Yves here. Below is a second post by Georgetown law professor Adam Levitin, who is a, if not the, top US expert on mortgage securitizations and secured credit generally. Levitin was a key player in the effort to combat foreclosure fraud. He provided extensive analysis of how many practices that had developed as the mortgage securitization industry, particularly its reliance on MERS and the contract-violating routine failure to transfer mortgages to securitization trust in the required time frame were meteor-hitting-the-planet-and-killing-all-the-dinosaurs level liability for mortgage securitizers and servicers, which included pretty much all big US banks.
But rather than use this enormous leverage to force servicers to make principal modifications, as was routine back in the day when banks retained the mortgages they originated, and investors also preferred to foreclosure, Obama instead gave banks and services a “get out of liability almost free” card in the form of the 2012 National Mortgage Settlement.
Levitin analyzed what could be inferred from Trump official William Pulte about the case against the Fed governor Lisa Cook in a an article we featured, The President’s “Firing” of Lisa Cook Is Illegal. Quite a few readers took issue with some points in Levitin’s argument, particularly regarding his point about the use of “principal” residence in the mortgage security instrument, which is less restrictive than “primary” residence.1
That distinction elicited some pushback, both from Levitin’s and our readers, and Levitin has returned to that matter. Now we don’t yet know if Cook actually will deploy an argument like the one Levitin suggests….but it seems like a promising point.
By Adam Levitin, Professor of Law, Georgetown University. Originally published at Credit Slips
I’ve been getting a lot of emails and on-line comments in recent days from people who work in the mortgage industry about the Lisa Cook mortgage situation. What I’m seeing in these comments is a serious gulf between lawyers and non-lawyers. The non-lawyers tell me that “This is how it is supposed to work.” To which my response is “Have you actually read the legal documentation?”
For example, lots of mortgage professionals (and too many journalists, following Pulte and Trump) are sloppy about conflating “primary residence” and “principal residence.” The term “primary residence” is used in the uniform residential mortgage application, but the uniform covenant in the security instrument refers to a “principal residence.” “Primary” is more restrictive than “principal.” That sort of terminology difference can matter a lot for legal purposes. I know that this sort of pedantry is why everyone hates lawyers, but it is also the sort of precision that allows parties to strike exactly the deal they want. (And if you love this sort of thing, then you really ought to be in law school or yeshivah.)This is hardly the first time the mortgage industry has learned that its legal documentation doesn’t work the way it thought it did. First there was the MERS debacle—the private mortgage title recording system just didn’t fit very well with state law. Then there was all of the securitization chain of title issues with non-delivery of notes indorsed in blank. Then there was the putback litigation–the putbacks that should have happened more or less automatically didn’t work very well when sellers resisted. And getting much less attention was litigation over the default servicing provisions in the Fannie/Freddie uniform security instruments or the contractual permissibility of post-acceleration late fees.
I’ve spent a lot of time reading, teaching, and testifying about the Fannie/Freddie uniform instruments. They are probably the most widely used standard contract in the United States. There’s scant interpretive caselaw, but there are lots of ambiguities and imprecisions in the documents. No one much cares…until litigation arises. But the documents don’t necessarily work the way mortgage professionals assume they do.
I’ll note that this is not an issue limited to the mortgage industry. It’s basically a version of the whole covenant loophole play that facilitates dropdown liability management exercises. (You see, there is a connection between the chapter 11 stuff I do and the consumer finance stuff…) Legal documentation often has glitches, gaps, and loopholes that no one notices when deals are going as intended, but fail the stress test of litigation.
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1 From that post:
Let’s consider the statutes that Pulte referenced in his referral. First, he referenced 18 U.S.C. § 1014, which criminalizes false statements in loan applications. The covenants in the security instruments are not “statements.” They are promises, not representations of current fact, so they cannot be false. A misrepresentation about intended occupancy on the Uniform Residential Mortgage Application could trigger 18 U.S.C. § 1014, but the representation there, that property will be the borrower’s “primary residence,” is very narrow given that no duration is specified. That vagueness cuts against a criminal prosecution.
Second, Pulte referenced 18 U.S.C. § 1344, which criminalizes “knowingly” defrauding a financial institution or obtaining credit “by means of false or fraudulent pretenses, representations, or promises.” That provision could encompass the promises made in the security instrument about the property serving as the borrower’s “principal residence,” but it is far from clear that Cook knowingly made the promise or that it was in fact false.
Most borrowers do not read their security instruments, so it is entirely possible that Cook had no idea what she was promising beyond that she would pay the mortgage note when installments came due. While contract law readily tags consumers with constructive knowledge of the terms and conditions of their prolix form contracts, criminal law doesn’t work like that.
Moreover, even if Cook did know that she was promising to have both properties be her “principal residence,” it isn’t clear that she was making a false promise. The term “principal residence” is not a defined in the security instruments, but it is not the same phrasing as “primary residence” (as used in the UMRA). “Principal” is more capacious than “primary,” and is capable of covering multiple residences. Imagine someone who has an co-op in NYC, a house in the New York suburbs, and a condo in Florida and splits time among all three depending on seasons and days of the week, spending roughly a third of the year at each. That person might very well consider himself to have more than one principal residence. (Pulte also referenced the wire fraud and mail fraud statutes, but those are lard-one statutes that require an underlying predicate fraud, which takes us back to the two statutes already discussed.)
The key thing here is that Trump’s only basis for action is Pulte’s referral letter, and that is not an adequate basis for concluding that Cook actually engaged in any wrong doing. Neither Pulte nor Trump have no idea whether Cook knowingly made the occupancy promise or what she interpreted the promise to mean.
