Abigail Field’s latest piece at Daily Finance is a great one-stop summary of the most thorny problem underlying the securitization mess: how can we clean up title given how badly it has been screwed up? As we and many others have noted, integrity of property ownership is an essential foundation of development; this is straight Hernando de Soto gospel. And as our Richard Smith has pointed out, the various fixes to get around this mess run roughshod over well established court procedures that date back to the 1677 Statute of Frauds. Why was it necessary to implement those rules? Because without them, wealthy people could use the court system to steal property. Sound familiar?
One thing that it is important to stress: that the abuses to established real estate transfer and recording processes were not inherent to the securitization model. I’m not a fan of securitization but the sad reality is that no one is prepared to go back to the more costly in terms of equity required, model of on-balance sheet banking (it would result in a shrinkage of credit that every respectable economist would recommend against and hence will never happen). But no one (except the FDIC, which keeps being ignored) is thinking seriously enough about what it would take to make securitization safer.
Everyone, from the bank originators to the investment bank packagers, got hooked on the easy profits, and kept pushing for ways to streamline the process, to both increase their profits and increase the size of the potential market. The biggest problems result from cutting corners, including the failure of the deal sponsors to adhere to their own agreements with investors, that led to this mess. Securitization had existed since the 1970s; MERS, one of the biggest culprits in the uncertainties over title, did not become a serious player until 1999. The widespread failure to convey notes (the borrower IOU) to securitization trusts appears not to have started until sometime between 2002 and 2004.
Some of the key sections of her piece:
But the settlement doesn’t go nearly far enough to save the housing market. In fact, it can’t go far enough, because it can’t address one of the most confounding problems the banks have created: the millions of properties nationwide that now have “clouded” titles.
To put it plainly: Because of these bad titles, property owners can’t prove they own the properties they think they bought, and banks can’t prove the had the right to sell them.
Even though it’s impossible to know how many properties are affected, I have confidence in saying millions nationally for the following reasons:
More than 1 million foreclosures have been completed since 2005; nearly 200,000 were completed in the third quarter of 2010 alone.
Foreclosures involving securitized mortgages seem to be flawed as a rule, not the exception.
Even when foreclosures may have been otherwise valid, the practices of foreclosure attorneys have clouded titles.
The problems are ongoing. More flawed foreclosures are completed every day.
The clouded title problem extends well beyond foreclosures. Both MERS, the electronic database that holds more than half the mortgages nationally, and possible securitization failures could have damaged the titles of the properties even though the borrowers are current on their mortgages.
One thing her piece does not discuss as clearly as it might is the depth of the mess will be state-specific. Minnesota, which passed MERS-friendly legislation, will not deem assignments in and out of MERS to be in any way impaired. But in many states, where the note is deemed to be the controlling instrument, botching up the transfer of the note causes serious title issues (in theory the note can be assigned at any time, but the securitization documents required notes to be transferred though a particular set of parties by a date certain, which has since passed for houses now facing foreclosure. For a host of reasons, the trust that is supposed to own the note needs to be the party that forecloses, but if the note didn’t get to the trust properly, the party earlier in the chain, who is in position to foreclose, is not the party that anyone wants to foreclose. And retroactive fixes are not an option).
But even in title theory states, where merely getting the mortgage (the lien against the property) assigned correctly would suffice, judges are also taking a dim view of certain widespread securitization practices. We discussed at some length the repercussions of a recent Massachusetts Supreme Judicial Court decision, Ibanez. Field elaborates:
A few months ago, the Massachusetts Supreme Judicial Court issued its Ibanez decision, which made it clear that the banks’ foreclosure practices — and indeed, the standard securitization deal — violated longstanding basic Massachusetts real estate law, and thus, many completed Massachusetts foreclosures were invalid. The foreclosing banks, which had either since sold the properties or still “owned” them, had no right to foreclose, and therefore had never owned those properties. So who owns them now? Well, the fact that it’s a question is the very definition of “clouded title.”
Since it has been a couple of months since the Ibanez decision, I called a couple of large title insurance companies in the Boston area to see how title insurance for improperly foreclosed properties is being handled….
One agent called improperly foreclosed homes in Massachusetts “uninsurable.” Another explained that the problem underscored in the Ibanez case has been around for years, and that any title company would need to look at foreclosures dating at least until the late 1970s, when securitization became more common, to make sure no improper foreclosure had happened in all those years. And some properties, she noted, had been foreclosed on multiple times.
That agent did note that the problem was worst for properties improperly foreclosed on in recent years that were still bank-owned. Those properties were truly uninsurable. That’s because the bank couldn’t make a claim on the title insurance policy it had purchased when making the original loan, since it was the entity that clouded the title. Indeed, honoring that policy would be like letting a arsonist collect on fire insurance. Thus much of the current bank-owned inventory in Massachusetts is largely uninsurable and thus unsellable.
No settlement with the servicers is going to solve that problem.
Note that this isn’t quite as cut as dried as Field suggests; law professor, securitization expert, and frequent industry Adam Levitin has dug further into pooling & servicing agreements based on Ibanez and sees plenty of cause for concern. But regardless of how bad this is, it’s clearly pretty bad if not absolutely dire in Massachusetts and their is reason to think that states with broadly similar laws will come to the same conclusion (the Massachusetts SJC is held in high esteem). And title insurers, who are not in the business of taking risk, have (as we noted months ago) been demanding that banks indemnify them for sales out of foreclosure.
A settlement cannot indemnify against this risk, but it will have the effect of halting state attorney general investigations, particularly if the release is as broad as we expect it to be.
The response by the authorities bears disturbing parallels to the Fukushima facility disaster response: a preoccupation with protecting “assets”, meaning the miscreant banks, while putting a much larger community at risk. The stakes were so high and the initial response so visibly insufficient that the prime minister intervened and ordered more aggressive measures be taken. But here, the federal government has cast its lot in with banks and is seeking to muscle the state AGs into line. The reality is that a bailout masquerading as a settlement won’t solve the underlying problem. The powers that be are deluding themselves as to how long it will be before an unaddressed mortgage mess goes critical.