Saturday, October 16, 2010

The Second Leg Down

¹²The Second Leg Down Of America's Death Spiral

By Gonzalo Lira | 16 October 2010

So this is what happened, more or less— the short version:

In the crazed frenzy to get as many mortgages securitized during the Oughts, banks took 'shortcuts' with the paperwork necessary for the Mortgage Backed Securities. The reason was because everyone in the chain of this securitization mania got a little piece of the action— a little slice of the MBS pie in the shape of commissions, fees, or bonuses. So in the name of "improved efficiencies" (and how many horror stories are we finding out, carried out in the name of those "improved efficiencies"), banks digitized the mortgage notes— they didn't physically endorse them, as they were supposed to by the various state and Federal laws.

Plus— once the wave of foreclosures broke, and the holes in this bureaucratic paperwork became evident and relevant— some of the big law firms handling the foreclosures for the banks started doing some document fabrication and signature forgery, in order to cover up the mistakes— which is definitely illegal. Long story short (since this is the short version): A lot of the foreclosed properties might not have been foreclosed legally. The people evicted might still have a right to their old houses.

The new buyers might not actually own the REO's they bought off the banks. The banks could be on the hook for trillions of dollars, and in the sights of literally millions of lawsuits. In short: This could become another massive hit to the banks and the Body Economic.

Now— the long version:

Homeowners can only be foreclosed and evicted from their homes by the person or institution who actually has the loan paper— only the note-holder has legal standing to ask a court to foreclose and evict. Not the mortgage— the note, which is simply the IOU that people sign— promising to pay back the mortgage loan. Before Mortgage Backed Securities, most mortgage loans were issued by the local Savings & Loan. So the note usually didn't go anywhere: It stayed in the offices of the S&L down the street.

But once mortgage loan securitization happened, things got sloppy— they got sloppy by the very nature of Mortgage Backed Securities. The whole purpose of MBS's was for different investors to have their different risk appetites satiated with bonds of different classes of 'risk'. Some bond customers wanted super-safe bonds— and were satisfied with low returns; others were willing to tolerate riskier bonds with, therefore, higher rates of return.

Therefore, as everyone knows, the loans were "bundled" into REMIC's (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then "sliced & diced"— ie, split up and put into 'tranches', according to their probability of default, their interest rates, and other characteristics. This slicing and dicing created "senior tranches", where the loans would be most likely to be paid in full, if past history of mortgage loan statistics were to be believed. And it also created "junior tranches", where the probability of some loans defaulting were greater, again according to past history and statistics. (A whole range of tranches were created, of course, but for purposes of this discussion, we can ignore all those countless variations.)

These various tranches were sold to different investors, according to their risk appetite. That's why some of the MBS bonds were rated "as safe as Treasury bonds", and others were rated by the ratings agencies to be about as risky as junk bonds. But here's the key issue: When an MBS was first created, all the mortgages were pristine— none had defaulted yet, because they were all brand new loans.

Statistically, some would default and some others would be paid back in full— but which ones specifically would default? No one knew, of course. If I toss a coin 1,000 times, statistically, 500 tosses the coin will land heads— but what will the result be of, say, the 723rd toss specifically? I dunno.

Same with mortgages.

So in fact, it wasn't necessarily that the "riskier" loans were only in the junior tranches and the "safe" mortgage loans were only in the senior tranches: Rather, all the loans were in all the tranches, and the tranches were simply set up so that if and when a mortgage in a given bundle of mortgages defaulted, the junior tranche holders would take the losses first, and the senior tranche holder take the loss last. But who were the owners of the junior tranche bond and the senior tranche bond? 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. Therefore, how to make sure the safe mortgage loan stayed with the safe MBS tranche, and the risky and/or defaulting mortgage went to the riskier MBS tranche?

Enter stage right, the famed MERS— the Mortgage Electronic Registration System.

MERS was the repository of these 'digitized' mortgage notes that the banks originated from the actual mortgage loans signed by homebuyers. MERS was jointly owned by Fannie Mae and Freddie Mac (who else[!?!]) The purpose of MERS was to 'help' in the securitization process.

Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially the operating table where the digitized mortgage notes were sliced and diced and rearranged so as to create the Mortgage Backed Securities. Think of MERS as Dr. Frankenstein's operating table, where the various pieces of the beast got put together.

However, legally— and this is the important part— MERS didn't hold any mortgage note: The true owner of the mortgage notes should have been the REMIC's. But the REMIC's didn't own the note either, because of a fluke of the ratings agencies: The REMIC's had to be "bankruptcy remote", in order to get the precious ratings needed to peddle Mortgage Backed Securities to insitutional investors.

So somewhere between the REMIC's and the MERS, the chain of title was broken. Now, what does "broken chain of title" mean? Simple: When a homebuyer signs a mortgage, the key document is the note. As I said before, it's the actual IOU.

In order for the mortgage note to be sold or transferred to someone else (and therefore turned into a Mortgage Backed Security), this document has to be physically endorsed to the next person. All of these signatures on the note are called the "chain of title". You can 'endorse' the note as many times as you please— but you have to have a clear chain of title right on the actual note: I sold the note to Moe, who sold it to Larry, who sold it to Curly, and all our notarized signatures are actually, physically on the note, one after the other.

If for whatever reason, any of these signatures is skipped, then the chain of title is said to be broken. Therefore, legally, the mortgage note is no longer valid. That is, the person who took out the mortgage loan to pay for the house no longer owes the loan, because he no longer knows whom to pay.

[ Normxxx Here:  Well, its not really as bad as that, just almost. Until the owner of the note is legally identified, however, the mortgagee is relieved of paying on it, though he may be required to put the monies owed into some kind of escrow account.  ]
To repeat: If the chain of title of the note is broken, then the borrower no longer owes any money on the loan. [[At least until such time as the chain is legally reestablished.: normxxx]] Read that last sentence again, please. Don't worry, I'll wait.

You read it again? Good: Now you see the can of worms that's opening up. The broken chain of title wouldn't have been an issue if there hadn't been an unusual number of foreclosures.

Before the housing bubble collapse, the people who defaulted on their mortgages wouldn't have bothered to check to see that the paperwork was in order [[and, in any event, even the courts were amenable to 'minor' paperwork 'irregularities'.: normxxx]].

But as everyone knows, following the housing collapse of 2007–2010-and-counting, there's been a boatload of foreclosures— and foreclosures on a lot of people who weren't sloppy bums who skipped out on their mortgage payments, but smart and cautious people who got squeezed by circumstances. These people started contesting their foreclosures and evictions [[especially when the banks turned HAMP into just another kind of scam: normxxx]], and so started looking into the chain of title issue… that's when the paperwork became important. So the chain of title became important. So the botched [[and doctored: normxxx]] paperwork became a non-trivial issue.

Now, the banks had hired "foreclosure mills"— law firms that specialized in foreclosures— in order to handle the massive volume of foreclosures and evictions that occurred because of the Housing Crisis. The foreclosure mills, as one would expect, were the first to spot the broken chain of titles. Well, hell, whaddaya know— turns out that these foreclosure mills might have faked and falsified documentation, so as to fraudulently 'repair' the chain-of-title issue, thereby "proving" that the banks had legal standing to foreclose on a delinquent mortgage. These foreclosure mills might have even forged the loan note itself—

— wait, why am I hedging? The foreclosure mills actually, deliberately and categorically faked and falsified documents, in order 'to expedite' those 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!

So in other words, a massive fraud was carried out, with the inevitable innocent bystander getting caught up in this fraud: The guy who got foreclosed and evicted from his home in Florida, even though he didn't actually have a mortgage, and in fact owned his house free-and-clear. The family that was foreclosed and evicted, even though they had a perfect mortgage payment record. Et cetera, depressing et cetera.

Now, the reason this all came to light is not because enough people were getting screwed that the banks or the government or someone with power saw what was going on, and decided to put a stop to it— that would have been nice, to see a shining knight in armor, riding up on a white horse. But that's not how America works nowadays. No, alarm bells started going off only when the title insurance companies started to refuse to insure the bogus titles.

In every sale, a title insurance company insures that the title is free-and-clear: That the prospective buyer is in fact buying a properly vetted house, with its title issues all in order. Title insurance companies stopped providing their service because— of course— they didn't want to expose themselves to the risk that the chain-of-title had been broken, and that the bank had illegally foreclosed on the previous owner.

That's when things started gettin' innerestin': That's when the Attorneys General of various states started snooping around and making noises (elections are coming up, after all). The fact that Ally Financial (formerly GMAC), JP Morgan Chase, and now Bank of America have suspended foreclosures signals that this is a serious problem— obviously.

Banks that size, with that much exposure to foreclosed properties, don't suspend foreclosures just because they're good corporate citizens who want to do the right thing, with all the paperwork in strict order— they're halting their foreclosures for a [valid self-serving] reason. The move by the United States Congress last week, to sneak through the Interstate Recognition of Notarizations Act? That was all the banking lobby— they wanted to shove down that law, so that their foreclosure mills' forged and fraudulent documents would not be scrutinized by out-of-state judges. (The spineless cowards in the Senate carried out their Master's will by a voice vote— so that there'd be no registry of who had voted for it, and therefore no accountability.)

And President Obama's pocket veto of the measure? He had to veto it— if he'd signed it, there would have been political hell to pay, plus it would have been challenged almost immediately, and likely overturned as un-Constitutional in short order. As soon as the White House announced the pocket veto— the very next day!— Bank of America halted all foreclosures, nationwide.

Why do you think that happened? Because the banks are screwed— again. By the same thing as the last time— those Mortgage Backed Securities!

If they've been foreclosing on people they didn't have the legal right to foreclose on, then those people have the right to get their houses back. And the people who bought those foreclosed houses from the bank might not actually own the houses they paid for [[and could turn around and sue the banks for fraud: normxxx]]. And it won't matter if a particular case— or even most cases— were on the up-and-up: It won't matter if most of the foreclosures and evictions were truly because the homeowner failed to pay his mortgage.

The fraud committed by the foreclosure mills casts enough doubt that now, all foreclosures come into question. Not only that, all mortgages come into question. [[And, not only that, but all of those $trillions of derivatives based on those mortgages become unmarketable— would you want to buy one?: normxxx]]People still haven't figured out what this all means— but I'll tell you: If enough mortgage-paying homeowners realize that they may be able to get out of their mortgage loan and still keep their house, scott-free [[at least for some indeterminate time: normxxx]]? That's basically a license to halt payments right now. That's basically a license to tell the banks to go stuff it.

What are the banks gonna do— try to foreclose and then evict you? Show me the paper, will be all you need to say. This is a major, major crisis.

[ Normxxx Here:  And still worse, if it turns out that all of those MBS purchasers don't have clear title to some subset of mortgages— and, moreover, never did, then they can turn around and sue the issuing banks for the full amount of their money back— regardless of the current market value of those bonds!  ]
This makes Lehman's bankruptcy look like a spring rain, compared to this hurricane. And if this isn't handled right— and handled right, quickly, in the next couple of weeks on 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? If this isn't handled right, then this will be the second leg down, in the American Death Spiral.

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