Five years ago a conservative federal judge in a conservative state stopped 14 foreclosure actions with a very simple demand for lenders: Show me the note.
This was not some picky technical requirement by a demented jurist, instead Federal Judge Christopher Boyko of the U.S. District Court in Ohio, an appointee of President George W. Bush, wanted to make sure that before people lost their homes the lender had the right to foreclose, a long-time legal standard which requires that the lender hold the mortgage note.
This is basic stuff. No note, no foreclosure.
More specifically, this used to be basic stuff. Traditionally, every time someone bought or sold a property, every time someone got financing or paid off a mortgage, such events were noted in the local records office. And recordation offices, for their services, happily collected fees for each document and transaction they processed.
You could bank on it. In fact, people did. Records offices across the country were famously accurate and as a result title insurance claims were minimal. In fact, title insurance claims are so rare that the biggest cost for title insurance is not actually coverage, it is instead the 70 percent or so of the premium paid out as commissions to settlement providers.
Mortgage Notes and Ownership
Today mortgage notes are bought and sold electronically and individual transactions are routinely “not recorded” by local property offices. Unlike the good old days of pen-and-ink it appears that some notes are missing. Could a lot of notes be missing? We don’t know.
Ginnie Mae, according to National Mortgage News, is expected to soon ask the nation’s ten largest lenders the Boyko question: Where are the notes? Not where are the notes in theory, but where do the notes physically exist.
This could be a big problem. The baseline issues raised in the 2009 Boyko decision have never gone away. Either lenders have the notes or they don’t, and if they don’t then massive issues emerge. Not only can’t lenders foreclose, they can’t sell notes they don’t have. They can’t sell the servicing rights for phantom paperwork.
Ask yourself: Is one note part of two separate mortgage-backed securities? How does anyone know without physical possession of the note? How can a note be an asset if it cannot be found? Will shareholders ask what their bank really owns? Can homeowners be forced to make monthly payments if there’s no evidence of a debt?
“This court acknowledges the right of banks, holding valid mortgages, to receive timely payments,” said Boyko in his 2009 decision. “And, if they do not receive timely payments, banks have the right to properly file actions on the defaulted notes — seeking foreclosure on the property securing the notes. Yet, this court possesses the independent obligations to preserve the judicial integrity of the federal court and to jealously guard federal jurisdiction. Neither the fluidity of the secondary mortgage market, nor monetary or economic considerations of the parties, nor the convenience of the litigants supersede those obligations.”
Translation: Courts should not be foreclosing unless all the usual standards for such actions have been met. And if the standards cannot be met then long-term guidelines will not be dumped merely because one party or the other is inconvenienced.
To this point mortgage settlements resulting from the foreclosure meltdown have totaled more than $100 billion. That’s a huge number but imagine how much bigger it might get if there’s a new round of demands for notes and other paperwork.
The first step in the face of such a demand will be a review of lender records. It will have to be an audit of lender records because with electronic transfers local property records offices are out of the loop.
We know from experience that lender reviews are not very satisfying. Remember the alleged “independent foreclosure reviews” from which were conducted by several federal regulators in an effort to pay off owners who had unfairly lost their homes to foreclosure? The process was so bad that American Banker had a headline which said: “Banks Hire Friendlies for ‘Independent’ Foreclosure Reviews.”
The “friendlies” did pretty well. The review process was supposed to pay out $3.6 billion in cash to homeowners but the audit process cost nearly $2 billion — or almost $20,000 per reviewed file, an oddity given that under the review program 2.4 million of 3.9 million borrowers received checks for only $300.
The lending industry has been successful defending its right to have unrecorded electronic mortgage transfers but it may now face a whole new set of issues: Okay, loans can be bought and sold electronically without documenting each ownership transfer in a local records office, but where, exactly, are the notes?
You need the notes to show a bunch of things. For instance, are mortgage-backed securities actually backed by, um, mortgages? If yes, where are the notes? If a mortgage is an asset and an asset is shown on the books then where is the note? Where is the note used to justify a foreclosure? Why should I pay my mortgage if the lender does not have the note? How can a home be sold if it secures a note which cannot be found?
There is now a very good chance that the toxic mortgage era will drag on, not in the sense of more foreclosures but with new efforts to find missing mortgage notes and other paperwork. Looking at the cost of cleaning up the paperwork mess, the money saved avoiding recordation fees — the incentive which lead in large part to electronic note transfers — must now seem like a false economy to many in the financial field.