Saturday, October 16, 2010

Taking notes

Some people are taking notes, and some aren't.

Guambat has joined the throng to blog on about the so-called "fauxclosure" fanfare of recent times, and this is not the post that will distract him from that hullabaloo.

Because, however hard it may be to swallow, the achilles heel to the security issues facing the real estate securitization cabal is the failure to keep notes, assignments and mortgages together, and the following stories may just be the first swallow of the spring, though, of course, one swallow does not a spring make.

But first, stop reading this post and go read this Washington Post article, for necessary background and color:

For foreclosure processors hired by mortgage lenders, speed equaled money
Millions of homes have been seized by banks during the economic crisis through a mass production system of foreclosures that was set up to prioritize one thing over everything else: speed.

Law firms competed with one another to file the largest number of foreclosures on behalf of lenders - and were rewarded for their work with bonuses. These and other companies that handled the preparation of documents were paid for volume, so they processed as many as they could en masse, leaving little time to read the paperwork and catch errors.

And the big mortgage companies overseeing it all - including government-owned Fannie Mae - were so eager to get bad loans off their books that they imposed a penalty on contractors if they moved too slowly.

The system was so automated and so inflexible that once a foreclosure process began, homeowners and consumer advocates say, there was often no way to stop it.

The financial incentives show that the problems plaguing the foreclosure process extend well beyond a few, low-ranking document processors who forged documents or failed to review foreclosure files even as they signed off on them. In fact, virtually everyone involved - loan servicers, law firms, document processing companies and others - made more money as they evicted more borrowers from their homes, creating a system that was vulnerable to error and difficult for homeowners to challenge.
As was said, go read the article, all of it. The authors did a great job.

Anyway, Michael A. Fox of Johnstown, Ohio, has been taking notes about the goings on down in Florida, because what happens in Florida hardly ever stays in Florida.

Johnstown man sues GMAC Mortgage, alleges fraud in foreclosure process
In his complaint, filed in Common Pleas Court, Fox seeks at least $25,000 in compensatory damages and $25,000 in a civil penalty, plus undetermined punitive damages that his attorney said will be 2 percent of GMAC's 2009 gross revenue.

The complaint states that Jeffrey Stephan, who signed Fox's foreclosure assignment Jan. 26, 2009, also testified in a Florida state foreclosure case that he signed 10,000 affidavits and assignments in a month without knowledge of the cases or verifying the accuracy of the information.

"Stephan knew or should have known that these hundreds of affidavits would be filed in Ohio courts and relied upon by Ohio common pleas court judges in deciding whether one plaintiff in the particular case had a right to foreclose on Ohio residents," Fox states in his complaint. "GMAC knew or should have known the same."

The court has not yet issued a final order, which precedes a sheriff's sale, said Fox's attorney, John Sherrod.

Sherrod said he has no idea who actually owns the promissory note on Fox's mortgage because it has been assigned so many times.

Barry Ritholtz related a little story about that guy, Jeffrey Stephan:
I’ll let Thomas A. Cox, a retired lawyer, describe GMAC’s foreclosure process and the work of its limited signing officer, Jeffrey Stephan in a court filing:
“When Stephan says in an affidavit that he has personal knowledge of the facts stated in his affidavits, he doesn’t. When he says that he has custody and control of the loan documents, he doesn’t. When he says that he is attaching ‘a true and accurate’ copy of a note or a mortgage, he has no idea if that is so, because he does not look at the exhibits. When he makes any other statement of fact, he has no idea if it is true. When the notary says that Stephan appeared before him or her, he didn’t.”

Meanwhile, an alleged mortgage originator seems to have joined Fauxclosures Anonymous, and issued something of a confession, for which Guambat fervently hopes he gets off at least as lightly as Angelo Mozilo.

The art of mortgage fraud
How do you get official approval of large-scale fraud, theft, and racketeering? You become a mortgage originator (i.e. a “Too-big-To-Fail bank”) like me. Let me walk you through the scheme:

Once you entice the “borrower” into your institution, you have them sign an IOU – a promise to pay on a mortgage which is backed by overvalued real-estate.

Now that you have their note, you're ready to make a real killing by trading this thing up. Stay with me, because this is where it gets really interesting. It's time to “secure” this debt by coming to agreeable terms with securitizers and ratings agencies. Let the raters AAA rate pretty much everything you throw at the securitizers who's job it is to bundle your mortgages into a trust. They can do this without even reviewing the paperwork because, and here is the beautiful part, there is no paperwork.

Why is there no securities paperwork, you ask?

Remember, the trust that underlies a mortgage backed security (MBS) must hold the borrower's note. If the trustee isn't given the note within 90 days after signing, the securities are not legal instruments. All that counts is that we “assign” the deed of trust to whomever “holds” the mortgage to keep the charade going.

Now, no one wants to pay pesky taxes and recording fees for every change of custody the mortgage takes. Let's get some background on this last point from L. Randall Wray, Professor of Economics at University of Missouri, a guy who's analyzed the goings on in the securities industry:

“MBSs are typically pooled through a Real Estate Mortgage Investment Conduit (REMIC) that must according to the Internal Revenue Code hold all the paperwork demonstrating a complete chain of title. Done properly, taxes are avoided. Since a number of intermediaries are usually involved from the mortgage originator through to the trustee of the REMIC, there must be endorsements all along the line. However, it now appears that most of the original notes are still held in the loan originator warehouses. There are no endorsements. The trustees do not have the notes.”

So why do we hold on to the promissory notes while fraudulently assigning the mortgages to a trust? Well, exposing the notes to investor scrutiny would be pretty silly. You don't inform the mark they're being conned. Wray does a great job of explaining how the situation has played out thus far:

“...The tranching process actually prohibited assignment of the notes to the REMICs. Bundles of mortgages of varying quality would be tranched into a variety of securities, say from AAA to BBB. But no individual mortgage is actually assigned to a particular tranche—until it defaults. When one defaults, it is assigned to a lower tranche security and then the foreclosure process begins. This means that from inception of that BBB security, there was no way to assign a note to the trustee because the trustee did not know in advance which mortgage would default. The REMIC trustees tried to get around that by using a dummy conduit called MERS (Mortgage Electronic Registration System) that would “hold” the mortgages and assign them to the proper tranches later. But they do not have the paperwork either, and some courts have rejected their claims as owners.”

Let's just hope borrowers don't start asking for their notes en masse (knock on wood). You see, in our greed and haste we successfully separated the note from the trust deed, leaving trustees with only an “accessory” instrument. If mortgage holders try to foreclose with only the mortgage assignment in their possession, well, in 45 US states they'll be out of luck in a court of law.

A foreclosure mess of their own design, by Andrew Leonard
Why do some courts consider a properly prepared document trail for mortgage loans so important? Christopher Peterson, a law professor at the University of Utah, provides part of the answer. He quotes a federal bankruptcy judge:
Lest one think that the ... Courts have exalted form over substance, it is critical to note several concepts.... [W]e are dealing with interests in Land -- not a security interest in an inventory of plumbing fixtures, in chinchillas, in canned corn, or in a lawn and garden tractor. Land. Land is certainly the asset which people deem to be their most important "possession": There is no other "thing" more important historically in our culture tha[n] an interest in land, whether that interest be in a condominium, in a house, or in farm. Land. The transferring of interests in land has been entrusted to a system of records that allows people to be certain that this single most important asset in their lives is indeed going to be theirs, and that the encumbrances recorded with respect to this asset are in fact accurate and valid. It is therefore absolutely imperative that transactions in land be guaranteed to vest title in the people who invested in those transactions, and that the investors know definitively the interests in the land in which they invest which may affect their interests in this singularly important asset. The record of land transactions in the Recorder's Office provides this critical assurance. Perhaps the most critical aspect of this "chain" of assurance is to guarantee as much as possible on the face of an instrument that a person purported to have signed a document which affects interests in land actually did sign that document.

That quote comes from the riveting paper, "Foreclosure, Subprime Mortgage Lending, and the Mortgage Electronic Registration System," published in the Summer 2010 issue of the University of Cincinnati Law Review. (Hat tip, Felix Salmon.)

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