Looming losses from ForeclosureGate qualify as the sort of systemic risk warranting the breakup of the too-big-to-fail banks under the new financial reform bill.
The new Financial Stability Oversight Council (FSOC) probably didn't expect to have its authority called on quite so soon, but Rep. Alan Grayson (D-Florida) has just put the Kanjorski amendment to the test. It provides federal regulators with new powers to pre-emptively break up large financial institutions that - for any reason - pose a threat to US financial or economic stability.
On October 7, Representative Grayson wrote a letter to the heads of the regulatory agencies tasked with cleaning up the fallout from the financial sector meltdown and preventing another catastrophe, asking for an emergency task force on foreclosure fraud.
"The liability here for the major banks is potentially enormous, and can lead to a systemic risk. Fortunately, the Dodd-Frank financial reform legislation includes a resolution process for these banks," Representative Grayson wrote, suggesting the government assert its new powers.
Calls for swift action to guard against foreclosure fraud have gained traction amid mounting revelations of systematic and widespread abuse by lenders against borrowers.
Grayson is seeking a foreclosure moratorium on all mortgages originated and securitized between 2005-2008, until such time as the FSOC task force is able to understand and mitigate the systemic risk posed by the foreclosure fraud crisis. Representative Grayson's letter continued:
"The banks didn't keep good records, and there is good reason to believe in many if not virtually all cases during this period, failed to transfer the notes, which is the borrower IOUs in accordance with the requirements of their own pooling and servicing agreements. As a result, the notes may be put out of eligibility for the trust under New York law, which governs these securitizations. Potential cures for the note may, according to certain legal experts, be contrary to IRS rules governing REMICs. As a result, loan servicers and trusts simply lack standing to foreclose. The remedy has been foreclosure fraud, including the widespread fabrication of documents.
There are now trillions of dollars of securitizations of these loans in the hands of investors. The trusts holding these loans are in a legal gray area, as the mortgage titles were never officially transferred to the trusts. The result of this is foreclosure fraud on a massive scale, including foreclosures on people without mortgages or who are on time with their payments." [Emphasis added.]
Allegations of coordinated fraud are not just political rhetoric. The situation, which has come to be known as "ForeclosureGate," has prompted attorneys general in all 50 states to launch investigations while some of the largest banks in the country have placed a temporary freeze on foreclosure proceedings.
Why Wasn't It Done Right in the First Place?
That raises the question, why were the mortgage notes not assigned to the trusts in the first place?
Representative Grayson says the banks were not interested in repayment; they were just churning loans as fast as they could in order to generate fees.
Securities expert Karl Denninger sees an attempt to hide the paper trail. "I believe a big part of why it was not done is that if it had been done, the original paperwork would have been available to the trustee and ultimately the MBS owners, who would have immediately discovered that the representations and warranties as to the quality of the conveyed paper were being wantonly violated," Denninger said, adding, "you can't audit what you don't have."
Both Representative Grayson and Denninger are probably right, yet these explanations seem insufficient. If it were just a matter of negligence or covering up dubious collateral, surely some of the assignments by some of the banks would have been done properly. Why would they all be defective?
The reason the mortgage notes were never assigned may be that there was no party legally capable of accepting the assignments. Securitization was originally set up as a tax dodge; and to qualify for the tax exemption, the conduits between the original lender and the investors could own nothing. The conduits are "special purpose vehicles" set up by the banks, a form of Mortgage Backed Security called REMICs (Real Estate Mortgage Investment Conduits). They hold commercial and residential mortgages in trust for the investors. They don't own them; they are just trustees.
The problem was nailed in a class action lawsuit recently filed in Kentucky, which accuses banks of violating the famous Racketeering Influenced and Corrupt Organizations Act - also known as RICO - a law originally passed to go after organized crime.
The suit claims that Mortgage Electronic Registration Systems (MERS) and the banks violated the RICO Act, a law originally passed to prosecute organized crime. Heather Boone McKeever, a Lexington, Kentucky-based lawyer for the homeowners who are bringing suit, said in an interview with Bloomberg, "RICO comes in because the fraud didn't just happen piecemeal. This is organized crime by people in suits, but it is still organized crime. They created a very thorough plan."
The complaint alleges:
53. The "Trusts" coming to Court are actually Mortgage Backed Securities ("MBS"). The Servicers, like GMAC, are merely administrative entities which collect the mortgage payments and escrow funds. The MBS have signed themselves up under oath with the Securities and Exchange Commission ("SEC,") and the Internal Revenue Service ("IRS,") as mortgage asset "pass through" entities wherein they can never own the mortgage loan assets in the MBS. This allows them to qualify as a Real Estate Mortgage Investment Conduit ("REMIC") rather than an ordinary Real Estate Investment Trust ("REIT"). As long as the MBS is a qualified REMIC, no income tax will be charged to the MBS. For purposes of this action, "Trust" and MBS are interchangeable....
56. REMICS were newly invented in 1987 as a tax avoidance measure by Investment Banks. To file as a REMIC, and in order to avoid one hundred percent (100%) taxation by the IRS and the Kentucky Revenue Cabinet, an MBS REMIC could not engage in any prohibited action. The "Trustee" can not own the assets of the REMIC. A REMIC Trustee could never claim it owned a mortgage loan. Hence, it can never be the owner of a mortgage loan.
57. Additionally, and important to the issues presented with this particular action, is the fact that in order to keep its tax status and to fund the "Trust" and legally collect money from investors, who bought into the REMIC, the "Trustee" or the more properly named, Custodian of the REMIC, had to have possession of ALL the original blue ink Promissory Notes and original allonges and assignments of the Notes, showing a complete paper chain of title.
58. Most importantly for this action, the "Trustee"/Custodian MUST have the mortgages recorded in the investors name as the beneficiaries of a MBS in the year the MBS "closed." [Emphasis added.]
Only the beneficiaries - the investors who advanced the funds - can claim "ownership." And the mortgages had to have been recorded in the name of the beneficiaries the year the MBS closed. The problem is, who ARE the beneficiaries who advanced the funds? In the securitization market, they come and go. Properties get sold and resold daily. They can be sliced up and sold to multiple investors at the same time. Which investors could be said to have put up the money for a particular home that goes into foreclosure? Because of the extraordinarily complex way these mortgages were packages, sold and resold, the answer to these questions are difficult (and may be impossible) to find.
MBS are divided into "tranches" according to level of risk, typically from AAA to BBB. The BBB investors take the first losses, on up to the AAAs. But when the REMIC is set up, no one knows which homes will default first. The losses are taken collectively by the pool as they hit; the BBBs simply don't get paid. But the "pool" is the trust; and to qualify as a REMIC trust, it can own nothing.
The lenders were trying to have it both ways; and to conceal what was going on, they dropped an electronic curtain over their sleight of hand, called Mortgage Electronic Registration Systems or "MERS." MERS is simply an electronic data base. On its web site and in assorted court pleadings, it, too, declares that it owns nothing. It was set up that way so that it would be "bankruptcy-remote," something required by the credit rating agencies in order to turn the mortgages passing through it into highly rated securities that could be sold to investors. According to the MERS web site, it was also set up that way to save on recording fees, which means dodging state statutes requiring a fee to be paid to establish a formal record each time title changes hands.
The arrangement satisfied the ratings agencies, but it has not satisfied the courts. Real estate law dating back hundreds of years requires that, to foreclose on real property, the foreclosing party must produce signed documentation establishing a chain of title to the property; and that has not been done. Increasingly, judges are holding that if MERS owns nothing, it cannot foreclose, and it cannot convey title by assignment so that the trustee for the investors can foreclose. MERS breaks the chain of title so that no one has standing to foreclose.
Sixty-two million mortgages are now held in the name of MERS, a ploy that the banks have realized won't work; so Plan B has been to try to fabricate documents assigning the properties to the investment trusts after the fact. Enter the robo-signers, who signed thousands of documents a month without knowing what was in them. Interestingly, it wasn't just one bank engaging in this pattern of cover-up and fraud, but many banks, suggesting the sort of "organized crime" that would qualify under the RICO statute.
But that ploy won't work either, because it's too late to assign properties to trusts that have already been set up without violating the tax code for REMICs, and the trusts themselves aren't allowed to own anything under the tax code. If the trusts violate the tax laws, the banks setting them up will owe millions of dollars in back taxes. Whether the banks are out the real estate or the taxes, they could well be looking at insolvency, posing the sort of serious, systemic risk that would bring them under the purview of the new Financial Stability Oversight Council.