Professor Cole's Finance Blog

Why are the Wall Street banks imposing a “freeze” on foreclosures when the average number of days to foreclose on a property, according to LPS Analytics, is at an all-time high of 478 days? The answer is that we have now entered Part II of the subprime crisis, which also can be characterized as “big banks behaving badly, yet again.” The subprime crisis was most notorious for the so-called “no-doc” and “NINJA” mortgages, where “no-doc” stood for “no documentation required” and NINJA stood for borrowers with “No Income, No Job or Assets.” In other words, it was a “paperwork problem.” Nothing to see here, folks; move on,” we were told. The big mortgage lenders, such as Bank of America, Countrywide, Wachovia and Washington Mutual, then sold these mortgages to Wall Street investment banks, including Goldman Sachs, Morgan Stanley, and Merrill Lynch, which sliced and diced them into collateralized debt obligations (“CDOs”). The ratings agencies blessed these CDOs with triple-A ratings, after which the soon-to-be junk securities were foisted off onto unsuspecting investors around the world. But then these subprime borrowers often failed to make even a single payment on their mortgages, sending the values of the CDOs plummeting into junk status and worse. In the financial carnage that ensued, Countrywide, Wachovia, Washington Mutual and Merrill Lynch failed, only to be folded into other Wall Street titans such as Bank of America and J.P. Morgan Chase, which then were bailed out by capital injections from the taxpayer funded TARP. Goldman Sachs and Morgan Stanley survived, but only after being rescued by the Fed, which under cover of night, granted them access to its Discount Window by converting them into bank holding companies. That is old news; the story of the subprime crisis, which is now over and done. Or is it?  

In recent weeks, several major mortgage lenders have ‘fessed up that they have discovered pervasive “paperwork problems” in their legal actions to foreclose upon delinquent borrowers. First, it was GMAC, but then Bank of America and J. P. Morgan Chase followed suit; others likely will follow. But what do the big banks really mean by “paperwork problems?” We have learned of so-called “robo-signers,” which refers to employees of these banks that filed affidavits with the courts handling the millions of foreclosure actions, swearing that they had read the loan files and knew that the information in these files to be true. Only later, when deposed in person, these same employees testified that, actually, they had not read the loan files and had no idea whether or not the information in the files was accurate. What information was inaccurate? Such small details such as “does the bank legally own the mortgage note.”

“Paperwork problem” is a misnomer; what we have here is “perjury problem.” Bank employees have sworn before the courts across this land to facts that were not true. Not once; not ten times; but tens of thousands of times. And that is only the ones who have ‘fessed up. According to RealtyTrac, more than 6 million homes have been seized by lenders during the past three years. 

Didn’t we impeach a sitting president a decade ago for lying to a court about a much lesser matter?  And why are these big bank employees lying about these foreclosure actions? The answer lies in the subprime securitization Gold Rush that took place from 2004 – 2007. In their rush to move mortgages from origination to securitization (garbage to gold, the ultimate financial alchemy), the big banks created a “virtual” system for tracking who owned the mortgage notes. This virtual system, known as MERS or the Mortgage Electronic Registration System, was founded back in 1997, in order to bring our nation’s “archaic” land-title system into the 21^st century. This system registered MERS as the “nominal” owner of the mortgage, and supposedly let the real owners to trade title among themselves without having to worry about niceties of the land-title system, such as “the need to prepare and record assignments when trading residential and commercial mortgages.” Without MERS, the securitization machine would not have been possible, or, at least, certainly not as profitable. MERS boldly advertised that it would enable lenders to “save” by avoiding filing fees required by counties across the country when ownership of real property is transferred. It now appears that lenders such as Countrywide and Washington Mutual took advantage of these savings by using MERS to track changes in ownership, but failed to file affidavits of ownership with county courts, as required by most state laws. 

Enter the “Statute of Frauds.” The Statute of Frauds refers to an English Common Law established back in 1677 to protect poor landowners from expropriation by the nobles. It simply requires that all contracts conveying an interest in real estate be in writing, with so-called “wet signatures” by both buyer and seller, as well as by a witness, typically a notary public. What we are now learning is that many lenders relied upon MERS alone to track title of the properties they sold; in order to save a buck on filing fees, they failed to comply with the state laws requiring a paper affidavit of ownership signed by both parties and notarized by a witness. With no “skin in the game,” why should they have worried? Now that Countrywide, Wachovia, Washington Mutual and Merrill have failed, we know why: they didn’t expect to be around for the carnage we now face. Unfortunately for Bank of America and J.P. Morgan Chase, those two megabanks ended up acquiring the legal carcasses of the failed mortgage lenders and now are saddled with the “paperwork/perjury problems” that the defunct lenders created.

So long as poor and ignorant borrowers simply handed over the keys to their foreclosed properties, there was no problem. But a few such delinquent homeowners had the temerity to hire lawyers and contest the foreclosure actions of MERS and the big-bank servicers. When represented by a competent lawyer, a startling trend began to emerge. When lenders were challenged to prove that they actually “owned the note,” many withdrew, or sought to amend, their foreclosure actions. A few bold defense lawyers were able to “depose” a few of the lenders’ employees, each of whom had signed, as we now know, thousands of  affidavits before the courts that the lenders owned the “notes” (i.e., the mortgages). Only then did the “robo-signer” scandal emerge. 

Now, the Wall Street banks are desperately trying to sell their egregious actions as a “paperwork problem.” Don’t buy their snake oil; this is really a “perjury problem.”  Yes, in most cases, the borrowers have failed to live up to their contractual obligations to repay mortgage loans. However, that does not deny these borrowers of the right to due process, or relieve the lenders of their legal obligation to prove that they actually followed the rules and hold legal title to the notes underlying the mortgages. In the rush to securitization gold, many mortgage lenders broke the rules, just as they broke the financial system and brought about what is now known as the Great Recession. By their perjurious conduct, the Wall Street banks have violated the trust of the court system and should be held accountable. As more and more judges are deciding, the best sanction is to dismiss their foreclosure actions with prejudice, effectively rendering their perjured affidavits of ownership worthless.

The fallout from this perjury problem goes far beyond the two million homeowners currently in the foreclosure process, and even beyond the additional 2.4 million borrowers who are seriously delinquent on their mortgages but not yet in the foreclosure process. The actions of these lenders have cast a cloud on the title of more than 60 million mortgages registered in MERS virtual registry. Did the lenders property assign ownership as they traded the notes underlying these mortgages? In many cases, we now know that they did not. How pervasive is the problem? No one yet knows. What we do know is that this is going to be an expensive problem to fix, requiring a detailed review of each and every document related to these 60 million mortgages. Who is going to pay for these reviews? Most likely, you and I will pay. In order to sell your house in the future, you are going to have to establish clean title. This problem is not going away.

Note: This blog appeared as an op-ed in the Oct. 22 print edition of the Washington Times and is available online at:

http://www.washingtontimes.com/news/2010/oct/21/big-banks-behaving-badly-again/print/