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Most Mortgages Are Probably Invalid And Courts Are Starting To Notice

Posted by MIKKEL FISHMAN, Economics Editor in Economy.
Oct 26th, 2009 | Comments

Naked Capitalism has a very interesting post up about the consequences of lazy mortgage securitization. A Federal judge has thrown out a mortgage that was challenged during a foreclosure hearing. Yes, he didn’t just throw out the foreclosure, but the mortgage itself, giving the owner the house free and clear.

While this is the first case of that happening, more and more judges are throwing out foreclosures in general, a trend that will make things interesting going forward.

The problem stems from the way that mortgages were securitized. To make a long story short, the banks took massive shortcuts in bundling them together and selling them off, and many houses went through layers of ownership. Instead of properly accounting for the change at each step, documents were kept that don’t conform to legal standards and at this point the majority of processes involving deeds rely on affidavits that the owner of the mortgage is the entity that claims to be. However, when people challenge the affidavits as being legally invalid, judges are agreeing.

This means that for tons of mortgages (probably the majority in the country at this point) the supposed owner isn’t the legal owner and the legal owner probably isn’t even aware that they technically own the home.

I’m an extreme novice in this area, so I’ll recommend you just follow the link instead of risking saying something that is incorrect. However I will say that the implications are astounding, and potentially hundreds of billions of dollars worth of securities are legally worthless.

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Tully

It's even a bigger mess than the problem described, though in a way that's GOOD for the property owners. In some cases of mortgages that were sold forward or securitized, the original loan papers failed to follow them. So homeowners in foreclosures are (rightfully) demanding that the original loan documents be presented, the ones with their signatures on them. And in many cases those documents are lost or no longer exist... or, as the story alludes, sometimes the documentation of the chain of transfers is inadequate.

Result: The homeowner can sometimes walk away with the house, free and clear, because the mortgage holders failed to properly document their ownership of the loan. Even when they DO have all the paperwork or can track it down eventually, just demanding it be produced can provide some extra time for the homeowner to get on top of the situation before their home is taken away from them.

DLS

It seems like a rash decision. What's next, a refund, including interest and other lost investment income that could have been had from mortgage payments? Why was ownership changed rather than requiring a new mortgage to be renegotiated?

Who is the legal owner, then, in cases like this? This could easily surpass the problems the West Germans had recovering property in the east after reunification (or what Cubans could face someday).

DLS

Judge Drain, of recent Delphi fame? This was no fluke.

mikkel

What do you mean by that? I didn't follow that one too closely other than wondering about other parts suppliers.

StockBoySF

Wow! This is amazing! I wonder if people who are not facing foreclosure will start questioning the ownership of their mortgages. I don't think one has to be in foreclosure (or facing foreclosure) to question the validity of legal contracts. Though if your mortgage is still "owned" by the original financial institution you dealt with then there wouldn't be a problem.

casualobserver

Well, since MBS are typically an institutional investment holding, how many financial institutions and pension funds do you think should be allowed go belly up by allowing these securities to now be worthless? Well, there is always Fannie, Freddie and the PBGC to backstop all these losses.

mikkel

Yes, it's unfathomable to think about the consequences if this started to become standard practice, yet there appears to be no way to resolve the issue.

In the comments of the Naked Capitalism post there are people that say that in the beginning of securitization this wasn't a problem because they followed the law, but during the last decade they cut corners for more profit and more flexibility.

Patrick E

My fellow practitioners and I have been kind of wondering when this shoe was going to fall. It is a major issue for many of the mortgage lenders. When you package out loans and cut them into 10 different slices and send them 10 different places it makes it hard to track.

However I am not sure how big of an impact this will have as the banks will continue to fight the issue, so only those with the money to keep going through the courts will be able to keep up the battle.

Indeed PHH is appealing this ruling, so it may be years before things are resolved

StockBoySF

"In the comments of the Naked Capitalism post there are people that say that in the beginning of securitization this wasn't a problem because they followed the law, but during the last decade they cut corners for more profit and more flexibility."

An unintended consequence of either mergers or management of financial companies cutting costs by relocating good stable departments to lower cost areas to save money is that many times the "new" management doesn't have the full experience to understand all issues.

In this case it seems that the number of bankers (and support staff) involved in these products increased so rapidly that they didn't have the proper training or insight to properly understand and manage the transfer process.

Father_Time

Short answer…..

Just make them all invalid. Gives these people their homes. Give the money back to the people by giving them their homes. They can then afford to pay their homeowner's tax, so money will flow more readily back to government. Consolidate the banks into fewer and stronger banks. The considerable disposable income people will have without mortgage payments will certainly spur the economy and/or increase savings for bank reinvestment.

All within the power and preview of the Government.

Patrick E

This is a big mess but we will have a long road to see where it goes.

Problem with 'giving people their homes' is that it begs the question of why not give everyone a free home ?

Or a free check for $ 200,000.

Jim_Satterfield

If the institutions screwed up as badly as it appears they have then they get what they deserve if the owner gets the home free and clear. It will only happen to those who didn't follow the law, though, so maybe this will be a lesson learned by these institutions since it will hit the bottom line and that's all they understand.

superdestroyer

Isn't this just a symptom that large organizations just do not develop the processes or the culture to support large ventures. The government, the banks, the schools all lose paperwork or fail to fill it out.

However, the costs of the lost of billions of loan dollars will hurt more than the banks. As pointed out above, this is like the Death of Common Sense. People are suing banks without realizing that their investment or retirement are tied up in the same type of investments.

I wonder how many of the lucky new homeowners will end up treating it like a lottery ticket or remortage everything hoping to get lucky a second time.

DLS

"What do you mean by that?"

That it was Drain that did it negates any suspicion that it was some activistic, impetuous no-name judge.

DLS

"Problem with 'giving people their homes' is that it begs the question of why not give everyone a free home ?"

Nobody sane demands that everyone be given "their" homes. (Or huge checks, as also would be "merited.")

No, lefties. There are no grounds for a Jubilee (especially prior to the next elections).

DLS

"I wonder how many of the lucky new homeowners will end up treating it like a lottery ticket or remortage everything hoping to get lucky a second time."

[snicker] It's too late for those who were foreclosed and had to leave -- they merely trashed the houses.

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