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.