Could Securitization of Debt Be Unraveling on Legal Grounds?

The Kansas Supreme Court has ruled that a company named Mortgage Electronic Registration Systems has no standing to file for foreclosures. MERS acts as a front for banks and investors, registering mortgages electronically and tracking changes in ownership, according to Ellen Hodgson Brown, JD at Web of Debt.com.

Brown reports that 60 million securitized mortgages are tracked by MERS. She writes:

"That is the number of American mortgages currently reported to be held by MERS. Over half of all new U.S. residential mortgage loans are registered with MERS and recorded in its name. Holdings of the Kansas Supreme Court are not binding on the rest of the country, but they are dicta of which other courts take note; and the reasoning behind the decision is sound."

Because MERS has registered mortgages and recorded them in its name without having ownership, a legal standing does not exist for representing a financial interest, according to the Kansas ruling. Furthermore, the court has found that mortgage originators, once the mortgage is sold, also has no financial interest or liability.

Brown states:

"MERS, as straw man, lacks standing to foreclose, but so does original lender, although it was a signatory to the deal. The lender lacks standing because title had to pass to the secured parties for the arrangement to legally qualify as a “security.” The lender has been paid in full and has no further legal interest in the claim. Only the securities holders have skin in the game; but they have no standing to foreclose, because they were not signatories to the original agreement. They cannot satisfy the basic requirement of contract law that a plaintiff suing on a written contract must produce a signed contract proving he is entitled to relief."

The way I read this, the ruling holds that a mortgage can not be sold to a third party without the contractual endorsement of the mortgagor (homeowner). To do so otherwise means that the third party and the mortgagor do not have a legally binding agreement. Perhaps an attorney knowledgeable in contract law can clarify this point.

Could this situation be simply corrected by changing the wording of mortgage contracts? Could these contracts simply identify the mortgagee and all successors as signatories to the mortgage agreement? Would this then maintain liability for the mortgage originators? Again a contract law expert is welcome to weigh in.

Taking this issue to another level, does this ruling have implications for all securitized debt? Does a direct contract need to exist between the holder of a debt security and the debtor? Are Wall Street smoke and mirrors about to be blown away on the basis of simple contract law?

Comments

[optionsgirl:]

If you can't foreclose on the property why would you need additional reserves for just that possibility? Would you then have an unprofitable unsecured investment that could be written off more easily ?

And, HTL, of course you are right- that if a lender or investor can't prove they own the debt they should not be able to foreclose. Some of us still believe in the most basics of contract law and the protections it affords all of us.

Sep 26 05:35 PM

[Mayascribe:]

Old Trader. I, too, recall a judge throwing out a case due to lack of a paper trail. I think it was in Indiana, though. The judge got "cornfused" because mortgage packages were sold and resold beyond 30 times, so many times that no paper trail could be determined authentic.

John: I remember in one of your articles you, after I had written about the Currency and Derivatives Debt being $645T, you wrote back that there would be a wash of these mind-numbing debts.

I remember thinking afterwhich of the article that Old Trader and I are refering to.

What's your take on this in how this might, if the judge is eventually overuled in a higher court, be the exact wash of which you were speaking?

Sep 26 06:10 PM

[optionsgirl:]

I would be very surprised if MERS appeals this. Who are they going to collect fees from if they lose? It's one thing to go after the foreclosure when you think that the debtor will be responsible for all the fees that you are loading on, including legal fees, and another to spend it yourself when there is a good chance you will lose a second time and it isn't even clear that you actually represent the secured party.

Sep 26 06:47 PM

[Steven Hansen:]

When we sign a mortgage, we acknowledge that this loan will be sold into a secondary market or securitized. There is no legal hurdle under common law that the new mortgage holder must accomplish with the borrower to validate this event.

What a majority of the court cases (such as this one) have pivoted over issues of standing or documentation. To stand up in court in a civil case, you have to prove you have been affected.

I would not view this case broadly. MERS came to court, and could not prove they were the owner of the mortgage. there is nothing to appeal. they need to go back, develop a documentation package which proves who owns the mortgage - and prove that they are representing the owner of the mortgage.

Law is about dotting 'i' and crossing 't'.

Sep 26 08:09 PM

[Tom Armistead:]

I would not rely on Ms. Brown's interpretation of the ruling and its legal implications. They have the ring of a populist on a mission. MERS lacked standing: the actual owner of the mortgage will have to exercise their rights.

Agree with Steven Hansen, mortgages or any contract that is going to be sold or assigned have provisions to that effect, it's boilerplate.

The courts are correct in requiring anyone who is going to foreclose on a mortgage to produce the original and show that they are the owner in due course.

Sep 26 08:58 PM

[John Lounsbury:]

Mayascribe - - -

I feel that the big "wash" will be in CDSs, not so much in other derivatives. This could be substantial if multiparty ("round robin") cross cancellations occurred. I have not read any analysis, but I expect a lot of this may already have been done.


You may be thinking of the posibility of unbundling CDOs. This would be much harder to do.

On Sep 26 06:10 PM Mayascribe wrote:

> Old Trader. I, too, recall a judge throwing out a case due to lack
> of a paper trail. I think it was in Indiana, though. The judge got
> "cornfused" because mortgage packages were sold and resold beyond
> 30 times, so many times that no paper trail could be determined authentic.
>
>
> John: I remember in one of your articles you, after I had written
> about the Currency and Derivatives Debt being $645T, you wrote back
> that there would be a wash of these mind-numbing debts.
>
> I remember thinking afterwhich of the article that Old Trader and
> I are refering to.
>
> What's your take on this in how this might, if the judge is eventually
> overuled in a higher court, be the exact wash of which you were speaking?

Sep 26 11:22 PM

[Old Trader:]

og,
If they THINK they own the debt, and account for it accordingly, and then..down the road, a judge rules its not owned...because of "xyz" is lacking, (after the fact)...they placed it there....now its not so clear.

Yes, you're correct in seperating debt service fees from onwnership of the debt...a totally different issue.
Sep 26

05:26 PM optionsgirl wrote:

> I'm missing this one, OT. If they don't own the debt what the hell
> is it doing on their balance sheets in the first place?
> If they are missing fee income for processing payments that aren't
> forthcoming, that is a whole other component is it not?

Sep 27 01:39 AM

[Ricard:]

This level of detail is a bit above my head.

It seems this MERS is akin to a very large title company - one that tracks and is supposedly able to change title on mortgages (or in this case, MBS components) on behalf of the transacting parties.

Now, correct me if I'm wrong, but a title company has no business trying to foreclose on anyone. That's the mortgage holder's right. If the mortgage holder can't find their documents, then it would follow that a court would take their case less seriously, regardless of how the documents got lost in the first place.

This sounds like a rather weak technicality that eventually would find some sort of solution in court. It is comical that such an issue is coming to light on the side of the lien-holder...usually borrowers are the ones who are caught with their pants down.

All in all, I think this is a non-issue. Comical, nonetheless.

Sep 27 02:21 AM

[John Petersen:]

John, your read is a little off because the homeowner's consent is not a condition to a valid mortgage assignment. But after reading your article and the Brown article, my law partner and I both went "eeew, that could be a real can of worms."

I want to make it clear that I don't have any experience with MERS, or for that matter the legal intricacies of mortgage lending. I also want to make it clear that the views expressed in this comment do not constitute legal advice to or an offer to provide legal services for any person. I don't know "the answers" and do not intend to devote any time to finding them. I will, however, offer a simplified analysis of what the problem seems to be.

Mortgage backed securities are a legal oddity because the link between a particular mortgage and a particular CDS is pretty tenuous. If a debtor makes his payments on time in accordance with the contract, the money goes to one class of CDS holders. If he defaults, the risk of loss goes to a different class of holders. For a legal system that likes clear chains of ownership and formal documentation of every step in the chain, the complexity of a CDS is daunting, particularly in the event of default because it's that event that creates uncertainty about who the owner is.

It sounds like MERS is the mortgage industry equivalent of DTC, meaning that it MERS charged with the responsibility of keeping track of who the record owners of a mortgage are. The problem seems to arise from the fact that a legal responsibility to keep track of who the owners of a mortgage are does not necessarily equate the power to enforce the legal rights of those owners. A couple examples of how things work in the securities business may help clarify the issues.

If I buy stock in XYZ Corporation and leave my shares street name, the record holder of my shares is the Depository Trust Company, or DTC. If XYZ corporation violates the securities laws or fails to observe a corporate law requirement that can serve as the basis for a stockholder suit, it's my responsibility to hire my own lawyer and bring a lawsuit. Since DTC is a mere legal nominee, it has no standing to enforce my rights or bring a lawsuit on my behalf.

If XYZ Corporation issues bonds, it will hire a third party to act as trustee for the bond holders. That third party will be the legal holder of the security interest and the note signed by the corporation. The bonds, in turn, represent a fractional interest in the rights held by the bond trustee. If XYZ Corporation defaults, the bond trustee is the only party that has the power to bring a lawsuit to enforce the rights of the bondholders. I might have some collateral right to bring a direct action against XYZ Corporation if there was also a violation of the securities laws, but when it comes down to enforcing the debtor-creditor relationship, it's the bond trustee who holds all the power.

The Kansas case discussed in the Brown blog basically held that while MERS has a record-keeping responsibility that is similar to the responsibility of DTC, it did not, in that particular case, have all the rights and powers of a bond trustee to sue the debtor for non-performance. It's impossible to tell whether the ruling has a broader significance, but it could portend grave problems if other courts follow the logic applied in Kansas.

Like I said at the beginning, I don't know the answers and couldn't even begin to offer any advice to anyone, but figuring it all out could get messy, particularly in cases where the documentation chain got a little sloppy.

Sep 27 06:01 AM

[lower98th:]

I have been interested in these cases in FL for three reasons.

1. Mortgage Fraud: "The dog ate my homework" (great line,Tadit Anderson) practice of foreclosures on the basis of lost documents is not merely technical where mortgage fraud is alleged. Some borrowers have claimed that the reset practices don't match the terms "as presented" at origination. And the package cannot be located by the forecloser.

2. Fractional Foreclosures: How does a fractional owner foreclose? What is the right, and the procedure, for a Fractional owner to foreclose? In the absence of a "trustee," to make ownership "whole," is a junior securitization more like a second mortgage.? So a lesser interest must foreclose and pay off the first to get any residual? Or do the juniors get foreclosed out, with no partial claim, as in a regular first lien foreclosure? And if this is the case, won't it be harder for lower MBS tranches to claim any market value?

3. Judicial or non-judicial: For the states that have either judicial or non-judicial, but only one go at it (sort of like double jeopardy), if a non-judicial foreclosure is selected but not possible to execute because of inadequate proof or standing, and the foreclosing party has already given up the avenue of a judicial foreclosure, Now What? And if more foreclosures are contested, and they all have to be judicial....what a mess.

Many savvy, if unethical, owners (strategic contestors....like strategic defaulters) are filing suits for the purpose of delaying foreclosure, even if they believe it will eventually happen. Why not? They continue to live rent/payment free. Their credit is saved the final "foreclosure" or BK hit. And servicers who really didn't foresee this potential staff burden, are putting the Strategic Contestors last on the foreclosure list.

Sep 27 08:14 AM

[lower98th:]

From Tadit Anderson: "I believe that there are grounds to challenge a securitized mortgage "holder" on a similar basis that in effect they will need to prove that they were not betting on the mortgagees failing to be able to pay their mortgages"

Very astute.
A securitization is set up with some (undisclosed) level of knowlege that it will fail. Failure is the purpose, so that 100% can be reimbursed through CDS (insurance)? Heck, you don't even need to service those loans!

Does the fine print say these are great investments because we have figured out a way to commit insurance fraud?

Exactly like overinsuring a delapidated house just before it mysteriously burns to the ground.

Sep 27 08:28 AM

[Tom Armistead:]

More like buying insurance on a house that is on fire- it doesn't work in P&C insuracne, why should it would in Financial Guarantee Insurance?


On Sep 27 08:28 AM lower98th wrote:

> From Tadit Anderson: "I believe that there are grounds to challenge
> a securitized mortgage "holder" on a similar basis that in effect
> they will need to prove that they were not betting on the mortgagees
> failing to be able to pay their mortgages"
>
> Very astute.
> A securitization is set up with some (undisclosed) level of knowlege
> that it will fail. Failure is the purpose, so that 100% can be reimbursed
> through CDS (insurance)? Heck, you don't even need to service those
> loans!
>
> Does the fine print say these are great investments because we have
> figured out a way to commit insurance fraud?
>
> Exactly like overinsuring a delapidated house just before it mysteriously
> burns to the ground.

Sep 27 10:19 AM

[lower98th:]

My apology in advance for this comment being an aside, but related to subsequent-party standing.

Contrary to what many assume, only 11 states are Non-recourse for first mortgages: Alaska, Arizona, California, Iowa, Minnesota, Montana, North Carolina, North Dakota, Oregon, Washington, and Wisconsin. (info from: all-foreclosure.com). The other 39 states, including Florida, allow the lender to collect on deficiencies. Attorneys until recently have generally advised clients that while they were "technically" subject to deficiency action, it wouldn't "really" happen. No Longer. As the $$$ value of the deficiencies have soared the vulture possibilities have risen, and Mortgage Deficiency Collection is rapidly becoming an industry in its own right. Below, an excerpt from a local legal expert:

Mortgage Deficiency Judgments: A Different Opinion From Creditors
In response to my statements on this Blog that most lenders do not pursue mortgage deficiency judgments, I received a email from an experienced collection attorney expressing a contrary opinion. The collection attorney stated that he knows that lenders will be pooling mortgage deficiency judgments and selling them to collection companies for pennies on the dollar. Credit card companies have an established practice of selling non-performing credit card debt at seep discount. This same attorney says that many borrowers who walk away from mortgages will be in for a big shock in the future when collectors who have purchased the mortgage companies deficiency rights surprise the borrower with legal action.

Whether or not the attorney’s prediction is correct will be seen in the future. As stated often, my own experience over the past few years is that deficiency judgments are rare, and most attorneys and bankers I have spoken with agree. Yet, if its economically practical to purchase mature deficiency claims then there might develop an industry to pursue some of today’s numerous homeowners walking away from their mortgages. The homeowner needs to be aware of all opinions and predictions in order to make informed financial decisions. (Jonathan Alper, bankruptcy and asset protection attorney, Orlando, Florida) "

Sep 27 11:21 AM

[ebworthen:]

In Wall Street and Washington's lust for Mammon, contract law has been desecrated already.

No doubt an equivocation with a requisite rationalization will emerge, with signatures from those who claim to represent the rule of law and the citizens.

Lest we forget, the Supreme Court in the KELO decision nullified individual property rights dating back to the Magna Carta.

The FDIC taking over Washington Mutual and the Government purchases or forced purchases of AIG, Citibank, GM, and others subsumed the rights of investors and bondholders by simple decree.

There are pockets of justice, as witnessed in the Kansas decision and the ruling that the Bank of America/Merril Lynch deal not be accepted; however, the moral and ethical tipping point has breached and socialized losses and privatized gains condoned and utilized as a bludgeon of tyranny.

Sep 27 01:16 PM

[John Lounsbury:]

lower98th - - -

For me, no apology is needed. Your comment is well related and very informative. I was not aware that so many states had recourse mortgage laws. Now, for every 100 billion in defaults sold into collection at 10 cents on the dollar that result in 40 cents recovery on 60% (all these numbers just hypothetical), that is a gross return of $24 billion on a $10 billion outlay. If half of the recovery is net, that's a 70% return.

If you don't like my hypothetical assumptions, plug in your own.

My point is, there are many who will view this as a big business opportunity. And why will they succeed in collecting? They can offer a clean credit slate for those who settle up.

Thanks for opening up this avenue of discussion, lower98th.

Sep 27 01:58 PM

[ebworthen:]

What the banking and legal industries don't realize is that the moral contract with the average citizen has been broken.

When the "prime" borrowers and "good" citizens revolt, there won't be enough lawyers or police to put humpty back together.

If the government can take away my right to property to increase tax revenues, and tax me into perpetuity to pay for the sins of the banking oligarchs, what duty do I have to that government? NONE.

The fabric of the nation is being held together with duct tape and burlap; thus the desperation to hold the big banks and car makers together and the government gravy flowing.

Throughout history, when the masses are cheated and robbed by those who purport to serve them; law has little meaning and heads roll.


On Sep 27 11:21 AM lower98th wrote:

> My apology in advance for this comment being an aside, but related
> to subsequent-party standing.
>
> Contrary to what many assume, only 11 states are Non-recourse for
> first mortgages: Alaska, Arizona, California, Iowa, Minnesota, Montana,
> North Carolina, North Dakota, Oregon, Washington, and Wisconsin.
> (info from: all-foreclosure.com). The other 39 states, including
> Florida, allow the lender to collect on deficiencies. Attorneys until
> recently have generally advised clients that while they were "technically"
> subject to deficiency action, it wouldn't "really" happen. No Longer.
> As the $$$ value of the deficiencies have soared the vulture possibilities
> have risen, and Mortgage Deficiency Collection is rapidly becoming
> an industry in its own right. Below, an excerpt from a local legal
> expert:
>
> Mortgage Deficiency Judgments: A Different Opinion From Creditors
>
> In response to my statements on this Blog that most lenders do not
> pursue mortgage deficiency judgments, I received a email from an
> experienced collection attorney expressing a contrary opinion. The
> collection attorney stated that he knows that lenders will be pooling
> mortgage deficiency judgments and selling them to collection companies
> for pennies on the dollar. Credit card companies have an established
> practice of selling non-performing credit card debt at seep discount.
> This same attorney says that many borrowers who walk away from mortgages
> will be in for a big shock in the future when collectors who have
> purchased the mortgage companies deficiency rights surprise the borrower
> with legal action.
>
> Whether or not the attorney’s prediction is correct will be seen
> in the future. As stated often, my own experience over the past few
> years is that deficiency judgments are rare, and most attorneys and
> bankers I have spoken with agree. Yet, if its economically practical
> to purchase mature deficiency claims then there might develop an
> industry to pursue some of today’s numerous homeowners walking away
> from their mortgages. The homeowner needs to be aware of all opinions
> and predictions in order to make informed financial decisions. (Jonathan
> Alper, bankruptcy and asset protection attorney, Orlando, Florida)
> "

Sep 27 04:02 PM

[John Lounsbury:]

Barry Ritholtz at The Big Picture has found some further explainatory information abiut MERS, mortgages and foreclosures. www.ritholtz.com/blog/.../

Sep 27 07:30 PM

[Mr. Ed, Jr.:]

Apparently, in some states, you don't even need to make the down payment-- or any payment. Just move in...

www.financialarmageddo...


On Sep 25 06:34 PM mna wrote:

> Wow, so you can basically buy a home in Kansas for the down payment,
> stiff the bank on mortgage payments, and live in it rent free for
> the rest of your life? LEGALLY?
>
> wow... I honestly don't know what to say anymore. Also, if you followed
> the link provided, the article that was quoted actually had a supportive
> tone for this travesty.
>
> Hell, why even work anymore. We might as well lie, cheat, and steal
> our way to prosperity. Seems like everyone else is. RIP America.

Sep 28 12:16 AM

[Graham and ...:]

Here are some other things that have come out of Kansas in the past.

seekingalpha.com/insta...

Sep 28 11:35 AM

[StephenH:]

I wanted to say that I think that yes this may be the case and it was the banks themselves that did not keep the correct paperwork of how they did this securitization. If they don

Oct 29 07:16 PM