Oh what a mess! Apparently in the heyday of securitizations of “liars loans” and other investment grade instruments (later to be viewed, in 20-20 hindsight, as “toxic” rather than safe), banks were a little shoddy in how they handled the paperwork. Loans were originally made the old fashioned way—by having a financial institution prepare the note, security instrument (mortgage or deed of trust), and related documents, a notary witness the signing and a title company or other agent record the security instrument—and then were converted into securities by pooling the loans into trusts or other vehicles. The process of pooling the loans required assignments of the note and security instrument to an agent acting on behalf of the holders of the securities (like the trustee in a bond indenture). Ideally the ultimate recipient of the note and security instrument (the agent) would record a transfer of the security instrument in the real property records of the borrower.
I’m not an expert in real estate mortgage backed securities (MBSs), but I can only imagine how chaotic it must have been to be a professional in this area in recent years. It is probable that various originators, servicers and agents had different practices when it came to their paperwork. Some may have required the originators to hold the original notes and security instruments, while others may have required that paperwork to be transferred to the servicers or agents. Given that these MBS pools included hundreds or thousands of mortgages and assembled and sold to investors in a matter of days or weeks (as opposed to months), it is also probable that many deals closed before each original note and security instrument was reviewed in its original form and properly filed away. While this may seem shoddy, the originators, servicers and agents were all parties to very strict agreements requiring them to take further action to facilitate the MBS securitization. Professionals in the industry probably relied heavily on the fact that, in the future, all of the participants would cooperate to locate paperwork and prosecute the foreclosure in compliance with those agreements. What a difference a few years makes!
Fast forward to the current crap (so-called “financial crisis” followed by “Great Recession” followed by “anemic recovery” followed by whatever we’re in now), and the system is in turmoil. Many originators, servicers and agents have merged or gone out of business. Banks and non-bank investors have purchased loans in bulk, and many of these loans have been assigned several times since they were made. When it comes to foreclosure, relying on the cooperation of the original parties to securitization to locate paperwork is simply impossible in many cases. After all some of those parties are gone. So what to do?
Well, clearly the banks were overwhelmed simply with the volume of foreclosures and were cutting corners to clear the decks. They may have been backdating assignment documents and employing unsophisticated people sign in court records that they “reviewed” loan documents in many thousands of cases (the so-called “robo-signers”). Some have opined that this is much ado about nothing, and they have a point. After all, these loans are in foreclosure because the borrowers have defaulted on their payments. It doesn’t appear that anyone who is actually current on their payments has been wrongly kicked out of their home. That said, there should still be come integrity to the process. Whether the lack of integrity warrants the political gnashing of teeth that has come as a response is debatable. That said, the unjustified finger-pointing and exaggerated claims for political gain are only just beginning. Welcome to democracy, particularly in election season.
Who loses in all this? Well, a lot of us, at least to the extent we are:
Bank Shareholders. The pension funds, mutual funds, and other investors who hold shares in lenders (including the US Treasury in some cases) will lose. They will lose because it will take them longer to eliminate the bad loans from their balance sheets, which may force them to raise more capital (dilutive to shareholders) or simply delay their ability to make performing loans (delaying interest payments and resulting revenues from those loans). And if someone decides to try to hold banks accountable to aggrieved buyers of homes for delays in closings, watch out.
Homeowners. The housing market is desperately searching for equilibrium. To get there it needs to rid itself of the backlog of foreclosures. While keeping people in “their” homes (as opposed to the banks’ homes) is good politically, it doesn’t come without a cost. Sellers have no pricing power with banks having to dump this large volume of homes, so prices stay low. This hurts people who are trying to move (perhaps for a new job) or refinance. And a halt to foreclosures just prolongs the pain, because it leaves an overhang of inventory that is due to be dumped on the market. Make no mistake, these homes will be seized and sold eventually. Waiting for extended periods of time is not good.
Buyers. Buyers of homes in foreclosure are now forced to wait to close. They’re going to have to live somewhere while they wait, and they may not even be able to wait. Buyers who are relocating for a new job are not going to be able to postpone their start date (as if they’d even ask) due to this mess.
Participants in the Larger Economy. Obviously to the extent housing impacts the larger economy (not an insignificant impact), everyone suffers. Refinancing slows, consumption is delayed, the velocity of money decreases. Large scale delays of any type of business transaction will cause harm, and delays on such a large scale will cause a lot of pain.
Not the borrowers. Indeed they’re going to prove to be the winners, because they’ll undoubtedly live a few more months for free in their homes. A lot of people are now living for free, either because they can no longer afford to pay their mortgage or because they no longer want to pay their mortgage. We sympathize with the first group of people, although it is still difficult to justify forcing others to pay for their housing. We can despise the second group of people, although they are simply acting in their self interest. Either way, clearing the system of its dry brush is essential. The defaulted borrowers who are living rent free are simply taking advantage of the inefficiencies built into the foreclosure system. Increasing those inefficiencies just makes things worse.
Who is at fault? This is largely an irrelevant question. Clearly some politicians will use this scandal as an opportunity to bash banks and businesses in an attempt to get a few ill informed votes in November. In my mind this is a symptom of the larger problem, not really a problem in and of itself. In a more normal circumstance the bank officers would be able to track down the foreclosure documents for each delinquent borrower, review them, sign off on that review, and then proceed with the foreclosure. But these aren’t normal circumstances. Banks are overwhelmed. The system can’t handle the volume. Now you can blame the banks if you like, but ultimately it is the responsibility of policymakers to work things out. Let’s hope they’re up to the task.
When it comes to the heart of the foreclosure crisis securitization is the main problem for the majority of major banks. Mainly because the majority of these banks did not properly securitize their mortgage loans.
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