“Clear and uncontested property rights are the foundation of the housing market. If these rights fall into question, that foundation could collapse.” -Ted Kaufman, Congressional Oversight Panel, November 16, 2010
The Congressional Oversight Panel, the TARP watchdog program formerly chaired by Elizabeth Warren and now helmed by former Senator Ted Kaufman, has released a report detailing the failures in the mortgage servicing industry, and the threats to the overall housing market, financial sector and greater economy. The report is chilling; while it rightly says that we don’t yet know the extent of the fraud involved (they call it “irregularities”), even a small chunk of the mortgage-backed securities market going sour would have major implications for all of us. As Ted Kaufman notes, the
private-label MBS market totals $7.6 trillion dollars. You don’t have to see much of that break down before you get to the total market capitalization of the biggest financial institutions on Wall Street.
The report (PDF) tries to get at the enormity of this problem, and tries to wake up regulators who are not seeing the serious systemic risk that mortgage companies have created. The panel clearly doesn’t buy the argument from the banks that this is merely about robo-signers, and once the documents get scrutinized better and put in order, the problem will go away. In fact, they give credence to the theory that the document fraud was and is an attempt to cover up a much larger fraud.
The worst-case scenario is considerably grimmer. In this view, which has been articulated by academics and homeowner advocates, the “robo-signing” of affidavits served to cover up the fact that loan servicers cannot demonstrate the facts required to conduct a lawful foreclosure. In essence, banks may be unable to prove that they own the mortgage loans they claim to own.
The risk stems from the possibility that the rapid growth of mortgage securitization outpaced the ability of the legal and financial system to track mortgage loan ownership. In earlier years, under the traditional mortgage model, a homeowner borrowed money from a single bank and then paid back the same bank. In the rare instances when a bank transferred its rights, the sale was recorded by hand in the borrower‟s county property office. Thus, the ownership of any individual mortgage could be easily demonstrated.
Nowadays, a single mortgage loan may be sold dozens of times between various banks
across the country. In the view of some market participants, the sheer speed of the modern
mortgage market has rendered obsolete the traditional ink-and-paper recordation process, so the financial industry developed an electronic transfer process that bypasses county property offices.
This electronic process has, however, faced legal challenges that could, in an extreme scenario, call into question the validity of 33 million mortgage loans.
It’s a thick report with a lot of data, essentially what we’ve been going through here for months: the chain of title questions, the improper conveyance of the mortgage and the note, the use of MERS as an electronic registry of questionable legality, the breakdown of the securitization process, the bad underwriting standards on loans that banks knowingly put into mortgage pools, the repurchase apocalypse, etc., etc. They point out that not only would the worst-case scenario lead to judges voiding foreclosures based on a lack of standing, it could spell problems for the foreclosure mitigation operations run out of Treasury. Servicers might not be able to legally grant a loan modification under HAMP. It could mean that you’ve been paying the wrong person your mortgage for years and years. It could mean that anyone buying a home could be at risk for having their sale nullified and the previous owners take control of the property.
The panel report makes three recommendations. One, Treasury should conduct new stress tests that take this potential danger into account and look at the exposure of the banks to this crisis. Two, Treasury should take a hard look at the effects of these documentation problems on foreclosure prevention programs like HAMP. Three, lenders and servicers “should not undertake to foreclose on any homeowner unless they are able to do so in full compliance with applicable laws and their contractual agreements with the homeowner.”
It’s a big report, and I’ll add more here if I find anything else noteworthy in it. More at the Washington Post and CNBC. A reminder that the Senate Banking Committee will hold a hearing on this issue at 2:30et today. I’ll be live-blogging the hearing.
UPDATE: I like this phrasing, from page 14:
Effective transfers of real estate depend on parties‟ being able to answer seemingly straightforward questions: who owns the property? how did they come to own it? can anyone make a competing claim to it? The irregularities have the potential to make these seemingly simple questions complex.
That’s the root of the problem – the actions of a group of companies who effectively broke the housing market, and are now breaking the law in a shortcut to putting it back together.
UPDATE II: From page 29, this is an element I haven’t harped on enough:
Local Actions – Despite the state attorneys’ general national approach to investigating document irregularities, there may be separate state initiatives. Under traditional mortgage recording practices, each time a mortgage is transferred from a seller to a buyer, the transfer must be recorded and a fee paid to the local government. Although each fee is not large – typically around $30 – the fees for the rapid transfers inherent in the mortgage securitization process could easily add up to hundreds of dollars per securitization. The MERS system was intended in part to bypass these fees. Local jurisdictions, deprived of mortgage recording tax revenue, may file lawsuits against originators, servicers, and MERS.
Basically, MERS was a highly sophisticated form of tax evasion. If county records offices credibly assert that MERS avoided fees on millions of loan transfers, they could seek that money from MERS and its sponsors. For tax-starved municipal governments, many of whom have been screwed by the banks with interest-rate swaps and other deals, this could be the way to get their comeuppance. I eagerly await the first municipality brave enough to try this.
UPDATE III: Good explanation of the Clayton Holdings due diligence scandal starts on page 39.
UPDATE IV: This is a VERY good explanation that adds further to the suggestion that servicers now have a strong incentive to foreclose instead of modify loans.
Another concern involves how HAMP servicers have been calculating the costs of foreclosure under the program‟s NPV test. Foreclosures carry significant costs leading up to the acquisition of a property‟s title. If, by cutting corners in the foreclosure process, servicers were able to lower the cost of foreclosure artificially, their own internal cost comparison analysis might have differed from the official NPV analysis. In such instances, servicers would have an incentive to lose paperwork or otherwise deny modifications that they would be compelled to make under the program standards.
Conversely, foreclosure irregularities could have the perverse effect of encouraging
servicers to modify more loans through HAMP. If foreclosure irregularities lead to additional litigation and delays in foreclosure proceedings, they will increase the costs of foreclosure. Treasury may then update the HAMP NPV model to reflect these new realities. With the costs of foreclosure higher, the NPV model will find more modifications to be NPV-positive, resulting in more HAMP modifications.
Basically, there isn’t much cost associated with foreclosures for the servicers, and so they do the cost-benefit analysis and find them preferable to modifications.