Georgetown law professor and securitization expert Adam Levitin has weighed in on the ruling in an Alabama case, U.S. Bank v. Congress, in which a state court judge ruled against what we have called the New York trust theory. For readers new to this terrain, the short form is that the parties to mortgage securitizations are governed by a so-called pooling and servicing agreement. The PSA, among many other things, described how the notes (the borrower IOU) were to be conveyed to a trust that would hold them for the benefit of investors. The trust was almost without exception a New York trust. New York was chosen because its trust law is both very well settled and very rigid. New York trusts have no discretion in how they operate. Any measure undertaken that is inconsistent with explicit instructions is deemed to be a “void act”.
Now it appears that the notes were not conveyed to the trusts as stipulated in the PSAs on a widespread basis. (You can read the details here). Because the trusts are New York trusts, that means you have a really big mess. You can’t convey the notes in now, that’s not permitted because the trust had specific dates for accepting the assets that have long passed. The party that has the note (someone earlier in the securitization chain) can foreclose, but no one wants to do that. It isn’t just that this would be an admission that that parties to the agreement didn’t fulfill their contractual obligations; there is no way to get the money from the party that foreclosed to the trust and then to the investors.
Since the securitization industry has had so little good news of late, and this New York trust issue has the potential to make the chain of title problems that banks are facing in courtrooms all over the US even more acute, Paul Jackson of Housing Wire was quick to jump on this pro-bank decision as a major victory. We argued that it was probably not a significant precedent, and that some of the legal reasoning looked like a stretch, other parts were at odds with decisions in other states (meaning those states were unlikely to change course based on a lower-court decision in Alabama). But we acknowledged that parts of the decision were hard to parse and over our pay grade.
Levitin has taken an even more dismissive view of the decision (although since his writing style is more measured than ours, you need to read for substance, not tone). As he reads it, the judge rejected the borrower’s case on procedural grounds. That means it cannot be seen as a ruling against the New York trust theory. So effectively, the New York trust theory remains untested rather than defeated on its initial outing. As Levitin wrote:
Perhaps the most important thing to note about the opinion is what isn’t there. There was no consideration of the chain-of-title issue in the opinion. Let me repeat, the court said nothign about whether there was proper chain-of-title in the securitization. Instead, the court avoided dealing with it. That means that this ruling isn’t grounds for sounding the “all clear” on chain-of-title. At best, it is grounds for arguing that homeowners won’t be able to raise chain-of-title problems…
The court played on the procedural posture of the case to reject this argument. First, the court explained that because this was an ejectment action, not a foreclosure, the question of ownership of the note was not an issue of standing, but an affirmative defense for which the homeowner had the burden of proof. The trial court here was citing to a recent Alabama appellate court decision (reversing a previous Alabama appellate decision) that concluded that standing is satisfied by virtue of the bank being named party on the foreclosure deed. That’s just crazy given that the foreclosure deed is a nonjudicial sale. [G.S.—maybe this explains why your shop saw your notaries’ seal forged on those foreclosure deeds.]
Crazy or not, however, this meant that the homeowner wasn’t actually challenging the trust’s standing. From there it was a small step for the court to say that the homeowner couldn’t invoke the terms of the PSA because she wasn’t a party to it…..
I don’t think there’s much to get excited about with Congress. If the homeowner had prevailed, the banks would have been saying “it’s just an Alabama state trial court,” and it might well have been overturned on appeal. But that doesn’t mean that the chain-of-title issue isn’t real. It just means that there’s still a search for the proper channel on which to advance the argument.
There’s more to his post, and I suggest legal types read it in full. There is an important discussion in it about the differing considerations regarding legal action on the note (the IOU) versus the lien (which is what allows the bank to make the foreclosure) that I want to address that in a separate post. It warrants some unpacking and further discussion.
Finally, he points out that investors have been getting their own reading on these legal issues and see them as valid, hence serious, concerns:
….numerous buy-side people (read MBS investors) have told me that they think there’s a serious problem with the securitization documentation. The problem that they have is that they don’t know what to do about it—they are trying to figure out a way that this can be used to put the mortgages back to the banks without it tanking the entire financial system. In other words, the banks are being protected by the too-big-to-fail problem. That’s letting them externalize their violations of their securitization contracts on MBS investors.
That suggests that investors are looking for the right leverage point on this matter but have yet to find one that is sufficiently surgical. Given how much they have at stake, I would bet they find it sooner rather than later.