Scientists keep finding new celestial objects when searching through outer space, but the biggest black hole is fairly local, the much-hyped effort to resolve claims by 50 state attorney generals relating to mortgages, robo-signing and securities disclosures. One of the most-important stories for the past few months has somehow disappeared and with it an important chance for higher real estate prices and fewer foreclosures.
Almost a year ago news reports began bubbling to the surface claiming that lenders and servicers had cut corners while foreclosing, in particular that foreclosure affidavits were improperly prepared and therefore some foreclosures were wrong. Clerks admitted to signing hundreds and even thousands of foreclosure affidavits per day while at the same time the electronic system used to record mortgage ownership was under fire with allegations of inaccuracy, lost assignments and missing notes.
There’s universal agreement that mortgage borrowers must pay their loans or face foreclosure. There’s also agreement that lenders must show they own the notes and prove that borrower payments have been missed before a home is auctioned off.
As a result of the robo-signing scandal and questions about lender loan sales and assignments courts are now requiring more accurate paperwork, a demand which has slowed foreclosure processing nationwide and in some cases brought it to a halt. In Maryland, for instance, one lender simply dropped 250 foreclosure claims after robo-signing issues arose.
So why would anyone care about paperwork snafus?
Let’s start with mortgage investors, the pensions, insurance companies and sovereign funds who buy mortgage-backed securities from banks and brokerages on Wall Street.
If lenders can’t quickly foreclose because paperwork is wrong or questionable they then have no leverage to force the repayment of their loans. To investors such new risks mean their mortgage-backed securities are less valuable. One result is that investors are busily suing the lenders and packagers who sold such financial products — and some individual claims can be measured in billions of dollars.
For more than a decade lenders have been using an electronic system called MERS to record and transfer loan ownership. In basic terms, a loan is originated and recorded by one lender and then sold into the MERS system. Once within MERS lenders claim they are able to buy, sell and assign loans electronically — and without paying recordation fees for each transfer or changing local property records.
“Lenders save at least $25 for every new loan they register on the MERS System,” the company reported in 2007. “Since the beginning, MERS has saved the mortgage industry over $1 billion in unnecessary costs.”
The validity of this system has now been called into question, with some courts supporting the MERS concept while others have not. The looming problem is whether local property records remain reliable — and who should pay if the system has been degraded.
For instance, the Oregonian reports that legislators considered a bill which would have prevented claims against lenders if property ownership was not correctly recorded in local records. The proposal was defeated, but why did it even come up if lender liability was not a worry? (See: MERS foreclosure amendment dies in Oregon House committee, June 1, 2011)
At some point there must be a resolution of the paperwork problem. This has to happen because buyers want clear title, lenders selling foreclosures want to avoid future liabilities and investors want leverage when borrowers don’t pay. No less important, it’s difficult to see how lenders can make loans or title insurance companies can provide coverage without the certainty of a credible property records system.
The ideal solution would be a universal settlement which clears the table. In this scenario lenders and servicers would say whoops, we didn’t do anything wrong but as a goodwill gesture we’ll fund a system to clean up the mess in exchange for an end to the claims against us.
This has been exactly the type of deal which major lenders and servicers have been trying to work out with state attorney generals for much of the past year. The talked-about settlement figure has been around $20 billion along with an extensive list of changes to the servicing and foreclosure system.
First, is $20 billion too much, too little or just about right? This is a hugely debatable issue and part of the discussion includes concerns that if the settlement number is “too” big the lending system could be destabilized.
Concerns about system frailty are real. As evidence, three of the largest financial companies in the United States — Bank of America, Citigroup and Wells Fargo — were all downgraded by Moody’s in late September.
Indeed, according to Bloomberg News the Bank of America might actually consider bankruptcy if litigation losses become too large.
This is a potent threat because the Bank of America is the nation’s largest financial institution. Such a bankruptcy would wipe out shareholder equity worth some $70 billion as of mid-September and by itself could potentially cripple the entire financial system. Already the bank has announced its intention to reduce its workforce by 30,000 jobs.
Second, exactly what is being settled? Are some claims in some states being settled or will all claims in all states related to robo-signing and recordation be resolved? What about related borrower claims, alleged securities violations and other claims?
There’s considerable disagreement among state attorneys general regarding the right approach. In particular, Eric Schneiderman, New York state’s attorney general, does not want a settlement which precludes other possible investigations. This is crucially important because mortgage-backed securities are generally written under the laws of his state.
Third, exactly who’s settling?
Earlier this year there was an effort to resolve claims against the Bank of America concerning Countrywide loans used to create mortgage-backed securities worth $174 billion. The proposal settlement would have included an $8.5 billion payout — but what about investors who were not a party to the deal? What would they get? Would they be able to make claims in the future?
“Lawyers representing 22 institutional investors, including the Federal Reserve Bank of New York, BlackRock and Pimco, contended that the deal was favorable,” said the New York Times.
But, added the paper, Schneiderman sued to block the deal, arguing that “the deal could ‘compromise investors’ claims in exchange for a payment representing a fraction of the losses’ experienced by investors and that it had been negotiated without the knowledge of all of the holders of the securities.”
The “solution” might be a bigger payment and no limit on future claims and investigations, but that’s plainly unacceptable to lenders and servicers. Alternatively, without a universal settlement there’s no end to the number of potential claims. For instance, the Federal Housing Finance Agency — the government office now running Fannie Mae and Freddie Mac — has just sued 17 lenders and servicers, alleging loans worth nearly $200 billion were misrepresented to investors.
Had there been a universal settlement of all toxic mortgage claims two years ago it’s unlikely that robo-signing deal or note ownership issues would have been included. The size and extent of such concerns were unknown at the time and that raises a problem: If there is now a universal settlement can we be sure that some new issue will not arise, an issue which because of a settlement cannot be investigated, fixed or funded?
“To revive the economy you have to re-start the housing sector and to re-start the housing sector the foreclosure inventory must be reduced,” said RealtyTrac spokesperson James J. Saccacio. “Unfortunately, we are now in a situation where to fix the foreclosures you have to resolve the paperwork problems and to fix the paperwork you have to figure out who will pay for the clean-up. The result is that we have a series of stumbling blocks that prevents us from going forward.
“Basically,” added Saccacio, “we need to create a fresh platform so we know all property records are good and all foreclosure claims are justified and valid. Once this happens it will then be possible to clear out the foreclosure inventory, buy and sell loans with traditional safety and get the housing sector back on track.”
In the end there will have to be a settlement with lenders and servicers. It’s the only way to solve the paperwork problem and with it the foreclosure mess. A mortgage settlement will not go as far as many people would prefer, but a deal which is too strong will dismantle some of the nation’s largest lenders — and with them a good chunk of the economy. That’s a price few are willing to pay.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.