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Banks Lose Paperwork – Foreclosures Slow Down

Yesterday, the Speaker of the House asked the Federal Reserve to investigate whether laws were broken, or regulation was lax following the announcement last week that several large mortgage lenders were suspending proceedings in twenty three judicial foreclosure states. Bank of America, JPMorgan Chase and Ally Financial (owner of GMC financial) all announced a suspension of foreclosure actions in those states. At the same time, the Texas Attorney General also sent a notice to thirty mortgage servicers ordering a freeze on foreclosures and a review of possible faulty affidavits used in the state.

What, if anything, does this portend for the employee mobility industry?  In order to answer that question, we need to brush up on the background facts.

The first is the recognition that residential mortgages are no longer held, to any large degree, by banks as an individual asset. After the savings and loan crisis in the 1980’s, a series of institutional changes and revised accounting rules made it impractical for banks to keep each loan on its books as a separate entry. Rather, the process of securitization became commonplace, in which a group of mortgages was “pooled” into one large bond, and that instrument was sold to investors. The earliest securitizers were the GSEs  -- Fannie Mae, Freddy Mac and Ginny Mae; soon commercial banks joined the group.

These bonds, known as mortgage backed securities, were sometimes packaged creatively, to say the least. They were purchased by investors, banks, and financial institutions around the world. At first, some pools contained high grade conventional mortgages exclusively, but as the bubble grew, many contained a mix of riskier mortgages, and the securitizer offered different “tranches”, or interests in the pool. The more the risk, i.e., the shakier the mortgages in the tranche, and the higher was the return to investors in the tranche. Of course, in the end, there turned to be far greater risk for all holders, regardless of the tranche.

The mechanics of putting together a MBS involved taking the note and theoretically storing it with all of the other deeds of the assets in the pool. Deeds of trust (trust deeds) needed to be modified, and trustees needed to approve the transfer into the pool, in most cases; substitute trustees needed to be appointed. Then, the documents, including the deeds of trust needed to be indexed and attached to the MBS so that the mortgages could be serviced, released on payoff, and handled just like any single mortgage is treated. There are, of course, long established procedures for doing this.

Before 2007, foreclosures were relatively uncommon, usually under 2-3% of all mortgages. Never the less, every state has a strong body of law and procedure which must be carefully followed in order to properly transfer ownership via foreclosure. Over time, states split between two methods, with some, like Texas, allowing either. The most common method is purely contractual; the trustee declares the note in default, and imitates a procedure where the house is sold after notice to the defaulting party and the public. Although these auctions are traditionally held on the courthouse steps, they require little action on the part of a court, and are known as nonjudicial foreclosures. About 27 states permit this type of foreclosure.

The other states follow a more formal sale procedure known as judicial foreclosure which requires a formal court hearing in which the trustee must prove the ownership and default, and then receives a court order allowing the sale and the distribution of proceeds. Because there are certain advantages in having a signed court order covering delinquent notes, most nonjudicial foreclosure states also have judicial procedures, too. In previous years, many lenders would file multiple foreclosure cases simultaneously to speed up the actual sale process, bypassing much of the notice and time requirements of the nonjudicial process.

The deflating housing bubble wrought havoc on the foreclosure process, partly because its volume overwhelmed the system, and partly because the securitizers got sloppy.  The first crack came in 2009 when a clever attorney for a borrower demanded that the lender produce proof it owned his client’s mortgage which was the subject of a judicial foreclosure. In normal cases, this request would automatically be a part of the lender’s case, and would be a simple proffer. But in this case, the note had been sold by the originating mortgage broker to a large commercial bank, and then added to a MBS pool. The rights to service the mortgage, i.e., collect the payments, pay the taxes, and administer the loan, were sold to servicing company.

In this case, the servicer could not find, or did not have, the proper proof of the assignment of the note and deed of trust to the commercial bank. Things apparently got a little sloppy during the fast and furious era of easy credit. After this case, and several which followed, several large bank securitizers and servicers initiated a process whereby every judicial foreclosure was accompanied by an affidavit which stated that the bank did indeed own the mortgage and had the paperwork to prove it. The paperwork was not supplied to the court, as the affidavit sufficed.

Unfortunately for the banks, another clever attorney demanded to see the actual paperwork for her client’s mortgage, a demand which many previous courts did not allow. The bank couldn’t find it, and the judicial foreclosures could not continue without proof that the banks owned the notes. Apparently the signers of the affidavits had not actually tracked down the paperwork they were swearing to. Some of the signers were actually machines, robosigners.

As much as anything, this is an administrative headache for the banks and servicers, but not a death blow to judicial foreclosures. But it does complicate the foreclosures of many pool mortgages, at least until the servicers or banks can get their paperwork in order. And it will likely result in at least short term write downs on the value of the assets underlying affected MBS, which has the potential of reducing available new mortgage funds.

Any long term constriction of mortgage money would have an adverse effect, of course, since abundant mortgage money is the lifeblood of home sale programs, especially on the sale (departure) side. If it turns out that the paper is irretrievably lost, the issue might get trickier. Fortunately, this hardly seems likely; it is more plausible that all of those deeds of trust and other documents are in warehouses somewhere.

So what effect, if any, will this fiasco have on our industry?  Probably not much, at least in the long run. In the short run, because of the diminution of value in the pool, it may increase the cost of funds or even curtail the availability of mortgages, but given the low housing demand, this likely will not be noticed or dramatic.

One practical idea comes up immediately, though. Since foreclosures are stopped, it might be a good time to negotiate hard on short sales, especially in those states where foreclosures are stopped or slowed.

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Foreclosures and the Housing Market: the Saga Continues

In previous blogs, I have looked at the housing market and the effects of the foreclosure problems on its recovery. Over the past few days, there have been additional events which add further uncertainly to the mix. Since many relocation policies, budgets, and moves are directly affected by the strength of the housing market, some prognostication is useful for all U.S. domestic programs, not just home sale programs. Delayed or postponed sales will affect more aspects of strategic talent placement than just home sale; renting will increase, moves will be slowed or refused, and predecision counseling will become even more important in preparing the potential transferring employee for any move.

The latest estimate of houses in foreclosure is approximately 4 million, with a current inventory of homes for sale (but not under foreclosure) is about an additional 1.9 million.  Sales of all existing homes, according to NAR, are running at about 4.13 million yearly. Thus just with the current inventory, the numbers imply that, everything else being equal, there is about a 14 month backlog in housing sales. Of course, everything else is not equal, and it is likely that this number is wildly inaccurate. Let’s look at the other variables, but first it is always useful to remind oneself that all housing is local; the data reflects an average, and places like Las Vegas and Washington, D.C. may look totally different.

The first of these additional factors is the existence of what it sometimes called the “shadow inventory”, i.e., houses which are over 90 days in arrears on mortgage payments, but which have yet to be foreclosed upon. There are about another 4 million in this category, and recent experience has shown that the vast bulk of these will go into foreclosure and will not be saved by virtue of the federal or lender remedial programs. The reason for this is simple; the soft economy and continuing high unemployment rates do not allow seriously delinquent borrowers to pull out of the freefall, and the still falling house prices drive them further underwater. Even at the current rate of sales, then, the addition of this group of houses to the market would slow absorption until sometime in 2012 or early 2013. Because of this overhang , it is quite probable that prices will not begin to recover in slow markets until the demand/supply balance is restored, which is normally around 60 to 120 days DOM (days on market) .

Second, there are several factors, mostly legal and political, which will likely prolong the mechanics of foreclosures, at least in the short run. While this might help the absorption rate somewhat, by holding in check any dramatic increase in DOM, it will also slow down any price recovery because of the uncertainty which it adds to the market. The most public of these factors is the foreclosure paperwork mess which I have blogged about earlier (October 6). It still looks to me that, from the legal standpoint, this is repairable. In fact, earlier this week Wells Fargo announced that it had rectified the paperwork on 55,000 foreclosure cases which will now presumably go forward. While the paperwork issues will continue to be slowly and painfully worked out, this factor alone looks like it will only slow down the process of getting the 4 million current foreclosures sold and off of the market. Of course, no one knows how long this will add to the timetable, but the estimates tend to be in the six month to one year range; still not a major increase to the 2012 to 2013 time frame for inventory clearance.

There are two political issues on the table, in addition, which could slow down the process. One regards proposed action by the attorneys general of the states, and the other is based on an issue raised by a Virginia state delegate.

The first, and potentially most troubling, is a group of 50 state officials, led by the Attorney General of Iowa, Thomas Miller, a long time opponent of electronic mortgage registration and MERS, to organize his counterparts in other states into a country-wide investigation into whether the foreclosure paperwork debacle constitutes a violation of state deceptive practices or consumer protection laws (Mr. Miller was reelected last night, but six of the twelve lead members of the group were not). Of course, all of these laws vary from state to state, but most are violated by purposefully creating false documents in the foreclosure situation. There is some resistance in many states regarding this investigation, since there is evidence that the motive is to force the lenders (and therefore the holders of all mortgage backed securities) to dramatically lower the principle amount of the indebtedness of many foreclosure properties. However, since most state deceptive practices laws provide for treble (triple) damages and the payment of attorneys’ fees, the incentive to settle these cases is very high, and, as may be expected, the major banks have been meeting with the key state attorneys general to try to work out an acceptable method of presenting documentation in judicial foreclosures. How this state investigation will affect the foreclosure timeline is not clear. Certainly the election has replaced many state attorney generals, so there will be a learning curve for the incoming officials. And demanding a lowering of principle in foreclosing houses will likely be a chimerical victory at best, since with an extremely soft economy and an over 10% unemployment rate, there are not many borrowers in foreclosure who can take advantage of the lower payments (which are also available through HOEPTA and the newer federal plans). The worst case here, in my estimation, is that state action could increase the overall increase in absorption for an additional six months, and add a significant cost to the lenders.

The second legal issue is one raised by a member of the Virginia House of Delegates, Robert Marshall, who has introduced a bill that would require MERS (which is a Virginia company) to pay county taxes on each transfer of ownership in its mortgage servicing and securitization transactions. In fact, Mr. Marshall claims that current law demands this, and he has asked the state attorney general for an opinion on it. Somewhat related is a lawsuit filed in Georgia which seeks class action status to determine whether MERS lacks the power to institute any foreclosures on behalf of lenders, servicers, or anyone else; this particular suit asks the judge to undo all previous foreclosures and give the deed back to the foreclosed borrowers.

Fortunately there has been no widespread attempt by county officials to collect any fees from MERS transfers, and the Georgia lawsuit is not likely to undo all foreclosures. Likewise, even if Virginia passes a transfer tax statute, the delays in foreclosures will likely not be great; only the cost will increase, affecting banks’ balance sheets, but not their need to clear these properties off of their books. Worst case, this, too, will add a delay to the process, but can likely be taken care of while the other delays are being dealt with.

The bottom line for the employee mobility industry is that, given what we know now, it looks like bank foreclosures will continue to slow housing absorption until about late 2013 unless the economy picks up rapidly and decisively, driving up demand and lowering foreclosures. It is likely that prices will decline slightly when the shadow inventory hits the market and that they will remain weak until inventory moves back to previous equilibrium levels, depending on the location.

Of course, any of these variables may change instantly, but that is the way it looks today, based the current legal and economic landscape.
Richard Mansfield at 11/3/2010 11:44 AM

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