Pending Massachusetts Supreme Court Ruling May Invalidate Securitization Mortgage Transfers

Bloomberg has a bombshell today, that a case before the Massachusetts Supreme Court may invalidate certain types of mortgage transfers, a central process in mortgage securitizations. A ruling for the plaintiffs would render some past foreclosures invalid, raising the possibility that the borrowers could sue for damages. It would also have far reaching implications, since it would also be a significant setback to the argument made by the American Securitization Forum and the major securitization law firms who have issued opinion letters in support of securitization industry procedures.

One procedure under question is so-called “endorsement in blank”. Recall that what we call a mortgage consists of two parts: the promissory note (the borrower IOU) and the lien (confusingly called the mortgage or in some states, a deed of trust). The note is a negotiable instrument, which means, just like a check, it is payable only to the party in whose name it is made out, or it can be endorsed in blank (think of when you sign the back of a check but don’t deposit it, in theory anyone can then make it payable to themselves).

The securitization agreements called for the notes to go through a specific number of parties, usually at least two between the originator and its final home, a trust. They required the note have a specific chain of endorsements (as in in theory each party could still endorse in blank, meaning not sign it over specifically to the next required party, as long as each party in the chain did sign it in blank and it bore evidence of indeed having passed through all the required parties). It appears Massachusetts may have problems with the endorsement in blank process, which was allegedly pervasive (indirect evidence comes from the ASF’s efforts to defend the practice).

From Bloomberg:

Massachusetts’s highest court is poised to rule on whether foreclosures in the state should be undone because securitization-industry practices violate real- estate law governing how mortgages may be transferred.

The fight between homeowners and banks before the Supreme Judicial Court in Boston turns on whether a mortgage can be transferred without naming the recipient, a common securitization practice. Also at issue is whether the right to a mortgage follows the promissory note it secures when the note is sold, as the industry argues…

“This is the first time the securitization paradigm is squarely before a high court,” said Marie McDonnell, a mortgage-fraud analyst in Orleans, Massachusetts, who wrote a friend-of-the-court brief in favor of borrowers. The state court, under its practices, is likely to rule by next month…

If loans weren’t transferred properly, the banks that sponsored such trusts may have to repurchase them, Adam J. Levitin, an associate professor at Georgetown University Law Center in Washington, said in prepared testimony in the U.S. House of Representatives in November.

If the problem is widespread enough, it may cost the banks trillions of dollars and make them insolvent, Levitin said.

There is “a surprising lack of consensus” as to “what method of transferring notes and mortgages is actually supposed to be used in securitization and whether that method is legally sufficient,” he said.

The case in question is referred to as Ibanez. The local court ruled against the banks trying to foreclose on a house because the note was transferred after the servicer initiated foreclosure proceedings, a clear no-no (provided the judge is awake and not reflexively pro-bank). The plaintiffs then tried arguing that the governing agreement, the pooling and servicing agreement, effectuated the transfer (we’ve called this the “intent works” claim, which actually is a valid notion in other areas, but looks to be quite a stretch here given the very specific stipulations of the PSA and the fact that enforcement of a mortgage requires in most states that the party be a “holder”, meaning have possession of the instrument, in this case the borrower note, and be the legally proper party to have it, which means that it be signed over to that party OR be endorsed in blank). The lower court judge nixed that notion too because the assignment of the mortgage (the lien) had not been recorded in the local jurisdiction, nor had the mortgage assignment named a specific assignee (in other words, the assignment was also in blank).

Even though state law, both statutory and case law, varies to some degree on these matters, state supreme courts have also cited rulings of other state courts in decisions against MERS when it has tried foreclosing in its own name (the party foreclosing should be the note holder, which MERS acknowledges that it is not). So a Mass. decision would potentially influence rulings in other states.

The stakes are very high for the securitization industry in this case. Stay tuned.

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  1. eric anderson

    O, to be a lawyer in these fraudulent times!

    The suits will go on for years and years and years and years…


  2. Dan

    So if the MA court system decides to hold up the law,
    I guess the hand-slap settlement FNM/FRE just completed with BAC is just a little fortuitous?

    As a taxpayer, I would like a mulligan please…

  3. bmeisen

    Harvard’s Glaeser suggests that MA would grow if it were easier to build houses there:

    More construction would lead to lower prices which would lead to population growth – there are buyers out there, they just can’t afford a house in MA (so they move to Houston). Growth would stabilize the state’s Congressional delegation, and give the Blues a fighting chance against the Reds.

    If the MA supreme court upholds the lower court’s decision and banks suffer substantial losses would that limit growth? A central argument for recent administrations is that the banking sector needs to be protected from losses in order to protect the economy at large from losses. But I don’t buy much of their arguments anymore.

  4. C.

    If the MA supreme court upholds the lower court’s decision and banks suffer substantial losses would that limit growth?

    Hi. Native Masshole here. A far greater impediment to new contruction in the state is onerous local zoning regs which are enforced, quite zealously and ideosycratically, by each and every one of the Commonwealth’s 413 towns and cities. There is no county government to speak of. Second, most towns in the state having been founded about 400 years ago, the infill problem is a lot greater than it is in Houston, at least if you want to live in a town with decent schools.

  5. albrt

    The Ibanez decision was primarily based on unusual features of Massachusetts real estate law, and does not necessarily have much application to other states.

    The case does, however, provide an example of how far the securitization industry overreached in representing that they had conveyed properly secured loans into the trusts.

    Better hurry and get those other penny-on-the-dollar putback settlements done, Barry and Timmy! Otherwise your million dollar a year retirement jobs as a loyal squid retainers might be in jeopardy.

      1. albrt

        The Massachusetts land title recording system is particularly strict and formal, and the Ibanez foreclosures were non-judicial, so the judge did not believe he had the ability to grant any leeway for assignments done out of order.

      2. Transor Z

        To add: I read your post on CR. Land Court just has exclusive original jurisdiction over title registration issues; that’s a question of trial court, not law. And if you actually read Judge Long’s decision you’ll see that Massachusetts has the not-very-unusual statutory requirement that you have to actually own the note (i.e., not have an assignment-in-blank) in order to foreclose on a mortgage. An assignment-in-blank gives you an equitable interest in the note but not actual ownership sufficient to foreclose.

        Technical point of law, yes, but is it really that unique upon nonjudicial foreclosure states?

        1. K. Williams

          “you’ll see that Massachusetts has the not-very-unusual statutory requirement that you have to actually own the note (i.e., not have an assignment-in-blank) in order to foreclose on a mortgage. An assignment-in-blank gives you an equitable interest in the note but not actual ownership sufficient to foreclose.”

          This is not the issue at stake in Ibanez. The problem in Ibanez is that the mortgage (not the note) was assigned in blank, and the noteholder claimed that this was irrelevant, because “the mortgage follows the note” — in other words, if you own the note, then you also own the mortgage. Massachusetts case law has typically rejected this idea, holding that possession of the note confers an equitable interest but not possession of the mortgage. But that’s an idiosyncratic position — in most of the US, the mortgage does follow the note, and that’s what the US Supreme Court held in Carpenter v. Longan (1872). So any decision predicated on the assumption that ownership of the note is not enough to enforce the mortgage will have important consequences in Massachusetts, but limited applicability elsewhere.

          1. davidgmills

            People keep missing the import of the separation of note and deed of trust or mortgage. It is one thing to have separation by accident, mistake, or negligence; it is quite another to have separation intentionally. Equity may very well correct a separation by mistake or negligence, but it should not correct an intentional separation. These MERS liens intentionally separate the note and lien ab intio — from the beginning.

            When you intentionally make MERS a strawman lienholder ab intio you have changed the entire recordation process and turned what was a public transparent and open system into a private and secretive one. When a strawman is the lienholder, no one can be sure who holds the note and who the person or entity is who must be paid to get a valid release of the lien. Can MERS give a valid release if it never was the note holder? Yet it is the entity with lien rights. Can anyone be sure that the lien was released by the noteholder when the identity of the actual note holder remains a mystery and is never in the chain of title?

            The radical change in recordation and the inability to track the note holders outside the chain of title is the real problem with these liens. It is one thing to be unable to track a note on occasion; it is quite another to be unable to track a note as a matter of common practice.

          2. Transor Z

            Yes, you are correct that I botched my earlier comment. The notes were endorsed in blank, not assigned in blank as I incorrectly wrote. The upshot of an endorsement in blank in Massachusetts is that you do not effect an assignment of the mortgage because failing to specify the assignee violates the recordation statute. This is what causes the note and mortgage to split. The note holder takes non-recourse but with the equitable right to compel the assignor to fix the problem — which has normally been an oversight and not a deliberate practice as davidgmills points out.

            In Ibanez, Judge Long hit a grand slam by pointing out that many of the intermediaries (who all endorsed in blank) are bankrupt or no longer in existence, not to mention that, as far as all the world is concerned, no record exists of their places in the chain of title at all.

            But all of this isn’t nutty or idiosyncratic. It’s good law with a solid pedigree in Anglo-American jurisprudence. And, btw, the U.S. Supreme Court has absolutely nothing to say about state real property common law.

            But davidgmills’ point of MERS being a black box with practices that deliberately ran roughshod over state law in Mass. and elsewhere is terrific. It is the heedless arrogance of usurping legislative authority that burns state judges’ asses. Watch how this plays out nationally. I’m telling you, this is going to be an important decision from the SJC with impact not confined to Mass.

  6. AR

    I liked this paragraph from the Bloomberg article:

    The banks said that if the Supreme Judicial Court upholds Long, the ruling should apply only to future foreclosures. Some people who bought from other homeowners — possibly as long as 15 years ago — would lose their property because of the bad chain of title, the Real Estate Bar Association for Massachusetts said in a brief to the high court.

    So how does the Real Estate Bar Association plan on making the chains of title on future foreclosures unbad?

    1. aet

      Add a “sleeping dog” rule to the laws: let sleeping dogs lie, if no adverse claims arise within some number of years.

      Possible legal claims are extinguished every day by Statutes of Limitations, and any clouds or defects may be similarly cleared.

  7. Parallel FORECLOSURE

    I don’t get all the complexities. The way I learned it was, Securitization is a change in terms to an original agreement between a homeowner and the original bank, and therefore, is subject to EXPRESSED, WRITTEN CONSENT from the homeowner each and every time the note is passed.

    That’s the trouble with learning about all this stuff, it begins to seem valid when it’s just dissolved horsecrap.

    Change in Terms is NOT allowed without permission of the homeowner.

    So, if ANYTHING changed from the original agreement, and it lead to a foreclosure, that foreclosure should be voided.

    A reduction in any of the following, no walk in service, payments take longer to process, reduction in telephonic customer service, increase in penalties or fees, less ability to renegotiate a mortgage, none of those changes are valid unless the homeowner was apprised of the CHANGE IN TERMS, and then AGREED TO THEM verbally and in writing.

    In theory, if apprised of the change, and the homeowner said no, the bank would have had to PAY THE HOMEOWNER to change the terms. Not offering a payout to the homeowner in exchange for a change in terms would be an additional excuse as to why securitization was done in secrecy (aka non notification or approval by the homeowner).

  8. Theodore G. Fletcher

    Ed Glaeser is full of it and speaking out of an ideological straight jacket here. Massachusetts and other Northeastern states have little or no cheap, undeveloped land and as a result have more complex zoning regulations to address the inevitable resulting community development conflicts.

    Also, I hate to be a pedant but it is the Massachusetts Supreme Judicial Court or Massachusetts highest appellate court. Maine is another state with a similarly named court.

  9. 60sradical

    Yves…the Mass. development brings some hope to this vast tangled web. Good post! Does this Mass. court take New York securitization law into consideration re: pooling and servicing agreements? It’s all moving quickly from day to day and I’m tryin’ to keep up. Thanks, as usual, for your hustle.

  10. killben

    I am sure Banks and its lobbyists would be hard at work … after all lots of lobbying to do .. am sure will be ably aided by the Fed, Treasury and Congress wherever they can chip in!!

    Winner is clear!!

  11. alan - with apologies for grandiosity

    Would like to know what the Title Insurers think of all this. If my mortgage has been bouncing around in this dodgy supply chain, does that affect the capability of my buyer to get Title Insurance?

    1. Transor Z

      Judge Cordy’s concurrence sums things up nicely:

      I concur fully in the opinion of the court, and write separately only to underscore that what is surprising about these cases is not the statement of principles articulated by the court regarding title law and the law of foreclosure in Massachusetts, but rather the utter carelessness with which the plaintiff banks documented the titles to their assets. There is no dispute that the mortgagors of the properties in question had defaulted on their obligations, and that the mortgaged properties were subject to foreclosure. Before commencing such an action, however, the holder of an assigned mortgage needs to take care to ensure that his legal paperwork is in order. Although there was no apparent actual unfairness here to the mortgagors, that is not the point. Foreclosure is a powerful act with significant consequences, and Massachusetts law has always required that it proceed strictly in accord with the statutes that govern it. As the opinion of the court notes, such strict compliance is necessary because Massachusetts is both a title theory State and allows for extrajudicial foreclosure.

      The type of sophisticated transactions leading up to the accumulation of the notes and mortgages in question in these cases and their securitization, and, ultimately the sale of mortgaged-backed securities, are not barred nor even burdened by the requirements of Massachusetts law. The plaintiff banks, who brought these cases to clear the titles that they acquired at their own foreclosure sales, have simply failed to prove that the underlying assignments of the mortgages that they allege (and would have) entitled them to foreclose ever existed in any legally cognizable form before they exercised the power of sale that accompanies those assignments. The court’s opinion clearly states that such assignments do not need to be in recordable form or recorded before the foreclosure, but they do have to have been effectuated.

      What is more complicated, and not addressed in this opinion, because the issue was not before us, is the effect of the conduct of banks such as the plaintiffs here, on a bona fide third-party purchaser who may have relied on the foreclosure title of the bank and the confirmative assignment and affidavit of foreclosure recorded by the bank subsequent to that foreclosure but prior to the purchase by the third party, especially where the party whose property was foreclosed was in fact in violation of the mortgage covenants, had notice of the foreclosure, and took no action to contest it.

  12. Eric

    As a current property owner and potential seller of same someday, I would like to see a mortgage business where the proper rights to foreclose are enforceable. So I make a huge distinction between cases of robo-signers where servicers intentionally created and presented false evidence to a court and situations where an endorsement in blank – or other process error – precludes foreclosure. I do believe that the parties involved in securitization foolishly took shortcuts – maybe principally aimed at reducing property recording expenses. Maybe a process should be allowed to restore the note and mortgage connection by paying all the recording fees plus an extra $1000 for every lien so recovered to a fund to assist in the defense against foreclosures. It is in my interest, and I believe the nation’s interest, that a situation where money can be lent against security with a highly effective mechanism to get that property in event of default be restored. I can agree that all kinds of people should have done more competent work, but if it takes new legislation to put this back together as per a reasonable view of the intention of all parties (borrowers, included) I say we do it. I don’t want to face a prospect that the pool of purchasers is reduced to those with 60% downpayments.

  13. RemoteDet

    Transor Z and Eric both give the banks and the brokerage firms the benefit of the doubt,…oh just mistakes, shody work, blah,blah,blah.

    Not so fast. I worked in the brokerage business for over 30 years in many hands-on roles, and saw the beginning of the mortgage securitization process from inception in 1982 when Shearson rolled out the “Key Client Mortgage”,….and I can assure you it was never in the interest of helping the client or improving work flow or record keeping, then or in the years afterward.

    Sandy “the ass bandit” Weil, cared little for the client or their situation. It was a way to grab the giant pool of money locked away in home equity.

    Over the years various other firms I worked for would push the MBS shit on the brokers to sell to their clients. The reason they liked this shit, was there was no open market where you could see your asset priced. It was a private market where they could package, slice tranches, and price the crap where they wanted (making a joke of the 5% markup rule),…and who would be the wiser, and they couldn’t figure it out if they wanted to. If a client tried to figure the value or get what the bid showed on his statement he would be screwed again.

    I never saw a client make money in a MBS or CDO,..and the motive was clear. And the default swaps were just another way to price stuff that didn’t trade actively, have no market to watch and were a leveraged license to steal.

    So when I hear excuses like the ones above about sloppy paperwork or carelessness,…I hear pure bullshit.

    The banks, brokers, and other peddlers of this deliberate dung heap had a racket going that was intentionally dark and hidden in order to gorge themselves on the most valuable asset in any family, their home, they are being caught and no 1,000 cases of air freshener will remove the stench.

    To bad. You Eric worry about being able to sell your house. This is so much bigger than your minor problem of a potential sale down the road.

    We are still early in the details phase, wait and see.

    And by the way, the banks never gave the consumers a spec of leeway after they took the initial $700 billion, or the subsequent trillions.

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