3. Just Who is The Lender?

CHAPTER

THREE

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Just Who is The Lender?

It seems to be a lousy bet on both sides: neither possesses a crystal ball that will remain clear for 30 years. In a free market, libertarian world would lenders make such a deal, or borrowers for that matter?

But the fact is that while the borrower is making a 30-year commitment, the mortgage originator likely isn’t. The banks are holding these loans “for more like thirty seconds or thirty minutes,” financial author Roger Lowenstein told Aaron Task on Yahoo! Finance. “The mortgages are immediately flipped to someone else. Why should the homeowner make anything but a cold, calculated business decision.”

In the fourth quarter of 2010, Bank of America and other lenders stopped foreclosures and attorney generals in all 50 states opened investigations to determine if there was wide-spread foreclosure fraud. The Achilles heel of securitization, that had been such a boon to Wall Street and the mortgage originators in the housing boom, was revealed by the crash.

“In essence, fast-paced modern finance is colliding with the much slower machinery of the U.S. legal system,” reported the Wall Street Journal on the front page on its October 16–17th edition. “While finance aims for efficiency and maximized profits, the courts demand due process. And that’s becoming the growing issue as lenders come under attack for taking shortcuts to oust homeowners who haven’t mailed in a mortgage check for months.”

As homeowners defaulted en masse, their lawyers were quick to determine that the “robo-signers” which were approving hundreds of foreclosure documents each day couldn’t possibly have been reviewing them, meaning the banks had not properly proved ownership of the loans.

More importantly, it was nearly impossible to determine whether lenders had the legal standing to foreclose in the case of mortgages bundled together into securitized debt pools.

Securitization, with the slicing and dicing of mortgages into MBS products has made it impossible to know who owns the actual physical promissory notes.

Real estate law requires the physical transfer of loan documents and loan sale assumption agreements. In the heady days of the housing boom it is questionable that all the paperwork and loan documents were transferred properly during each step of the securitization process or in the case where loans were sold numerous times. And if the paperwork was not transferred properly, “the whole system comes to a halt,” Georgetown law professor Adam Levitin told the WSJ.

Blogger Gonzalo Lira explained the foreclosure issues faced by the banking industry due to securitization in a lengthy post that was reprinted widely on the web with and without attribution.

The colorful Lira emphasized that only the holder of the actual paper and ink signed note has the standing to file foreclosure and evict homeowners. Not so many years ago this wasn’t an issue because the savings and loan down the street made the loan and kept it on its books.

Securitization changed all of that as local mortgage originators sold the loans and the loans became part of mortgage-backed securities (MBS). The paperwork got sloppy with all of this selling and packaging.

Lira explained that the purpose for these MBS was to appeal to the risk appetites of a variety of investors; from those that wanted super-safe no-brainers to dicer paper sporting higher yields. To accomplish this, the loans were bundled into real estate mortgage investment conduits (REMICs) and carved into tranches to be marketed to investors.

Mortgages thought to be the safest were put into one tranche, riskier paper in another, adjustable rate loans in another, and so on. The combinations were only limited by the creative genius of Wall Street salesman and underwriters.

The tranches that would absorb the last losses would be pitched to the ratings agency to be called AAA and sold to investors demanding paper with that rating. First default tranches would be rated junk and the yields would reflect that.

Of course the problem presents itself very quickly. No one knew which loans would default first. The mortgages were all good going in, but when the housing market crashed and loans began to default en masse, the question was: “But who were the owners of the junior-tranche bond and the senior-tranche bonds?” asks Lira. “Two different people. Therefore, the mortgage note was not actually signed over to the bond holder. In fact, it couldn’t be signed over. Because, again, since no one knew which mortgage would default first, it was impossible to assign a specific mortgage to a specific bond.”

Fannie Mae and Freddie Mac created the Mortgage Electronic Registration System (MERS) to deal with this problem. The MERS system would direct defaulting mortgages to the proper tranche. MERS sliced and diced the digitized mortgage notes. But MERS didn’t have possession of any of the actual notes And while the REMICs should have held the notes, but “the REMICs had to be ‘bankruptcy remote,’ writes Lira in order to get the precious ratings needed to peddle mortgage-backed securities to institutional investors.”

It is between REMICs and MERS that the chain of title to the notes was severed. And a foreclosing lender must have proof by way of properly endorsed assignments of those notes in order to have the standing necessary to foreclose.

And a broken chain of title, in Lira’s view, means the borrower doesn’t know who the lender is and who he or she should pay. And if you don’t know who you owe, you don’t owe anyone.

Of course none of this made a difference until the housing bubble popped and the number of defaults skyrocketed. No one till now has been backtracking to see if the foreclosing banks have their paperwork in order. As Lira explains, this meltdown has caught a much smarter, savvier group of borrowers in its wake. They won’t lose their homes without hiring a lawyer and putting up a fight.

The banks started foreclosing in a hurry by using foreclosure mill law firms and these firms spotted the broken chain of title, and in Lira’s opinion (and others), “did actually, deliberately, and categorically fake and falsify documents, in order to expedite these foreclosures and evictions. Yves Smith at Naked Capitalism, who has been all over this story, put up a price list for this ‘service’ from a company called DocX ... yes, a price list for forged documents. Talk about your one-stop shopping!”

Title companies started refusing to insure the titles of these foreclosures for fear that they would be stuck with millions in liability if the foreclosures were found to be not up to snuff. That’s when all fifty Attorney Generals around the country began to take notice and call for investigations.

The banking lobbyists quickly got the Interstate Recognition of Notarizations Act passed by Congress which would have made the fraudulent documents good to go. However, recognizing the likely constitutional challenge of the bill and the political heat within days of the mid-term elections, President Obama pocket vetoed the bill.

The mortgage mess was coming back to bite the banks again. The fraudulent foreclosures would make all mortgage payers think twice about paying. “This is a major, major crisis,” wrote Lira. “The Lehman bankruptcy could be a spring rain compared to this hurricane. And if this isn’t handled right ... and handled right quick, in the next couple of weeks at the outside ... this crisis could also spell the end of the mortgage business altogether. Of banking altogether. Hell, of civil society. What do you think happens in a country when the citizens realize they don’t need to pay their debts?”

Commenting on Lira’s post, financial author and analyst John Mauldin wrote that the chain-of-title foreclosure mess should not be allowed to bring the system down. “Let’s be very clear,” Mauldin wrote on InvestorsInsight.com. “If we cannot securitize mortgages, there is no mortgage market. We cannot go back to where lenders warehoused the notes. It would take a decade to build that infrastructure. In the meantime, housing prices are devastated.”

American sports marketing executive and social scientist turned consumer and investor advocate and activist, Nye La Valle analogized the foreclosure problem this way:

This may sound crude, but it’s the only analogy that’s easy for people and judges to understand. A woman goes to a party or is promiscuous and sleeps with 6 men in a night or week. The following week she is pregnant.

There is one man who is the best-looking, strongest, in best shape and richest of them all, so she wants him to be the daddy. Two other men, who find out she’s pregnant, claim paternity. NOW, before the age of DNA and computers and all, it was simply someone’s word and testimony against another.

However, with the advent of DNA testing and sequencing genes, we can tell who the daddy is.

So, a judge would understand the following:

Judge, this has been a very promiscuous note. It’s gotten around (transferred, pledged, sold, assigned) quite a bit and it never used protection (recording in public records, assignments, or proper endorsements). After being with at least a dozen different partners, our note is now pregnant (ripe for pay off/liquidation).

The MOM (MERS, servicers) says Daddy #1 is the daddy, but the baby (original note) has blond hair and blue eyes judge, but the mom and claimed dad are both dark hair and dark eyes so we’re suspicious.

Two dark hair and brown eyes men come forward and state: Judge, we both slept with this woman during the time she claimed to be pregnant. Now, 3 different men have potential paternity.

NOW, THE ONLY WAY you can determine who the father (holder in due course) is to take blood samples (accounting, servicing, custody, investor reports and data) from EACH MAN (servicer/transferee, etc.) to see whose DNA it was and all the others to determine the dad and who owes child support.

Unless you do the DNA (forensic accounting analysis of all docs and records), it doesn’t matter what the bank lawyers or servicers say really transpired here!

Without seeing where that NOTE (not mortgage) came on and off anyone’s books; how it was endorsed and when; who has possession and custody and who negotiated the note and PAID for it, you’ll never be able to answer the age old question, “WHO’S YOUR DADDY?”

The New York Times’s Gretchen Morgenson reported in October 2010 that in Florida it was standard practice to destroy original notes when the loan file was converted to an electronic one, “to avoid confusion.”

“But because most securitizations state that a complete loan file must contain the original note,” Morgenson wrote, “some trust experts wonder whether an electronic image would satisfy that requirement.”

Real estate attorney Michael Pines speculated on Dylan Ratigan’s show on MSNBC, “that nobody in this country knows for sure who owns any real estate, residential or commercial” because of securitization.

Fannie Mae and Freddie Mac began putting mortgages back to big lenders like Bank of America because the loan files didn’t meet representations and warranties.

Bank analyst Chris Whalen surfaced another problem to Larry Kudlow on Kudlow’s CNBC show that aired October 18, 2010. Whalen’s supposition is that the mortgages that J. P. Morgan owns from its purchase of Bear Stearns were sold multiple times to different buyers.

Whalen said that government policies made each bank in the United States a loan production office and that Bank of America would be forced to buy back $60 billion in mortgages from Fannie Mae and Freddie Mac for failing to meet representations and warranties. In other words, the paperwork was not in order.

In late October 2010, Compass Point Research & Trading estimated that mortgage investors would demand the nation’s banks buy back $55 billion to $179 billion in mortgages, while FBR Capital Markets took the rosier view that only $24 billion to $51 billion would be demanded.

During the housing boom, Fannie and Freddie became two of the largest investors in privately issued mortgage-backed securities that were backed by mortgage loans that were called “subprime” because less than credit-worthy borrowers were the mortgagees or the originating lenders required little or no documentation for the borrowers to gain loan approval.

As the housing market was peaking and began declining in 2006 and 2007, Fannie and Freddie purchased $227 billion in subprime-backed bonds. The losses from those bonds would be the final nails in the coffins of Fannie Mae and Freddie Mac, entities that were formally taken over by the federal government in September 2008 and by late 2010 had cost the taxpayers $148 billion dollars to keep in business with the Associated Press reporting that the tab could eventually be $259 billion.

In the first half of 2010, Fannie and Freddie had put back $6 billion in mortgages to the originating banks. Bank of America pushed back against Freddie Mac in late 2010 threatening not to send any more better-quality 2010-originated mortgages if the Government Sponsored Entity (GSE) didn’t back off of its demands for buybacks. Bloomberg reported October 21, 2010, that Bank of America would start sending its mortgages to Fannie Mae instead. The bank didn’t put the threat in writing, but got the attention of Freddie Mac’s board of directors because the GSE needed “a steady supply of healthy new loans to climb out of their financial hole.”