This week one of my clients asked me to explain the on-going foreclosure debacle in “plain English” as she put it. It dawned on me that there may be a lot of readers out there who would benefit from the same thing, so here goes.
The first point to understand is that homeowners can only be foreclosed and evicted by the person or institution that actually holds the mortgage loan note. That note holder is the only entity that has the legal authority to ask the courts to foreclose and evict the mortgage holder. That note is what you sign and give to the original lender, promising to pay the loan back over 10-20-30 years. It is that note (not the mortgage) that is the important legal document.
Back in the day, before mortgage-backed securities and loan securitization, most mortgage loans were issued by your local S & L or bank. The note stayed with the local financial institution who serviced the loan, just like in the movie “It’s a Wonderful Life.”
Then some Wall Street rocket scientists decided to modernize that business. Since all mortgage holders are not the same and some are riskier than others, these Gordon Gekko lookalikes decided there was a buck to be made in wholesaling mortgage loans to investors hungry for higher yield securities. Wall Street bought these mortgage loans off the banks and bundled them into huge pools called Real Estate Mortgage Investment Conduits (REMICs). At that point, these mortgages were spliced and diced into tranches according to their risk, (among other variables). The REMICS never owned the mortgage notes, but were simply re-packaging the mortgage loans, taking a fee and selling them to others.
Investors bought these loans, which were separated into a whole range of tranches according to how much risk the investor wanted to take on. What is important to understand is that each tranche holder owned a portion of the same mortgage, rather than investor A owning my mortgage and investor B holding yours. If my mortgage defaulted and you owned a junior (riskier) tranche of my mortgage (times many, many more) then you would be hit with that loss first. If there was still some loss left over, the more senior (safer) tranche holder would take a hit as well. It was physically impossible, even if the sellers owned the notes, to divide them fractionally between thousands if not millions of buyers. So once again these mortgages (tranches) were sold but not the notes.
Imagine the complexity of keeping track of what mortgages were defaulting versus those that were not and how much loss to assign each individual tranche holder? Enter the Mortgage Electronic Registration System (MERS), which became the repository for millions of digitized mortgage notes that all the financial institutions originated from the actual mortgage loans signed by you and me. These digitalized mortgage notes were sliced and diced and rearranged once again and came out the other end as mortgage-backed securities. The problem was that MERS didn’t actually hold the mortgage notes either. And therein lies the rub. Legally, the chain of title for these mortgage loans has been broken a couple of times.
As I’ve explained, the key document in taking out a mortgage is the note. In order for that note to be sold or transferred to someone else (for example, transformed into a mortgage-backed security), the note has to be physically endorsed over to the next person. If it isn’t, the chain of title is broken. If the chain is broken than legally the mortgage note is no longer valid. The person who took out the mortgage no longer owes the loan, because he no longer knows who to pay. In my opinion, I still believe that everyone has an obligation to repay money they have borrowed, otherwise, the entire system of credit will disintegrate.
Of course, with the number of foreclosures that have hit the nation, this issue was bound to be discovered as homeowners began to contest eviction. The banks, realizing their error, hired foreclosure mills, (legal firms that specialized in foreclosures), to remedy the problem. Accusations that these foreclosure mills actually went back and falsified documents in order to repair the broken chain of titles caught the attention of Attorney Generals throughout the nation as did stories of robo-signers who were signing their names to foreclosure documents that attested that they had reviewed the loan documents when they hadn’t.
In an election year, this issue has disrupted everything to do with the mortgage markets from foreclosure to new home sales. Everyone from the White House, the Justice Department, the U.S. Treasury and the Housing Departments are announcing task forces to dig deeply into this mess. In my opinion, the digger they deep the worse the true story will become so stay tuned.