Lawyers representing delinquent homeowners have been shouting for years about documentation problems in residential mortgages. Now that their complaints have gained traction with investors, attorneys general and some state court officials, the question of consequences looms large.
Is the banks’ sloppy paperwork a matter of simple technicalities that are relatively easy to cure, as the banks contend? Or are there more far-reaching consequences for banks and the institutions that bought mortgage-backed securities during the mania?
Oddly enough, the answer to both questions may be yes.
According to real estate lawyers, most banks that have gotten into trouble because they didn’t produce proper proof of ownership in foreclosure proceedings can probably cure these deficiencies. But doing so will be costly and time-consuming, requiring banks to comb through every mortgage assignment and secure proper signatures at each step of the way — and it surely will take much longer than a few weeks, as banks have contended.
Once this has been done appropriately (not by robo-signers, mind you) the missing links in the banks’ chain of ownership can be considered complete and individual foreclosures can proceed legally.
None of this will be easy, however. And it will be especially challenging when one or more of the parties in the chain has gone bankrupt or been acquired, as is the case with so many participants in the mortgage business.
Still, addressing all of these lapses is possible, according to Joshua Stein, a real estate lawyer in New York. “If there are missing links in your chain of title, you go back to your transferor and get the documents you need,” he said in an interview last week. “If the transferor doesn’t exist any more, there are ways to deal with it, though it’s not necessarily easy or cheap. Ultimately, you can go to the judge in the foreclosure action and say: ‘I think I bought this loan but there is one thing missing. Look at the evidence — you should overlook this gap because I am the rightful owner.’ ”
Such an unwieldy process will make it more expensive for banks to overhaul their loan servicing operations to address myriad concerns from judges and regulators, but analysts say it can be done.
ON the other hand, resolving paperwork woes in the world of mortgage-backed securities may be trickier. Experts say that any parties involved in the creation, sale and oversight of the trusts holding the securities may be held responsible for any failings — and if the rules weren’t followed, investors may be able to sue the sponsors to recover their original investments.
Mind you, the market for mortgage-backed securities is huge — some $1.4 trillion of private-label residential mortgage securities were outstanding at the end of June, according to the Securities Industry and Financial Markets Association.
Certainly no one believes that all of these securities have documentation flaws. But if even a small fraction do, that would still amount to a lot of cabbage.
Big investors are already rattling the cage on the issue of inadequate loan documentation. Last week, investors in mortgage securities issued by Countrywide, including the Federal Reserve Bank of New York, sent a letter to Bank of America (which took over Countrywide in 2008) demanding that the bank buy back billions of dollars worth of mortgages that were bundled into the securities. The investors contend that the bank did not sufficiently vet documents relating to loans in these pools.
The letter stated, for example, that Bank of America failed to demand that entities selling loans into the pool “cure deficiencies in mortgage records when deficient loan files and lien records are discovered.” Bank of America has rejected the investors’ argument and said that it would fight their demand to buy back loans.
Mortgage securities, like other instruments that have generated large losses for investors during the crisis, have extremely complex structures. Technically known as Real Estate Mortgage Investment Conduits, or Remics, these instruments provide investors with favorable tax treatment on the income generated by the loans.
When investors — like the New York Fed — contend that strict rules governing these structures aren’t met, they can try to force a company like Bank of America to buy them back.
Which brings us back to the sloppy paperwork that lawyers for delinquent borrowers have uncovered: some of the dubious documentation may undermine the security into which the loans were bundled.
For example, the common practice of transferring a promissory note underlying a property to a trust without identifying it, known as an assignment in blank, may run afoul of rules governing the structure of the security.
“The danger here is that the note would not be considered a qualified mortgage,” said Robert Willens, an authority on tax law, “an obligation which is principally secured by an interest in real property and which is transferred to the Remic on the start-up day.” If, within three months, substantially all the assets of the entity do not consist of qualified mortgages and permitted investments, “the entity would not constitute,” he said.
If such failures increase taxes for investors in the trusts, Mr. Willens said, the courts will have to adjudicate the inevitable conflicts that arise.
What if a loan originator failed to provide documentation substantiating that what’s known as a “true sale” actually occurred when mortgages were transferred into trusts — documentation that is supposed to be provided no longer than 90 days after a trust is closed? Well, in that situation, a true sale may not have legally happened, and that doesn’t appear to be a problem that can be smoothed over by revisiting and revamping the paperwork.
“The issue of bad assignment has many implications,” said Christopher Whalen, editor of the Institutional Risk Analyst. “It does question whether the investor is secured by collateral.”
In other words, were the loans legally transferred into the trust, and, if not, do the trusts lack collateral for investors to claim?
For example, according to a court filing last year by the Florida Bankers Association, it was routine practice among its members to destroy the original note underlying a property when it was converted to an electronic file. This was done “to avoid confusion,” the association said.
But because most securitizations state that a complete loan file must contain the original note, some trust experts wonder whether an electronic image would satisfy that requirement.
All of this suggests that while a paperwork cure may eventually exist for foreclosures, higher hurdles exist when it comes to remedying flaws in mortgage-backed securities. The only way to wrestle with the latter, some analysts say, is in a courtroom.
“The whole essence of this crisis is fraud and unless we restore the rule of law and transparency of disclosure, we are not going to fix this,” said Laurence J. Kotlikoff, an economics professor at Boston University.
By Gretchen Morgenson