An Overview of the Improper Actions
Of Lending Institutions Over the
Last Ten Years & How Most
By Bob Faulis
bobf@BeatTheBank.org (760) 212-3729 (888) 527-4249 4/12/2011
The current flood of foreclosures is riddled with cases of illegitimate process, forgery, and lack of legal standing. The large numbers of foreclosures are actually the result of the actions of the banks to convert non-liquid Mortgage Notes into highly traded Mortgage Backed Securities that were sold on Wall Street. The huge influx of capital into these new investment vehicles resulted in huge profits for the banks and caused a lack of regard for the actual sustainability of the loan by the borrower, a disregard for the underlying value of the property, and a loss of focus on legal requirements for recording or documentation. The financial instruments sold to the investors are backed by the cash flow from the underlying assets (the mortgage notes) but not controlled by the deed of trust signed at closing.
The securitization of the mortgage obligations by assignment into a trust indenture trustee, with the resulting pool of assets being sold as a mortgaged back security creates a huge questions as to the legal standing of foreclosure. What most often happens is that the borrower assumes that because he signed a note with some lender, that any bank claiming money due must be the true owner of the note with legal standing to foreclose. Thus the borrow typically walks away in defeat. Additionally, if the borrower should question the validity of the foreclosure; the judicial system or non-judicial process involved immediately assumes that since a bank is involved that all legal requirements are in place and that since the borrower originally signed for indebtedness; there is a valid claim. In truth, when really digging into the legal obligations of all parties involved, it is discovered that most often a third party, the servicer of the loan; is the foreclosing party who is operating without legal standing and often with forged or invalid documentation.
Back in 2000, the banks realized that they could generate a great deal of revenue by converting a secured mortgage into an unsecured bond that is backed by the underlying cash flow of the mortgages in the Trust in which it is held.
A mortgage-backed security (MBS) is a securitized interest in a pool of mortgages. It is a bond. The securatization of a mortgage was performed by investment banks such as Bear Stearns, Merrill Lynch, JP Morgan, Morgan Stanley, Citigroup, Lehman Brothers, and Goldman Sachs.
Instead of paying investors a fixed rate coupon plus principal, it pays out the cash flows from the underlying pool of mortgages. It is possible to segregate the cash flows from a pool of mortgages into different bonds offering different maturity, risk and return characteristics. The bonds can then be sold to investors with different investment objectives. Such mortgage-backed securities are called collateralized mortgage obligations. (CMO).
In order to maximize the appeal and value to the investor of a CMO, the Trust which holds the pool of mortgages was designed as a Special Purpose Vehicle and a Qualified Special Purpose Entity to protect the mortgage assets from bankruptcy of the securitizer, those who manage the Trust (the trustee)- the assets are “bankruptcy remote.” Under such structure, the Qualified Special Purpose Entity controls the assets itself.
To further improve the investment value of the pool of mortgages, the Specialized Vehicle Entity was set up as a REMIC which prevents double taxation of both the trust and the bond holders (Tax reform Act of 1986 – 100 Stat. 2085 , 26 U.S.C.A § § 47, 1042). To qualify for a single taxable event, all interest in the mortgage is supposed to be transferred forward to the bond holders. There is a complete pass through of cash flow directly to the thousands of bond holders who are the ultimate beneficiaries of the underlying mortgages. This is an important concept in terms of legal standing for the due process of foreclosure.
With the many thousands of investors receiving the cash flow from the mortgages being dispersed through out the world, an issue arises as to how to collect the payments or negotiate any modifications to maximize cash flow. A solution is that pooled mortgages continue to be serviced by the originator who collects a monthly fee for doing so. This servicing fee is a fixed percent of outstanding principal, say 0.25% annualized. The fee is subtracted from interest payments to investors. Their actual rate of return depends upon what they pay for the pass-through. The originator may sell the rights to service the mortgages to a third party. There is a market for such serving rights. Very often the borrowers are not clearly informed when there is a transfer of their mortgage into a Trust to create a pool of mortgages or when there is a transfer of servicing rights. The borrower is confused that the originator retaining servicing rights is still the holder of the note or they believe that transfer of servicing rights is a transfer of ownership of the note.
A Special Purpose Vehicle can not sell any individual mortgage because individual mortgages are not held individually by the bond holders, the thousands of mortgages held in the name of the REMIC are owned collectively by the bond holders. Likewise, the bond holders can not sell the mortgages. All the bond holders have are the securities (bonds), which can be traded publicly. Furthermore, because the bond was issued on the current assets of the Trust at closing of the Trust (IRS section 860 requires that all steps in the sale and contribution process be complete within three months of formation of the REMIC), no additional assets may enter or leave the Trust. This also creates an issue with the Trust even being able to foreclose and bring the asset of a house into the Trust.
In order to meet the filling of all assets into the Trust in a three month period, the investment bankers would sometimes pre-sell investment into the Trust with a Trust filled with sample mortgages, only to be replaced with the actually mortgage pool once the Trust was fully funded. This will create issues of legal standing in executing documents, trustees, etc which shall be discussed below.
The term “securitization” is derived from the fact that the form of financial instruments used to obtain funds from the investors are securities. As a portfolio risk backed by amortizing cash flows – and unlike general corporate debt – the credit quality of securitized debt is non-stationary due to changes in volatility that are time- and structure-dependent. If the transaction is properly structured and the pool performs as expected, the credit risk of all tranches of structured debt improves; if improperly structured, the affected tranches will experience dramatic credit deterioration and loss.
The central complaint against the process of securitization is it removes the oversight function from the lender. For example, it use to be that a bank held a loan for the entire life of the loan. As a result, the bank had a strong incentive to perform a large amount of due diligence to make sure the borrower would repay the loan. Compare that to a “lend to securitize” model where lenders make loans they never intend to hold as a long-term asset, thereby removing the incentive to actually perform an analysis of the borrower. Combine that with a ratings “system” that is at best incompetent, investment bankers providing pressure on loan originators for more and more product, a regulatory oversight system which is non-existent and incredibly cheap money and you get a disaster waiting to happen.
Yet securitization provides two incredible advantages. First, it adds liquidity to the financial sector. Instead of having to hold a mortgage until it was paid off, a bank could sell it for cash and then use that cash to make another loan. This allows banks to increase the number of loans it can underwrite, thereby freeing up credit. Secondly, it allows individual investors to target needs and purchase products for those needs. In short, securitization increases overall credit and provides more tools for financial management — both of which increase overall economic growth when property structured.
Private firms—banks or mortgage originators— pool mortgages and sell them as pass-throughs without implicit government guarantees offered by Fannie Mae and Genni Mae. Such private label MBS traditionally had some form of credit enhancements to obtain a triple-A credit rating. Credit enhancement fees would be subtracted from mortgage cash flows along with servicing fees.
The complexity of the financial trick and mirrors was increased with the offering of Credit Default Swaps by firms such as AIG. The advantage of a Credit Default Swap was that it was not considered insurance and thus does not require any amount of capital in reserve to back up losses. Thus AIG could generate millions of dollars of profit without worry about retaining a reserve to cover losses. The buyer of protection doesn’t have to actually own this bond (the reason the Fed was required to step in and bailout AIG). This was an ideal setup for the investment bankers. The generated huge profits through the rapid turnover of increasingly risk laden mortgage pools and were to realize a greater return through the expected default of thousands of loans within the pool. The banks were selling a security which they knew was destine to fail.
If there is a default, the investment banker is essentially made whole because they get par for the bonds (even though they do not own them anymore). When the bond finally defaults, they can then buy the bond in the secondary market at a steep discount, then sell it to the seller of protection at par and make a huge profit.
Starting in the early 2000s, private label MBS were increasingly issued with little or no credit enhancement and on pools of risky sub-prime mortgages. For the first time, MBS posed significant credit risk. Because credit risk made these instruments fundamentally different from earlier mortgage pass-throughs, many market participants avoided calling them MBS, preferring to label them asset-backed securities instead. Volume in these risky instruments grew rapidly until 2007, when defaults accelerated and the market values of the instruments plunged. This caused a liquidity crisis that spilled into other segments of the capital markets. A number of hedge funds with leverage exposures to sub-prime mortgages folded. The meltdown had begun.
THE ISSUE OF LEGAL STANDING IN FORECLOSURE:
With the conversion of a Mortgage Note into an unsecured bond which is backed by the cash flow of the underlying mortgages comes an issue with the Trust Deed (also called Mortgage) and the concern that it still has legal effect. The Trust Deed is a document that points specifically to the Mortgage note. It gives rights to the Trustee to transfer ownership of the real property to the holder of the note should there be a default in payment. There is strong legal question as to the actually existence of the original Mortgage Note when it is paid off by the Wall Street investors and converted into an unsecured bond. It is akin to taking a gold ring which has value and melting it down with other rings to make a gold car. The gold ring can never be repossessed but instead the holder of the gold ring has converted it into another commodity of value.
Beyond the legal question of the existence of a viable Mortgage Note, come the question of proper transfer of the note to subsequent holders of the note. If you remember from the securitization process described above, the originator of the loan (lender/bank) sells the note to the investment banker who then transfers it into the Trust which pays off the investment banker with the funds from the numerous investors. These REMICS are setup under New York Trust Laws which have precise requirements in the sale and transfer of such assets into the Trust. In the Alabama Supreme Court Ruling of Phyllis Horace vs. LaSalle Bank NA that a mortgage note must be properly indorsed into a trust following securitization laws of New York. Additionally, the transfer of the mortgage note through the securitization chain requires a tied transfer of the Trust Deed and that the two are inseparable as found in Carpenter Vs. Logan. The mortgage note holder is required to notify the buyer of any transfers within 30 days as required by Title 12 of U.S.C § 2605 and UCC § 3-204 which requires the name and signature of both beneficiary and the original note and the original creditor is disclosed on the same document. Section 3-204(d). The signature of the borrower must be included as well into the assignment or transfer , unless a clause in the deed of trust/mortgage waives that (most deed of trusts disclose this in clause #20). Furthermore, most transfers of the note holder are done in violation of the Pooling and Service Agreement within the Trust itself. Of particular question is the industry standard of signing a blank transfer without any transferee identified.
There has been much press concerning the utilization of MERS (Mortgage Electronic Recording Service)- a company founded by the banking industry. Within the clauses of the Deed of Trust which borrowers sign, is a provision that all transfers of ownership must be recorded in the public county land records department. Making such recordings for the numerous ownership transfers in the Wall Street transactions (assuming the invalid position that the Trust Deed is still legally tied to the Mortgage Note) would prove not only costly to record with the individual county fees but would also be too cumbersome. As a solution, the banking industry created MERS to privately record in secret the ownership. Unfortunately, this does not meet legal requirements nor the terms of public disclosure which is for the protection of the borrower to ensure they are paying the right party of interest.
As a result of the many court cases ruling against MERS and their private transfer of ownership of the note, there has been must spotlight on the Foreclosure Mills such as DOCX which have been forging missing documents and assignments. Many wrongful foreclosure cases have been won in light of these frauds. Of particular interest are the many ruling of New York Judge Arthur M Schack which have dismissed with prejudice the foreclosure of many homeowners- based on lack of standing and/or false documentation.
One of the primary pillars of defense against the servicer, or other party with out interest; is a challenge of legal standing in the foreclosure process (UCC § 3-301 and UCC § 3-309). A most typical and simplistic approach is a “wet ink defense” that under contract and foreclosure law, legal standing that one requirement in proving a legal standing is that the holder present the original and un-tampered loan document signed by the borrower. The borrower is relying on the information that most loans are transferred and recorded through MERS who had destroyed the vast majority of notes. This approach alone is dangerous in that not all judges rule in favor of this statute alone (California courts Hwang vs. Bank of America, NA). Instead a careful and deliberate attack must be on all aspects of standing from loan securitization to proper recording and transfer of the alonge for the Trust Deed.
There are numerous other points of law which invalidate the foreclosure process. There are issues of non-disclosure and fraud on the borrower when the originator did not disclose that the funds utilized where not there their own, nor that their mortgage note would be utilized as collateral in the big Trust Scheme to be sold on Wall Street.
Even after foreclosure, there is hope for the borrower. After digesting the statutory requirements for enforcement of a promissory NOTE, and it is determined that the foreclosure claimant had failed to establish standing pursuant to the statutory requirements of UCC § 3-301 and UCC § 3-309, it would be logical to conclude that the foreclosure was wrongful pursuant to the court’s lack of subject matter jurisdiction over the case, therefore, the court’s judgment in favor of the foreclosure claimant is voidable. An action to void a judgment for lack of subject matter jurisdiction over the case can be brought up at any time, even after judgment, appeal, and subsequent execution of the judgment. See Rules of Civil Procedure, Rule 60(b), (void judgment – lack of subject matter jurisdiction).
Further obstacles in the foreclosure process are the servicer’s role in collecting money. To perform this obligation, they receive fractions of a percentage point to service the loan. The borrowers most often think that the servicer is the true note holder and thus the party interested in resolving any default issues through loan modification. Unfortunately, this is not true. Their profitability is actually maximized through the penalties and service fees imposed on the borrower during the default period. It is in the final foreclosure by the servicer on a property which they have been previously paid on by Wall Street, insurance, and the Federal Government that they realize their final gain.
The deception and fraud by the banking industry has not fully come to the attention of the public. But as the press and grassroots organizations dig deeper into the industry and its abuses of securitization and as case law builds; things will need to change. It is estimated that their will be some 13 million foreclosures through 2014- the majority of these will be without legal standing, proper documentation, and fraudulent actions. A new booming business will grow as lawyers are able to utilize new findings to reverse and correct the wrongs.
Ultimate, Congress will step in and most likely impose a small fine on the banking industry, absolve them of their misdoings and ultimately pretends all the errors and fraud did not occur in the best interest of the economy. The banks might be required to settle on a percentage of value of the mortgage which in truth they have no claim, but in the end the borrowers weren’t expecting a free home anyway. Morally the question is, Do they deserve a free home? I ask your response to this scenario: If you go into a restaurant and order a meal (borrower) and a person at the next table (investors on Wall Street) pays your bill and walks out the door, are you responsible for the bill? No bill exists, it has been paid in full. You can’t even find the good Samaritan that paid your way. The restaurant did not have a loss, should they sue you? I say, homeowners; enjoy your meal because in the end you are paying for it with bailout from taxpayer money.
COMMENTS: Bob Faulis
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