a greater incentive to take risk. Second, their performance relative to other managers matters.

The knowledge that managers are being evaluated against other managers can induce superior performance, but also perverse behavior.

One is the incentive to take risk that is concealed from investors—since risk and return are related , the manger then looks as if he outperforms peers,,, typically the kind risks that can be concealed most easily… are known as tail risks.

Both behaviors can reinforce each other during an asset price boom…An environment of low interest rates flowing a period of high rates is particularly problematic, for not only does the incentive of some participants to “search for yield” go up, but asst prices are given the initial impetus which can lead to an upward spiral, creating conditions for a sharp messy realignment…..

…the most important concern is whether banks will be able to provide liquidity to financial markets so that if tail risk does materialize, financial positions can be unwound and….the real consequences to the real economy minimized.”

The balance of the Rajan paper was a development of these ideas along with the presentation of considerable amount of supporting evidence. He referenced over 50 plus scholarly papers. Rajan never forecasted or predicted the crises which were to follow relatively quickly. However, he concluded:

a risk management approach to financial regulation will be important to attempt to stave off such states through the judicious operation of monetary policy and through macro-prudential measures. I argue some thought also should be given to attempting to influence incentives of financial institutions mangers lightly, but directly.

Kohn was a Discussant, but his response was not so much a discussion or rebuttal of the Rajan theses as it was simply a restatement of his and presumably the Fed’s belief that the greater dispersion of financial risk away from banks necessarily implied lower levels of systemic risk. There was no discussion of the implication of the changes in incentive structures or herding behavior. Kohn dismissed concerns about tail risk citing reduced volatility of output and inflation over the previous twenty years. However, who believes that tail risk has to either manifest itself in a twenty year period, or be non-existent. Furthermore, the factors cited by Rajan had come to dominate the financial sector only during the prior ten years.

No mention was made of LTCM or the Tech bubble. Concerns that low interest rates may contribute to increased risk in the financial system were dismissed on the grounds that those policies contributed to greater stability in output and inflation. Kohn never addressed the point that the shift away from bank-center finance might leave the system short of liquidity should risks materialize.

In short, Kohn’s response to Rajan’s theses was nothing more than a curt dismissal when compared to his detailed response to the specter of imbalanced -induced concerns voiced by the unnamed commentators in 2003. It appears that the perceived need to respond, even if only in words, to well researched warnings by prominent economists had disappeared.

Furthermore, Kohn on this occasion and presumably others, never publicly revisited (to my knowledge) the contingencies which were in part the basis of his rejection of the warnings in 2003. Interest rates had risen very slowly amidst a jobless recovery and a failure of investment spending to propel the economy. Ten year Treasury yields were only about 25 bps higher and monetary policy remained accommodative. Loan to value ratios had started to erode as had lending standards. If Kohn had re-checked the reasons he cited in his in 2003 rejection of warnings he would have found that the conditions he had cited for being sanguine no longer obtained.

In summary, numerous people, including well respected economists and officials saw the grounds for economic and financial crises being laid. Furthermore, these warnings were brought to the attention of US policymakers. Assuming the two presentations cites above are representative, the warnings were at first treated as worthy of a serious response. However, even as evidence of serious imbalances and bubbles grew, the responses to warnings became perfunctory and devoid of serious analysis.

Houston, we have a problem.

McClatchy, the only major US news organization to question the Iraq war until is was obvious to all that it was a misguided exercise in neocon hubris, has started a series on Goldman’s famed “short subprime” exercise. While the timing and overall outline are not new (as to when and allegedly why the investment bank went short), it delves into some details that have heretofore not been examined, as to how much subprime paper it dumped onto investors during this period, whether this duplicity was permissible, and what sort of damage was visited on foolhardy borrowers.

Unfortunately, for my taste, the series does not appear to be getting enough into the nitty gritty (and it indicates clearly that Goldman has successfully kept mum about the details of how it executed its short). I am keenly interested, because my understanding is that any simple subprime index short would have blown out spreads and thus been very costly to execute.

Goldman used another route….and the road, not surprisingly, was through AIG. From an e-mail over the summer:

This also points out a *VERY* good nugget re: banks who used CDOs/AIG offensively as opposed to as a hedge. This is likely what bothered me most about the AIG debacle. The trades GS had on with AIG were generally *not* super senior CDOs GS was long simply because they had
underwritten CDOs and were “stuck” with the AAA risk as a result. Rather, GS had a whole program of issuance — something they called “Abacus” — which were deals they put together with the sole purpose
of getting short subprime/CDO risk. Their sole purpose in doing the deals was to get long protection/short risk on the underlying collateral. AIG was simply the vehicle they chose to moneitze that PnL. Call me crazy, but I put the AIG counterparties in two different camps: guys like SocGen, who bought bonds in good faith and then hedged the credit risk by buying CDS from AIG, and guys like GS, who used AIG as their lottery ticket for offensively constructed trades to capitalize on mispriced subprime risk. The former, to me, seem much more deserving of a bailout than the latter…

DeutscheBank had a broadly similar program called Start.

This of course makes complete sense. There simply was not enough insurance capacity (the monolines plus the volume on the Markit indexes) to account for the big names that went short (Paulson, Goldman, one other large but secretive player we are aware of). That road had to go through AIG as well.

And bear in mind another fact: asset backed securities CDOs (and the subprime kind were that type) were managed rather than passive. That mean when the collateral paid down, the manager would go and find new collateral. Again from an e-mail:

AIG got out of subprime in 2005/2006 – whenever – but it didn’t matter.  Why??  Because the same crappy borrowers that made it into 2005/2006 subprime RMBS refinanced and ended up in the 2007 vintage.  Guess who had to buy the 2007 subprime RMBS paper when the 2005/2006 paper repaid?  You got it – the 2005/2006 CDOs.  CDOs have reinvestment periods (4 yrs for SF CDO) whereby they have to continue to be fully invested rather than letting their liabilities get repaid.  The liability buyers don’t want their valuable paper to be repaid early – or, do they????

Readers who know the terrain, and Abacus and Start in particularly, are very much encouraged to comment or ping me at yves@nakedcapitalism.com.

Now to McClatchy:

McClatchy’s inquiry found that Goldman Sachs:

Bought and converted into high-yield bonds tens of thousands of mortgages from subprime lenders that became the subjects of FBI investigations into whether they’d misled borrowers or exaggerated applicants’ incomes to justify making hefty loans.

Used offshore tax havens to shuffle its mortgage-backed securities to institutions worldwide, including European and Asian banks, often in secret deals run through the Cayman Islands, a British territory in the Caribbean that companies use to bypass U.S. disclosure requirements.

Has dispatched lawyers across the country to repossess homes from bankrupt or financially struggling individuals, many of whom lacked sufficient credit or income but got subprime mortgages anyway because Wall Street made it easy for them to qualify.

Was buoyed last fall by key federal bailout decisions, at least two of which involved then-Treasury Secretary Henry Paulson, a former Goldman chief executive whose staff at Treasury included several other Goldman alumni.

The article continues here.

Hoisted from comments:

I am a lawyer who has been involved in corporate finance for over 25 years. First, if you beleive that securitization offers benefits (cost reductions) to consumers then MERS is not per se a bad thing in that it reduces overall transation costs which should in part be passed on to the homeowner borrower. As you note, the problem is more a change in standards (perhaps ethics and morality) in the last ten years in the industry.

The problem is not MERs by itself but how the securitization industry has changed in recent years to the detriment of cosumers and investors in the banks and other companies that have blown up as a result of an important industry being turned into basically a circus. I can share my own expereince as a homeowner to demonstrate how crazy things have become.

I had a mortgage on my home that was originated over 15 years ago at a local bank. The mortgage had been sold (through five intervening transactions)over the years to Washington Mutual. Two years ago I decided to pay the loan off. At the end of a month, I sent in a check for the full balance of principal and interest on the loanand requested a deed release be filed. This was all in accordance with the terms of my promissory note and mortgage the legal agreement governing all parties.

Two weeks later I received my check back in the mail from WMU with a letter stating that the payoff was not in accordance with Washington Mutual policy. No one at Washington Mutual had bothered to read the mortgage agreement (the legal agreement binding the parties). Instead the letter stated that payoffs had to be preceeded by paying $75 for a “payoff quotation” and must be made by wire transfer and other terms which were obviously made to increase the profitablity to WMU which had no basis in the legal agreements.

Since WMU had no legal basis for its demands, I stopped paying my mortgage. Within three months my credit score had been lowered 300 points, all of my credit cards were canceled (I never kept a balance on any card) and I was receiving daily harrassing collection calls. Eventually, I sent a couple of letters to the WMU General Counsel’s office and began to work towards a class action lawsuit. Despite this, it took another three months to get someone’s attention at WMU who could put two and two together and I finally received a call and letter from a senior attorney who agreed to forgive thousands of dollars in interest, put a person full time on reestoring my FICO score etc etc. and fix the problems that never should have occured.

The point is that the securitization industry 5-10 years ago made a collective choice to ignore the terms of contracts, state and local laws and legal convesntions developed over hundreds of years. Why? Because they could. Our legal system and conventions were built on the assumption that most businesses would choose to follow them. Instead, the securitization industry simply developed a cost/benefit approach to following the law and adhering to contracts. It worked quite well becaseu most individuals just aren’t equipped to read and enforce their mortgage agreements or fully understand the law.

This is why the banks are fighting so hard against the Consumer Financil Protection Agency. The CFPA will have the ability to level the playig field and thus change the economics of banks simply ignoring laws, contracts and convention.

Note this mess got resolved only because the consumer in question was an attorney, and he still had to threaten a class action suit to get the servicer’s attention. And even then, it took months to clear matters up, and completely trashed his credit score in the meantime, resulting in the loss of ALL his credit cards.

How many people can afford that? Seriously. For instance, if you need to rent cars or stay in hotels in your line of work, and either your company does not provide you a corporate credit card, or you are self employed (business credit is based on your personal FICO), you’d be stuck. And if you were looking for a job, many employers pull a credit report and will not consider a candidate with a low FICO.

In other words, very few people are able to contest abusive behavior and overbilling by servicers due to the hard costs (attorney’s fees) and soft ones (damage to credit score).

Update 5:20 PM: Another sighting courtesy reader i on the ball patriot:

Bank of America and Countrywide Home Loans destroyed mortgage documents, and “recreate” them by “insert(ing) data as they see fit,” to cover up their own failure to keep records – or their fraud – according to a federal RICO class action.

Article continues here.
Update 9:30 PM: Further detail from the lawyer who provided the comment at the start of the post:

To clarify:

1. I sent WAMU a personal check for the full mortgage balance in accordance with the terms of my Promissory Note.

2. WAMU returned the check -not cashed- becasue I had not paid the additional fees that WAMU had unilaterally imposed as a precondition to paying off the mortgage. I stopped paying because I had a legal right to do so after tendering the correct payoff.

3. Yes, I was in a position that the vast majority of consumers are not – both as an attorney and being able to live without credit of any sort for an extended period. I’m old school and never borrowed except for home mortgages.

I beleive the fallout from the mass assignments (and re-assignments) is just starting from an administrative standpoint. I helped a friend this summer who had sold her house in Boston but was unable to close the sale because an earlier mortgage lender had failed to file a Deed of Release after being paid off with a refinancing a couple of years ago.

The prior lender had flipped the mortgage and had gone bankrupt. The payoff went to a lender three links down the chain and the attorney handling the refi never obtained copies of assignements or the Deed of Release from the parties. The immediate resolution was to close the current sale (a neceesity given the market) and hold all of the sale proceeds in escrow until a Deed of Release could be obtained. I spent two months tracking down a senior executive fromn the bankrupt lender who after weeks of cajoling and ultimately legal threats agreed to sign a Deed of Release which we filed. The ironic part of it is that the executive actually had no legal right to sign the Deed of Release becasue the bankrupt lender had sold the loan and had no right to sign the release.

Sounds like a nightmare right? It was and would have cost my friend probably $25K to get it resolved. I know because I spoke with a couple of attorneys who are are speacilizing in this kind of thing – a very recent specialization caused by the increasing frequency of problems associated with the caviler treatment of assignments by the industry.

Lastly,I would add that the reason for MERs existence is transitory. Electronic signatures are now valid in every state I beleive and deed registrys across the country are adopting electronic filings and records. I estimate 3-5 years before all the filings are done online.

Submitted by Edward harrison of Credit Writedowns

Yves covered this in an earlier post overnight. Here’s my take. This is probably my fourth post on the tangled web woven by securitization, which puts a considerable distance between home owners and mortgagees which own a mortgage.  The issue is causing huge problems in bankruptcy and foreclosure in courts around the U.S. 

Update: I now see Barry Ritholtz has a piece out on this as well.

This morning, Gretchen Morgenson has another good piece out describing how a judge nixed all claims by mortgagee which refused to modify a home owner’s mortgage.

The debtors’ revolt is on.

For decades, when troubled homeowners and banks battled over delinquent mortgages, it wasn’t a contest. Homes went into foreclosure, and lenders took control of the property.

On top of that, courts rubber-stamped the array of foreclosure charges that lenders heaped onto borrowers and took banks at their word when the lenders said they owned the mortgage notes underlying troubled properties.

In other words, with lenders in the driver’s seat, borrowers were run over, more often than not…

But some judges are starting to scrutinize the rules-don’t-matter methods used by lenders and their lawyers in the recent foreclosure wave. On occasion, lenders are even getting slapped around a bit.

One surprising smackdown occurred on Oct. 9 in federal bankruptcy court in the Southern District of New York. Ruling that a lender, PHH Mortgage, hadn’t proved its claim to a delinquent borrower’s home in White Plains, Judge Robert D. Drain wiped out a $461,263 mortgage debt on the property. That’s right: the mortgage debt disappeared, via a court order.

I see this as a watershed case in jurisprudence surrounding mortgage-related bankruptcies and foreclosures.  The reason this is huge is that it echoes the case in Kansas I have written about in two previous posts:

• “Why mortgages aren’t modified and what a ruling stopping foreclosures means”
• “What are the legal rights of lenders and homeowners in foreclosure?”)

At issue is the question of what legal rights do lenders or their agents have in foreclosure in the new byzantine world of securitized mortgages.  In the New York case the judge nixed the entire claim as the mortgagee could not prove it had legal claim to the mortgage note. With the mortgagee unable to show ownership, the homeowner might even be able to stay in his home mortgage-free, Morgenson attests. That’s huge – and we should definitely expect an appeal.

In the Kansas case, MERS, a mortgage registrar, and a second-mortgage mortgagee were not informed of the homeowners bankruptcy and disposition of assets and claims before judgment was made. Nevertheless, the district court, the appeals court AND the Kansas supreme court all upheld the original summary judgment arguing that MERS was not contingently necessary.  While I would expect this case to be appealed because of the precedent it could set, I don’t see how it can be overturned after affirmation in every court – that is except through a politicization of the verdict.

Notice how PHH and MERS, the two lender agents in each cases, are not the actual owners of the mortgages. They are the agents of the mortgagees. This is why these cases have a lot to do with securitization

See also: How much money is Wells Fargo really making? for how some of this affects earnings at money center banks.

Morgenson had another article of merit on this topic last week. See her piece The Mortgage Machine Backfires.  This could get interesting.

Oh, and in an unrelated case, but also involving bank customers successfuly contesting big finance, Citibank Belgium is being held liable by state prosecutors for duping its savers into taking safe money out of their savings account and investing it in Lehman Brothers. When Lehman went bust, 128 million euros of their savings money went poof. See my story here. Agence France Press has covered it, but don’t expect it to get huge coverage in the U.S. Mish thinks Citigroup is in “serious trouble” globally. So do I. Let the backlash against reckless finance begin.

Gretchen Morgenson of the New York Times reports on the latest instance of judges taking issue with the rather haphazard procedures of lenders and servicers in handling mortgage assignments.

As most people know (and many by first hand experience) mortgages often pass through a lot of hands, and the securitization industry has played plenty fast and loose in making sure the transfers are handled properly. The system by which these sales are executed is coming under increasing scrutiny. From Pam Martens:

The problems grew out of the steps required to structure a mortgage securitization. In order to meet the test of an arm’s length transaction, pass muster with regulators, conform to accounting rules and to qualify as an actual sale of the securities in order to be removed from the bank’s balance sheet, the mortgages get transferred a number of times before being sold to investors. Typically, the original lender (or a sponsor who has purchased the mortgages in the secondary market) will transfer the mortgages to a limited purpose entity called a depositor. The depositor will then transfer the mortgages to a trust…

Because of the expense, time and paperwork it would take to record each of the assignments of the thousands of mortgages in each securitization, Wall Street firms decided to just issue blank mortgage assignments all along the channel of transfers, skipping the actual physical recording of the mortgage at the county registry of deeds.

Yves here. I know I have said this before, but I am gobsmacked every time I read this stuff. When I was briefly in the securities business (early 1980s), even a teeny weeny error in a securities offering was completely unacceptable, a career limiting event for lawyers and bankers involved. And even though due diligence wasn’t what it should have been, there were certain steps that were absolutely necessary to avoid liability (having the deal counsel read the issuer’s board minutes and having someone from the lead manager visit the major facilities of a first-time issuer, for instance).

The finesse in mortgage securitizations was a company called MERS. Fore those not familiar with their procedures, Marten gives a good overview:

on August 28, 2009, Judge Eric S. Rosen of the Kansas Supreme Court took an intensive look at a “straw man” some Wall Street firms had set up to handle the dirty work of foreclosure and serve as the “nominee” as the mortgages flipped between the various entities. Called MERS (Mortgage Electronic Registration Systems, Inc.) it’s a bankruptcy-remote subsidiary of MERSCORP, which in turn is owned by units of Citigroup, JPMorgan Chase, Bank of America, the Mortgage Bankers Association and assorted mortgage and title companies…

In recent years, MERS has become less of an electronic registration system and more of a serial defendant in courts across the land…

MERS doesn’t have a big roster of employees or lawyers running around the country foreclosing and defending itself in lawsuits. It simply deputizes employees of the banks and mortgage companies that use it as a nominee. It calls these deputies a “certifying officer.” Here’s how they explain this on their web site: “A certifying officer is an officer of the Member [mortgage company or bank] who is appointed a MERS officer by the Corporate Secretary of MERS by the issuance of a MERS Corporate Resolution. The Resolution authorizes the certifying officer to execute documents as a MERS officer.”

Kansas Supreme Court Judge Rosen wasn’t buying MERS’ story… Judge Rosen wrote:

“The relationship that MERS has to Sovereign [Bank] is more akin to that of a straw man than to a party possessing all the rights given a buyer… What meaning is this court to attach to MERS’s designation as nominee for Millennia [Mortgage Corp.]? The parties appear to have defined the word in much the same way that the blind men of Indian legend described an elephant — their description depended on which part they were touching at any given time. Counsel for Sovereign stated to the trial court that MERS holds the mortgage ‘in street name, if you will, and our client the bank and other banks transfer these mortgages and rely on MERS to provide them with notice of foreclosures and what not.’ ” (Landmark National Bank v. Boyd A. Kesler)

Yves here. So you see what happened? The securitization industry decided to impose the convenience of “street name” holdings of securities to mortgages, simply ignoring hundreds of years of precedent and a thicket of local laws (no joke here, the US precedent on the primacy of title documents goes back to at least 1818 in the US. No deed is like “no tickie, no laundry.”) Back to Marten:

Lawyers for homeowners see a darker agenda to MERS. Timothy McCandless, a California lawyer, wrote on his blog as follows:

“…all across the country, MERS now brings foreclosure proceedings in its own name — even though it is not the financial party in interest. This is problematic because MERS is not prepared for or equipped to provide responses to consumers’ discovery requests with respect to predatory lending claims and defenses. In effect, the securitization conduit attempts to use a faceless and seemingly innocent proxy with no knowledge of predatory origination or servicing behavior to do the dirty work of seizing the consumer’s home. While up against the wall of foreclosure, consumers that try to assert predatory lending defenses are often forced to join the party — usually an investment trust — that actually will benefit from the foreclosure. As a simple matter of logistics this can be difficult, since the investment trust is even more faceless and seemingly innocent than MERS itself. The investment trust has no customer service personnel and has probably not even retained counsel. Inquiries to the trustee — if it can be identified — are typically referred to the servicer, who will then direct counsel back to MERS. This pattern of non-response gives the securitization conduit significant leverage in forcing consumers out of their homes. The prospect of waging a protracted discovery battle with all of these well funded parties in hopes of uncovering evidence of predatory lending can be too daunting even for those victims who know such evidence exists. So imposing is this opaque corporate wall, that in a ‘vast’ number of foreclosures, MERS actually succeeds in foreclosing without producing the original note — the legal sine qua non of foreclosure — much less documentation that could support predatory lending defenses.”

Yves again. Again, I know this has been rumbling around in the news for months, but it is hard for me to believe this has gone on as long as it has. I have heard (from my attorney first hand on situations she has been involved in, not urban legend) of a corporate lawsuit being thrown out of court because the contract between the parties had the name of the entities wrong….by a comma! Now real estate law is a different area, but title is one of its fundamental principles. Selling securities in a trust when the trust does not have clear title to assets in the trust is fraud. If judges keep nixing foreclosures based on the servicer (acting on behalf of the trust) not being able to demonstrate ownership, we could see a very interesting knock-on, of investor litigation against the trusts. But it’s too early to tell.

But it isn’t surprising that judges are plenty unsympathetic, and in cases, outraged. The law is all about sanctity of process, both the underlying law and court proceedings. Cases typically revolve around disputes of fact or grey areas of the law. This isn’t grey (whether a party has standing to file a suit is fundamental) and the law in this area is well established. Basically, the securitization industry tried creating rules outside any established legal framework and judges are having none of it.

Morgenson offers an interesting new sighting, involving a Federal judge in the Southern District of New York. This is significant because the Federal bench is generally pretty high caliber, and the Southern District of NY is particularly well respected. Moreover the ruling can’t be dismissed as a judge favoring the locals over the big bad out of town servicer:

…..on Oct. 9 in federal bankruptcy court in the Southern District of New York. Ruling that a lender, PHH Mortgage, hadn’t proved its claim to a delinquent borrower’s home in White Plains, Judge Robert D. Drain wiped out a $461,263 mortgage debt on the property. That’s right: the mortgage debt disappeared, via a court order.

Yves here. Translation: the judge was pissed. He could have dismissed the case without prejudice, meaning PHH could get its ducks in a row and try again, but he sent a much stronger message. Back to the story:

….the case is an alert to lenders that dubious proof-of-ownership tactics may no longer be accepted practice. They may even be viewed as a fraud on the court…..

Yves here. Lawyers can correct me, but I believe “fraud on the court” would mean that lawyers that bringing that sort of action could be sanctioned. Back to Morgenson:

According to court documents, the borrower bought the house in 2001 with a mortgage from Wells Fargo; four and a half years later she refinanced with Mortgage World Bankers Inc.

She fell behind in her payments, and David B. Shaev, a consumer bankruptcy lawyer in Manhattan, filed a Chapter 13 bankruptcy plan…

Mr. Shaev said that when he filed the case, he had simply hoped to persuade PHH to modify his client’s loan. But after months of what he described as foot-dragging by PHH and its lawyers, he asked for proof of PHH’s standing in the case…..

Mr. Shaev received a letter stating that PHH was the servicer of the loan but that the holder of the note was U.S. Bank, as trustee of a securitization pool. But U.S. Bank was not a party to the action.

Mr. Shaev then asked for proof that U.S. Bank was indeed the holder of the note. All that was provided, however, was an affidavit from Tracy Johnson, a vice president at PHH Mortgage, saying that PHH was the servicer and U.S. Bank the holder.

Among the filings supplied to support Ms. Johnson’s assertion was a copy of the assignment of the mortgage. But this, too, was signed by Ms. Johnson, only this time she was identified as an assistant vice president of MERS, the Mortgage Electronic Registration System. This bank-owned registry eliminates the need to record changes in property ownership in local land records.

Another problem was that the document showed the note was assigned on March 26, 2009, well after the bankruptcy had been filed….

According to a transcript of the Sept. 29 hearing, Mr. DiCaro [representing PHH] said: “In the secondary market, there are many cases where assignment of mortgages, assignment of notes, don’t happen at the time they should. It was standard operating procedure for many years.”

Judge Drain rejected that argument, concluding that what had been presented to the court just did not add up. “I think that I have a more than 50 percent doubt that if the debtor paid this claim, it would be paying the wrong person,” he said. “That’s the problem. And that’s because the claimant has not shown an assignment of a mortgage.”….

Late last week, PHH appealed the judge’s ruling. But Mr. DiCaro and PHH are in something of a bind. Either they will return to court with a clear claim on the property — including all the transfers and sales that are necessary in the securitization process — or they won’t be able to produce that documentation. If they do produce it, they will then have to explain why they didn’t produce it before.

Yves again. And given that they presented that little assignment with a date after the bankruptcy was filed….that would seem to say that any cleaned up paper trail was fraudulent.

Of course, presumably everyone in foreclosure land will get smarter and at least post date their documents more carefully. But maybe not.

And we have an even more interesting set of possibilities. Say servicers and MERS fail to clean up their act, and more judges start throwing out foreclosures. Kansas Supreme Court Judge Rosen didn’t just say he didn’t see an acceptable paper trail; elements of his ruling were a much more fundamental attack on MERS. If more judges start challenging MERS’s legitimacy, that could strike at the heart of foreclosures in securitizations. In other words, a few more of these rulings may accomplish what the folks in DC have been unwilling and unable to do: force banks to negotiate. The problem, of course, is the impact will be very inconsistent. Some jurisdictions and judges will no doubt be more sympathetic to this line of argument than others.

Stay tuned, this looks certain to get even more interesting.

This is starting to get interesting, although it is far from conclusive.

Massachusetts Land Court judge Keith Long reaffirmed a 2009 ruling (Ibanez) that invalidated foreclosures on two properties because the lenders did not hold clear title to them at the time of the foreclosure sale. Now this decision is still subject to appeal, and Richard Vetstein of the Massachusetts Law Blog (hat tip reader Barbara W) thinks the Massachusetts Supreme Judicial Court might hear the case directly, given the potential significance of the ruling.

I am still gobsmacked that this issue is even in dispute. Who has ownership is the foundation of commercial as well as property law, and it permeates our life in ways most people do not recognize. The reason you get a receipt at the grocery store is that it is evidence that the title of the goods transferred from the store to you. The idea that banks were too lazy to do a decent job of keeping on top of title instruments, when that was the SOLE basis for their ownership interest in the collateral underlying their loans, is equally stunning. I have seen all sorts of deals in other areas founder (water rights is a biggie) because investors were unable to “perfect” certain rights they sought. This is a well established area of law, but the banks couldn’t be bothered to spend the money and time to do things correctly. And now they think they can simply assert, “Yeah, we really do own this stuff” and get away with it it is brazen. If you lost a $1000 bill or a bearer bond, no one would take “yeah I really do own this stuff” claims seriously either.

From Ralph Vetstein:

When mortgages are packaged to Wall Street investors, the ownership of a mortgage loan may be divided and freely transferred numerous times on the lenders’ books. But the documentation (i.e., the assignments) actually on file at the Registry of Deeds often lags far behind….

Despite the lender’s attempt to convince him otherwise, Judge Long came out (again) in favor of consumers:

The issues in this case are not merely problems with paperwork or a matter of dotting i’s and crossing t’s. Instead, they lie at the heart of the protections given to homeowners and borrowers by the Massachusetts legislature. To accept the plaintiffs’ arguments is to allow them to take someone’s home without any demonstrable right to do so, based upon the assumption that they ultimately will be able to show that they have that right and the further assumption that potential bidders will be undeterred by the lack of a demonstrable legal foundation for the sale and will nonetheless bid full value in the expectation that that foundation will ultimately be produced, even if it takes a year or more. The law recognizes the troubling nature of these assumptions, the harm caused if those assumptions prove erroneous, and commands otherwise.

Judge Long also had some choice words for lenders:

[T]he problem the [lenders] face (the present title defect) is entirely of their own making as a result of their failure to comply with the statute and the directives in their own securitization documents… What the plaintiffs truly seek is a change in the foreclosure sale statute (G.L. c. 244, § 14), which can only come from the legislature.

The New York Times has an article about the woes at the FHA which has enough omissions of relevant history so as to render it misleading at points.

Mind you, the main message of the story is sound, namely, that the FHA, long a mainstay of lower-income housing, is suffering increasing losses, because it has been pressured to take a bigger role, which these days is code for to “lower lending standards to prop up the housing market”:

Problems at the Federal Housing Administration, which guarantees mortgages with low down payments, are becoming so acute that some experts warn the agency might need a federal bailout….

In testimony before a House subcommittee, the F.H.A. commissioner, David H. Stevens, assured lawmakers that his agency would not need a bailout and that it was managing its risks.

But he acknowledged that some 20 percent of F.H.A. loans insured last year — and as many as 24 percent of those from 2007 — faced serious problems including foreclosure, offering a preview of a forthcoming audit of the agency’s finances….

Since the bottom fell out of the mortgage market, the F.H.A. has assumed a crucial role in the nation’s housing market….The government is giving as many people as it possibly can the chance to buy a house or, if they are in financial difficulty, refinance it. The F.H.A. is insuring about 6,000 loans a day, four times the amount in 2006. Its portfolio is growing so fast that even F.H.A. backers express amazement.

What bothers me about the piece is that it implies that the losses are due to the low down payments:

In the aftermath of the crash, there is wide divergence on how easy, or how hard, it should be to become a homeowner. Skittish lenders are asking for 20 percent down, which few prospective borrowers have to spare. As a result, private lending has dwindled.

The government has stepped into the breach, facilitating loans with down payments as low as 3.5 percent and offering other incentives to stabilize the market. Real estate agents in some hard-hit areas say every single one of their clients is using the F.H.A.

What is wrong with this? The FHA has ALWAYS been in the low down payment business! It has long offered loans requiring only 3% down, long before “subprime” was part of the lexicon. Historically, FHA loans did not show default rates materially worse than prime loans. That experience has been replicated by not for profit lenders in low income neighborhoods.

In fact, when subprime became a big business (the post 2000 incarnation; there were subprime mortgages in the 1990s, but those were mainly for manufactured housing), it first took share from FHA and then expanded the market. And the big difference from how the FHA once did business versus its subprime competitors was…..the FHA screened loans on an individual basis. The process was time consuming and somewhat intrusive. Private lenders were faster, easier, and (lo and behold) less stringent.

My objection is that the article implies that low down payment loans are a bad idea. They aren’t necessarily. Low down payment loans can be a viable business, but lenders need to screen borrowers much more carefully than when they have a much bigger loss cushion.

And using low down payment loans as a way to prop up the housing market IS a bad idea. The fact that the FHA is cranking so many loans through more or less the same administrative platform is strong evidence that its lending standards have gone out the window.

There has been a peculiar disconnect between the “the crisis is over, on with the recovery” drumbeat of news, and the sobering reality that a good deal of credit bubble overhang still remains to be dealt with.

One of the biggest areas is commercial real estate. Various experts, including Apollo Management’s Leon Black warned of $2 trillion in losses in the offing in the commercial real estate arena. Yet those losses seem not to have hit bank balance sheets and earnings.

The reason is simple. The Wall Street Journal tells us that banks have been dragging their feet on reserving for the losses:

Banks in the U.S. “are slow” to take losses on their commercial real-estate loans being battered by slumping property values and rental payments, according to a Federal Reserve presentation to banking regulators last month….

…banks with heavy exposure to such loans set aside just 38 cents in reserves during the second quarter for every $1 in bad loans, according to an analysis of regulatory filings by The Wall Street Journal. That is a sharp decline from $1.58 in reserves for every $1 in bad loans from the beginning of 2007.

The Journal’s analysis includes more than 800 banks that reported having more half of their loans tied up in commercial real-estate, ranging from apartments to office buildings to warehouses…

Mr. [K.C.] Conway’s presentation painted a bleak picture of the sliding real-estate values and enormous debt that will need to be refinanced in the next few years. Vacancy rates in the apartment, retail and warehouse sectors already have exceeded those seen during the real-estate collapse of the early 1990s, Mr. Conway noted. His report also predicted that commercial real-estate losses would reach roughly 45% next year. Valuing real estate has always been tricky for banks, and the problem is particularly acute now because sales activity is practically nonexistent….

Last month’s Fed presentation supports criticisms that banks have been slow to take losses on bad commercial real-estate loans. The value of commercial real-estate loans as recorded by banks has declined at a much slower rate than property values since 2005. But banks have been slow to absorb losses on their loans partly due to “capital preservation” concerns, the report states…

Commercial real-estate loans are the second-largest loan type after home mortgages. More than half of the $3.4 trillion in outstanding commercial real-estate debt is held by banks.

The Wall Street Journal provides a short update on the weak conditions in the apartment rental market. Vacancies have just hit a 23 year high, and experts expect them to increase.

The story, however, is largely silent on the implications for the housing market are concerned. Some have argued that the housing market is stabilizing, and one of the encouraging signs was that purchase prices were normalizing in relationship to rentals. But in markets where rental prices are still declining, that will apply further pressure to purchase prices. Apartments are admittedly not direct substitutes for houses, but an apartment glut will put pressure on home rental prices, which will in turn affect purchase prices. While many renters lack the resources to buy a house, the two markets nevertheless overlap to a degree.

From the Wall Street Journal:

The U.S. vacancy rate reached 7.8%, a 23-year high, according to Reis Inc., a New York real-estate research firm that tracks vacancies and rents in the top 79 U.S. markets. The rate is expected to climb further in the fall and winter, when rental demand is weaker, pushing vacancies to the highest levels since Reis began its count in 1980.

Meanwhile, the air leaving the market is driving rents down, most sharply in markets that had been chugging along until a year ago, when unemployment accelerated, including Tacoma; San Jose, Calif.; and Orange County, Calif….

Driving the change is the troubled employment market, which is closely tied to rentals. With unemployment at 9.8% — a 26-year high — more would-be renters are doubling up or moving in with family and friends during periods of job loss. Landlords have been particularly battered because unemployment has been higher among workers under 35 years old, who are more likely to rent. Nationally, effective rents have fallen by 2.7% over the past year, to around $972.

“When job losses stop, rents will firm and occupancies will firm,” said Richard Campo, chief executive of Camden Property Trust, a Houston-based real-estate company.

The second and third quarters typically are the strongest periods for rental landlords because they are popular times for people to move. But this year, “vacancies just continued rising,” said Victor Calanog, director of research for Reis.

During the third quarter, vacancies increased in 42 markets, improved in 26 markets and remained unchanged in 11 markets. Omaha, Neb., saw the largest rise in vacancies, with the rate rising 1.1 percentage points to 7.4%. Other big rises were seen in Memphis, Tenn., Indianapolis, Raleigh and Tacoma.

The media seems curiously indifferent to the continued and deserved anger of the public regarding bank bailouts. Of course, the fundamental problem is that we were sold a bill of goods. The money was clearly going to fill existing black holes in financial firms’ balance sheets. That would have been a legitimate use of taxpayer dollars if incumbent management had been thrown out, bad assets were disposed of, and the industry was put on a short enough leash to prevent this sort of thing from happening again in the near future. Instead, citizens were given a bald-faced lie: that the funds would go to support new lending.

Now one can argue that too much lending was what got us into this mess in the first place, but that does not alter the basic conundrum: that the bailouts were badly misrepresented but the media for the most part seems unwilling to push too hard on this front. Yes, the papers carry the occasional “banks aren’t lending” story. But we haven’t seen much pushback on the deception underlying this entire operation.

One piece of this is the inability of cutting the Gordian knot of restrurcturing underwater mortgages. Before I get the usual howls from readers objecting to supposed deadbeats or greedy people getting an unfair break, I suggest you consider a few facts. First, no one seems to have a problem with Chapter 11 for companies, in which they get a stay from creditors and they work out a plan which includes writing down debts to a level that the company can support. We (and just as important, the lenders themselves) recognize that half a loaf is better than none.

In the stone ages before securitization became widespread, banks would do what we now call mortgage modifications with viable (stress viable) borrowers. If a homeowner still had a source of income, the bank recognized in most cases the losses would be lower if the homeowner could be kept in place than if the bank incurred the costs of foreclosure and bore the risks and uncertainty of disposing of the house.

As most readers know all too well, this pattern has been turned on its head. The complexities of the structuring of mortgage securities means that the trancheholders who will bear the brunt of losses in a foreclosure are in most cases are different than the ones that take the hit in a principal reduction (the only type of mortgage mod that has decent odds of succeeding). An even bigger barrier is that services profit from foreclosures and are set up to do them on a streamlined basis, while mods are best done one-on-one, and even attempts to standardize procedures still take a fair bit of individual attention.

Reader Barbara, a mortgage industry veteran, is disgusted by the fact that servicers who have refused to make mortgage mods are getting large government bribes inducements and are still doing perilous little. See pages 22 and 23 of this October 2 TARP update which shows the total dole to servicers.

McClatchy, which was the only major news organization to offer critical coverage of the Iraq war, seems to be the only one taking servicer misdeeds seriously. It has two stories by Chris Adams on servicer misdeeds. One discusses how some recipients of TARP funds, such as Select Portfolio Servicing (formerly Fairbanks Capital) and Countrywide have had run-ins with state officials about customer abuses.

A second, longer piece, “Firms are getting billions, yet aren’t averting foreclosures,” is pointed but also does a good job of covering the bases:

The federal government is engaged in a massive mortgage modification program that’s on track to send billions in tax dollars to many of the very companies that judges or regulators have cited in recent years for abusive mortgage practices.

The firms, called mortgage servicers, have been cited for badgering, manipulating or lying to their customers; sticking them with bogus fees, or improperly foreclosing on them…

The reliance on such companies points to an ironic paradox for federal regulators: Cleaning up the nation’s financial crisis often rewards the firms that helped create the mess. …

To make matters worse, the Government Accountability Office, Congress’ watchdog, has said that the Treasury Department hasn’t done enough to oversee the companies participating in what’s known as the Home Affordable Modification Program…

Since it began this spring, only 12 percent of a potential 3 million delinquent mortgages have begun the process of being reworked, or put into “a trial modification,”…

Although it’s early in the Treasury Department’s program, housing advocates say the servicer industry for years has resisted helping customers with modifications….

It shouldn’t have been a surprise that the mortgage service companies would have trouble executing wide-scale mortgage modifications. They generally aren’t set up for the complicated business of reworking loans.

In 2007, an assistant attorney general in Iowa, Patrick Madigan, analyzed the looming mortgage meltdown and found that mortgage service companies have a “highly automated process, spending as little time as possible on an individual loan and preferably no time actually talking to the customer.”

“Loan modifications, by contrast, are a time-intensive process that requires a great deal of individualized attention,” he wrote. “In some situations, it may be easier and cheaper for a servicer to simply foreclose on a borrower than to try to fix the underlying problem.”

Service companies had high turnover and employees who saw their jobs as akin to that of collection agents. Some were known to hang up on callers if they started to get tough questions, Madigan wrote. He urged mortgage service companies to hire far more staff and boost training….

By this year, more federal and private efforts were under way to modify millions of troubled mortgages, and customer service was beginning to improve. Companies, though, were still having trouble getting the job done.

“It is difficult for homeowners to initiate productive discussions with lenders because many servicers lack the capacity to deal with a large volume of modifications,” the Congressional Oversight Panel reported. “Servicers are generally understaffed for handling a large volume of consumer loan workouts.”

The panel found that it’s “unlikely” that mortgage servicers will be able to do all they’re being asked to do: “Servicers are simply in the wrong line of business for doing modifications en masse,” it said.

The full story is here.