Janet Tavakoli
Obviously banks that kept their own sound mortgage originations or always properly handle the paperwork won’t have any problem. For the rest, courts will enforce the law, which means there must be full recording of note transfers (the deed of trust and the promissory note). Again, there won’t be a problem with many mortgages if the paperwork was properly transferred. But I believe there was a NJ judge who found more than 40% of the foreclosure docs weren’t in order, but he didn’t keep track of how many were later successful after having obtained the necessary docs.
[Obviously, banks made their self-inflicted plight worse by 1) forging docs or presenting fraudulent docs and 2) aggressively trying to seize property.]
Regarding securitizations - the problem with this multi-faceted fraud is that securitization “professionals” got so sloppy with the necessary documentation that perfecting the security interest in the collateral was among the many things not done properly, but it is unclear how many mortgages are affected. There is so little transparency, that I cannot say, and if anyone else is saying they know, I’d like to know how they arrived at their conclusions. Ironically, the banks that enabled fraud-riddled mortgage lenders are the ones having the most problems with the documentation, and that is no surprise.
What happens next?
Really, it’s a mess, and no one is exactly sure. I believe it is likely the following will happen. First, if a “lender” tries to foreclose, it will have to have the proper signed paperwork showing it has the right to foreclose. If the note transfer wasn’t recorded, the bank can’t foreclose. But this is the most fundamental part of banking, so it is entirely the banks’ fault. We know how much they love “sanctity of contracts” when it comes to bonus agreements, so the same applies here.
But it doesn’t mean the borrower doesn’t owe money. Obviously there will be records of payment and loan statements and evidence of delinquency. It will be difficult for the borrower to deny the existence of the debt and the obligation to pay. [If it is in doubt to whom the money is owed, then courts might put future payments in escrow, but it seems likely that it will be easier to establish debt/payment than foreclosure rights. Really, I don’t know, but to say the loan will be unenforceable when one can prove payments were made, doesn’t seem like it will fly in the courts.] But absent proper paperwork, a bank cannot take a house in satisfaction of the debt, so the bank will be an unsecured creditor. Once this is established as the case, if the borrower has the wherewithal to pay on say, a reduced principal balance and a lower fixed coupon, then the borrower will be in an excellent position to renegotiate the terms of the loan by offering to sign a properly documented mortgage. This may succeed where HAMP failed. I’m not saying it will be easy to sort this out, only that this has potential.
In some cases, the borrower is a hopeless case, now unemployed, broke, and drowning in credit card debt and other debts. Yet, a bank cannot seize the house, and the borrower still owes the money. In that case, it might be a good idea to negotiate a deal with the bank. Take the house, but erase all credit blemishes, and if the loan balance exceeds the recovery on the house, then the bank has to eat the loss with no blemish on the borrower.
Obviously, I don’t have the answer to the problem, and nothing suggested so far to courts (by the banks) is as reasonable as the above, but we’ll have to see what develops. In any case, states will insist that everyone follow the law.
This fits with the expectations summarized by Adam Levitin during Citi's recent call with clients on the same issue, which we posted on previously. On the other hand, as even as benign outcome will likely mire the legal system for years in sundry legal cases, and result in a major impairment to the banks, we would not be surprised if the administration does nonetheless opt for a shotgun approach seeking wholesale settlements, which Levitin summarized as the possibility of “some payment” being exacted from the lenders and servicers, followed up by the Administration bargaining for more mortgage principal write downs, which will force a broad-based reduction in wholesale private sector debt. Whether that approach has any success of passing is likely mostly correlated to the president's approval rating. Unfortunately, per the latest Reuters/Ipsos, Obama's disapproval rating is currently at 53%, the highest since he took office, and that 63% of Americans say country on wrong track, highest since Obama took office. So, alas, a shotgun solution is certainly not looking good.
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