At the beginning of the mortgage crisis, a mortgage industry watcher started a blog. The news of the blog grew as company after company imploded. The blog captured early images of an industry collapsing as fast as the business world has ever seen.
The spotlight quickly turned to mortgage insurance companies and mortgage bond rating companies. So, as we look at the event horizon of the mortgage black hole, let’s step back and understand the secondary mortgage market. Understanding that market gives us an appreciation, an understanding, of what has happened and what is likely to happen in the future.
If you had a mortgage secured by property in Texas, the mortgage would actually consist of a promissory note and a deed of trust to secure the mortgage payment. You would physically have the original note and record the deed of trust in the real estate records of the county where the property is located. Let’s also assume that you have various documents in your file, a mortgagee’s title policy, an application, disclosures – all the normal things you would find in a mortgage file.
Selling the mortgage means that you would endorse the note to the new owner, just as you would endorse a check: “Pay to the order of ABC Corp.” It would also execute an assignment of the lien to ABC Corp., also recording the assignment in the real estate records.
This procedure was followed for years. Mortgages were not widely traded in a market and the process worked.
Fast-forward to the housing boom of the early 2000s. Lost in the press is the fact that Wall Street commodified mortgages so they could be traded as easily as pork belly and orange juice futures. The mortgages were sold in groups, owned by a trust, and sold as a bond. The trust held thousands of bonds secured by properties across the country. The bonds were divided into “tranches,” or tranches, based on credit score, loan-to-value ratio, or level of documentation.
This is where the cracks in the system became visible.
Mortgage bankers used lines of deposit to extend credit to finance mortgages. The line of credit was guaranteed by the individual mortgage. Instead of endorsing the note to the depository bank, the mortgage bank executed a dilution and returned the original diluted note to the depository bank. An aiguille was literally conceived as an additional sheet of paper to record the signatures endorsing a note to the new owner. It was used only after there was no space left in the original note.
To complicate matters, the warehouse bank required a blank extension: they would only fill in the details of the note, as long as they needed to seize it, if the mortgage bank defaulted on the warehouse credit line.
The escrow bank also required a blank assignment: the assignee’s name was not included in the assignment, but it contained all other information and was signed by the mortgage bank.
Sounds pretty easy, right? So now multiply this by thousands of mortgages each month. Putting loan volume into perspective, Lehman Brother’s Aurora Loan Servicers, a big player in the mortgage market, went from zero in loan purchases to more than $1 billion in a month. All in less than 12 months. The ALS underwriting offices resembled the last scene of the original Raiders of the Lost Ark. Files scattered across floors and floors.
The bonds were frequently sold, but the property remained in the name of a Trustee, who managed the bond. Individual mortgages were bought and sold as loans were paid off and had to be replaced. Or they defaulted and had to be replaced to satisfy replays and guarantees in bond agreements.
Blank extension cords have become the industry standard. But what about that persistent assignment? The industry created the Mortgage Electronic Registration System (MERS). MERS allowed the industry to bypass allocations, making it easier to buy and sell individual mortgages.
Massive defaults now cast a harsh glare on the system. Who owns the loans? The trustee of the bond? Who is the trustee? How do they prove ownership? How is the note? What do you know about the chain of title? Does the servicer claiming the right to foreclose own the note?
Remember that annoying homework? That is what actually gives the owner of the note, the beneficiary of the trust deed, the right to exercise the terms of the trust deed. Who is the beneficiary of the trust deed? Who is the beneficiary if there is no recorded transfer, the original owner?
What complicates matters is the fact that many of the original owners are out of business. Many of the owners in the chain of title are also out of business.
An amusing sidebar to this story is that many cash-strapped county governments fail to claim that Wall Street circumvented state recording statutes and are now seeking millions in lost recording fees from the industry.
Pointing fingers is not new in the industry. Once the mortgage implosion began, mortgage insurance companies hired thousands of former underwriters to review claims on their mortgage insurance policies in order to avoid those claims. The usual defense of the mortgage insurance industry is fraud. Finger pointing has returned to the author and now back to Wall Street.
So the lesson for the current foreclosure mess is to require the trustee to prove that they have the power to foreclose, to prove the chain of title. Remember those keywords of yesteryear: Follow the Money.