“In the West, this formal property system begins to process assets into capital by describing and organizing the most economically and socially useful aspects about assets, preserving this information in a recording system—as insertions in a written ledger or a blip on a computer disk—and then embodying it in a title. A set of detailed and precise legal rules governs this entire process. Formal property records and titles thus represent our shared concept of what is economically meaningful about any asset. They capture and organize all the relevant information required to conceptualize the potential value of an asset and so allow us to control it . . .

The reason capitalism has triumphed in the West and sputtered in the rest of the world is because most of the assets in Western nations have been integrated into one formal representational system . . . By transforming people with real property interests into accountable individuals, formal property created individuals from masses. People no longer needed to rely on neighborhood relationships or make local arrangements to protect their rights to assets. They were thus freed to explore how to generate surplus value from their own assets.”

-Hernando de Soto, The Mystery of Capital


The woes in the mortgage market are complex, deep and structural. This is more than just a few shortcuts taken by paralegals here and there — there are endemic structural problems within the US real estate and mortgage markets.  (Yesterday, we touched upon the problems associated with foreclosure mills).

We are not discussing economic problems of too many homes for sale and falling prices. What is being discussed here is a full blown crisis underlying home titles, foreclosure procedures, and securitized mortgages.  The rampant, epidemic and systemic abuse of legal property protections is now reaching a crisis.

Today, we will put that crisis into the greater context of the entire real estate industry, from purchases to the securitization of mortgages to default and foreclosure. What this discussion reveals are a series of short cuts, (il)legal fictions, and an utter disrespect for the mechanisms of legal property transfer that underlies our entire system of Capitalism. As Hernando de Soto discovered, the organized, reliable, functional systemic approach to property rights is the key reason why “Why Capitalism triumphs in the West and fails everywhere else.”

And we will see that at every step along the process, the reckless rush for easy profits has systemically undermined these legal property rights — how mortgages are recorded, the bungled bundling of notes to be securitized, the electronic system that fictionalized the process of assembling transfer documents, and how all the players along the way — The investment firms, banks, law firms, even court system, utterly lost sight of what they were doing.

If de Soto were to come to the United States today and review all of this, he would see a system that ignores its own laws, cheats on process, engages in wanton fraud, and is in danger of sliding not just backwards to the 18th century, but slipping towards a third world nation of dubious legal protections and the worst form of crony capitalism.

Welcome to 21st century America.


Capitalism in the West thrives because of our ability to legally transfer property, with confidence and certitude. A buyer knows they will be getting good title to  what they are buying, a lender can confidently encumber a property.

Only, not so much any more.

Centuries of property law have been undercut by the entire Real Estate financing complex.  From the mortgage brokers who told borrowers “just leave those lines blank, I’ll fill them in” to the banks that taught their own agents how to game their computer loan approval systems to the financial engineers assembling the mortgage sausage to the myriad law firms, process servers and courts that oversee those loans final resting place, the entire system has been corrupted as a cost-savings/profit maximizing exercise.

Here’s how to eviscerate the advantage of western law & economics in three simple steps

1) MERS:  We start with the Mortgage Electronic Registration Systems. MERS is a computer registry that was “created by lenders seeking to save millions of dollars on paperwork and public recording fees every time a loan changes hands.” It holds over 60 million mortgages on American homes. Thanks to a legal fiction that pretends to follow the law — but actually does not — MERS has saved banks more than $1 billion. It has also turned what was a very successful system of tracking who owns what property and making it easy to transfer into a dysfunctional nightmare.

Gretchen Morgenson explains exactly how this worked, and then unraveled:

“For centuries, when a property changed hands, the transaction was submitted to county clerks who recorded it and filed it away. These records ensured that the history of a property’s ownership was complete and that the priority of multiple liens placed on the property — a mortgage and a home equity loan, for example — was accurate.

During the mortgage lending spree, however, home loans changed hands constantly. Those that ended up packaged inside of mortgage pools, for instance, were often involved in a dizzying series of transactions.

To avoid the costs and complexity of tracking all these exchanges, Fannie Mae, Freddie Mac and the mortgage industry set up MERS to record loan assignments electronically. This company didn’t own the mortgages it registered, but it was listed in public records either as a nominee for the actual owner of the note or as the original mortgage holder . . .

As long as real estate prices rose, this system ran smoothly. When that trajectory stopped, however, foreclosures brought against delinquent borrowers began flooding the nation’s courts. MERS filed many of them . . .

As cases filed by MERS grew, lawyers representing troubled borrowers began questioning how an electronic registry with no ownership claims had the right to evict people. April Charney, a consumer lawyer at Jacksonville Area Legal Aid in Florida, was among the first to argue that MERS, which didn’t own the note or the mortgage, could not move against a borrower.Initially, judges rejected those arguments and allowed MERS foreclosures to proceed. Recently, however, MERS has begun losing some cases, and the Kansas ruling is a pivotal loss, experts say. While the matter before the Kansas Supreme Court didn’t involve an action that MERS took against a borrower, the registry’s legal standing is still central to the ruling.”

Because of the egregious abuse of the property transfers in the legal system, MERS eventually lost its legal shield and cloak of privacy.

More significant than that, their unique combination of legal fictions and incompetence implies a huge underlying problem with many of the structured finance. This means that Residential mortgage-backed securities (RMBS) and Collateralized Debt Obligation (CDO) that relied on MERS have enormous structural problems.

2) Improper Construction of RMBS/CDOs:

Structured mortgage securities are typically constructed as Trusts. The Trust holds the mortgage notes, which allows the bundling to occur.

Under normal circumstances, the re should be some assignment of  the Note by the original lender to the Trust. Frequently, this step did not occur. Nor did the requisite filing of the mortgage lien with the appropriate county clerk.

These errors plus the MERS issue led to very serious problems for much of the structured finance that was built on top of it. The creation of an RMBS or CDO needs at least two legal events to occur: One, the actual note the bank holds needs to be deposited into the Trust. Observe that it is the note holder who is entitled to receive principle and interest payments, who has a lien against the encumbered property, and has the right to foreclose and take the property in the event of a default.

The Note seems to  have been somehow ignored in the structuring process. And on top of that, the proper filing of the mortgage note every time a structured product changes hand was mostly ignored. As Corrente noted:

“Because of the expense, time and paperwork it would take to record each of the assignments of the thousands of mortgages in each securitization, Wall Street firms decided to just issue blank mortgage assignments all along the channel of transfers, skipping the actual physical recording of the mortgage at the county registry of deeds.

Astonishingly, representatives for the trusts have been foreclosing on homes across the country, evicting the families, then auctioning the homes, without a proper paper trail on the mortgage assignments or proof that they had legal standing. In some cases, the courts have allowed the representatives to foreclose and evict despite their admission that the original mortgage note is lost. (This raises the question as to whether these mortgage notes are really lost or might have been fraudulently used in multiple securitizations, a concern raised by some Wall Street veterans.)

See also The American Banker.

Karl Denniger went so far as to suggest the entire MERS/structured finance industry engages in such systemic illegality as to be guilty of RICO — the Racketeering statute used to bring down drug lords and mafia kingpins. If he is right, and I suspect he is, our Banana Republic status is getting ever closer.

3) Foreclosure Fraud: This is the third and final step to the disassembling of Capitalism’s property rights. It is indirectly related to prior two steps. Mostly it reflects the same disrespect for legal process int he headlong rush for profits, legal and otherwise.

We’ve discussed this before. Rather than repeat that diatribe, let me show exactly how endemic this is, via the price list for fabricating Foreclosure documents. From naked capitalism, (4ClosureFraud Posts Lender Processing Services Mortgage Document Fabrication Price Sheet), we learn that for a price, a firm will fabricate whatever documents need for foreclosure, real or otherwise.

This makes Denniger’s RICO accusation even more poignant. Need paper work for a foreclosure, legal or otherwise? There’s an app for that.

You can view the entire Lender Processing Services price sheet here.

Welcome to the Banana Republic…



How to Get an “Iffy” loan approved at JPM Chase (March 28th, 2008 )

The Mortgage Netherworld (April 26th, 2009)

Mortgage Electronic Registration Systems Loses Legal Shield (September 23rd, 2009)

Gretchen Explains MERS For You (September 27th, 2009)

Slowing the Runaway Foreclosure Train (October 4th, 2010)

How ‘Flawed’ Was the Paperwork? (October 4th, 2010)

The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else by Hernando de Soto

Category: Bailouts, Credit, Foreclosures, Legal, Real Estate

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

117 Responses to “Foreclosure Fraud Reveals Structural & Legal Crisis”

  1. [...] Barry on the foreclosure fraud crisis.  (TBP) [...]

  2. rktbrkr says:

    Nationwide foreclosure moratorium on the burner…
    Lawmakers push for mortgage-lender inquiry. Rep. Nancy Pelosi and dozens of other lawmakers sent a letter to the Justice Department yesterday calling for an investigation of the nation’s largest mortgage lenders. The group said recent reports that lenders have initiated hundreds of thousands of questionable foreclosures “amplify our concerns that systemic problems exist,” and specifically cited such lenders as Bank of America (BAC) and JPMorgan (JPM). The move will likely add momentum to a push for a nationwide moratorium on foreclosures, though critics warn such broad measures could overwhelm the court system and scare away potential buyers of foreclosed properties.

  3. [...] By Barry Ritholtz “In the West, this formal property system begins to process assets into capital by describing and organizing the most economically and socially useful aspects about assets, preserving this information in a recording system—as insertions in a written ledger or a blip on a computer disk—and then embodying it in a title. A set of detailed and precise legal rules governs this entire process. Formal property records and titles thus represent our shared concept of what is economically meaningful about any asset. They capture and organize all the relevant information required to conceptualize the potential value of an asset and so allow us to control it . . . [...]

  4. rktbrkr says:

    I think there will be multiple tranches of home values – at least in many sand states.
    1) Properties that have never been foreclosed.
    2) Properties that have been foreclosed but are insurable.
    3) Properties that have been foreclosed by robo signing big banks but are still insurable (maybe by bank’s captive insuror). Subsequent resales might not be insurable if captive insuror operates on a “one and done basis)
    4) Foreclosed properties that cannot be title insured

    A big open question is what happens if not all the fragmented mortgage note holders can be found in order to sign off and provide clear title at a non-foreclosure sale? At that point even non-foreclosed properties may become clouded. In the past title insurance companies may not have been sensitized to the issue and provided the insurance. A routine resale with fragmented note ownership for owner #1 may have occurred in 2008 and owner #2 may have gotten title insurance without a hitch but when he attempts to resell in 2010 and when pending owner #3 attempts to get title insurance and the title insuror takes a closer look at the preceding transaction and cannot find documentation of signoff by all the fragmented owners what happens?

  5. Jon_Roland says:

    When I was learning law (the hard way) in Texas in the 1980s, one of the defenses a debtor had to a claim by a creditor was the “best evidence rule”, according to which the claimant had to produce the original signed note in court, not just a photocopy, and certainly not just an affidavit that the attorney for the claimant, or his agent, was the “owner and holder in due course” of that note. After all, each signed instrument was a separate obligation. Two signed notes was two obligations, not duplicates of one another.

    Somewhere along the way courts started letting creditors offer only affidavits, and now it is coming home to roost. If they had stuck to the best evidence rule all long we might not have the current financial meltdown. It should be noted that the Best Evidence Rule appears to be the law in federal courts and in every state except California, although widely ignored. http://en.wikipedia.org/wiki/Best_evidence_rule

  6. Captain Jack says:

    From forementioned Bloomberg piece, yowza:

    While homeowners in those states and elsewhere must usually show damages to win a lawsuit, “attorneys general can just sue over deceptive sales practices and get penalties,” said Christopher Peterson, a University of Utah law professor who specializes in commercial and contract law.

    In Ohio, penalties include fines of up to $25,000 per violation, with each false affidavit or document considered a violation, according to state law enforcement officials. In Iowa, fines rise to a maximum of $40,000 for each violation.



  7. Banks ILLEGALLY breaking into peoples homes, changing locks BEFORE foreclosures

  8. zapatajoseph9 says:

    My name is Randy Zapata and i am from Miami, Florida. I am one of those millions of victims in the Mortgage Fraud. I have filed everything as per the process intails. But come to find out that Mr. McCollum and his co-conspiriderMr. Crist allowed thes types of mortgages into Florida. I have ended up filing complaints to the Attorney Generals office. As I have just found out that Mr. McCollum is under investigation. I hope that his helpers the Florida Financial regulation Board and the Miami-Dade Mortgage Fraud Task force who was implemented by Mayor Carlos Alvarez, which have turned to be a mere waste of time because the Head chiefs which allowed these scandal to occur and sat back and did nothing will not have them do nothing. These departments were merely developed to cover political tracks until after the elections. I agree with the articles statement because it ws the bnks like Wilshire Credit Corp, Countrywide, Resmae Corp for example that were in conjunction and they came out of the west. Our Govenemnt needs to launch an large investigation into these Banks and the Lawyers who represented them who also unlawfully seized thes properties from us, while hiding under the Gray-ared Ethnic rule. They I urge evreyone who is a victim to file complaints with the Attorney’s Generals Office. We need for the culprits to be held accountable. This is the only way that we will receive justice. remeber the voice of the voters is the most powerfull that we have, in numbers we are strong

  9. rktbrkr says:

    Somebody is going to shoot or turn their dog loose on one of these vultures.

  10. [...] Systematic Illegality Excerpts from Barry Ritzholtz’s article, appearing here in full: [...]

  11. JGBHimself says:

    There are a few problems that even you may not have seen “incoming” yet.

    First, is the assumption many make that all those “ownership” problems ONLY affect “judicial foreclosures”. That, so far, are all the foreclosures that have been stopped. In a judicial foreclosure the judge is required to check/determine that the person/entity trying to foreclose actually owns the interest being foreclosed. In non-judicial foreclosures NO body checks – literally don’t ask, don’t tell.

    Second, the problem with BOTH is that you cannot obtain back and then convey what you do not have a right to have. So, if the title they obtained, and then you obtained from them, is fraudulent, you might have to file a Quite Title action to solve the/your problem. This is true even IF you obtain title insurance covering the foreclosed title. Even if the title co pays on the insurance, that still does not solve the title issue. Which makes all those foreclosed “bargains” for U.S. a wee bit more dicey/pricey.

    As we learned in the Army, all Shiites run downhill.

  12. [...] The Rule of Law is Sacrosanct: Our system of private property has developed due to the rule of law. The ability to demonstrate ownership, pass clear title, resolve disputes has worked for 100s of [...]

  13. [...] we noted previously, esteemed economists such as Hernando de Soto have identified that the respect for title, proper [...]

  14. [...] few more details have come to light since our past few missives on this subject that I wanted to bring your attention: 1) Title [...]

  15. [...] Foreclosure Fraud Reveals Structural & Legal Crisis (October 5th, 2010) [...]

  16. [...] Foreclosure Fraud Reveals Structural & Legal Crisis (October 5th, [...]