June 17th, 2011
The mortgage industry defenders are looking more and more like fools or liars.
Last year, a case called Kent v. Countrywide created a firestorm because both Bank of America’s attorney (who was admittedly just a typical foreclosure mill type) and a senior executive from Countrywide’s servicing unit said that Countrywide as a matter of business practice retained mortgage notes. That was the wrong thing to say in court. From a November post: Follow up:
We’ve had a series of posts (see here, here, and here) on the judge’s decision in a case called Kemp c. Countrywide, which provided what appeared to be the first official confirmation of what we’ve long suspected and described on this blog: that as of a certain point in time post 2002, mortgage originators and sponsors simply quit conveying mortgage notes (the borrower IOUs) through a chain of intermediary owners to securitization trusts, as stipulted in the pooling and servicing agreements, the contracts that governed these deals. We say “appeared to be” because Bank of America’s attorney promptly issued a denial, effectively saying that the employee whose testimony the judge cited in his decision, one Linda DeMartini, a team leader in the bank’s mortgage- litigation management division. didn’t know what she was talking about. As we discussed, this seems pretty peculiar, since she was put on the stand precisely because she was deemed to be knowledgeable about Countrywide’s practices….
If true, this has very serious implications. As we’ve indicated, it means that residential mortgage backed securties are not secured by real estate, or as Adam Levitin put it, they are “non mortgage backed securities….With the ramifications so serious, expect industry denials to continue apace until the evidence becomes overwhelming.
That time has arrived. Abigail Field did a small scale study in two New York counties and found none of the Countrywide originated loans had been conveyed properly, and also found that a majority of the non-Countrywide originated loans were similarly not transferred as stipulated, raising overwhelming obstacles to foreclosure if the law were obeyed. Wonder why document fabrication and forgeries have become common? Look no further.
We have been advised that the New York State attorney general Eric Schneiderman was looking into the same issues as Field, namely, that of whether notes had been conveyed correctly by Countrywide and others. I don’t expect the results to line up with the industry’s PR.
The stakes here are high. Field had concluded, ” And if Countrywide’s mortgage securitizations systematically failed as it appears they did, Bank of America’s potential liability dwarfs its shareholder equity.”
The efforts of the banks to sweep this massive fraud under the rug look to be coming to an end. Independent of Schneiderman’s efforts, there is simply too much evidence piling up at courthouses all over the nation to deny that this massive violation of industry contracts and well settled practice took place. And it also looks likely to prove, as we have said repeatedly, that the eight week “multi agency” Federal Foreclosure Task Force review last year was a cover-up.
New York Attorney General Eric Schneiderman has targeted Bank of America, the biggest U.S. bank by assets, in a new probe that questions the validity of potentially thousands of mortgage securities and their associated foreclosures….
The inquiry could prove explosive: Wall Street’s great mortgage securitization machine took millions of home loans and bundled them into securities for sale to investors. If the legal steps that guide securitization — like taking mortgage documents from one party to another, a critical step under New York law — were not undertaken, then the investors who bought the bundled loans could force the companies to buy them back, compelling them to eat enormous losses.
It isn’t clear what the remedy might be. I’ve heard a number of legal arguments, and although this summary is too approximate to make an attorney happy, one interpretation is that the RMBS investors have what is tantamount to unsecured creditor paper: that the “well we treated it as if the transfer happened even though it didn’t” is adequate for the ongoing payments, but far short of the degree of perfection of rights needed to foreclose. And remedies at equity won’t work, since as Adam Levitin point out, you need to have clean hands for remedies at equity to succeed, and they are sorely absent on the bank side.
The other possibility is that if no notes made it to the trust in the stipulated time frame (typically within 90 days of closing), under New York law, which governs the overwhelming majority of trusts, you have contract formation failure. I suspect lots of people are very loath to turn over that rock because it leads to the mother of all litigation. Back to HuffPo:
Schneiderman’s inquiry also raises questions about the speed the Obama administration and a coalition of state attorneys general and bank regulators are moving towards a settlement agreement to resolve claims of widespread foreclosure abuse….
Sheila Bair, the chairman of the Federal Deposit Insurance Corporation, said at a Senate panel last month that “flawed mortgage banking processes have potentially infected millions of foreclosures.”
“The extent of the loss cannot be determined until there is a comprehensive review of the loan files and documentation of the process dealing with problem loans,” she added.
Despite that appraisal, Bair, along with Treasury Secretary Timothy Geithner and Shaun Donovan, secretary of Housing and Urban Development, have said they want a quick settlement.
As we’ve indicated, the “now way less than 50″ state attorneys general settlement seems to be dying under the weight of its own incompetence. And if not, the embarrassing words that at least one AG is going systematically after abuses should deter any public official in a state with a high rate of foreclosures from signing up for a banking industry “get out of liability almost free” farce.
Gretchen Morgenson has an article out, which is being cited by Bloomberg (reader Barbara W’s Google Alerts confirms mine) when it appears Shahien broke the story. But they have different focuses, and Shahien’s was on the BofA angle. Morgenson has some additional detail, namely that Delaware is joining New York in the probe (which means another defection from the “less that 50″ state attorney general effort) and more important, that two of the four biggest trustees, Bank of New York and Deutsche Bank, are also being targeted. This confirms that chain of title issue are front and center.
As we have indicated in previous posts, trustees have potential major, current liability. While the statue of limitations has passed for securities fraud on pretty much all RMBS (the limit is usually three years; parties can sue for breach of contract, but the standards for proving fraud as opposed to a mere breach are much higher), that is NOT the case for trustees. They are required under the pooling and servicing agreement to provide annual certifications that they hold the trust assets in good order (this is the concept rather than the actual language). Clearly that is untrue if the notes are not in their possession or they never bothered to confirm, as they once did, that all the notes had been endorsed properly. Trustees can get that requirement waived if a deal has fewer than 50 investors, but even so, most trustees filed at least one annual certification in addition to the one at closing before applying for a waiver, and it seems likely that most deals had more than 50 investors.
From Gretchen Morgenson:
Opening a new line of inquiry into the problems that have beset the mortgage loan process, two state attorneys general are investigating Wall Street’s bundling of these loans into securities to determine whether they were properly documented and valid.
The investigation is being led by Eric T. Schneiderman, the attorney general of New York, who has teamed with Joseph R. Biden III, his counterpart from Delaware. Their effort centers on the back end of the mortgage assembly lines — where big banks serve as trustees overseeing the securities for investors — according to two people briefed on the inquiry but who were not authorized to speak publicly about it.
The attorneys general have requested information from Bank of New York Mellon and Deutsche Bank, the two largest firms acting as trustees. Trustee banks have not been a focus of other investigations because they are administrators of the securities and did not originate the loans or service them. But as administrators they were required to ensure that the documentation was proper and complete.
Both attorneys general are investigating other practices that fueled the mortgage boom and subsequent bust. The latest inquiry represents another avenue of scrutiny of the inner workings of Wall Street’s mortgage securitization machine, which transformed individual home loans into bundles of loans that were then sold to investors…
The rules governing the securitization process are labyrinthine, and there are steps required if the investment is to comply with tax laws and promises made by the issuer in its offering document. If the trusts did not comply with tax laws, for example, the beneficial treatment given to investors could be rescinded, causing taxes to be levied on the transactions.
The terms of these mortgage deals varied, but many of them required that the trustee examine each of the loan files as soon as they came in from the Wall Street firm or bank issuing the security. For a file to be complete, it would typically have to include all of the information necessary to establish a chain of ownership through the various steps of the bundling process, as when the originator transferred it to the issuer of the security who then moved it to the trustee.
I’ve gotten multiple confirmations from people who have spoken to the Tresury that it is not going to purse the tax issue, so this is not a source of potential liability. The latest of many reports:
I asked around and I have it from the horse’s mouth that the IRS is unlikely to do anything about the securitization transfer formalities problem that Levitin is complaining about. The IRS and the private bar agree that the REMICs are the tax (read economic) owners and that theycould have done the formalites right if they had wanted to. So the result will be benign neglect of the issue, no statement one way or the other.
The problem that the tax law has with formalities is the opposite of the foreclosure problem. In tax shelters, people arrange the formalities one way and the economics going the oppposite way, so the legal owner gets a tax benefit with no economic exposure. So the tax law strives to find the economic owner.
This bit from Morgenson is the first time I’ve seen an estimate of the percentage that were New York trust versus Delaware trusts:
The trusts were governed by the laws of the states in which they were set up. Roughly 80 percent of the trusts are governed by New York law with the rest by Delaware law.
This isn’t consistent with what I have heard from foreclosure defense attorneys, but I suspect the difference may be that “private label” deals, which are the overwhelming proportion of ones litigated, elected New York law for the trust, and GSE deals were a mix of New York and Delaware trust elections.
As indicated above, this development will hopefully put a brake on the rump state AG-Federal mortgage whitewash now in progress. And even if they try to pretend these probes are not moving forward, I have a funny feeling Mr. Market will take notice.
The Mortgage Mess by Yves Smith
Servicer Driven Foreclosures: The Perfect Crime? by Yves Smith
Daniel Tarullo – Problems in Mortgage Servicing by John Lounsbury
Mortgage Problems: Yves Smith Interview by Harry Shearer by John Lounsbury
Elizabeth Duke of Foreclosures and Documentation Issues by John Lounsbury
Elizabeth Duke Understates the Problems with Mortgages by Derryl Hermanutz