Systematic Illegality

Excerpts from Barry Ritzholtz’s article, appearing here in full:

And we will see that at every step along the process, the reckless rush for easy profits has systemically undermined these legal property rights — how mortgages are recorded, the bungled bundling of notes to be securitized, the electronic system that fictionalized the process of assembling transfer documents, and how all the players along the way — The investment firms, banks, law firms, even court system, utterly lost sight of what they were doing.

Centuries of property law have been undercut by the entire Real Estate financing complex.  From the mortgage brokers who told borrowers “just leave those lines blank, I’ll fill them in” to the banks that taught their own agents how to game their computer loan approval systems to the financial engineers assembling the mortgage sausage to the myriad law firms, process servers and courts that oversee those loans final resting place, the entire system has been corrupted as a cost-savings/profit maximizing exercise.

Here’s how to eviscerate the advantage of western law & economics in three simple steps

1) MERS:  We start with the Mortgage Electronic Registration Systems. MERS is a computer registry that was “created by lenders seeking to save millions of dollars on paperwork and public recording fees every time a loan changes hands.” It holds over 60 million mortgages on American homes. Thanks to a legal fiction that pretends to follow the law — but actually does not — MERS has saved banks more than $1 billion. It has also turned what was a very successful system of tracking who owns what property and making it easy to transfer into a dysfunctional nightmare.

2) Improper Construction of RMBS/CDOs:

Structured mortgage securities are typically constructed as Trusts. The Trust holds the mortgage notes, which allows the bundling to occur.

Under normal circumstances, the re should be some assignment of  the Note by the original lender to the Trust. Frequently, this step did not occur. Nor did the requisite filing of the mortgage lien with the appropriate county clerk.

These errors plus the MERS issue led to very serious problems for much of the structured finance that was built on top of it. The creation of an RMBS or CDO needs at least two legal events to occur: One, the actual note the bank holds needs to be deposited into the Trust. Observe that it is the note holder who is entitled to receive principle and interest payments, who has a lien against the encumbered property, and has the right to foreclose and take the property in the event of a default.

The Note seems to  have been somehow ignored in the structuring process. And on top of that, the proper filing of the mortgage note every time a structured product changes hand was mostly ignored. As Corrente noted:

“Because of the expense, time and paperwork it would take to record each of the assignments of the thousands of mortgages in each securitization, Wall Street firms decided to just issue blank mortgage assignments all along the channel of transfers, skipping the actual physical recording of the mortgage at the county registry of deeds.

Astonishingly, representatives for the trusts have been foreclosing on homes across the country, evicting the families, then auctioning the homes, without a proper paper trail on the mortgage assignments or proof that they had legal standing. In some cases, the courts have allowed the representatives to foreclose and evict despite their admission that the original mortgage note is lost. (This raises the question as to whether these mortgage notes are really lost or might have been fraudulently used in multiple securitizations, a concern raised by some Wall Street veterans.)

See also The American Banker.

Karl Denniger went so far as to suggest the entire MERS/structured finance industry engages in such systemic illegality as to be guilty of RICO — the Racketeering statute used to bring down drug lords and mafia kingpins. If he is right, and I suspect he is, our Banana Republic status is getting ever closer.

3) Foreclosure Fraud: This is the third and final step to the disassembling of Capitalism’s property rights. It is indirectly related to prior two steps. Mostly it reflects the same disrespect for legal process int he headlong rush for profits, legal and otherwise.

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2 thoughts on “Systematic Illegality

  1. Here is how foreclosure and securitized mortgages work or don’t work.

    First Person A buys new home and gets a mortgage from Bank B (Wells Fargo).

    Wells Fargo packages this mortgage in to an MBS and sells the bond to Bank C (Citibank). Citibank is now the owner of that mortgage and Wells Fargo the servicer. Citibank hedges this investment by buying credit default swaps with AIG.

    Now Homeowner A after paying his mortgage for 12 months, loses his job and starts defaulting on his payments.

    Since many of the other mortgages in the MBS have a similar fate, it goes into default and triggers the CDS to be paid in full. However AIG is bankrupt because it sold too many CDS’s on MBS’s.
    The government steps in and bails out AIG to the tune of $80 billion.

    Citibank gets paid in full for its MBS.

    Homeowner A has been foreclosed on and is evicted from his home which is now returned to Citibank, who carry the market value of the house on their books.

    Citibank has been paid twice for its investment.
    The government (i.e the tax payer) already paid for the house by bailing out AIG – the insurer.

    This is America and the new math in the 21st century where for mortgages at least 1 + 1 = 4.

  2. Mortgage industry after April of 2011
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