This commentary, forwarded by David Kotok, is a very worthwhile read — but it has a significant legal flaw in it that requires me to preface it with the following: Courts have long had the authority to apply principles of equity, as opposed to common or statutory law, to cases brought before it.

Included in this means is preventing outcomes that unjustly enrich wrongdoers, or other similar bad outcomes. With the foreclosure fraud cases, we have two actors that are not blameless here: The homeowner, who is in default, and the banks/securitizers, that failed to do the document creation and title management correctly.

Judges in civil cases do not want to see an absurd outcome. Rewarding either the homeowner (free house!) or the lenders (No penalty for massive screw ups!) would offend those principles of equity and fairness.

What might be a “just” outcome in these cases?  An example of a possible fix in a full blown litigation might be for the court to order the mortgage modified to the current equity value of the home, so that it a) punishes the lenders who failed to do their proper legal work on the documents, but b) does not give a home to a defaulted homeowner for free. The odds would be that the homeowner still gets foreclosed on, but does not owe additional monies to the bank. Since these are very often uncollectible judgments anyway, the court’s judgment can mete out justice fairly, not give anyone an undeserved windfall, yet move the cases forward. That is but one “just” solution, and I am confident that most courts have the sophistication to fashion an appropriate remedy.

Courts of “equity” (meaning “just, fairness”) can apply these principles to avoid ridiculous outcomes. Whether they choose to do so or not will be determined by them.

-BR

~~~

The Foreclosure Mess
October 15, 2010
David Kotok
>

[BR: Update: The original post was written by Gonzalo Lira].

Dear Readers, this text came to me in an email from sources that are in the financial services business and with whom I have a personal relationship.  The original text was laced with expletives and I would not use it in the form I received it.  Therefore the text below has had some substantial editing in order to remove that language.  The intentions of the writer are undisturbed.  The writer shall remain anonymous.  This text echoes some of the news items we have seen and heard today; however, it can serve as a plain language description of the present foreclosure-suspension mess. There is a lot here.  It takes about ten minutes to read it.

-David Kotok

>

Homeowners can only be foreclosed and evicted from their homes by the person or institution who actually has the loan paper—only the note-holder has legal standing to ask a court to foreclose and evict. Not the mortgage, the note, which is the actual IOU that people sign, promising to pay back the mortgage loan.

Before mortgage-backed securities, most mortgage loans were issued by the local savings & loan. So the note usually didn’t go anywhere: it stayed in the offices of the S&L down the street.

But once mortgage loan securitization happened, things got sloppy—they got sloppy by the very nature of mortgage-backed securities.

The whole purpose of MBSs was for different investors to have their different risk appetites satiated with different bonds. Some bond customers wanted super-safe bonds with low returns, some others wanted riskier bonds with correspondingly higher rates of return.
Therefore, as everyone knows, the loans were “bundled” into REMIC’s (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then “sliced & diced”—split up and put into tranches, according to their likelihood of default, their interest rates, and other characteristics.

This slicing and dicing created “senior tranches,” where the loans would likely be paid in full, if the past history of mortgage loan statistics was to be believed. And it also created “junior tranches,” where the loans might well default, again according to past history and statistics. (A whole range of tranches was created, of course, but for the purposes of this discussion we can ignore all those countless other variations.)

These various tranches were sold to different investors, according to their risk appetite. That’s why some of the MBS bonds were rated as safe as Treasury bonds, and others were rated by the ratings agencies as risky as junk bonds.

But here’s the key issue: When an MBS was first created, all the mortgages were pristine—none had defaulted yet, because they were all brand-new loans. Statistically, some would default and some others would be paid back in full—but which ones specifically would default? No one knew, of course. If I toss a coin 1,000 times, statistically, 500 tosses the coin will land heads—but what will the result be of, say, the 723rd toss? No one knows.
Same with mortgages.

So in fact, it wasn’t that the riskier loans were in junior tranches and the safer ones were in senior tranches: rather, all the loans were in the REMIC, and if and when a mortgage in a given bundle of mortgages defaulted, the junior tranche holders would take the losses first, and the senior tranche holder last.

But who were the owners of the junior-tranche bond and the senior-tranche bonds? Two different people. Therefore, the mortgage note was not actually signed over to the bond holder. In fact, it couldn’t be signed over. Because, again, since no one knew which mortgage would default first, it was impossible to assign a specific mortgage to a specific bond.

Therefore, how to make sure the safe mortgage loan stayed with the safe MBS tranche, and the risky and/or defaulting mortgage went to the riskier tranche?

Enter stage right the famed MERS—the Mortgage Electronic Registration System.
MERS was the repository of these digitized mortgage notes that the banks originated from the actual mortgage loans signed by homebuyers. MERS was jointly owned by Fannie Mae and Freddie Mac (yes, those two again —I know, I know: like the chlamydia and the gonorrhea of the financial world—you cure ‘em, but they just keep coming back).

The purpose of MERS was to help in the securitization process. Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially where the digitized mortgage notes were sliced and diced and rearranged so as to create the mortgage-backed securities. Think of MERS as Dr. Frankenstein’s operating table, where the beast got put together.

However, legally—and this is the important part—MERS didn’t hold any mortgage notes: the true owner of the mortgage notes should have been the REMICs.

But the REMICs didn’t own the notes either, because of a fluke of the ratings agencies: the REMICs had to be “bankruptcy remote,” in order to get the precious ratings needed to peddle mortgage-backed Securities to institutional investors.

So somewhere between the REMICs and MERS, the chain of title was broken.
Now, what does “broken chain of title” mean? Simple: when a homebuyer signs a mortgage, the key document is the note. As I said before, it’s the actual IOU. In order for the mortgage note to be sold or transferred to someone else (and therefore turned into a mortgage-backed security), this document has to be physically endorsed to the next person. All of these signatures on the note are called the “chain of title.”

You can endorse the note as many times as you please—but you have to have a clear chain of title right on the actual note: I sold the note to Moe, who sold it to Larry, who sold it to Curly, and all our notarized signatures are actually, physically, on the note, one after the other.

If for whatever reason any of these signatures is skipped, then the chain of title is said to be broken. Therefore, legally, the mortgage note is no longer valid. That is, the person who took out the mortgage loan to pay for the house no longer owes the loan, because he no longer knows whom to pay.

To repeat: if the chain of title of the note is broken, then the borrower no longer owes any money on the loan.

Read that last sentence again, please. Don’t worry, I’ll wait.

You read it again? Good: Now you see the can of worms that’s opening up.

The broken chain of title might not have been an issue if there hadn’t been an unusual number of foreclosures. Before the housing bubble collapse, the people who defaulted on their mortgages wouldn’t have bothered to check to see that the paperwork was in order.

But as everyone knows, following the housing collapse of 2007-’10-and-counting, there has been a boatload of foreclosures—and foreclosures on a lot of people who weren’t sloppy bums who skipped out on their mortgage payments, but smart and cautious people who got squeezed by circumstances.

These people started contesting their foreclosures and evictions, and so started looking into the chain-of-title issue, and that’s when the paperwork became important. So the chain of title became crucial and the botched paperwork became a nontrivial issue.

Now, the banks had hired “foreclosure mills”—law firms that specialized in foreclosures—in order to handle the massive volume of foreclosures and evictions that occurred because of the housing crisis. The foreclosure mills, as one would expect, were the first to spot the broken chain of titles.

Well, what do you know, it turns out that these foreclosure mills might have faked and falsified documentation, so as to fraudulently repair the chain-of-title issue, thereby “proving” that the banks had judicial standing to foreclose on delinquent mortgages. These foreclosure mills might have even forged the loan note itself—

Wait, why am I hedging? The foreclosure mills did actually, deliberately, and categorically fake and falsify documents, in order to expedite these foreclosures and evictions. Yves Smith at Naked Capitalism, who has been all over this story, put up a price list for this “service” from a company called DocX—yes, a price list for forged documents. Talk about your one-stop shopping!

So in other words, a massive fraud was carried out, with the inevitable innocent bystanders getting caught up in the fraud: the guy who got foreclosed and evicted from his home in Florida, even though he didn’t actually have a mortgage, and in fact owned his house free –and clear. The family that was foreclosed and evicted, even though they had a perfect mortgage payment record. Et cetera, depressing et cetera.

Now, the reason this all came to light is not because too many people were getting screwed by the banks or the government or someone with some power saw what was going on and decided to put a stop to it—that would have been nice, to see a shining knight in armor, riding on a white horse.

But that’s not how America works nowadays.

No, alarm bells started going off when the title insurance companies started to refuse to insure the titles.

In every sale, a title insurance company insures that the title is free –and clear —that the prospective buyer is in fact buying a properly vetted house, with its title issues all in order. Title insurance companies stopped providing their service because—of course—they didn’t want to expose themselves to the risk that the chain –of title had been broken, and that the bank had illegally foreclosed on the previous owner.

That’s when things started getting interesting: that’s when the attorneys general of various states started snooping around and making noises (elections are coming up, after all).

The fact that Ally Financial (formerly GMAC), JP Morgan Chase, and now Bank of America have suspended foreclosures signals that this is a serious problem—obviously. Banks that size, with that much exposure to foreclosed properties, don’t suspend foreclosures just because they’re good corporate citizens who want to do the right thing, and who have all their paperwork in strict order—they’re halting their foreclosures for a reason.

The move by the United States Congress last week, to sneak by the Interstate Recognition of Notarizations Act? That was all the banking lobby. They wanted to shove down that law, so that their foreclosure mills’ forged and fraudulent documents would not be scrutinized by out-of-state judges. (The spineless cowards in the Senate carried out their master’s will by a voice vote—so that there would be no registry of who had voted for it, and therefore no accountability.)
And President Obama’s pocket veto of the measure? He had to veto it—if he’d signed it, there would have been political hell to pay, plus it would have been challenged almost immediately, and likely overturned as unconstitutional in short order. (But he didn’t have the gumption to come right out and veto it—he pocket vetoed it.)

As soon as the White House announced the pocket veto—the very next day!—Bank of America halted all foreclosures, nationwide.

Why do you think that happened? Because the banks are in trouble—again. Over the same thing as last time—the damned mortgage-backed securities!

The reason the banks are in the tank again is, if they’ve been foreclosing on people they didn’t have the legal right to foreclose on, then those people have the right to get their houses back. And the people who bought those foreclosed houses from the bank might not actually own the houses they paid for.

And it won’t matter if a particular case—or even most cases—were on the up –and up: It won’t matter if most of the foreclosures and evictions were truly due to the homeowner failing to pay his mortgage. The fraud committed by the foreclosure mills casts enough doubt that, now, all foreclosures come into question. Not only that, all mortgages come into question.

People still haven’t figured out what all this means. But I’ll tell you: if enough mortgage-paying homeowners realize that they may be able to get out of their mortgage loans and keep their houses, scott-free? That’s basically a license to halt payments right now, thank you. That’s basically a license to tell the banks to take a hike.

What are the banks going to do—try to foreclose and then evict you? Show me the paper, Mr. Banker, will be all you need to say.

This is a major, major crisis. The Lehman bankruptcy could be a spring rain compared to this hurricane. And if this isn’t handled right—and handled right quick, in the next couple of weeks at the outside—this crisis could also spell the end of the mortgage business altogether. Of banking altogether. Hell, of civil society. What do you think happens in a country when the citizens realize they don’t need to pay their debts?

–David R. Kotok, Chairman and Chief Investment Officer

Category: 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.

49 Responses to “The Foreclosure Mess”

  1. VennData says:

    Ridiculous. I’ll take the ‘Don’t’ on civil society imploding.

    Kotok, I’ll sell you all the CDS you want on “civil society ended.”

  2. mathman says:

    With millions of cases, mortgages being sliced and diced so that no one knows who owns the note on some houses, and all the rest of the crazy stuff that we’ve documented over the past few weeks here, how exactly is the court going to find the time to adjust each of these (with more to come)? It’s a clusterfuck!

  3. Patrick Neid says:

    “What are the banks going to do—try to foreclose and then evict you? Show me the paper, Mr. Banker, will be all you need to say.”

    This crisis may be many things but defaulting homeowners will not be getting their houses, that you can be sure off. What this will certainly be is another make work attorney program grinding whatever fledgling housing recovery to a halt. Without the foreclosure process there can be no recovery.

  4. Tarkus says:

    Since the big banks also were responsible for the investment trusts set up using the mortgages, they have a problem with the investors in those trusts too. Lots more lawsuits headed their way.

    But its good they can sneak in some record bonuses before the major media focuses enough light on it. They have to reward themselves for keeping the lid on it for so long.

    Maybe FCIC2 will be formed (like CDO2′s).

  5. PrahaPartizan says:

    >>”…The purpose of MERS was to help in the securitization process. Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially where the digitized mortgage notes were sliced and diced and rearranged so as to create the mortgage-backed securities. Think of MERS as Dr. Frankenstein’s operating table, where the beast got put together…”<<

    It sounds like the pari-mutuel tote board at a horse racing track, calculating the odds on the nags as the bets were being placed. Too bad that the whole process didn't finally work pretty much the same way in the end. Perhaps we have yet seen the photo finish (which likely should be of bank executives doin' the perp walk).

  6. chartist says:

    Tarkus has it right…..

    The big problem will be when the pension funds who bought the CMOs realize that the banks knew they were garbage all along.

  7. Winston says:

    Do the people who have been erroneously evicted look prepared to launch a class action suit yet? I am curious if RICO will be used to pursue what appears to be coordinated (and so – organized) criminal activity.

  8. Petey Wheatstraw says:

    “Courts have long had the authority to apply principles of equity, as opposed to common or statutory law, to cases brought before it.”
    ___________________

    The court not only has the authority, it has the responsibility. The courts have failed to act responsibly. The authority to decide cases in equity should be removed, in favor of codifying the division and distribution of assets in question, or by a return to the Constitutional limitations on the courts’ authority to decide cases in equity (the constitutional mandated option that any suit regarding a matter in excess of $20 be decided by jury, was long ago trampled and left by the wayside by the courts. Once they ignored this law, they were free to ignore any they wished).

    7th Amendment:

    “In Suits at common law, where the value in controversy shall exceed twenty dollars, the right of trial by jury shall be preserved, and no fact tried by a jury, shall be otherwise re-examined in any Court of the United States, than according to the rules of the common law.”

    In fact, I’d say the the vast majority of civil cases are decisions regarding equity, not law. The courts are the ultimate manifestation of the capture of our government by special interests, via the various Bar Associations. The courts are a business and an industry. If you doubt tis is true, ask yourself how many billions of dollars per year are spent on litigation in this country? Why do the courts even need, much less require, attorneys in order to adjudicate cases? The Courts exist to enrich their industry. The courts are not beholden to the letter of any law, nor constrained by the oversight from the Executive or Legislative branches.

    In addition, the courts are mandated to decide cases and apply the law and rules of the court in a fashion that will instill confidence in the citizenry regarding the fairness, impartiality, and justice they mete out. Try to find an attorney who specializes in Legal Malpractice. Try to find one who, having received an appropriate degree of law from an accredited School of Law, can practice his or her profession without belonging to the Fraternal Order of the Bar. Try finding a case, absent overwhelming evidence of Judicial wrongdoing (that is to say, a case in which the evidence could only be decided against by an incompetent or a crony), and many times in the presence of damning evidence, where the Judiciary has moved to instill confidence in the citizenry that the common person will get a fair shake from the most powerful and effectual branch of our government.

    Realize that the Courts could and should, if working purely in the interest of the People they “serve,” would have never allowed the bloated, confusing, and unwieldy set of laws (and, in being such, opening the doors to all cases decided by the most liberally construed and personal opinions of the Judges deciding them), that now burden the population.

    Check this link for a related story:

    http://streetwiseprofessor.com/?p=4428

    Need there be more reason to immediately remove a Judge (who, by the way, was and is allowed to continue ruling, in spite of his admitted prejudice, until his accuser/peer, apparently out of fear of retaliation for breaking ranks with his Fraternal Brothers, has decided to retire)?

    The courts are the face and embodiment of corporatist corruption.

  9. Petey Wheatstraw says:

    dit:

    Realize that the Courts could and should, if working purely in the interest of the People they “serve,” would have never allowed the bloated, confusing, loophole-laden, and unwieldy set of laws (creating the condition that any or all cases may be decided by the most liberally construed and personal opinions of the Judges deciding them), that now burden the population.

    Damn, BR, get an edit button.

  10. Petey Wheatstraw says:

    Jeez:

    Edit, not ‘dit’!

  11. nebyarg says:

    Barry, I think intention is part of this judgement. The banks intended to process these mortgages as expeditiously as possible, including, many illegal procedures, which is fraud. The defaulting homeowner didn’t have the intent to default, but many used very poor judgment in buying a house.
    Were I to set the cruise control above the speed limit at 80 mph then I intend to speed, but if I keep up with traffic, which may be five or ten mph above the posted limit, then the intent is more likely to not impede the flow of traffic.
    The banks have definite policies and chain of command and managers are responsible for their employees’ practices. Whereas, I can’t imagine any home buying wanting to go go through this legal life changing ordeal.
    Money crime incarceration facilities prevent the real learning lessons of being raped by fellow inmates. Bankers committed fraud and should be keelhauled or put in penitentiaries with added prohibitions of ever working in the financial sector again.

  12. Arequipa01 says:

    @Marcus Aurelius-

    Might I suggest a nice cup of tea in the morning.

    The link to streetwise is excellent, thank you. Here is Painter’s retirement notice (6 pages-5 of them an article): http://www.futuresmag.com/SiteCollectionDocuments/Guides_PDFs/Judge%20Painter%20Notice%20and%20Order.DCpdf.pdf

    The second para is stunning. Also, the Wendy Gramm referred to in the pdf is former Texas Senator Phil “I’m an agent for Operation Paperclip” Gramm. Surprise! Surprise! Surprise!

  13. dead hobo says:

    I’m getting ready to flip flop on this issue, again. BTW, thanks, BR, for acknowledging the concept of unjust enrichment. Your explanation in the preface was excellent. I won’t say I told you so.

    About the flip flop: I just looked up a REMIC. Its a pass-through entity similar to a partnership in many respects. Its well defined in the IRS Tax Code. Basically, it appears the mortgage is assigned to the REMIC, which may be loosely regarded as a partnership. The REMIC internally slices and dices the various mortgages internally on its books and sells these ‘bookkeeping’ interests to investors in the REMIC. In other words, the mortgages remain whole and the owners of the ‘partnership’ decide among themselves via the ‘partnership agreement’ how to divide profits and losses. Investors in he REMIC have no assigned interests in the underlying mortgages.

    So, if this analysis is correct, the problem reverts to how the mortgage was initially sold and if it was transferred properly. If the transfers were flawed then the problem only involves the identification of the types of transfer problems and the most equitable way to resolve the problem. I doubt putbacks will become a problem.

  14. Tarkus says:

    dead hobo Says: If the transfers were flawed then the problem only involves the identification of the types of transfer problems and the most equitable way to resolve the problem.

    The laws governing the trusts may be more complicated than that, limiting the time allowed for modifications. If the transfers were flawed, then the tax implications/penalties are what the investors will be focused on.

  15. dead hobo says:

    Tarkus Says:
    October 17th, 2010 at 10:31 am

    The laws governing the trusts may be more complicated than that, limiting the time allowed for modifications. If the transfers were flawed, then the tax implications/penalties are what the investors will be focused on.

    reply:
    ————
    Very true. Since the Tax Code is now intimately involved, the problem is knotted up by an order of magnitude. The Kotok piece is flooded with sensational conjecture (as were some of my earlier writings). If, however, the ‘partnership’ was managed properly but the property owned by the ‘partnership’ was transferred in improperly, then it becomes a different flavor of the same title transfer problem. As I said earlier, someone needs to be a property, securitization, tax, and Wall Street attorney to sort this out properly. If, however, you assume the REMICs were otherwise managed properly, then the issues become simplified considerable.

    We need a piece from a securitization or REIT atty to add perspective.

  16. whskyjack says:

    The note is property and the owner should be the last valid owner in that signature string. That person then has responsibilities to those he passed the note on to or made guarantees of payment to.
    So I don’t see the defaulting home owner getting anything out of this, He signed the note and there are many recorded copies of that note on file. It is just a matter of doing the work to determine the rightful owner of the note.
    So , no I don’t think it is the end of the world. But for those who tried to shortcut the process with fraud and perjury it should be.

  17. bobabouey says:

    Reposting this from earlier as it is still applicable.

    Quote: “To repeat: if the chain of title of the note is broken, then the borrower no longer owes any money on the loan.”

    I believe this just isn’t true. If the chain of title is broken, then best case the borrower would still owe payments to the last party on the unbroken chain of title. Then all of the people later in the chain of title have various legal options to claim against that last party in the chain, and ultimately to clean up the broken chain.

    It is a mess, but it just isn’t true that this mess means homeowners, delinquent or not, no longer have to pay their mortgages. Apparantly, the note is a requirement for foreclosure, but it is not the only requirement to establish a legal debt. Borrowers who take that position will doubtfully find the courts to be receptive.

    The people encouraging non-payment of loans where there is a broken chain of title are snake-oil peddlers no different than the legion of rip-off artists still convincing random idiots that a federal income tax isn’t required for a whole variety of stupid theories.

  18. b_thunder says:

    2 ways out: TARP 2.0 or the bank-funded death squads that systematically eliminate/evict non-payers.

  19. Petey Wheatstraw says:

    bobabouey Says:

    “I believe this just isn’t true. If the chain of title is broken, then best case the borrower would still owe payments to the last party on the unbroken chain of title.”
    _____________

    And if that party is not the party trying to foreclose? What if that party no longer exists? What if that party has already been paid in full when the loan was securitized (and would incriminate themselves by asserting any relationship to the loan or title to the underling asset, whatsoever)? What if two parties present conflicting documentation, of dubious validity (of course), claiming a lien against the property? Should the borrower pay half or the full amount to both?

    Like it, or not, outside strict proof of claims to the contrary, the party in possession of the asset has sole legal standing in these matters (why else would the banks be changing the locks on doors without court approval? Why would they have even considered suspending ANY foreclosure action?). There is no counter-party.

  20. Shasta says:

    I’m no lawyer but I just can’t agree with the argument of “principle of equity” in the preface as it relates to who has “actionable standing” in a foreclosure action. Just doesn’t make any sense. If a foreclosure action has simply been accepted on its face by the court, can the court apply principle of equity to the defendants challenge (show me the paper, motherfucker) to actionable standing? I seriously doubt it.

    I suspect case law is very rich in a realm where the rule of law goes back at least two centuries. And I also suspect that in those cases found to have a broken title chain challenged by the defendant, those cases have simply been thrown out of court (already happening) or a ruling that establishes that the last link in the chain prior to when the chain was broken has actionable standing.

    But think about what such a ruling would mean in the context of MBS….it would effectively invalidate the entire MBS ponzi universe and it all comes crashing down back on the securitizer.

    ~~~

    BR: You seem to have misunderstood the basic principle.

    Equity wont get you standing — it exists to allow judges to avoid obviously absurd outcomes — a free house for a defaulter, or a free pass for not doing their actual work legally, correctly and accurately for the banks.

  21. mark says:

    As soon as the White House announced the pocket veto—the very next day!—Bank of America halted all foreclosures, nationwide.

    That the banks are aware of major problems that they are trying to obfuscate is supported in a post by a purported MBS expert at NakedCapitalism (http://www.nakedcapitalism.com/2010/10/guest-post-so-why-did-the-mortgage-servicers-use-robo-signers.html)

    Having witnessed a servicer and its counsel lie repeatedly in a court where I was testifying, I can say with confidence that the incorrect statements they made were not mistakes. I wondered why they spent so much money to dispute our claim that the form of the note and mortgage were not in the proper form. If the servicer had just made a technical error, why didn’t they just go correct it and re-submit the foreclosure in the name of the party actually holding title (rather than the people they wanted to be holding the title)?

    Yves Smith has made the point that it will be impossible for Congress to fix the banks apparent very real problems with new federal laws since real estate is a 50 state issue, the trusts are governed by New York state law and should congress try there will be serious push back from the states both politically and constitutionally.

    I wonder if anyone knowledgeable here can comment on this.

  22. VP says:

    I have become so cynical with the way things work here now that I am thinking..”Is it possible that this is being done to actually benefit the banks and the politicians in bed with them in any way? —– that is..until they sneak in something through congress to get around this”
    1) Foreclosures are being stopped –> No need recognize the losses on their balance sheets
    2) House prices will not find their “true” level..so all the borderline cases will continue paying the mortgage.
    3) Since house prices stop falling, it should make some people less anxious before they vote in the elections

    Is it possible that all the really bad loans have been foreclosed on and that the banks are trying to squeeze those last drops blood possible?

  23. Milt says:

    Barry writes, “An example of a possible fix in a full blown litigation might be for the court to order the mortgage modified to the current equity value of the home, so that it a) punishes the lenders who failed to do their proper legal work on the documents, but b) does not give a home to a defaulted homeowner for free. ”

    What legal right does a court have to “… to order the mortgage modified to the current equity value of the home”? I didn’t know a court can break the terms of a contract. Only the lender can change this key part of a contract. Hey, but maybe I’m wrong, and a court can decide that the same actions are worth a “punishment” of $50,000 to $1,000,000 depending on the zip code of the property.

    How is it fair or equitable in our society, to all the neighbors who are paying their mortgage? Who fully paid for their house? To the renters in the apartment a couple blocks away who didn’t buy a house because they thought the selling prices 8 years ago was way too high. To those that decided they were not real estate experts and were not going to get caught up in the house flipping mania. I thought something like over 90% of houses, condos, apartments, etc., are not any phase of mortgage non-payment to foreclosure cycle; so how is it fair or equitable in a society for a court to reward losers in a free market economy by reducing the amount of money they owe?

    If a court is going to “… to order the mortgage modified to the current equity value of the home” then the court is also fixing the deed of title issues – it is fixing the chain of signatures. And if it is doing this, then there is no side stepping the legal due process that the fraudsters and Florida courts have been committing. So Barry’s solution requires administering US laws properly – which will take more time than the fraudsters wanted to spend on their business and legal obligations. And that is all this mess is about: banks, mortgage processing companies, judges and courts willing to commit fraud for expediency. What should happen is that these actions should be prosecuted and not some sort punishment via principle reductions.

    People who can’t pay their mortgage should have already moved into an apartment or smaller house or to house in lower priced neighborhood. In a free market capitalist economy if you mess-up, if the market turns against your trade, your investment, your business, if the factory is closed and moved to Mexico or China – well tough. You suffer the economic consequences. This notion of principle reduction (and of course it must include all the interest monies not paid…its all one big reduction in what is owed) is another symptom of Americans wanting the easy solution like the Greenspan put, and now the Bernanke put.

  24. bobabouey says:

    Petey,

    I agree that the lack of a clean title is a foreclosure mess. I was pointing out that the inability to foreclose because the title is not clean does not mean the mortgagor is relieved from the legal obligation to pay the loan. At worst, the loan is due to the last party with the clean, unbroken title to the note, but in addition, the evidence of the transfer of the right to the payment – even if not the actual legal note holder – can be established through other documents, MERS, etc.

    There are people out there telling mortgagors to stop paying their mortgage unless the bank can establish clean title. That is a breach of contract, and a recipe for trouble for the mortgagor, even if in the short term (until the chain of title is cleaned up) they can’t be foreclosed on.

  25. rlux says:

    Back in 2006 I was having lots of conversations with friends about how crazy the RE market was, how bad the new mortgage products were, and why sitting the whole thing out was a good idea.

    Looking back now I wonder if I wasn’t the Greater Fool. [BEGIN RANT] The very idea that all those fools could potentially walk away with a free house or a greatly reduced mortgage obligation just makes me see red. I played it safe, did the financially prudent thing, and now I feel like I’m being punished for it. [END RANT]

    OK rant over, thanks for letting me vent.

    I rent a very nice condo today from an owner who hasn’t been able to sell it for the price they want. Luckily for me, the owner bought pre-bubble so I don’t think any of this mess will wash up on us, but if they refinanced, who knows…..

  26. Petey Wheatstraw says:

    Milt Says:

    “What legal right does a court have to “… to order the mortgage modified to the current equity value of the home”? I didn’t know a court can break the terms of a contract.”
    ___________

    In many cases, it can be argued that the contract has already been broken, and is null and void.

    “How is it fair or equitable in our society, to all the neighbors who are paying their mortgage? Who fully paid for their house?”
    ___________

    These people — the neighbors — aren’t party to the contracts in dispute. If they are paying their mortgage and not paying attention, it can be argued that they, indeed, are paying it to the wrong party: a party that has no provable legal interest in the property.

    “People who can’t pay their mortgage should have already moved into an apartment or smaller house or to house in lower priced neighborhood. In a free market capitalist economy if you mess-up, if the market turns against your trade, your investment, your business, if the factory is closed and moved to Mexico or China – well tough.”
    ___________

    People who can’t pay their mortgage should be evicted from the property by due process, initiated by a party with standing to do so. Period. Where they go after that is their problem.

    In a free market economy, if, in your hurry to “profit” by defrauding investors of perhaps trillions of dollars, you “accidentally” sever your ability to collect on the front end of the process, and instead end up screwing yourself six ways to Sunday, but good, that’s your own damned problem.

  27. bobabouey says:

    Petey says:

    “In many cases, it can be argued that the contract has already been broken, and is null and void.”

    Based on what? The mortgage permits the note to be assigned, the loan is documented by various documents, the fact that there are holes in the assignment process does not affect the contractual obligation. Foreclosures have a higher standard, that is a specific problem that has nothing to do with whether a valid debt has been established, in writing, as required by the statute of frauds.

  28. Thor says:

    “The very idea that all those fools could potentially walk away with a free house or a greatly reduced mortgage obligation just makes me see red.”

    Why the focus on this? Do you think the majority of people losing their homes today are doing to because they bought something they could never afford in the first place? Do you have any statistics to back this up?

    I would argue that the majority of people losing their homes today are regular Joe’s like you and I. People who worked hard, played by the rules, but because they happened to the banking or construction industry, might have lost their jobs through no fault of their own, and are now being foreclosed upon.

    All this talk about “victims” or people getting something for nothing is beside the point. The Banks are responsible for this mess, not the former home owners who are now taking advantage of the chaos the banks created.

    Oh wait, I see we’re going to try to blame Fanny and Freddy for this now too. . . .

  29. bergsten says:

    Neither the time nor place to start arguing the merits of the American Legal System, but when I was a kid, my father who (by definition) had far more experience with the legal system (as an attorney, not a “participant”) than I. told me that America has two courts, the court of juris prudence (laws and precedent), and the court of equity (fairness).

    He said that once the court of equity was established, the legal system was doomed, as there was no longer even a pretense at objectivity, and any judge could pretty much rule any way he/she liked.

    This, along with other fine American contributions to law, such as conspiracy-to-commit and precedent (neither of which seem to exist in Great Britain) make the legal system something to stay far away from.

    Or, to quote a sign from a Pogo comic strip from the late 50′s, “Justice for All — See Judge for rates.”

  30. tracycoyle says:

    Chief Justice Shirley S. Abrahamson
    Wisconsin Supreme Court
    Madison, WI 53701-1688

    Chief Justice Abrahamson,

    Over the last 10 years I worked for a Madison attorney helping people deal with foreclosure and bankruptcy. During that time we saw many cases of debtors that had defaulted on loans with no hope of being able to continue to make payments. We also saw many examples of mortgage lenders that had lost payments, failed to accurately report payments and in one or two cases, foreclosed despite having received the payments. In Federal Bankruptcy Court, a lender when confronted with illegal accounting of bankruptcy payments (misapplication of funds) asked, “do you expect us to change our procedures just because someone is in bankruptcy?” to which the Court responded, “Yes.” Increasingly over the last five years, we began noticing that lenders were foreclosing that were not the original mortgage lender, in many cases there were no assignments of mortgages and even more troubling, notes were not included in the documentation, either because the lender was NOT the note holder or it had become ‘lost’.

    In my personal life, situations resulted in the default on our mortgage. Our original mortgage lender was Indymac Bank. It failed in 2008 and One West Bank purchased many of its assets (according to press reports). One West Bank’s foreclosure documents did not include the original note to Indymac Bank. When we brought up this deficiency with the court at our hearing (10CV00820), Dane County Court Judge C. William Foust, Branch 14, indicated the lack of the note was a technicality and that he was satisfied with the affidavit of default provided by the lender. The lender did not address the lack of note. We understand the default judgment now replaces the missing note.

    In light of the recent actions by the State Attorney General, I am asking the Supreme Court to give guidance to the Municipal Courts in the state to NOT just accept foreclosure documentation that is ‘technically deficient’ in the interest of speeding up the process. We brought the issue to the attention of the Court in our case and it was ignored. Hundreds if not thousands of Wisconsin homeowners are facing foreclosure and are unable to afford legal help to defend themselves.

    False affidavits, lost notes and historically bad accounting are being ignored by courts in the interest of ‘processing’ hundreds of thousands of foreclosures throughout the country and in Wisconsin. We are asking you and the Supreme Court of Wisconsin to maintain the integrity of the court system for all parties – not just those lenders hoping to take advantage of distraught homeowners to sweep all the bad acts under the foreclosure rug.

    In my case, the issue might soon be over, but lenders who have foreclosed and received judgment are also failing to complete the process. We have seen lenders foreclose, homeowners leave the home and then the lender fail to hold a sheriff’s sale. The lender leaves the homeowner to maintain the empty home indefinitely, including municipal fines for failure to mow or shovel snow, insurance and minimal utilities.

    The Courts expect homeowners to abide by the terms of their mortgages, it is time for the court system to make sure the lenders abide by the law.

    Sincerely,
    Tracy C. Coyle

    PS: While your preface has a nice ring to it – giving the house to the lender that is foreclosing without a note is not being equitable, it is giving a house to someone that can’t prove it belongs to them because of the default. It MIGHT belong to the original note holder, as a matter of fact, if the original note holder shows up next year, they have an enforceable claim against …everyone, including the hapless former homeowner….

  31. Petey Wheatstraw says:

    bobabouey Says:

    “Based on what? The mortgage permits the note to be assigned, the loan is documented by various documents, the fact that there are holes in the assignment process does not affect the contractual obligation.”
    ____________

    Based on the chain of title being broken during the securitization process. There is no doubt that there’s a loan. If you can unsecuritize it (and you can — but at enormous, bankrupting cost to the banks) and disentangle the assignments of the loan at each instance it was illegally conveyed to a new owner, that loan can then be collected BY THE PARTY HAT CAN PROVE IT HOLDS TITLE (and thus, the debt owed on) to the property. It’s my contention that any party having proven it owns the title and the loan would open itself to huge civil and criminal penalties.

    If the holes in the assignment process do not affect the contractual obligation, why have the banks stopped foreclosing? The answer is that they can no longer show that they are entitled to collect, based on the documents they themselves created and proffered to the court.

  32. Geoffrey says:

    Barry,

    Thanks for your objective commentary on the legal points involved with this unfolding area. The writer of the text is Gonzalo Lira, posted on his blog Tuesday, the 12th.

    Entire text is at http://gonzalolira.blogspot.com/2010/10/second-leg-down-of-americas-death.html

    Lira’s been getting more exposure in recent weeks on other sites.

  33. Eric says:

    Barry, a quick couple of things I think you are over looking when you say the court can make the bank write down the principal of the loan. I think you are wrong. Why? Because if the bank can’t show standing to begin with, if they have no standing they can not modify the loan they don’t own.

    Next, what if your defaulted loan was in a Pool of mortgages that hit a certain percentage of losses and triggered payment of a credit default swap. The investor or investors that assigned your loan to them after the default may have been made whole or nearly whole with the insurance they had taken out to cover losses. Not so simple is it. Technically according to Lira all tranches owned the loan simultaneously, and then assigning after default? How do you determine standing to foreclose from that.

    Secondly, I agree the courts are equipped to deal with this. No one will get a free house but the courts still have a remedy and the person still owes the debt to someone. The court will simply invalidate the ability of the mortgage to be used for foreclosure. Essentially the mortgage will be stripped off of the asset, the house. The lender or investor that can actually show standing can sue for a separate money judgement if someone refuses to pay the now unsecured mortgage/loan. So everyone has remedies but we don’t need the court applying a solution that would over reach their authority as you suggest above to be fair to the banks.

    In some cases people will end up with a house free and clear but will still owe the debt when the real owner of the notes presents the note to the court. It will just have been stripped off of the house. The real owner of the note can sue for a money judgement. However, in some states like Texas the owner of the note will have a hard time collecting because under Texas state law you can not lien someones house due to a homestead exemption nor can holder of a judgement garnish wages.

    Let’s face it if the banks screwed up they don’t get a pass either. They need to prove the loan was properly assigned to them after it went through the MERS sausage maker. Banks are not above the law. So I agree with Gonzalo Lira, some will have free houses.

    Just some food for thought.

    Regards,
    Eric

  34. Eric

    We are agreed

    Standing is the first issue

    If a specific bank cannot show standing, SOMEONE must have it.
    Eventually, they will figure out who has standing to bring an action.

    I was referring to a bank – with standing — but has other bad paperwork, and a defaulted homeowner

  35. favjr says:

    Well, you might have standing, but you might not care if you have already passed on the risk to someone else.

    You know, I don’t think I would mind some outright investment failure here. There should be risk in trying to securitize everything and having it blow up, and a lesson needs to be learned than creating more complex financial products is a risky business. The financial industry still hasn’t learned that lesson yet.

    I’m just afraid this will lead to another bank bailout in one way or another. I would much rather “bail out” random delinquent homeowners by letting them stay put than banks who chose to get involved with risky securities. Less of a moral hazard.

    I am really curious as to the short term effects of this, though. Foreclosures typically have a deflationary effect, because debt is being destroyed. But if they are slowed down, does this mean less deflation in the near term? And is there any correlation with the current growing asset bubbles? I suppose it may depend on how the banks account for the problem mortgages on their books.

  36. Jan Rogozinski says:

    You guys talking about “equity courts” are all smoking dope. There are no equity courts in the USA and never have been.

    As a legal historian, I know what I am talking about. There have been other countries with equity courts, there have been none in the USA. American courts are very rigid. One must say the right words in the right order. It’s like the Roman Catholic doctrine of transubstantiation. If the priest says “Scooby, scabby, do do” instead of “This is my body,” the bread and wine stay bread and wine.

    What you are saying is this. A case comes before a judge rules, “the law says a shall do x in order to get y. 100% of the evidence proves that in this case a did not do x. Nevertheless. I as judge will still give a what he wants, which is y. I have the right to say we shall ignore the text of the law and do the opposite of what the law commands, because to obey the plain meaning of the law would not be a nice and lovely thing to do.”

    You really think that decision would stand up on appeal? Then you really are stoned on something.

  37. Winston Munn says:

    It only goes to show that if it were not for the triplets of anti-capitalism, reason, common sense, and the rule of law, the Efficient Market Hypothesis would work perfectly damn near every time.

    Thank God the productive of the world did not let us dive off a cliff in order to prove some arcane illusion of mores. We are made of stearner stuff – as well as lehman stuff, Bank of America stuff, Goldman stuff, …

  38. beaufou says:

    Thor @ 1.19

    thank you, exactly.

  39. killben says:

    While it may be fair to say that banks did loan out the money to the foreclosed home owner, why not penalise them till they produce the note.

    Let government foreclose the house and take over the ownership of the house. Auction the homes and keep the money in an escrow account. Let the bank show the note and take the cash else they lose it. Use it for government spending .. that way government can spend without increasing its deficit and banks get the richly deserved screw and home owner loses his/her home. All just and fair.

  40. [...] “This crisis could spell the end of the mortgage business [...]

  41. All that shows that plain people aren’t secured in such deals and the mortgage isn’t an exception.

  42. Steve Hamlin says:

    @Jan Rogozinski: Incorrect. there are still some separate equity courts in the U.S., although not many. It doesn’t matter in any event, because the legal concept of an “equitable remedy” is ingrained in the U.S. traditional court system (courts of laws).

    “In general, a litigant cannot obtain equitable relief unless there is “no adequate remedy at law”; that is, a court will not grant an injunction unless monetary damages are an insufficient remedy for the injury in question…The federal courts and most state courts have merged law and equity in the courts of general jurisdiction, such as county courts. However, the substantive distinction between law and equity has retained its old vitality.”

    - http://en.wikipedia.org/wiki/Equity_%28law%29#United_States

  43. boveri says:

    Kotok is just another alarmist looking for a big problem to make bigger.

  44. WFTA says:

    Interesting dynamic working in a number of the comments here: Individuals have a moral imperative to honor a contract even unto bankruptcy. Corporations can default on an obligation and it is merely a financial decision.

    Should a borrower continue to make payments when it is not clear that when 30 years of payments have been made he will have clear title to the property?

  45. [...] October 18, 2010 by Attain Capital Leave a Comment Good post on the Big Picture blog today covering the new mess we (USA) find ourselves in with a lack of proper documentation for most foreclosures and indeed mortgages. Read the post here:  http://www.ritholtz.com/blog/2010/10/the-foreclosure-mess/ [...]

  46. ToNYC says:

    Please consider immediately ceaseless using the phrase “free house”. That the only free stuff on the planet is the Sun should be a necessary condition to entering High School. There will be at least one claimant to the debt that remains uncured; that is for sure. Where is our Moliere or Voltaire in the comedy of errors?

  47. Old Geezer Pilot says:

    If you don’t have standing, you don’t have the right to sue for foreclosure. You can sue for damages, but that is another story.

    REMICs have been around for decades. Fannie and Freddie were two examples of well-run REMICs. But, they never tranched. Therefore, the investors in those REMICs had a direct line to a share of the IOUs backing them up. There was money coming back to the investors each month, because mortgages were always terminating whether through resales or payoffs. Even if you held a 7 year Fannie REMIC, chances were you would be redeemed well before that.

    As I see it, the real issue here is the tranching. While it makes sense statistically, it really does remove the investor from the IOU. Before tranching, all investors shared in the outcome of a specific, named and titled, pool of IOUs.

  48. sue806 says:

    Here’s a common sense and logical approach, all foreclosures are indeed halted until:

    1- It is determined whether negative equity exist or not, because if there is NO negative equity the homeowner had the option to sell the property maybe earning a profit and it is what they agreed to, capitalism. If the chain of title is broken and there is equity involved, the homeowner will lose his home because he didn’t pay the mortgage as agreed but the investor pays a fine equal to the “savings” in unrecorded filing fees (to the states/counties) correcting the chain of title. The homeowner is not financially compensated since he/she was not financially harmed, injured or affected, THE REASON FOR THE LAW.

    2- But if there is negative equity, a uniform fair and reasonable modification must be offered that addresses the negative equity, EVERY negative equity homeowner must be offered the same modification with the same perks/rewards and penalties, there are no exceptions for differences in income, assets, ratio’s, hardships or type of loan, THE IMPLIED TERMS OF THE AGREED TO LOAN CHANGED when the homeowner’s option of selling the property was taken away and the investor will take an automatic loss because of the negative equity. This is not a new concept but one that over 25% of negative equity homeowners have received already to avoid the investor’s financial loss with negative equity foreclosures. Insisting on one modification program for every negative equity homeowner is fair and playing by the rules (FAIR AND HONEST DEALINGS). The necessity of having one program eliminates the fraudulent, deceptive and unfair business practices being utilized to enhance the financial industry profits with the disparity in loan modifications issued or denied based on factors outside of the negative equity itself. The investor will still be responsible for the fine equaling the savings in unrecorded filings fees to correct the chain of title. Again, the homeowner is not compensated for the broken chain of title but is INCENTIZED with a negative equity modification to remain a negative equity homeowner when it is financially in their best interest to default based on the precedent set by the financial industry themselves in changing the rules and standard operating procedures of foreclosing to modifying.

    3- If the chain of title was broken and the home was resold after a foreclosure occurred due to a true error of – the homeowner didn’t owe bank #1 the mortgage payment or there wasn’t a mortgage on the property or the homeowner was paying his mortgage or if the homeowner was paying a lower modified payment that was agreed to or the homeowner can prove payments were made and were either returned or credited to another account, the investor/bank pays a fine equal to UP TO two times the current value of the home to the original owner that was foreclosed on. The award must be applied to the unrecorded filing fees correcting the title, any outstanding mortgages and deficiency amount including tax liabilities resulting from the foreclosure with the balance going to the original owner as compensation, they were financially harmed, the reason for the law.

    4- If the chain of title was broken and a foreclosure occurred from NOT PAYING but the homeowner was still in residence, they have the option of accepting the ImNotLeaving Streamlined Uniform Modification System or vacating the property within a reasonable length of time, 60 days max without fear of any deficiency judgment or tax consequences, if the home was left in good condition. (They weren’t financially harmed because of the broken chain of title but they were financially harmed from negative equity and a modification was offered to compensate them for the negative equity, they choice to accept or decline)

    I have sent the ImNotLeaving Uniform Modification System proposal/solution to the government and financial industry addressing negative equity and the chain of title issues hoping to avoid this “dilemma” but was advised that while I raised some interesting points, they will decide whether it is the best solution for them at this time. For a copy of my proposal please feel free to email me at Sue806@aol.com