Update 2: Yves Smith points out that this is a narrow ruling that is largely about MA law:
The judges based their ruling strictly on Massachusetts law issues, and did not opine on the New York trust law issues we have highlighted. The ruling emphasized the horrible job the banks did in protecting and documenting their ownership interest and the overall carelessness of the securitization process. Massachusetts. law is somewhat unique in requiring that not only the note (the borrower IOU) be assigned correctly, but also that the lien (the so-called mortgage, or deed of trust) also be conveyed properly.
As such, my generalizations may prove to be unfounded at this time. She (and her commenters) conclude that it is more a sign of the general weakness of securitization rather than a coup de grace and to expect more lawsuits that target the issues I discuss below.
Update: Calculated Risk says that the concurring opinion has specifics that argue this is not a systemic risk. However, as noted below, this is true in a narrow sense. The “but it’s a simple paper work” argument would be true if there was not systemic fraud in the actual mortgages themselves, but forcing the entire process to open up to do proper assignment will shine light on the systemic corruption that has been widely reported by the (few) audits done directly on the loan portfolios. Doing the reassignment will give a chance for the trusts to argue that the terms of the securitization were invalid and request putbacks. So in the end the ruling provided a direct and simple (albeit costly) resolution to the problem, but it is one that the banks were trying to avoid at all costs. If it is followed through then the greater points about property rights will be addressed, at the cost of exposing the size of the balance sheet holes.
Remember how a few months back there was a big flareup about the point that most mortgages weren’t properly assigned into their securitization trusts and there was systemic fraud? Yeah well none of that was ever actually resolved, contrary to the banks’ pronouncements that it wasn’t a big deal and therefore case closed.
Well now the Massachusetts Supreme Court has ruled that the securitization process was invalid when reviewing a case that was fighting a foreclosure. In the most narrow sense, this means that the particular foreclosures are overturned and opens the way for many more state foreclosures to be overturned as well. In the more general sense, Bloomberg notes that it opens up the banks to lawsuits from the trusts that will force them to buyback all the mortgages that were improperly transferred, which by many accounts is nearly all of them. Lastly, Yves Smith notes that the ruling will most likely be used as a pattern when deciding cases in other states and that people that were foreclosed upon may be able to sue for damages.
This brings up some important questions:
- What happens to the people that are in foreclosure but still in their houses? From what I’ve read people aren’t entirely sure, as it’s agreed that they still legally owe money but there is argument about whether the mortgage would still be technically asset backed. One camp believes that technically the mortgages would become unsecured loans.
- What happens to the people that have already lost their homes, and to the people that bought them? If you follow the letter of the law then the chain of title has been broken and the new owners don’t actually own the property.
- Will banks be forced by the trusts to buy back the mortgages at par (which the trusts will want) and how large will it be? Potentially in the trillions of dollars…
- How systemic is the problem? Well even more to the point, how large is the problem in the absolute sense, not just the paperwork sense. There are many affidavits coming out that there is widespread fraud in order to make up the legal paperwork chain when needed, so just because the banks say that there aren’t problems doesn’t mean anything.
- Will the government investigate and prosecute cases of fraud? The state AGs got together and said that they would open a criminal inquiry into cases of paperwork fraud but recently backed off that promise. However, after this ruling homeowners will have lots of motivation to attack the integrity of the paperwork chain so this will put heat on the whole apparatus and eventually the AGs I’d imagine.
- Will Congress step in and make blanket laws to “fix” the problem? This has been the whispered resolution of the whole mess from the beginning, but would be an infringement on the state based nature of property law that has existed from the beginning.
This brings up the excellent article written by Matt Taibbi (in his usual bombastic style) about foreclosure mills in Florida. This passage is too true:
Now all of this — the obviously cooked-up documents, the magically appearing stamp and the rest of it — may just seem like nothing more than sloppy paperwork. After all, what does it matter if the bank has lost a few forms or mixed up the dates? The homeowners still owe what they owe, and the deadbeats have no right to keep living in a house they haven’t paid for.
But what’s going on at the Jacksonville rocket docket, and in foreclosure courts all across the country, has nothing to do with sloppiness. All this phony paperwork was actually an essential part of the mortgage bubble, an integral element of what has enabled the nation’s biggest lenders to pass off all that subprime lead as AAA gold.
In the old days, when you took out a mortgage, it was probably through a local bank or a credit union, and whoever gave you your loan held on to it for life. If you lost your job or got too sick to work and suddenly had trouble making your payments, you could call a human being and work things out. It was in the banker’s interest, as well as yours, to make a modified payment schedule. From his point of view, it was better that you pay something than nothing at all.
But that all changed about a decade ago, thanks to the invention of new financial instruments that magically turned all these mortgages into high-grade investments. Now when you took out a mortgage, your original lender — which might well have been a big mortgage mill like Countrywide or New Century — immediately sold off your loan to big banks like Deutsche and Goldman and JP Morgan. The banks then dumped hundreds or thousands of home loans at a time into tax-exempt real estate trusts, where the loans were diced up into securities, examined and graded by the ratings agencies, and sold off to big pension funds and other institutional suckers.
Even at this stage of the game, the banks generally knew that the loans they were buying and reselling to investors were shady. A company called Clayton Holdings, which analyzed nearly 1 million loans being prepared for sale in 2006 and 2007 by 23 banks, found that nearly half of the mortgages failed to meet the underwriting standards being promised to investors. Citigroup, for instance, had 29 percent of its loans come up short, but it still sold a third of those mortgages to investors. Goldman Sachs had 19 percent of its mortgages flunk the test, yet it knowingly hawked 34 percent of the risky deals to investors.
Since these mortgage-backed securities paid much higher returns than other AAA investments like treasury notes or corporate bonds, the banks had no trouble attracting investors, foreign and domestic, from pension funds to insurance companies to trade unions. The demand was so great, in fact, that they often sold mortgages they didn’t even have yet, prompting big warehouse lenders like Countrywide and New Century to rush out into the world to find more warm bodies to lend to.
In their extreme haste to get thousands and thousands of mortgages they could resell to the banks, the lenders committed an astonishing variety of fraud, from falsifying income statements to making grossly inflated appraisals to misrepresenting properties to home buyers. [MY NOTE: the meme that the subprime crisis is primarily one of borrower fraud has been widely shown to be incorrect as the majority of fraud occurred somewhere in the lender side of the chain.] Most crucially, they gave tons and tons of credit to people who probably didn’t deserve it, and why not? These fly-by-night mortgage companies weren’t going to hold on to these loans, not even for 10 minutes. They were issuing this credit specifically to sell the loans off to the big banks right away, in furtherance of the larger scheme to dump fraudulent AAA-rated mortgage-backed securities on investors. If you had a pulse, they had a house to sell you.
In short, all of this was a scam — and that’s why so many of these mortgages lack a true paper trail. Had these transfers been done legally, the actual mortgage note and detailed information about all of these transactions would have been passed from entity to entity each time the mortgage was sold. But in actual practice, the banks were often committing securities fraud (because many of the mortgages did not match the information in the prospectuses given to investors) and tax fraud (because the way the mortgages were collected and serviced often violated the strict procedures governing such investments). Having unloaded this diseased cargo onto their unsuspecting customers, the banks had no incentive to waste money keeping “proper” documentation of all these dubious transactions.
“You’ve already committed fraud once,” says April Charney, an attorney with Jacksonville Area Legal Aid. “What do you have to lose?”
Taibbi elucidates the core point that all the spin about paper work and blaming the borrowers is an attempt to obfuscate the core issue that unmitigated greed and goverment/rating agency acquiescence was at the heart of the financial meltdown, yet there have been no prosecutions and Wall Street bonuses are hitting new records; not to mention that the number of financial sector people at the highest levels of government is continuing to increase.
In their haste to blow the biggest bubble in history, they relied on “standards” that were created on the fly and are against centuries of established property law. This has led to a fundamentally unjust situation. Unjust because some homeowners are acting in good faith and losing their homes while some are not acting in good faith and staying in them; it’s nearly impossible to tell the difference between the two. Unjust because the chain of title has been broken which not only invalidates future transfers but opens up the path for multiple claims on the same property as there is anecdotal evidence that many mortgages were sold off multiple times into trusts. Unjust because of the repercussions for pensions and investments both domestic and international that were hoodwinked into buying “safety” based on a lie. And most of all unjust because if we were ever to be honest about the situation in its clear terms, our entire financial system would be on the brink of collapse yet again and trillions more in bailout money would be demanded. So we are covering our eyes to see no evil and thus implicitly endorsing the immense moral bankruptcy that led to the problem in the first place…which of course will be repeated again.
This ruling is another chance to set off events to peel back the veil.
Update: Just yesterday Yves Smith noted: “the US trustee, which is a Department of Justice overseer of bankruptcy courts, in two cases in Albany, New York…has filed responses which are effectively in support of the debtor (the bankrupt borrower) and in opposition to creditors, which in this case are servicers claiming to act on behalf of securitization trusts. The issue? The parties trying to foreclose haven’t presented a document trail that the bankruptcy trustee finds persuasive.”