Sonya Robison, who faces a foreclosure suit, sits in her home in Yoder, Colorado. More and more homeowners are demanding legal recourse over bank missteps. (Photo: Kevin Moloney / The New York Times)
Whose moral hazards, which moral buzzards?
Is it a good idea to let the foreclosures roll on? Absolutely, say the banking and mortgage industries, among others. "Home repo" is critical to economic recovery, they argue. Stopping foreclosures would cut the legs off of a still wobbly rebound. In the industry's view, the fewer foreclosures, the fewer resales; the fewer resales, the more depressed the home prices and the greater the losses; the greater losses, the less capital to lend. And we are back on the precipice of depression.
There are many ironies in the disaster of mortgage securitization - the process that turns mortgages into tradable investments. Consider how legal and moral obligations have served the wealthy and disadvantaged everyone else. "Moral hazard" makes it taboo to "forgive" the debt of "underwater" borrowers, whose mortgages amount to more than their home value. Letting them out of their obligations would only encourage them to continue to live beyond their means, borrowing more than they can afford, believing there are no adverse consequences. On the other hand, "moral hazard" did not deter the trillion-dollar plus bailout of Bear Stearns, Citibank, Goldman Sachs, AIG, their Wall Street wannabes and hundreds of multibillion-dollar hedge fund entrepreneurs. The latter were too big to fail, which trumps "moral hazard." Borrowers were not.
Every week, federal government prosecutors bring mortgage fraud indictments against desperate con artists for cheating on loan applications. But not one bank executive has been charged for his or her role in the signature, "systemic," economic crime in American history. If a loan officer persuades you to inflate your income by $25,000, you may both go to prison. But bury $60 billion in mortgage-derived "toxic assets" in "off-balance sheet" accounts (as did Citibank), or "insure" trillions of dollars in potential losses on the same "assets" without setting aside ten cents in reserves (as did AIG) and you go skiing in Aspen.
Americans in the 21st century have experienced the most massive and noxious expropriation of wealth by the top from the bottom since slavery. It is theft of an entirely new boldness and magnitude. The country is only now beginning to feel the fuller deprivation from this grandest of larcenies.
The latest episode, so-called "robo-signing" foreclosures, brings mortgage securitization home to roost. Financial institutions have routinely used false affidavits to foreclose on the homes of delinquent debtors. To get the courts to approve disputed foreclosures, the banks have claimed in sworn statements that they own the specific note (the IOU) and mortgage. In fact, the same mortgage loan rights passed through so many hands, without any reliable paper trail, that banks do not know who owns what. Once "robo-signing" became widely acknowledged in October 2010, several banks declared a "moratorium" on further foreclosures. They claimed they needed time to straighten out what they dismissed as "sloppy paperwork" and "technical errors." But robo-signing - "perjury," to be precise - is not any mistake. It is a late-stage symptom of unregulated mortgage securitization.
Instead of providing a cogent explanation, the financial services industry, federal government and corporate media have obscured the origins and consequences of the real estate securitization debacle. Indeed, the fragmentary official story has been built on myths - that the "bubble" just happened, a side effect of America's irrational exuberance and irrepressible innovation; that the Wall Street experts who traded mortgage and real estate "assets" and "derivatives" every day for years, making huge profits along the way, did not understand what they were dealing in; and that a lot of the blame rests on irresponsible borrowers, who should have known they could not afford to borrow the money the loan originators were pushing on them. The political and industry players, moreover, are now burying events under a mound of committees, task forces, agency studies and entirely new federal bureaucracies. Most absurdly, they have decreed that the "Great Recession" ended in June 2009. The banks and their protectors do not want ordinary Americans to think about the securitization racket - or to learn just how badly they've been taken. The message is emphatic: Nobody understands the reasons for the economic crisis. Surely, working Americans should not waste time in the futile task of trying to unravel the impossibly complex interplay of exotic economic, financial and legal transactions and arrangements.
Admittedly, it may be difficult to believe that a small group of wealthy businesses, assisted by their patrons and political cabin boys, stole trillions of dollars from tens of millions of Americans. It may also be hard to accept that the scheme depended on duping middle-class America to borrow from itself and pay Wall Street exorbitant interest rates and fees for the privilege. But there is nothing complicated about how they did it.
It is as simple as "Stick 'em up!"
How Do We Know Who Owns the Mortgage and Why Does It Matter?
When a buyer borrows money to pay for a house, the lender loans the cash in exchange for a note (spelling out repayment schedules, interest rates, and so on) and a mortgage on the property. If the homebuyer does not pay on time, the bank (or other business) owning both note and mortgage can foreclose. Logically, the bank has to prove that it alone has the right to foreclose. That usually means submitting evidence of the original note, the original mortgage and official records from the registry of deeds to show that there are no conflicting claims to the property. The laws of most states require mortgages and subsequent assignments to be recorded in the name of the mortgage holder in a designated public registry. Indeed, the enforceability and relative priority of a mortgage depends on its recording in the public record. These recording systems are based on the venerable legal principle of notice - that it is inequitable to permit one claiming a superior, but hidden, right in real property to deprive a later "good faith" buyer or lender of his property interest.
For centuries, the legal technicalities of "conveyancing" - the transference of title and recording of interests in real property - ably served the interest of lenders. When lending money, banks want to know that they will be able to seize the property if the borrower does not pay (or know that they will not be able to, or be in "second place" behind an earlier mortgage and decide whether to make the loan anyway). Real property can be loaded up with all sorts of rights and interests and claims - liens, easements, litigation, fractional ownerships, things real estate lawyers call "encumbrances" or "clouds on title." If the buyer defaults, the banks do not want to slog through expensive legal brawls with other banks, the town, the IRS or others claiming some superior right. They want to grab the property, sell it and get as much of their money back as they can. Over time, all the states developed elaborate technical regulations for performing and recording real property transactions. These technicalities suited the banks just fine - until they became an impediment to greater profits.
What Does Mortgage Securitization Accomplish?
In the 1980s, some genius - many claim it was Louis Raneiri of Solomon Brothers, one of the "greatest innovators" of the 20th century, according to Businessweek - figured out a way to make lots of money with little risk by marrying the real estate market to the securities market. Basically, in a "securitization," the original lender sells the note and mortgage to a buyer, who ultimately sells them - as part of a pool of mortgages - to a trust. In between, the same mortgages and notes are often bought and sold several times. The trust, in turn, issues "mortgage-backed securities" (MBS) in the form of certificates to investors. The mortgages themselves are supposed to secure the investors' ability to collect - hence, "mortgage backed."
From a bird's-eye view, a securitization looks like two parallel rivers of cash running in opposite directions. One river flows from certificate investors through a trust to the original lenders and on to homebuyers in the form of loans. In the other direction, principal and interest payments from the homeowners flow into the trust and, ultimately, on to investors in the form of dividends and redemptions. In the middle stand the trust and the "servicer," which collect the mortgage payments and pay them out to the investors.
The lenders, banks, Wall Street investment banks, an entire multi-layered industry of financial intermediaries, all make money in mortgage securitization by essentially skimming fees and trading profits from the cash flowing in both directions. As in any skimming operation, to make real money, the industry needs volume and velocity. The stodgy business of recording mortgages at dusty, old registries, waiting for all that Dickensian-era paperwork, puts a drag on the cash flows. Why should big finance sip from a trickling brook while great lakes of money lay dammed up behind "conveyancing" rituals? The solution was simple: the mortgage securitization industry abandoned the centuries-old laws and practices governing real estate transactions. Instead, in 1995, they created "MERS" - the Mortgage Electronic Registration System - ostensibly to keep track of who owned what by database.
In theory, MERS is an enormous virtual registry of deeds, where sellers and buyers record mortgage transfers at light speed. To make things easier, the banking consortium that created MERS denominated MERS as the "legal" owner of most mortgages. In the authoritative public records, "MERS" is recorded as the mortgage owner - even though it has no bona fide ownership interest whatsoever. Once a mortgage is entered in MERS, it may be assigned and reassigned multiple times to different owners. But no record of those transactions is made in the actual land registries. Today, it is estimated that MERS nominally owns at least 60 percent of residential mortgages by dollar amount and well over 50 million in number.
Tossing aside the conveyancing system proved to be stupid. When the banks (via the "servicers"), behind the mask of MERS, started to foreclose on early subprime loan defaults in 2006, judges across the country began to ask the "plaintiff" a basic question: "Who the hell are you?" Although "legal" owner of the mortgage, MERS owns nothing. It has no more right to bring a foreclosure action than the registry of deeds, the institution it was meant to displace.
More critically, the volume and velocity of mortgages churning through the belly of the securitization beast destroyed any credible chain of ownership. Many banks (and servicers) do not have the notes and mortgages. They don't know where they are. They do not know how to find them. There are no official records that establish their ownership. An official of Countrywide, the biggest supplier of subprime mortgages to the securitization market, recently admitted that the company did not transfer the notes when selling the mortgages.
The size of this big, bank-made mess is not known. But mess it is. Some foreclosing banks may possess the notes (the right to the loan payments), but not the mortgage (the right to foreclose); others may have the mortgages, but not the notes; some may have neither; others may have both - but only as a matter of fortuity. Under these circumstances, "robo-signing" - affidavits falsely attesting to ownership or "loss" of the documents - was the only way many banks could foreclose. The Congressional Oversight Panel in a recent report concluded that the industry's reliance on the MERS process could "in an extreme scenario, call into question the validity of 33 million mortgage loans."
For What Does a Bank Profit?
If the state courts apply the law (as many have already done), the banks and others whose mortgage is recorded only in MERS will not be able to foreclose, usually a speedy and cheap legal action. The banks, of course, can sue homeowners who actually owe the money. Without evidence of an enforceable mortgage, however, they will not be able to seize and sell the property in a relatively short period of time. Most delinquent homeowners don't have any assets other than their homes. To collect anything, the banks will face expensive and uncertain litigation over property claims - the same headaches that the old conveyancing technicalities had helped them avoid. The Congressional Oversight Panel's report summarizes the worrisome possibilities:
Clear and uncontested property rights are the foundation of the housing market. If these rights fall into question, that foundation could collapse. Borrowers may be unable to determine whether they are sending their monthly payments to the right people. Judges may block any effort to foreclose, even in cases where borrowers have failed to make regular payments. Multiple banks may attempt to foreclose upon the same property. Borrowers who have already suffered foreclosure may seek to regain title to their homes and force any new owners to move out. Would-be buyers and sellers could find themselves in limbo, unable to know with any certainty whether they can safely buy or sell a home. If such problems were to arise on a large scale, the housing market could experience even greater disruptions than have already occurred, resulting in significant harm to major financial institutions. For example, if a Wall Street bank were to discover that, due to shoddily executed paperwork, it still owns millions of defaulted mortgages that it thought it sold off years ago, it could face billions of dollars in unexpected losses.
To understate the obvious, hundreds of billions more in uncollectible loans pose immense "systemic risk." Add that to a financial industry that has been chronically insolvent due to several hundreds of billions of dollars in unrecognized losses. Under pressure of the banking industry and a compliant Congress, the accounting-standard setters changed the rules in 2008 to permit the banks to avoid writing down "toxic assets" (the same "mortgage-backed" and derivative securities they peddled) based on nothing more, in substance, than the wish to avoid write-downs. At the same time, the money the government gave to the "too big to fail" investment houses in the first wave of bailouts helped them acquire weaker banks and other "assets." They have become "too big"ger than ever. Mountains more bad debt on top of a super-consolidated, debt-ridden industry spells catastrophe.
Who Bought All Those "Securities?"
If the Wall Street banks and others selling "mortgage-backed" securities in fact sold "nothing-backed" securities, the buyers, who poured huge volumes of cash into these "AAA"-rated investments, bought the illusion of "mortgage-backed" securities. The illusion held and even paid dividends, as long as the financial industry kept the securitization riverboat afloat. Like a lot of greed-driven and morally-rudderless "innovations," however, the MBS illusion was doomed to capsize. A bad market, like a falling tide, not only lowers all ships. It exposes the crap under the surface.
But the question remains: Who bought the MBS? Who were all those fools who believed that their right to collect a fraction of thousands of strangers' monthly home loan payments could be enforced by mortgages?
Congratulations, Middle America: You Were
Working Americans bought MBS through pension plans, mutual funds, 401(k) plans, local governments, insurance companies and a large stable of community and regional banks, both by direct investment and through the Federal Home Loan banks. Of course, they were not alone. Wall Street peddled MBS throughout the world and sold them to foreign institutions, banks and "sovereign wealth funds." The big banks themselves ate some of their own cooking, most notably Citigroup. But they were too savvy to be long-term investors. Instead, like Roman nobles, they gorged, then purged, in gross quantities, never holding much for very long, buying MBS to stuff into "collateralized debt obligations" and selling among themselves and to others. When the vomitorium closed on September 16, 2008 - the day Lehman Brothers filed for bankruptcy - many of the banks were bloated with not so "mortgage-backed securities" (although, as noted, they haven't had to write off much of this since the accounting rules were changed to accommodate them).
It is impossible to exaggerate the cunning (short-sighted as it was) by which Wall Street and its social-register patrons sucked wealth from working people through mortgage securitization. Middle- and lower-middle class Americans essentially borrowed their own money at usurious interest rates to buy their own houses at absurdly hyped prices. Once those prices started to deflate, Americans lost both their home equity and the value of their 401(k)s, mutual funds, pension investments, and so on. More accurately, the "recession" revealed that Wall Street had swindled Americans to trade in the real value of their homes and retirement accounts in exchange for counterfeit wealth. Wall Street gave America a phony two-dollar bill for every real dollar America gave to Wall Street. The coup de grace came in the various bailouts - in substance, working Americans bought over a trillion dollars more of the same "AAA"-rated fraudulent bonds they had already purchased at the same bogus prices.
The Goldman Sachs and Bank of Americas should be crucified for selling "nothing-backed" securities at inflated prices to finance loans at inflated prices. For once, existing law strongly favors working Americans, victimized at both ends of the racket. Thanks to their own greed, the banks should be legally unable to collect on all those delinquent loans from struggling borrowers. For that very same reason, they also face massive legal exposure to those who bought MBS. It is basic securities law that if A sells B a security by means of a "material misrepresentation," B has the legal right to "rescind" the sale and get his money back. Now that it looks like there were no mortgages backing the mortgage-backed securities, all those pension plans, mutual funds, local governments, small banks, and so on should be able to "rescind" those transactions and recover their investments. Scores of such lawsuits have already been filed.
The irony is gratifying to contemplate: Because the banks cannot collect the money working Americans borrowed, they will have to return (again, indirectly) the money they stole from those Americans to loan in the first place.
The Bigger They Are, the More They Can't Fail
Unfortunately, the financial industry's comeuppance probably will never arrive. Despite the law, justice and the irrefutable theft of their money and resources, the "too big to fail" hammer is bound to come down on "Main Street's" plea for legal protection and redress. From the moment the "robo-signing" scandal broke, the financial industry has been arguing to its well-trained politicians that any compelled moratorium on foreclosures will crush the fragile economic recovery. Worse, if working people are allowed to use the laws that have been on the books for hundreds of years, the argument goes, the financial system will be pushed into the abyss - and drag the rest of the economy with it.
The Obama administration has already made it clear that it will not allow overburdened homeowners to thrust America into more "systemic risk." In October, Obama's Housing and Urban Development Secretary, Shaun Donovan, succinctly demonstrated in a Huffington Post piece what Americans can expect when "moral hazard" meets "too big to fail." Regarding robo-signing, he wrote: "The notion that many of the very same institutions that helped cause this housing crisis may well be making it worse is not only frustrating - it's shameful ... But a national, blanket moratorium on all foreclosure sales would do far more harm than good - hurting homeowners and home buyers alike at a time when foreclosed homes make up 25 percent of home sales."
It is perverse that the nation's highest official for housing thinks that families will be "harmed" if allowed to stay in their homes instead of getting thrown into the street. Moreover, the Kool Aid consumed by those arguing that foreclosure freeze is stifling home sales must be softening their mental faculties. The chaos in residential property ownership records leaves most of today's potential "home buyers" clueless as to whether they are buying a house with good title. Except for speculators and the chronically gullible, potential homebuyers should wait for "clean title" - either through reliable proof in the specific instance (not likely to come) or by some arbitrary legislative fix of the system.
It is a myth that US economic survival depends on Goldman Sachs and JP Morgan and UBS and Bank of America and so on. But Henry Paulson, Tim Geithner and others turned the myth into reality by using it to justify the massive bailouts and guarantees the United States government gave and continues to give those Olympian figures of finance. "Too big to fail" has become a "fact on the ground." The question now, then, is not whether the myth will prevail. No matter how compelling, there are no facts or arguments that can outmuscle "too big to fail." What remains to be seen is how the powerful will quash the rights of delinquent homeowners and defrauded investors.
While there are many possibilities, in the short term, it is likely that the politicians will wait and see if the courts do the dirty work for them. They should not be optimistic. The courts in general have been barring or at least slowing down MERS-tainted foreclosures. The trend suggests that the judges will protect debtors' rights. No matter how clear and precise, however, the law often is too flimsy a restraint to prevent a judge from reaching conclusions for the sake of desired outcomes. We have yet to see how the courts will respond to heavy-handed government claims that continued insistence on technicalities of title threatens global economic collapse. But in the event that the courts continue to bar robo-foreclosures and allow investor rescission suits to proceed, the Congress and White House can be counted on to come up with legislation that, ostensibly for the greater good and to prevent economic collapse, crushes the claims of working Americans.
The irony of "moral hazard," as a policy argument for robo-foreclosure, is that it has nothing to do with morality. The "hazard" is that the lesser classes will start to view economic relations just as the rich and the "too big to fail" do - that contract obligation is for suckers. The wealthy and their banks maintain their status only through the general willingness of members of the subordinate strata to pay their debts. Fear ensures that the mass of hapless debtors continue voluntarily to fund Wall Street's standard of living. Americans can gamble recklessly on credit and may, sometimes, even hit the jackpot. In the end, though, the house always wins. And the house will never give you a break. You will pay and pay until you have nothing left. Not even a place to sleep.