If a few Virginia lawmakers have their way, the business of selling mortgage-backed securities worldwide could radically change, property titles would be more certain, foreclosures would always be reviewed by a judge and maybe — just maybe — the cost of mortgage financing would soar.
How is it possible for a few state officials to completely tilt the financial system? To answer this question — and to see why Wall Street is beginning to shudder — we have to look at how mortgages are made.
In basic terms a mortgage is a loan secured by real estate. Once the loan is created, information about the debt is recorded in local property records. If the debt is sold, the name of the new owner is recorded. If the property must be foreclosed, the identity of the lender is easily found in the local property records.
The traditional system is fully in place today, however a parallel system has also developed to further the sale of mortgage-backed securities (MBS).
To create an MBS, firms on Wall Street buy local mortgages. Title to those mortgages is then often recorded in the name of a third party called the Mortgage Electronic Registration Systems or MERS.
With MERS as the mortgage holder, the loan can be bundled with thousands of other loans to create an MBS. Since the title remains in the name of MERS, there are no additional state recordation fees to be paid each time the loan is bought or sold, a savings of better than $1 billion dollars for what lenders claim are unnecessary costs.
Changing loan owners under MERS without the need to record each transfer of ownership has been largely unchallenged until recently. Now, at least seven state supreme courts have ruled against the MERS concept.
The issue of loan ownership leads directly to foreclosures. A lender can’t foreclose unless it has “standing” and to have standing it must own the note.
In Utah, for example, the Salt Lake City Tribune reports that it was not possible in one foreclosure case to serve papers to MERS because “it was not the legal owner of title to the property. Those were title companies. In addition, attorneys contend, MERS cannot be the ‘beneficiary’ or holder of the promissory note because it readily has admitted it has no financial interest in any notes or mortgages.”
Well, okay, don’t serve papers to MERS, serve them to a title company. But no, that also doesn’t work.
“Normally,” explained the paper, “a trustee named in a trust deed has a legal duty in Utah to the entity that holds the promissory note and for fair dealing with the homeowner. But in the townhouse case, First American Title filed a response to the quiet title action saying that it had no idea who had the right to collect payments on the promissory note, nor did it admit to knowing any other basic information about the property.” (See: How accurate are property records? January 16, 2011.)
The unbelievable conclusion: It appears the homeowner has no obligation to pay a $132,000 mortgage because no one owns the note.
This case and similar cases going back to the 2007 Boyko opinion are increasingly bad news for Wall Street.
How big a deal is this? According to Laurie Goodman with the Amherst Securities Group, private-label MBS worth $1.3 trillion were outstanding as of December. MBS derivatives — bets made on future price movements — could be worth many times more. As of June 2010 the total value of derivatives of all types was thought to be more than $580 trillion.
At first the bi-partisan proposals of Virginia state Del. Robert G. Marshall, R, and Sens. Donald McEachin, D, and Chap Peterson, D, appear entirely modest: As Marshall wrote in the Virginian-Pilot, “no one would expect a convenience store clerk to pay off a $5 lottery ticket without the patron producing the lottery stub.”
“This is not simply a problem that affects upside-down mortgages, out of work Virginians or ‘dead beats,'” said Marshall, a conservative from the suburbs south of Washington, DC. “The lack of proof of legal title to a home potentially affects up to 65 million mortgage holders in the U.S., even if they never defaulted on mortgage payments — in short, nearly everyone who purchased a home since 1997 whose mortgage was part of a mortgage-backed security investment.”
Here’s what’s being proposed:
- HB1506: Increases the minimum foreclosure notice period in Virginia from 15 days to 45 days. Defines the submission of a falsified foreclosure affidavit as perjury and allows borrowers to sue for damages.
- SB 795: Requires that all mortgage note assignments in Virginia to be recorded locally.
SB 798: Requires that all Virginia foreclosures go through the court system, converting Virginia from a non-judicial foreclosure state to one that requires approval by a judge before any home can be foreclosed. Would require lenders to show a complete trail of loan ownership before being able to foreclose.
- HB 1665: Allows delinquent borrowers to bring loans current up to the day of foreclosure. Requires lenders to provide information regarding the status of the loan, answer borrower questions and provide information regarding steps that might be used to avoid foreclosure. Also provides borrowers with an 18-month period to cure defaults in situations where the lender has not provided required information.
What Could Go Wrong?
The Virginia proposals hardly seem revolutionary. Lenders have always been required to show “standing” — actual ownership of the loan note — before a judicial foreclosure or when challenged in court. In practice such borrower protections have been widely ignored.
For big lenders and Wall Street, however, the Virginia proposals undermine the system of instant and electronic ownership changes because there’s nothing fast or quick about recording new ownership with each loan transaction. And since Virginia loans are scattered among large numbers of MBS, the entire system would be impacted.
“There’s no reason we cannot have a secondary market for the purchase and sale of mortgage notes that trades less speed for stronger documentation and greater investor protection,” said James J. Saccacio, chief executive officer of RealtyTrac. “In today’s world that’s a swap mortgage investors would welcome and it would surely be good for real estate investors as well.”
One can argue that if passed the Virginia rules would instantly increase mortgage rates to stratospheric levels because investor demand for mortgages would decline. It’s also possible that mortgage investors might actually prefer the Virginia system to electronic assignments. Think about it this way: As a mortgage investor would you want to own the Utah loan which is uncollectible or a Virginia mortgage where the chain of ownership is certain?
Under the current system, for example, the Richmond-Times Dispatch reports that one homeowner faced foreclosure demands from four separate lenders, all of whom claimed ownership of the same note. Even without advanced math skills it’s plain that at least three lenders cannot possibly collect.
Lastly, if you want to buy a foreclosure — properties which have been selling at a 32 percent discount in recent months — you surely want more than just a lower cost. You want to know that the property has good, marketable and insurable title — something created under Virginia’s proposed requirements.
It’s possible that the Virginia proposals will be stalled and not pass; it’s also possible that the Congress could step in and re-write foreclosure laws to protect the MERS concept with a “unified” national system. Recent political trends, however, favor less federal regulation — especially when someone’s home is at stake.
Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, OurBroker.com.