Guest Author: William K. Black is Associate professor of Economics at University of Missouri, Kansas City. From 1990-1994 Prof. Black was Senior Deputy Chief Counsel, Office of Thrift Supervision, which was formed in 1989 to supervise the thrift industry following the Saving & Loan crisis. Full bio here.
This article appeared originally at New Economic Perspectives
Follow up:Those consequences are invariably negative. The narrative is the government intended to achieve some goal, e.g., help the poor, and ended up harming the poor. Four counter narratives virtually never appear in these tracts. Theoclassical economists rarely mention: 1. Any governmental program that succeeds in its aims 2. Any governmental program that has unanticipated, positive consequences 3. Any private action that has negative unanticipated consequences 4. Any private action that has negative, intended consequences
These two successful government programs (public recordation of land titles and transfers and public land surveys) achieved their intended goals. They made it far easier to pledge real property, which made real property more valuable. Public recordation greatly reduced the risk of fraudulent pledges. Reducing the risk of fraudulent pledges makes lenders more willing to lend and reduces the interest rates on secured lending. Reduced interest rates mean a lower “hurdle” rate for investment, which means that more productive investments will occur and economic growth will increase.
Public recordation in the U.S. became even more effective in spurring growth and efficiency with the development of Article 9 of the Uniform Commercial Code (UCC). Article 9 set out to make it far easier for lenders to access public records of liens by dramatically increasing the degree of uniformity in how and where such records would be kept. Article 9 was not only a governmental program that achieved its aim – it was the brainchild of an academic (Yale Law School's Professor Grant Gilmore). Article 9 further reduced the risk of fraudulent pledges and greatly increased efficiency. Business, particularly lenders, strongly supported its adoption.
MERS (Mortgage Electronic Registration Systems) sought to privatize key aspects of the public title system. The primary purpose was to avoid recordation fees when interests in real property were assigned or transferred. MERS' founders read like a who's who of the entities who caused the recent financial crisis, so some scholars view its creation as an example of a private sector action intended to harm the public. This column assumes that MERS' harms were, originally, unintended. It focuses on the insanity – from the standpoint of honest lenders and investors – of MERS' devastation of a public system of recordation that had served business, particularly lenders and investors, brilliantly.
MERS' problems are legion, but they are also inherent in its structure. This column addresses only one aspect of its “agency” problem. MERS is set up in a bizarre fashion designed to minimize costs. It has only a trivial number of real employees. It has no ability to check its members' initial or continuing quality or integrity. MERS appoints its members' personnel as MERS officers and exercises no meaningful oversight over their actions.
As I have explained in prior articles, MERS' members have endemic, severe problems with mortgage documentation. They originated, purchased, or agreed to service loans and collateralized debt obligations (CDOs) without the underlying mortgage note. Fraud begets fraud. The exceptional incidence of underlying mortgage origination fraud led to widespread failure to prepare and maintain proper documentation – and that was before the mortgage originators failed. When the mortgage originators failed, as they did by the hundreds, mortgage documents were frequently thrown away. Mortgage documentation became particularly defective because originators could sell mortgages without the purchaser even checking whether the seller was delivering the original note.
The secondary market in nonprime mortgages operated under the financial version of “don't ask; don't tell.” The incidence of fraud and defective documentation in nonprime loans was so large that the purchaser faced an inescapable dilemma. If it did competent underwriting it would detect widespread fraud and missing notes and document that it knew that the nonprime loan portfolio it was purchasing (and then reselling them as the collateral for CDOs) was fraudulent. Documenting that one is selling CDOs one knows to be backed by fraudulent loans that often lacked the underlying note is an excellent strategy for going to prison and being sued by every CDO purchaser. The alternative was not to do any meaningful underwriting when purchasing nonprime loans. The no meaningful underwriting alternative, however, maximized the already perverse incentives to originate and sell fraudulent loans lacking essential documentation.
MERS' members, therefore, had overwhelming incentives to engage in foreclosure fraud. The loans they were seeking to foreclose on often lacked essential documentation and were induced by defrauding the borrower. They had no legal right to foreclose, but that result was unacceptable to the senior officers controlling the loan servicers. They insisted on results, and did not monitor compliance with the law. The result was tens of thousands of felonies – monthly – by some of the largest financial institutions in the world. Filing false affidavits became business as usual. No one senior in the Justice Department or administration appears to be seriously upset about this. These felonies were committed by, or at the direction of, MERS “officers” – and MERS does not appear to be seriously upset about fraudulently foreclosing on the homes of tens of thousands of Americans. I study fraud by elites, and even I am stunned by the frequency and nature of the frauds and felonies and the lack of prosecutions and the overall blasé attitude by CEOs to the fraud and felonies.
The Mortgage Mess by Yves Smith
We Must Prosecute Fraud by Washington's Blog
How Can the Architects of Crisis Investigate It? by William K. Black
Elizabeth Duke on Foreclosures and Documentation Issues by John Lounsbury
The Alchemy of Securitization by John Lounsbury