I have not blogged in a couple of months due to being swamped with the startup of my new company Strategic Governance Solutions, but the headlines of the past week about the abrupt, wholesale failure of the real estate foreclosure process is more than I can resist.
This is a crisis that has been a long time in the making, but there have been significant revelations about the depth and breadth of the problem In the past week. Bank of America, GMAC and JP Morgan Chase have all suspended foreclosure actions on the news that legal documents filed in support of foreclosure actions emanating from the leading ‘foreclosure mills’ are fatally flawed and may have been fraudulent. In the wake of these disclosures, Congress and a number of states Attorneys General have launched investigations into foreclosure practices. A few days ago, one of the nations largest title insurance firms stopping writing title insurance for foreclosed properties.
If this were simply a matter of crooked lawyers, paralegals and notaries from a hand-full of foreclosure mills ‘robo-signing’ fraudulent legal filings, a few disbarments or perjury convictions followed by perfecting the pleadings would be the end of the matter. Lawyers cutting corners is nothing new, but the ugly truth is that many of the 64 million mortgages in the Mortgage Electronic Registration System (MERS) many not be capable of have the titles for the underlying properties cleared. See, Peterson, Christopher Lewis, Foreclosure, Subprime Mortgage Lending, and the Mortgage Electronic Registration System (October 5, 2009). University of Cincinnati Law Review, Vol. 78, No. 4, 2010. Available at SSRN: http://ssrn.com/abstract=1469749).
The root of the problem is not that MERS or the banks have failed to maintain the information or records required to secure their interests for reasons of technological or records management incompetence. Rather, the banks and MERS made a conscious decision to avoid the state and country title recording fees because their desire to securitize and trade mortgages with the regularity and speed of the stock market was at odds with the centuries old practice of recording the changes in ownership in the county title recording offices. As Peterson details in his law review article, rectifying this problem will not be easy. First, the trail of ownership from origination through securitization of the mortgage may not be able to be reconstructed due to mortgage originators who no longer exist or poor record keeping on the part of the mortgage servicers or the trusts administering the Mortgage Backed Securities. Moreover, even if the paperwork can be reconstructed,some courts may still not accept that MERS has standing to foreclose in the more than 20 states that require a judicial proceeding to foreclose. This non trivial legal risk seems to be yet another “Black Swan” the Banking Risk Management and legal management community somehow failed to account for while being mesmerized by the prospect of saving a few hundred dollars in filing costs over the life of the mortgage.
I don’t know how this is going to turn out, but speculate that one way or another the courts and the regulators will find a way to prevent the unjust enrichment of deadbeat mortgagors by giving them title to properties they have defaulted on. At the same time, I doubt that many of the state legislatures and courts (who have the most direct control over foreclosure practices will permit the current MERS based system to continue to operate without significant changes. (indeed, just this morning JPMC announced that it stopped using MERS for most purposes back in 2007). The confluence of circumstances will make the banks rethink the risk of a MERS model which does not provide for local title recording and a real repository of the title along with the rest of the mortgage origination/servicing file so that both can be easily obtained and authenticated. I don’t expect these changes to come about because of an altruistic desire to improve the foreclosure process, but because ‘Mortgage-gate”, i.e., the revelation that many mortgages may not be worth the paper they are printed on, will kill the market for Mortgage Backed Securities absent the MBS buyers believing that the underlying assets can be foreclosed on in the event of default. With smart Hedge Funds and lawyers crawling all over the situation and looking for a payoff from someone with deep pockets, suddenly saving a few hundred dollars per mortgage by reducing expenditures for filings and servicing suddenly seems like a recipe for huge losses and the destruction of the Mortgage Backed Security business.
In the past the banking community has created shared archiving solutions that can be extended to provide the Records Management arm of MERS or other bank controlled mortgage servicers. For example, look at the banking community’s response to the Check 21 law. The banks understood that having a better electronic check image archive was not a competitive advantage, so most of the larger banks created Viewpointe to maintain their check archive. The Viewpointe archive now contains about 200 billion check images which are available not only to the banks, but to their checking customers as well. It’s not hard to imagine a similar solution for mortgage records. Most customers think it is a valuable service to have their check images available on line, expect they would feel the same way about their mortgage records. Given the relatively minimal cost of creating a proper archive vs, the risk of not being able to foreclose on properties in default, it is hard to image the banks will let this situation continue.