You can pretty much bet there was a lot of cheering when Judge Robert D. Drain erased a $461,263 mortgage claim in a New York bankruptcy case. This sounds like a big victory for the good guys — but before the celebrations get out of hand it might be wise to sort out the winners and losers.
In basic terms, the PHH Mortgage went into a bankruptcy court to collect an unpaid mortgage debt. This is a natural and normal process and the usual outcome is fairly common: Given the inability of bankruptcy judges to modify residential mortgages the unpaid debt is usually seen as earned, due and payable and the property is instantly foreclosed.
But this time around the debtor made a different argument, one we are likely to see more often. While it may be that bankruptcy judges cannot modify mortgage loans under the so-called Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, lenders still have to show that they actually have a claim.
Speaking for the homeowner, attorney David B. Shaev argued that the PHH is the loan “servicer” while the U.S. Bank National is the “trustee” for a securitized trust that actually owns the debt. A securitized trust, in turn, could be a mortgage-backed security (MBS) with many investors.
As a servicer, said Shaev, PHH had no claim against the homeowner. He argued that:
- PHH is not the beneficiary of the note;
- PHH has no financial rights under the note;
- PHH is not the real party in interest;
- The real owner of the mortgage, U.S. Bank, is not a party to the court case;
Due to all of the above, PHH has no standing to file the proof of claim in this bankruptcy.
PHH, according to Shaev, could not even prove that it was the servicer because it could not produce the Pooling and Servicing Agreement (“PSA”) which would give it authority to collect the debt. Also not proven, according to Shaev, is who actually owned or was holding the mortgage note.
Judge Drain ultimately ruled against PHH and accepted Shaev’s arguments.
The PHH decision, says The New York Times writer Gretchen Morgenson, “may put a new dynamic in play in the foreclosure mess: If the lender can’t come forward with proof of ownership, and judges don’t look kindly on that, then borrowers may have a stronger hand to play in court and, apparently, may even be able to stay in their homes mortgage-free.” (See: If Lenders Say ‘The Dog Ate Your Mortgage’, October 24, 2009.)
Sounds great, but Morgenson — a financial writer who I generally admire — has seriously missed the point on this one.
The Legitimacy of Debt
In the PHH case there was never a dispute that a mortgage was originated. The borrower got a mortgage, but for purposes of collecting the debt the issue was who actually owned the note or represented the note holder at the time of the bankruptcy. If you’re not the loan owner or owner’s agent then you have no right to foreclose on someone’s home.
While Morgenson says judges have not looked kindly at loan claims by lenders who cannot produce notes, the opposite is true. Most foreclosure actions whiz through the legal system because in many cases no court action is required and — when a hearing is required — judges have routinely accepted claims regarding the electronic assignment of notes. There’s a reason why law firms which handle lots of real estate cases are called “foreclosure mills.”
Only recently — most notably with the 2007 decision of Judge Christopher Boyko to stop 14 foreclosures in Ohio — have judges begun to demand proof of loan ownership from lenders.
The result is a small but growing number of court cases where lenders, servicers and trustees have been required to show that they have physical possession of the note and that servicers and trustees have the right to represent note holders in court.
Despite such minimal barriers to foreclosure, in many instances appropriate paperwork cannot be found. The lack of paperwork is not a problem for lenders when judges don’t ask for such evidence or where a borrower does not have an attorney, but more and more often judges do ask and more and more borrowers now have lawyers. From this point forward foreclosures may not be so fast or so easy.
The Marketplace Threat
“The problems note holders face in proving their foreclosure claims should not obscure the fact that mortgages were made, security was pledged and payments are due,” says Jim Saccacio, Chairman and CEO at RealtyTrac.com, the leading online marketplace for foreclosure properties. “A wholesale dumping of lender claims would be disastrous, not just for lenders but for all property owners.”
Imagine that a few lenders lose track of their notes and that borrowers start hiring lawyers when faced with foreclosure. Imagine too that a small number of well-publicized mortgage claims are erased.
What would happen next? For some borrowers the new system would be like winning the lottery, but for the rest of us the dollars available for mortgages would disappear. Why would investors want to buy new mortgage-backed securities if the mortgages are uncollectible? It would make equal sense to invest in czarist railroad bonds or ENRON futures.
With fewer dollars from investors, what happens the next time you want to finance or refinance a home? Either the money won’t be there or it will only be there at insanely-high rates.
Ask yourself: What would happen to the value of your home if it can’t be financed when you want to sell? How many people can pay cash? And how much cash do you think they would offer if mortgages were largely unavailable?
The PHH case is wrongly decided for a very simple reason: If it’s true that PHH had no right to sue, why should U.S. Bank be punished? That’s the direct result of erasing the mortgage claim in this case. It’s not PHH that’s being hurt or the borrower, it’s U.S. Bank — the folks who put up the cash to originate or buy the loan.
What To Do
Some time ago I was speaking with the friendly folks at the IRS about their record-keeping system. How far back, I asked, does your system go? Remarkably, they were instantly prepared to send complete copies of my returns — going back to the 1960s.
There’s a lesson here for the lending industry. It’s time mortgage records were right and instantly accessible.
Why not a central depository where all mortgage notes are physically maintained — with back-up centers in other geographic areas? The notes would be bar coded, digitally copied, and available online. In other words, if FedEx and UPS can track packages minute by minute, why can’t lenders do the same with notes and deeds?
A city, for example, would be able to instantly access all notes for a given property. Title companies would be able to get certified copies instantly. Closing agents would be given serial numbers to use the system and upload new notes. Local property records offices would be paid for an official recordation each time a note is originated, transferred, assigned or paid off. Notes could be physically moved by certified mail with return receipts or by overnight delivery — but in all cases paper notes would be tracked from the moment of origination until pay-off.
I really do mean minute-by-minute tracking. There are printing facilities which track paper from machine to machine and from place to place using barcodes. If you can’t find a piece of paper you always know where and when it was last spotted.
The IRS has its major records center in West Virginia. There’s plenty of land available there and elsewhere for additional records centers, but there’s no room for the instability which now plagues the mortgage system and threatens home values nationwide.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.