If you want to know why the latest mortgage headlines matter you have to go back to 1998 and the deal worked out by the tobacco industry to avoid bankruptcy.
For decades before the settlement the tobacco industry had successfully fought and defeated every liability claim. The most audacious defense was that because everyone had long known tobacco and cancer were related manufacturers could not be responsible for the consumption of a lawful product. Volenti non fit injuria claimed the companies, citing an old legal concept, "to a willing person, no injury is done."
The prevailing view for many years was that the tobacco companies were immune to liability because they had the cash, industry-funded “research” and political power to grind down any opponent. But over time public attitudes changed, the cost of tobacco-related healthcare grew, and the glaring falseness of industry arguments could no longer be ignored. The result was that the industry would either be bankrupted by individual smoker lawsuits or it could accept a universal settlement and survive. Knowing the game was up, the industry agreed in 1998 to pay state governments more than $200 billion to off-set healthcare costs over a 25-year period.
We now have a similar situation emerging with mortgages, real estate and foreclosures. After decades of unstoppable power, the lending industry has an increasing need to settle.
Much attention has been given to the just-announced decision by the Massachusetts Supreme Court, which said lenders have no right to foreclose unless they actually own the mortgage note. This decision is not groundbreaking and not especially negative for lenders. It is, however, a sign of change.
To start, courts have been ruling for several years that lenders cannot foreclose unless they own the note. The Boyko ruling in Ohio from 2007 as well as court decisions in Kansas, Missouri, and Nevada all point to the same conclusion.
As Wells Fargo explained in the latest case, “the court’s ruling does not prevent foreclosures on loans in securitizations. The court simply set forth a standard legal process that mortgage servicers must follow in Massachusetts.”
This analysis is no doubt right and therein lies the problem: A growing number of courts have ruled that servicers did not follow the rules. All 50 state attorneys general have joined together to examine foreclosure issues. Moreover, this is no longer a minor or technical matter hidden from public view; the term “robo-signing” has become a generic description for many foreclosure disputes.
The problem, then, is not that lenders do not have a right to foreclose; the issue is that they must follow rules. Fake affidavits, claims of loan ownership after a foreclosure action has been started and woeful accounting practices now need to be undone. “What is surprising,” one Massachusetts Supreme Court justice explained, is the “utter carelessness with which the plaintiff banks documented the titles to their assets.”
“The direction of court decisions has begun to change and foreclosures in many jurisdictions will now require stronger evidence of loan ownership and standing,” says Jim Saccacio, Chairman and CEO at RealtyTrac, the foreclosure tracking and data service. “As well, you can expect mortgage investors to support efforts to establish a better audit trail.”
The Other Front
Borrower cries of “show me the note” can no longer be brushed off, meaning that foreclosures in many states will now be slowed or even stopped temporarily. But borrowers are not the only party with an interest in foreclosure issues.
The states have begun to realize that the electronic transfer of mortgage notes is a big business — one that removes huge revenues from state coffers at the very time when state budgets are deeply in the red.
Loan investors — such as pension funds and insurance companies that buy mortgage-backed securities — have begun to make claims under the pooling and servicing agreements they have with loan servicers. Efforts to force banks and servicers to buy back questionable mortgages are increasingly common. Fannie Mae and Freddie Mac, as one example, have just collected $3.3 billion in loan buy-backs — what is surely just the start of numerous claims against numerous lenders.
“I’m concerned that the settlement between Fannie Mae, Freddie Mac and Bank of America over misrepresentations in the mortgages BofA originated may amount to a backdoor bailout that props up the bank at the expense of taxpayers, says Rep. Maxine Waters, D-Calif. “Given the strong repurchase rights built into Fannie Mae and Freddie Mac’s contracts with banks, and the recent court setback for Bank of America in similar litigation with a private insurer, I’m fearful that this settlement may have been both premature and a giveaway. The fact that Bank of America’s stock surged after this deal was announced only serves to fuel my suspicion that this settlement was merely a slap on the wrist that sets a bad example for other negotiations in the future.”
Like the tobacco industry before it, the lending community is neither weak nor inactive. Increasingly unable to win in court or in the media, it is instead attempting to change the rules to limit if not entirely remove liabilities.
For instance, the Interstate Recognition of Notarizations Act of 2009 managed to get through both the House and the Senate without hearings, debate or recorded votes. Had it been signed by the President the act of notarization would have forced courts to accept lender affidavits.
Also, there's now a movement to “unify” state rules under a single federal foreclosure standard. This would do away with pesky state requirements and replace them with federal regulation, an arena where borrowers have virtually no say.
The catch is that borrowers are not the only ones seeking big money from lenders and servicers. Investors and state governments — who DO have representation in Washington — are seeking enormous sums from lenders. The Maine State Retirement System, as one example, has sought $352 billion from the Bank of America.
And that's just one case.
Where We're Headed
Given the trends now in place, we're headed for something along the lines of the tobacco settlement.
- The deal must be big if only because the amounts at stake are huge, but it cannot be so big that we bankrupt every major lender and servicer and demolish the financial system.
- There must be relief for the states because 50 separate state suits with 50 separate results is untenable for lenders and servicers.
- There will have to be a safe harbor period, say three to five years, so lenders and servicers can go back and develop an audit trail for every loan that has been securitized.
- There will have to be a settlement with title insurance companies who potentially face enormous claims because of false affidavits and other issues.
- There will have to be a forum for borrowers who lost their homes unjustly during the past few years; that is, borrowers who were current or could have qualified for a loan modification if their paperwork was correctly handled. Statutory damage limits will have to be established.
- As part of the deal all stated-income, interest-only and subprime mortgages made before July 21, 2010 will have to be reviewed to see if borrowers now qualify for conventional, VA or FHA financing. Prepayment penalties will be waived with such conversions as part of the settlement. (The 2010 date was when the Dodd-Frank Wall Street Reform Act was signed).
- As part of any settlement, money from lenders and services will be set aside to help underwrite the newly formed Consumer Finance Protection Bureau.
- The electronic recordation system will be changed to assure that notes are physically available to borrowers and lenders at all times and to compensate the states for initial recordation activities.
- Those who have bought foreclosures at auction or from lenders will have to be compensated in the event title claims arise.
How will lenders and servicers react to the mortgage settlement? As a result of the tobacco settlement the cigarette companies gained improved finances because advertising and litigation costs were reduced. The money saved was used to pay dividends and buy companies outside the tobacco arena. While tobacco usage has generally declined the industry has prospered — a result lenders and services will not be able to overlook.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.