October 14, 2010
With the foreclosure process grinding to a halt, reports of the banks' paperwork problems keep worsening. Banks and mortgage servicing firms sometimes can't prove who owns the title to the property in foreclosure.
And that threatens to make a bad situation worse.
To understand this latest issue, picture yourself facing foreclosure. You are running out of time ... and options. Finally, you say to your bank: "Show me the note."
That simple request is tying banks in knots.
Gary Klein is a lawyer representing people fighting foreclosure. He says that in many cases, banks cannot, in fact, show them the note. And that, he says, is a big problem.
"The fundamental issue is that no one really knows who owns hundreds of thousands of mortgages that have been made in the last decade, and really no one really knows who has the right to foreclose," Klein says.
Sometimes banks have no record of the original loan. Or, there are faulty records of which investor owns the loan. And that's not all.
I've heard that at certain points they found it too costly to even store all the notes, and a lot of them just got shredded.
- Alan White, a law professor at Valparaiso University
"The issue, as these cases start to shake out, is not always whether the paper is public, the issue is whether the paperwork exists at all," Klein says.
How could this be? The answer is a problem of both complexity and volume.
Many of the mortgages generated in the past decade were bundled, then sold in the form of securities. As many as half of mortgages were bought and sold at least four times before reaching their final investors. The chain of ownership became hard to follow.
Every time that ownership changed, there should have been a record of that transfer. Not just digital forms, but actual 20th-century-style paper that physically traveled to each investor. But in the rush to process millions of new mortgages, the papers often didn't make it.
Alan White, a law professor at Valparaiso University, says the industry began cutting corners.
"They devised various shortcuts with the assurance of some high-powered lawyers that these shortcuts were fully, legally equivalent to doing it the old-fashioned way. But nobody really knew for sure whether they were the full legal equivalent or not. And now we're going to find out," White says.
White says to "show you the note," banks or their loan servicing operations might have to do some forensic digging. Some of the paper might exist at a warehouse somewhere. Some might exist in the MERS, the industry's mortgage electronic registration system. But some might not exist at all.
"And I've heard that at certain points they found it too costly to even store all the notes, and a lot of them just got shredded," White says.
The lack of a note may mean some owners can avoid foreclosure - although that's not exactly clear.
The real new issue here is what this might mean for the banking industry.
Investors in mortgage securities - which in many cases have lost all or most of their value - might turn to banks to cover their losses.
My concern is, is maybe this is the tip of the iceberg and there were other shortcuts taken that we don't completely understand.
- Paul Miller, managing director of financial services, FBR Capital Markets
Chris Katopis, executive director of the Association of Mortgage Investors, says investors are protected by agreements that say if there's any defect with the contract, the banks will buy back those securities.
"What we're hoping for is banks to step up and do what they're legally accountable to do under these agreements, and be responsible," he says.
Paul Miller, managing director of financial services at investment firm FBR Capital Markets, says banks "will probably be held most responsible if there is a problem."
He says the evidence so far does not indicate that the problem will hold up most foreclosures. But no one knows yet for sure.
"My concern is, is maybe this is the tip of the iceberg and there were other shortcuts taken that we don't completely understand," Miller says.
And if that is the case, Miller says, these paperwork issues could amount to a huge economic problem