The real Foreclosure crisis has just begun.

Why Foreclosure Fraud Is So Dangerous to Property Rights

By Barry Ritholtz - October 12th, 2010, 8:00AM

There seems to be a misunderstanding as to why the rampant and systemic foreclosure fraud is so dangerous to American system of property rights and contract law. Some of this is being done by people who are naked corporatists (i.e., the WSJ Editorial Board) excusing horrific conduct by the banks. Others are excusing endemic property right destruction out of genuine ignorance.

This morning, I want to explain exactly why this RE fraud is so dangerous, and explain the significance of the rights that are currently being trampled. I also want to demonstrate that the only way the nation could have the quantity and magnitude of errors we see is by willful, systemic fraud.

Perhaps this commentary will allow for a more intelligent debate of this issue, and focus on what can be done to fix the problems, rather than the blind parroting of talking points.

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The process of purchasing a home in America culminates with an event called “the Closing.” It is an hour plus long contract signing that ensures the buyer is legitimately taking title, possession and legal ownership of a unique parcel of land and any structures upon it. The process gives any buyer specific rights to that property that cannot be abrogated under the laws of the United States.

At the closing, buyers sign and initial numerous documents. The goal is to accomplish the following:

1) Papers are signed that will be filed with the County Clerk (or appropriate officer) along with recording fees, for the official transfer of title from the prior owner to the new owner. The enabling purchase loan (i.e., mortgage note) is also filed with the Clerk.

2) The buyer receives title (ownership) of the land;

3) The mortgage lender establishes a new interest in that property contingent upon their mortgage note;

4) All other claims, liens, tax obligations and prior mortgages, home equity lines or second notes are satisfied and extinguished before title passes to the new owner.

5) Third party claims of any interest in that property superior to the buyer are eliminated;

6) Title Insurance is purchased and issued so the buyer has a recourse in case of defects in ownership occurs.

Every step of the process is designed to protect the property rights of all parties. The result is more than a mere transaction selling property from one party to another; rather, this has created a system where ownership interests are clearly defined; where title history can be reviewed going back decades and centuries. There is a certainty to the purchasers of this property against all future claims.

Everything about this process has been created to make sure the transfer goes off perfectly. In a nation of laws, contract and property rights, there is no room for errors. Indeed, even small technical flaws can be repaired via a process called “perfecting title.”

As we noted previously, esteemed economists such as Hernando de Soto have identified that the respect for title, proper documentation, contract law and private property rights are the underlying reason capitalism works in Western nations, but seems to flounder elsewhere.

We cannot have free market capitalism without this process. So what does it mean if banks have been systemically, fraudulently and illegally undermining this process?

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The closing process described above took place with all parties participating voluntarily. The buyer wants the house, the seller wants the transaction, the financing bank wants to make the mortgage loan.

What happens during a proper foreclosure? The prior closing is essentially reversed, only its done involuntarily. The process requires another RE closing, only this time, the Note holder is exercising their right to repossess the house if the borrower has failed to uphold the terms of the mortgage note. It typically states that if a borrower fails to make the requisite payments, they become delinquent. After an extended period of delinquency, they go into default. That allows the note holder to exercise their rights to foreclose on the property, and take title and possession.

The same care and attention to detail that occurred during the initial closing must also occur in the foreclosure process. All of the steps noted in our initial closing must occur here also. But since it is an involuntary process for the (soon-to-be former) property owner, extra care must be taken to make sure that property rights are being maintained and respected. The entire process is, if anything, is even more rigorous.

The law does not tolerate any errors in this process. What does the foreclosure process legally require? It varies by state and mortgage note, but the following is a good outline:

1) Notice of Delinquency is sent to a borrower who has fallen behind his payment schedule;

2) Notice of Default is sent to a delinquent borrower who has missed the requisite number of mortgage payments;

3) Notice of Foreclosure is sent to the defaulted borrower, and the process begins;

4) Affadavit by the bank’s representative are signed attesting to: Ownership of the note, who the borrower is, the property in question, the date of last mortgage payment, amount of delinquency, tax escrow owed, other payments (such as homeowners insurance);

5) Notarized documents: A Notary Public affirms that the affidavit was actually signed by the signatory, and this allows it to be entered into the court as documentary evidence;

6A) Notice of Pendency (Lis Pendens) is filed with the County Clerk putting the world on notice as to the foreclosure action;

6B) Summons and Complaint are prepared by bank attorneys, who further verify the specific information attested to by the bank executives. The attorneys then file the Complaint, commencing the Foreclosure Action;.

7) Service of Process is filed, either hand delivered to the home owner, or nailed to the door of the home;

8) Referee is Appointed to review and process the case; calculate the amount owed, and report back to the Court; The Referees report is also notarized;

9) Judgment of Foreclosure is moved for by Note holder;

10) Court orders the property auctioned. The court specifies a notice of the auction, publicizing the property auction;

11) Bidders must Close on the auctioned house in 30-90 days; In the event of no sale, the bank takes possession (REO);

The fraud that has come to light are primarily occurring in steps 4, 5, 6 and 7. The verification of the specific data that is mandated legally is not taking place by bank executives. Reviewing a file can take anywhere from, 20 minutes to well over an hour. Yet some bank employees are testifying that they have signed off on as many as 150 per day (Wells Fargo) or 400 per day (Chase).

It is impossible to perform that many foreclosure reviews and data verifications in a single day. The only way this could happen is via a systemic banking fraud that orders its employees to violate the law. Hence, how we end up with the wrong house being foreclosed upon, the wrong person being sued for a mortgage note, a bank without an interest in a mortgage note suing for foreclosure, and cases where more than one note holders are suing on the same property that is being foreclosed.

This is more than mere accident or error, it is willful recklessness. When that recklessness is part of a company’s processes and procedures, it amounts to systemic fraud. (THIS IS CRIMINAL AND SHOULD BE PROSECUTED).

The next step in our cavalcade of illegality is the Notary. Their signature and stamp allows these fraudulent documents to be entered into court as actual evidence (no live witness required). Hence, we have no only fraud, but contempt of court on top of it (BOTH OF WHICH REQUIRE PROSECUTION).

Law firms preparing the legal documents are not doing their job of further verifying the information. And, it seems certain states such as Florida have foreclosure mills who were set up from the outset as fraudulent enterprises. (EVEN MORE PROSECUTION NEEDED).

Lastly, some service processors are not bothering to do their job. This is the last step in the foreclosure proceedings that would put a person on notice of the errors (YET MORE FRAUD).

There are multiple failsafes and checkpoints along the way to insure that this system has zero errors. Indeed, one can argue that the entire system of property rights and contract law has been established over the past two centuries to ensure that this process is error free. There are multiple checks, fail-safes, rechecks, verifications, affirmations, reviews, and attestations that make sure the process does not fail.

It is a legal impossibility for someone without a mortgage to be foreclosed upon. It is a legal impossibility for the wrong house to be foreclosed upon, It is a legal impossibility for the wrong bank to sue for foreclosure.

And yet, all of those things have occurred. The only way these errors could have occurred is if several people involved in the process committed criminal fraud. This is not a case of “Well, something slipped through the cracks.” In order for the process to fail, many people along the chain must commit fraud.

That it is being done for expediency and to save a few dollars on the process is why the full criminal prosecution must occur.

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The approach of most Western nations to property is an important legacy. In the United States, it has been enshrined in the Constitution. Even the rare exercise by the State to take private property during Eminent Domain requires an extensive and proper process. The Fifth Amendment to the US Constitution guarantees that no “private property be taken for public use, without just compensation.” The Supreme Court has detailed the process required for the State to seize any citizen’s private property without the owner’s consent.

There is simply no reason we should tolerate unlawful property seizure merely when it is done by banks. They are not the State, not the King, and not above the law.

Foreclosure Fraud For Dummies, 2: What is a Note, and Why is it So Important?
Posted in Uncategorized by Mike on October 11, 2010

(This is a series giving a basic explanation of the current foreclosure fraud crisis: Here is Part One. This is Part Two, Part Three, Part Four, and Part Five.)

The SEIU has a campaign: Where’s the Note? Demand to see your mortgage note. It’s worth checking out. But first, what is this note? And why would its existence be important to struggling homeowners, homeowners in foreclosure, and investors in mortgage backed securities?

There’s going to be a campaign to convince you that having the note correctly filed and produced isn’t that important (see, to start, this WSJ editorial from the weekend). This is like some sort of useless cover sheet for a TPS form that someone forgot to fill out. That is profoundly incorrect.

Independent of the fraud that was committed on our courts, the current crisis is important because the note is a crucial document for every party to a mortgage. But first, let’s define what a mortgage is. A mortgage consists of two documents, a note and a lien:



The note is the IOU, it’s the borrower’s promise to pay. The mortgage, or the lien, is just the enforcement right to take the property if the note goes unpaid. The note is crucial.

Why does this matter? Three reasons, reasons that even the Wall Street Journal op-ed page needs to take into account. The first is that the note is the evidence of the debt. If it isn’t properly in the trust then there isn’t clear evidence of the debt existing.

And it can’t be a matter of “let’s go find it now!” REMIC law, which governs the securitization, is really specific here. The securitization can’t get new assets after 90 days without a tax penalty, and it can’t get defaulted assets at all without a major tax penalty. Most of these notes are way past 90 days and will be in a defaulted state.

This is because these parts of the mortgage-backed security were supposed to be passive entities. They are supposed to take in money through mortgage payments on one end and pay it out to bondholders on the other end, hence their exemption from lots of taxes; the tradeoff is that they can’t be de facto managers of assets, and that’s what going to find the notes would require.

For Distressed Homeowners

The second is that it also matters a great deal for homeowners who are distressed. The note lays out the terms of late fees and other penalties. As we will discuss in the next section about mortgage servicers, the process of trying to get people behind on their payments current instead of driving them into bankruptcy has broken down. But for now it’s clear that mortgage servicers don’t have great incentives to get distressed homeowner’s records correct.

There’s well-documented evidence that extra fees are tacked on to mortgages that have fallen behind, fees that aren’t following the terms of the note. This is usually only found out in bankruptcy where there is a lawyer (and multiple parties), not in foreclosure cases. But if homeowners wants to challenge whether what the servicers claim is the correct final due amount, the terms of the note are necessary for the court.

This will matter a great deal for many homeowners. Small, marginal differences in the total owed could allow for a short sale. It could determine if the homeowner has any equity in their home. And this can only be determined by producing the note.

For Investors, Who Took This Seriously at the Beginning

Last reason: you can tell it’s important because all the smartest finance guys in the room thought it was important. Let’s look at a Pooling and Service Agreement form from 2006 between “GS MORTGAGE SECURITIES CORP., Depositor, and DEUTSCHE BANK NATIONAL TRUST COMPANY, Trustee.” (h/t Adam Levitin for this example.) Let’s reproduce the chart from part 1 to see the chain between depositors and trustees who oversee the trust:



So what agreement did they come to when it comes to the proper handling of notes in securitization? Did they think this was no big deal, or that it is something serious? From the PSA (my bold):

(b) In connection with the transfer and assignment of each Mortgage Loan, the Depositor has delivered or caused to be delivered to the Trustee for the benefit of the Certificateholders the following documents or instruments with respect to each Mortgage Loan so assigned:

(i) the original Mortgage Note (except for up to 0.01% of the Mortgage Notes for which there is a lost note affidavit and the copy of the Mortgage Note) bearing all intervening endorsements showing a complete chain of endorsement from the originator to the last endorsee, endorsed “Pay to the order of _____________, without recourse” and signed in the name of the last endorsee…

The Depositor shall use reasonable efforts to cause the Sponsor and the Responsible Party to deliver to the Trustee the applicable recorded document promptly upon receipt from the respective recording office but in no event later than 180 days from the Closing Date….

In the event, with respect to any Mortgage Loan, that such original or copy of any document submitted for recordation to the appropriate public recording office is not so delivered to the Trustee within 180 days of the applicable Original Purchase Date as specified in the Purchase Agreement, the Trustee shall notify the Depositor and the Depositor shall take or cause to be taken such remedial actions under the Purchase Agreement as may be permitted to be taken thereunder, including without limitation, if applicable, the repurchase by the Responsible Party of such Mortgage Loan.

Read that again through to the end and use the chart to follow the chain. If more than 0.01% (!) of mortgage notes weren’t properly transferred, the trust can force the sponsor (in this case, Goldman Sachs) to repurchase the bad mortgages. And this is just one contract for one part of the ~$2.6 trillion dollar mortgage backed securities market. How’s that for systemic risk? Especially if this is found to be widespread….

Looking at the documents you see that the smart guys who created these mortgage-backed securities put large poison pills into them to try and prevent the kind of note fraud we are currently experiencing as a country. They took the policing and legal recourse (and legal ability to cover their ass) very seriously on this issue. So seriously they can force repurchases of this bad debt.

So don’t believe the hype of anyone who says these are just technicalities; the people who wrote the contract didn’t believe they were.

Institutional Holders of Countrywide-Issued RMBS Issue Notice of Non-Performance Identifying Alleged Failures by Master Servicer to Perform Covenants and Agreements in More Than $47 Billion of Countrywide-Issued RMBS


HOUSTON, Oct. 18 /PRNewswire/ --Today, the holders of over 25% of the Voting Rights in more than $47 billion of Countrywide-issued RMBS sent a Notice of Non-Performance (Notice) to Countrywide Home Loan Servicing, as Master Servicer ("Countrywide Servicing"), and to Bank of New York, as Trustee, identifying specific covenants in 115 Pooling and Servicing Agreements (PSAs) that the Holders allege Countrywide Servicing has failed to perform.

The Holders' Notice alleges that each of these failures has materially affected the rights of the Certificateholders under the relevant PSAs. Under Section 7.01 of the PSAs, if any of the cited failures "continues unremedied for a period of 60 days after the date on which written notice of such failure has been given ... to the Master Servicer and the Trustee by the Holders of Certificates evidencing not less than 25% of the Voting Rights evidenced by the Certificates," that failure constitutes an Event of Default under the PSAs.

In a previous release, the Holders emphasized their intent to invoke all contractual remedies available to them to recover their losses and to protect their rights. Kathy Patrick of Gibbs & Bruns LLP, lead counsel for the Holders, emphasized that the Holders' notice does not seek to halt loan modifications for troubled borrowers. Instead, it urges the Trustee to enforce Countrywide Servicing's obligations to service loans prudently by maintaining accurate loan records, demanding the repurchase of loans that were originated in violation of underwriting guidelines, and compelling the sellers of ineligible or predatory mortgages to bear the costs of modifying them for homeowners or repurchasing them from the Trusts' collateral pools.

Patrick also noted that the group of Holders that tendered today's Notice of Non-Performance is larger, and encompasses more Countrywide-issued RMBS deals, than were included in the August 20 instruction letter. When asked why the group of holders was larger, Patrick replied, "Ours is a large, determined, and cohesive group of bondholders. We have a clearly defined strategy. We plan to vigorously pursue this initiative to enforce Holders' rights."

The Notice of Non-Performance, which is the first step in the process of declaring an Event of Default, was issued on behalf of Holders in the following Countrywide-issued RMBS:

I have no idea what this (last article) means. Can someone give me a basic translation?

Historically, though, there is a strong correlation between home ownership and personal wealth.

This is a painful correction, but it is not a reason to completely avoid home ownership.

it's hardly a liquid asset.

...

It's a reason to avoid home ownership if the only reason you have to buy a home is to invest.

failures art wrote:

it's hardly a liquid asset.

...

It's a reason to avoid home ownership if the only reason you have to buy a home is to invest.

No, it's not a liquid asset. Has anyone claimed that it is?

And I don't think I've seen anyone give advice to the effect that one should buy a home just to make money on it.

Buying a home is a long-term investment. The payoff is at the end.