Mortgage Wars Zahm Bna

A BNA, INC.

REAL ESTATE !
LAW & INDUSTRY REPORT

Reproduced with permission from Real Estate Law &
Industry Report, 4 REAL 4, 01/11/2011. Copyright
2011 by The Bureau of National Affairs, Inc. (800-372-
1033) http://www.bna.com

MORTGAGES

As the U.S. housing sector continues to struggle, one of the aggravating factors is the on-
going crisis of foreclosures, legal disputes, and confusion. In this article, the author offers
some keen insights into the ‘‘fog of war’’ that envelopes the home mortgage industry. In a
fanciful comparison between the current battle for Americans’ mortgages and an all-out
war, he identifies the combatants, describes the battlefield and weaponry, chronicles the
attacks and counterattacks, and assesses the disputants’ strategies. This first in a two-part
series focuses on what the author characterizes as the Land War.

The Battle for U.S. Housing Finance: Lines Drawn Between Lenders and Borrowers

I. Land War.

F
or the past two years they’d been kept outside the
perimeter. There had been attempts to break
through, to be sure. But isolated, dejected—
unarmed—they’d been kept at bay, effortlessly. Borrow-
ers would approach the wire and they’d be zapped by
the system, like bugs. Titles transferred, sheriffs ap-
peared at the doors, houses were abandoned. Borrow-
ers would dee-dee out in the night, back to the apart-
ment blocks and trailer parks where they’d started.
Early on, few people believed that it would turn into
a war. It wasn’t a war that Lenders had necessarily
planned for, much less wanted. It was a meeting
engagement—fighting at a time and place that neither
BY RICHARD ZAHM

COPYRIGHT 2011 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 1944-9453

2

side had intended. But they were making the best of an Lenders’ heads down. Worse, they were emblematic of
unfortunate situation. And the truth was, it was going tools that were in common use in the industry. They in-
pretty well. cluded false affidavits of indebtedness, lost note affida-
The Lenders had control. In trust deed states like vits, lost summons affidavits, backdated mortgage as-
California, foreclosures took place largely outside the signments, counterfeited notes, mortgages and assign-
court system. Silently, efficiently. Many of the houses ments.
being seized were there, thankfully. The initial flurry focused on the attestations con-
In states requiring judicial involvement, the biggest tained in the signed affidavits. Affidavits carry the same
problem wasn’t getting title—it was getting through the weight in foreclosure proceedings as testimony. They’re
queue just to get a judge’s signature on the docs. Courts relied on by the courts to describe the foreclosing par-
were overwhelmed by the sheer volume of cases, piles ty’s ownership interests in the properties, as well as the
of file folders stacked in corridors and spare offices like calculation of amounts owed. Robo-signing undercut
cord wood. Thousands of them. But the system was still both of these elements.
working. The foreclosure blades were whacking. Ker- Here was evidence that servicers were basically fab-
chunk. Another family out, another unit into the dis- ricating testimony, and that it was industry practice not
tressed portfolio. only to sign documents by the thousands, but to back-
The problem wasn’t really in the mechanism. The date them and, when needed, recreate originals them-
number of foreclosures had clogged up the blades, but selves.
increased documentation efficiencies had alleviated The import of this would become apparent several
some of the pressure. In many ways, the entire system weeks later. It was discovered that robo-signing was not
had been automated, with computers generating the confined to foreclosure filings. It extended to securitiza-
calculations, making the determination as to when to tions. It wasn’t just about Borrowers. Now it involved
pull the trigger. Investors.
Document signers could attach their John Hancock’s The only thing truly terrifying to the Lenders was a
thousands of times a month, as needed, and the nota- mass uprising, people simply refusing to pay their
ries would back them up. In a pinch, backdating was ac- debts, and using lawful means to get there. As Borrow-
ceptable business practice. The real problem was the ers poured across the perimeter, Lenders, whose de-
sheer number of houses coming onto the market, or fenses had always seemed impregnable, responded as
waiting to come onto it. The success of the foreclosure they always had. They popped illumination flares and
strategy was beginning to cost real money as home tugged on the lanyards connected to Claymore mines. It
prices sought a bottom. had worked before.
It had been touch-and-go earlier, until the feds The Claymores consisted of a simple message that
stepped in with bail-out money. But since then, the took out everything they faced.
Lenders had enjoyed virtually perfect air cover, pro-
The message had been absorbed and accepted com-
vided care of a host of regulators who declined to fol-
pletely: A mortgage is sacrosanct, a moral obligation.
low up on consumer complaints and the objections of a
Borrowers knowingly took on their obligations. They’d
couple of ineffective attorneys general from fly-over
squandered their equity on vacations, flat screen TVs,
states. Servicing fees were flowing, penalty fees were
and bunk bed sets from IKEA. Folks who don’t make
accumulating, profits were up—and bonuses were back.
their payments are deadbeats. They deserve to lose
In October 2010 the Lenders received chilling news: their homes.
Borrowers were inside the wire. Hacking through they
The message was simple, the reaction visceral. It was
system’s vines, climbing across trenches filled with ear-
absorbed as easily as claims against Communism were
lier Borrowers—the ones who’d taken out the sub-
decades before, absorbed with the same certainty as the
primes—crossing between the enfiladed bunkers,
Domino Effect, of the need to protect the American
they’d taken isolated CPs (command posts). And they
Way. If your neighbors walked away from their mort-
weren’t alone.
gages, you were the one who suffered. You lost equity
State AGs were also inside, moving fast. They had in your home. You’re paying for your mortgage: They
subpoenas. Worse, they were moving together, a coor- should do the same. Period.
dinated band of 50. Worse still, they had lethal ammu-
nition with them: judges. There was no subtlety behind the perception. It was a
case of winning hearts and minds. The focus remained
The satchel charges sappers pushed into the wires
on the borrowers who deserved not to have the homes
had an unexpected form. They were depositions held in
they’d bought. It wasn’t extended to the next level—
the outskirts—Maine. Former Lender lawyers knew the
who actually did deserve to have the houses. And why.
weak points in the defenses. They deposed a low-level
servicer employee, a guy with a mullet who carried mul- So if the Borrowers deserved to be tossed out, docu-
tiple VP titles, but who couldn’t describe the basics of ments required to complete the task were basically a
the company he was representing—MERS [Mortgage formality. Irregularities in their paperwork were techni-
Electronic Registration Systems]. He could describe calities, easily remedied by filing amended pleadings.
how he signed thousands of foreclosure documents and They were all just actions resulting in a kill. Whatever.
was quite open about having no idea of what they con- Legal pleadings can be amended according to state
tained. and local law and rules. But local judges can choose not
The press caught wind and they attached a catchy to accept new or amended affidavits. New affidavits suf-
term: ‘‘robo-signers.’’ fer from an inherent disadvantage—they have to com-
pensate or explain why the first ones were wrong, or
They were inside. Robo-signers were an unfortunate how they violated court rules. And even if judges do ac-
weapon for Lenders. They released flechettes across the cept them, they don’t necessarily override the original
spectrum of operations. Easy to deploy, they forced documents.

1-11-11 COPYRIGHT 2011 BY THE BUREAU OF NATIONAL AFFAIRS, INC. REAL ISSN 1944-9453

3

Most important for homeowners, they don’t prevent Foreclosures without knowledge of underlying cir-
the argument that the Lender doesn’t have the right to cumstances didn’t happen. Before you ‘‘offed’’ a Bor-
bring a case against a borrower in the first place. rower, you had to see the whites of his eyes. You had to
listen to his breathing on the other end of the phone
Strategic Defaulters. The Viet Cong of the Borrowers when you told him he was done. Now everything was
were the Strategic Defaulters. Nimble, educated, effec- performed at a distance, on computer screens, auto-
tive, they’d pushed back on a portion of the perimeter mated.
with minimal casualties. They’d received some press
attention—mainly as cultural oddities, soulless merce- Lender foot soldiers were no longer the grizzled col-
naries gaming the system. Absorbing hits to their credit lections veterans of earlier times. They were now ‘‘fore-
scores, moving on, minimizing collateral damage to closure specialists,’’ working in shifts around the clock.
their finances and families, their actual numbers were High school graduates or GED certificate holders were
far less than their potential—about 20 million. Even if preferred, and fast typing skills were a plus. Drawing
one in four homeowners were underwater, not every- from the ranks of fast food restaurants and hair salons,
one was cut out to be a guerrilla. pay ranged from $10 to $12 per hour.
The bigger cuts in the wire came from the AGs. Bet- They had one goal: speed. Some—those had worked
ter equipped than the Borrowers (few of whom even in the mortgage industry previously—brought with
showed up to contest their foreclosures), they brought them the practices and ethics that had enabled the
considerable firepower. origination of the types of loans they were now shutting
Lenders dropped into their bunkers and responded in down.
force. Foreclosures were halted by The Big Four: Bank Despite the dynamic growth potential of the industry,
of America, JPMorgan Chase, Wells Fargo, and Citi. In- casualties were not unknown. State investigations of
vestigations were announced. Days later, the foreclo- foreclosure mills resulted in peremptory firing squads
sure machines, well-oiled, started up again. ‘‘Paper- by Lenders. In late October the Law Offices of David J.
work errors’’ had been corrected (in their hundreds of Stern, Florida’s premier foreclosure firm, laid off more
thousands). Lenders reiterated that Borrower attacks than 500 workers, 70 percent of its staff, in a single day.
only served to extend the economic discomfort being They were notified of their loss by e-mail.
experienced by all.
A defaulting homeowner doesn’t have a right to stay The MERS Mineﬁeld. By Nov. 18 they’d lost the high
in a house if the proper mortgagee forecloses. But that air cover afforded by the feds—at least temporarily. But
was the key—it’s not who deserves to not to have the the Lenders were able to scramble choppers to D.C.
house. It’s who does have the right to take it. Until now, Lobbyists were on the ground, briefing congressional
the law had yielded to the Lenders’ convenience. staffers and distributing white papers to shore up their
defense.
Why the War? The root problem stemmed from an in- They used MERS as their lever. If they could only get
herent disconnect within the securitization process it- legislation passed affirming MERS’s legitimacy—or at
self. Securitized mortgages—the vehicles—were de- least blocked legislation denying it—there was hope for
signed according to meticulous standards. Documenta- slowing the rout. The effort was nothing new, but it had
tion and transferal accuracy were central to its never been viewed as vital. Since 2008, a million dollars
operation. To its designers—and to the investment had been allocated to lobbying, plugging holes punched
bankers, rating agencies, and investors—the model into MERS by lower courts ruling against its primacy.
worked. MERS was the creation of the Lenders, a VIN system
The calculation that wasn’t made was this: The pro- for mortgages that was designed to supplant traditional
cess doesn’t scale, particularly under time pressure. county recording office methods of tracking ownership
Lawyers had designed and created intricate machines— of mortgages.
which were then shipped off to assembly plants.
If they were successful, they’d moot the lawsuits
And the assembly plants had a different focus than
across the country. And some serious firepower was
precision: speed. Faced with insatiable investor demand
ranging in on MERS. One lawsuit in California sought
for mortgages, just-get-it-out-the-door production took
unpaid-but-owed recording fees of between $60 billion
precedence. Legal hair-splitting took a back seat to
and $120 billion. If they weren’t successful—if a new
common sense and efficiency. Human nature kicked in.
federal registry system were created—their business
What wasn’t important was what the lawyers told you
would be vaporized.
to do. You did what your boss told you to do.
Production was geared in one direction: intake and And the ultimate stake was much higher—the valid-
sale. And solid faith was placed in automation. Automa- ity of MERS transfers brought into question the entire
tion to assess borrowers, automation to generate loans securitization process. Some 66 million mortgages
and to track them through an (automated) recording could conceivably be foreclosure-proof.
system. In the end, automation could correct documen- The lobbyists argued that rulings against it were
tation oversight, and late dates and, finally, human re- merely local, and that MERS offered a wonderful base
view and signatures. to establish one unambiguous, centralized, computer-
It hadn’t always been this way. Before the securitiza- ized tracking system. States would have to lose their
tions, before the models and algorithms, a Lender had power over property law, unfortunately. MERS would
to know a Borrower. Lending decisions weren’t based receive a hall pass from the feds.
on the poor judgment of loan officers and easily ma- The argument overlooked two elements. First, MERS
nipulated automated origination software. A loan was viewed in a negative light at the time. Second, re-
wasn’t a mass production item churned out by data pro- cording issues are firmly rooted in state, not federal
cessing factories. It was a considered investment deci- law. U.S. Supreme Court cases have repeatedly found
sion, a relationship that could continue for decades. real estate transactions to be beyond the reach of the

REAL ESTATE LAW & INDUSTRY REPORT ISSN 1944-9453 BNA 1-11-11

4

Commerce Clause, and not subject to federal interven- took place with note allonges: multiple signatures, elec-
tion. tronically forged.
The most damning argument against MERS centers
on its claim that it acts as a mortgagee of record. Mort- Parallel Foreclosures. It was Lender industry practice
gages registered in its name in local courthouses repre- to simultaneously pursue foreclosure while negotiating
sent that MERS is both the nominee of the mortgage loan modifications with Borrowers. While ostensibly
and the mortgagee—something that’s not possible, akin parleying under a white flag—a truce—Lenders contin-
to being a principal and an agent at the same time. ued to tunnel under Borrowers’ defenses.
In 45 states, a mortgagee must be a creditor. The note The practice was endorsed by the government-
is the critical document and is accompanied by the sponsored housing enterprises (GSEs) Fannie Mae and
mortgage, which is deemed an ‘‘accessory’’ to the note. Freddie Mac. The justification, as with so much of the
MERS doesn’t lend money or collect interest payments, Mortgage War, was speed. Loan modification programs
and it maintained that the note and the mortgage could required time, and the passage of time increased the
be separated—and then reunited. cost of what was the generally inevitable outcome: fore-
Case law in virtually every state follows Carpenter v. closure. Parallel tracking was an efficient method of
Longan 83 U.S.271, 21 L.Ed.313 (1873): ‘‘The note and placating Borrowers as they stood in line for the firing
mortgage are inseparable; the former as essential, the squad.
latter as an incident. An assignment of the note carries The curious factor was that the government’s loan
the mortgage with it, while an assignment of the latter program had always banned banks and others from
alone is a nullity.’’ foreclosing on Borrowers attempting to obtain modifi-
MERS itself has a bizarre structure. The mortgage cations. The GSEs just hadn’t adopted these measure-
and servicing database has no employees; its parent, . . . and the Lenders, it appeared, had simply ignored
MERSCORP, has around 50 employees. But the em- them.
ployees of MERS’s members, carrying titles such as Collateral Damage. Foreclosures look clean enough on
‘‘MERS vice president’’ and ‘‘MERS assistant secre- paper—assuming that the documents are in order, more
tary’’ are more numerous. There are more than 20,000 or less. But the size of the confrontation was creating its
of them. own headaches. War makes a mockery of plans, and
MERS end users are under no obligation to update this one was no different.
the MERS database. It’s also not responsible for the ac-
In an effort to staunch the flow of homes hitting the
curacy of information provided by a member. So, if
market, and dragging values down still further, Lenders
there is any collusion outside the system, any set of
had hit upon an approach that seemed to combine the
transfers could be input and confirmed.
best of two worlds. It was called ‘‘bank walkaway’’ or
There’s also no reconciliation process, matching ‘‘dropped foreclosure’’ and was most common in Ohio,
transfers with one another. MERS doesn’t capture what Michigan, and Indiana. Possession of homes was
actions were taken by a particular ‘‘certifying officer.’’ obtained—the Borrowers were out—but the final steps
MERSCORP devotes 16 employees to audit and quality of foreclosure were delayed. The properties remained
control . . . overseeing more than 20,000 people acting in limbo. This provided the double benefit of delaying
on behalf of MERS. liability for taxes and maintenance of the properties,
The result is this: MERS is a system that is nontrans- while allowing the Lenders to ease the REO onto their
parent to outsiders, and there is no party with absolute books as needed.
responsibility or true oversight over the assignments
The irony was that bank walkaways were the mirror
that occur within it.
image of strategic defaults. The GAO estimated there
We may no longer know who owns the land. were about 35,000 of these zombie properties.
Bullets. Loan files were the basic component of the But while strategic defaults created focused losses on
war. If the property—and the equity and cash flows— Lenders’ balance sheets, bank walkaways created col-
were what was being fought over—the documentation lateral damage, intensifying the deteriorzation of the
served to provide the goal. And yet, little was known market and complicating stabilization efforts. Neigh-
about them. bors were being impacted in colorful ways that at-
Home mortgages consist of three different file types. tracted the press. With the passage of time, vacant
There is an origination file, consisting of the mortgage homes generated more than overgrown lawns and lime-
application, appraisal, employment verification, bank green swimming pools. Pipes burst. Roofs separated.
statements, etc. There is a servicing file, which includes Windows shattered. Houses began to grow mold.
documents created during the life of the loan, such as In cities with row houses, like Baltimore and Phila-
communications from the Borrower and notes from the delphia, these problems weren’t just happening next
collector. door. Like conjoined twins, homeowners began to suf-
And there is a collateral file, the collection of docu- fer from ills affecting empty units next door. Baltimore
ments describing the ownership interests in the mort- counted more than 5,000 of them, and had less than
gage loans. These documents give the trust right of en- $500,000 available to make repairs. The money was
forcement and collection. The contents of the collateral spent on 13 abandoned homes.
file are defined by each pooling and servicing agree- On the other end of the spectrum, homeowner asso-
ment (PSA)— they create the ‘‘collateral’’ for the trust. ciations (HOAs) were feeling the pinch from a shortfall
This is the crux of the robo-signing issue: The collat- of dues. Lenders were declining to pay both taxes and
eral files were recreated. These included the note, the dues for their empty homes. Only about 30 percent of
Borrower IOU—a negotiable instrument requiring an REO properties were making assessment payments,
original with ‘‘wet-ink’’ signatures. To do this, a Bor- placing the burden on the associations and other prop-
rower’s signature had to be forged. The same practice erty owners.


5

About half of associations polled said they lacked the values. As a result, the most efficacious solution to the
funds to carry out their responsibilities and were bor- housing crisis was actually placed out of reach. Princi-
rowing, levying special assessments and restricting ser- pal balance reductions (the only viable solution: do the
vices. math), were exactly what servicers didn’t want. This
Florida courts offered some relief to HOAs, allowing route only served to cut into servicers’ profits: their own
‘‘Mortgage Terminator’’ suits against Lenders. Quiet fees were based on principal balances.
title actions required Lenders to pay up. If they didn’t, Loans defaulting en masse required exactly the oppo-
associations could take title to the property and then site types of skill sets and processes servicers pos-
force the primary lien holder to initiate its own foreclo- sessed. Loss mitigation entails negotiation, the creation
sure proceeding, or release its mortgage to the associa- of repayment plans, loan modifications, short sales and
tion so that it could sell the unit itself. The legal theory deeds-in-lieu. It requires sensitivity to all parties’ needs,
is that the Lenders had abandoned their mortgages- determining the least-worst solution for frantic home-
. . . and their claims. owners. It requires trained employees. Instead, ‘‘loss
mitigation’’ was treated as a factory process allowing
The Corps: Servicers. The last wars are the ones pre- use of low-skilled personnel: this was the exact opposite
pared for and this one was no different. The foot sol- of what was needed.
diers of investors and banks were the servicers. Servic-
Worse, loss mitigation labor expenses are considered
ing was traditionally a low margin/high volume line of
overhead, non-reimbursable expenses to the servicers.
business, the role being relatively straight-forward.
Worse still, it cut across the real profit center available
Mortgage statements were sent out, mortgage pay-
to them: default fees.
ments were collected, and the proceeds pushed up-
stream. A $200,000 loan would bring in $500 to $1,000 The most efficient business model for servicers was
per year. to opt for foreclosure. The trouble was, their own inter-
It was a damnable predicament. Lenders had covered ests were at odds with those of the investors they were
all the angles, creating interlocking enfilades between supposed to be serving. Every organism—every
the Borrowers with their loans and Investors with their business—ultimately seeks its own survival. Servicers
portfolios. By owning the servicers, they controlled the were no different. Ill-equipped to handle the surge of
flow. They determined which loans would be modified, defaults beginning in ’07, they reverted to their roots.
and by how much. Unthinking, automated assault. By 2010 they were vir-
Better yet (and more profitable), they controlled the tually at war with borrowers, investors, and the
foreclosures. The late fees, the default penalties, and economy itself.
the equity juice left from the foreclosures . . . it all Servicers were a lot like an army foraging off the
flowed to them. countryside, sustaining themselves at the expense of
those it was ostensibly designed to serve. They received
Cooks to the Front. Servicers were the odd ducks on sustenance from four sources: 1) A flat servicing fee for
the line—the cooks and clerks sent up to the front. each loan; 2) Income float—investment income on
Their original role has been pretty mundane—they mortgage payments received, but not paid to investors;
made the mortgage calculations, collected the pay- 3) Fees—a plethora of them, everything from late fees
ments, and dealt with the occasional default. But they to property inspection fees; 4) Investment in securities
were completely unprepared for the challenges they they were servicing themselves, in the form of junior
faced. Times had changed and the tools available to liens.
them were inadequate, especially given the market
challenges they faced. Fragging. On the cost side, servicers were caught in
Exploding loans demanded skills, training, and ex- an uncomfortable position. First, they had operational
pertise that servicers just didn’t have. Solutions that expenses—billing and collections. Next, they were li-
they were supposed to come up with—for Borrowers able for principal and interest payments owed to inves-
and Lenders—weren’t to be had. Unemployed Borrow- tors, but not paid to the borrowers. They also relied
ers couldn’t respond to the traditional collection heavily on outsourced platforms: Lending Processing
squeeze. Underwater homes had no equity to tap into Services handled more than half the foreclosures in the
for refinance. United States. And when failures occurred on their end,
as would eventually be the case, the impact would rage
through the servicer industry like a tsunami.
This amount could be ultimately retrieved once a
Afﬁdavits carry the same weight in foreclosure loan was foreclosed upon and the property sold. But as
servicers learned, these sums could be a long time in
proceedings as testimony. They’re relied on by the coming. Or, in the case of a rapidly declining market,
that time might never come at all.
courts to describe the foreclosing party’s But ultimately, the foraging became so thorough, and
the resources so scarce, that the servicers began scav-
ownership interests in the properties, as well as enging off of those they were supposed to be serving:
Investors.
the calculation of amounts owed. Robo-signing
In all fairness, servicers faced considerable obstacles
undercut both of these elements. when it came to loan modifications. Although they were
supposed to manage the loans as if for their own ac-
count, modifications could only be made on loans that
were in default or where default was imminent.
The servicing function and its compensation struc- Being practical business people, it made sense to as-
ture had been created in a time of appreciating property sist Borrowers in clarifying their status. When they


6

called to request some type of loan assistance, the rec- Center report listed 36,000 complaints of lost docu-
ommended course was to not make their mortgage payments and inability to get a servicer response.
ment for a series of months. This served to remove lin- HAMP applications stacked up. Treasury guidelines
gering doubt. called for a response and action within 30 days. The av-
Limitations were in place in order to protect a range erage length of time homeowners sought HAMP modi-
of interests having little to do with actual loans. These fications was 14 months.
included maintaining off balance sheet status; pass If they didn’t qualify—and had been paying a lesser
through tax treatment to avoid double-level taxation; amount during this period—they were billed the differ-
and the need to match the timing of a trust’s income ence, with fees plus interest, in one lump sum.
from mortgages with the timing of the payment to the A variation on this was for servicers to advise Bor-
trusts. rowers not to make their mortgage payments while they
PSAs—the governing documents between servicers were being qualified for modifications. This approach
and investors—vary in the types of modifications al- would often be coupled with two tracks: while the loan
lowed. Some allow only interest rate reductions. Some modification possibilities were being explored, foreclo-
cap the number of loans that can be modified within a sure proceedings would be initiated (in the interest of
pool without consent from a third party (often 5 percent saving time).
of the pool). Some limit the amount of the interest rate But the most egregious traps were coming to light:
reduction, require a particular capitalization method for Foreclosures occurring even when Borrowers had made
amounts past due, or limit the number of loan modifica- every single mortgage payment. The seemingly safe
tions that can be made within a given year. terrain—pay the mortgage on time, keep the house—
Some simply prohibit any modifications. Although would suddenly part, sending homeowners into a pit.
there is a limited safe harbor for servicers to perform Whether by mistake or design, servicing error or fraud,
loan modifications, many choose to avoid the risk of in- Borrowers would find themselves impaled on sharp-
vestor suits—or Securities and Exchange Commission ened punji stakes below.
action—by minimizing their modification activity . . . or The stakes took the form of compounding fees and
by extending the processing time. charges. There was no appeal and little chance of es-
Servicers often find themselves in competition with cape.
investors for loan proceeds. In situations where there The traps worked this way. A mortgage payment
are insufficient funds to pay all parties in full, the ser- would be credited as being late. Maybe it had been sent
vicer has the senior most claim on the loan’s proceeds. late; maybe it had been processed late—or not at all. In
Not only are servicers the first at the trough: their any case, a late fee would be assessed, say, $75.
share isn’t fixed. Worse (for investors): compensation This amount would be charged against the next
structures encourage servicers to both inflate the size of month’s payment. Except that the Borrower didn’t
their claims, while controlling what these claims are. know about this—he would tear off another mortgage
Slow is good. Of the 5 million Borrowers who were de- coupon, and send in his regular payment.
linquent in their mortgage payments, about a third had But this second payment wasn’t applied fully to the
been ‘‘in process’’—and generating fees—for more than mortgage: it would be applied to servicing fees. So the
a year. borrower would then be charged a fee for insufficient
payment, and maybe a late fee on top of this. With two
Search and Destroy. Lenders had not always been in late fees assessed, a broker price opinion (BPO) would
this position. For years, they’d enjoyed almost complete
be required. A broker would drive by the house, snap a
freedom, venturing out unopposed, setting mantraps.
few photos, and offer an estimate of what he thought
But by December 2010 even their watchword that ‘‘no
the house was worth. Cost: $250, charged to the Bor-
unwarranted foreclosures have ever occurred’’ was un-
rower. Fees and charges begin to accelerate.
der attack.
Force-placed insurance provided an additional rev-
enue stream. Triggered by default, (or when servicers
allowed existing policies to expire) it could be many
The most efﬁcient business model for servicers times more expensive that regular policies. Added to
monthly payments, it boosted fees some more. It also
was to opt for foreclosure. The trouble was, their created a conflict. Lenders owned both servicers and in-
surers, and they received fees on the policies they pur-
own interests were at odds with those of the chased on behalf of borrowers. Policies would occasion-
ally be backdated, to collect premiums for time periods
investors they were supposed to be serving. already passed.
Within a short time these bloated to thousands of dol-
lars. The Borrower would learn of this when he was
contacted by a gunjy servicer, or when he received a
Wrongful foreclosures had in fact been taking place foreclosure notice.
for years. But as always, Borrowers had been too belea- Servicer records are difficult to obtain, and even
guered, too isolated, to mount a coordinated defense. more difficult to decipher and reconcile. It’s a tough
Foreclosure kill spots took several forms: One in- proposition, even for an attorney. In times past, the
volved blocking or delaying Borrowers from modifying most common solution for the hapless Borrower would
their loans, even if they qualified. The results were the simply be to pay up—or refinance, forking the differ-
same: Borrowers were snagged, and investors picked ence to the servicers.
up the tab. Declining home values had blocked this exit for
And it was so easy: Just ‘‘lose’’ some papers and homeowners, but it didn’t change the long-standing
route calls to voice mail. A February 2010 HAMP Call practice. Servicer-driven foreclosures accounted for


7

about half the cases handled by foreclosure defense keep HELOCs in their own portfolios. Banks with ser-
lawyers. The irony was that with the ocean of foreclo- vicing subsidiaries own 10 percent to 15 percent of the
sures taking place, they went largely unnoticed. second mortgages on the firsts they service. So there is
There were even more egregious foreclosures, horror a strong incentive for servicers to modify the firsts to
stories from homeowners facing foreclosure who didn’t free up money for Borrowers to pay on the seconds.
even have a mortgage; homeowners facing foreclosure For banks, the numbers were huge, and concen-
from two different Lenders, simultaneously. trated. The Big Four (BofA, Wells Fargo, JPMorgan
As more investigators entered the fray, patterns were Chase, Citi) held $423 billion of HELOCs with $151
discerned. There were ‘‘Linda Green,’’ signatures. billion—more than a third—of this amount to Borrow-
Green had worked for document processing company ers who were underwater, or close to it. The loans were,
LPS and had been listed, variously, as an executive for in effect, unsecured.
BofA, Wells Fargo, US Bank, American Brokers Con- If the seconds had loan-to-value (LTV) ratios greater
duit, National City . . . and dozens more. The amusing than 100 percent, it would stand to reason that the loans
part was that the ‘‘Linda Green’’ signatures bore little would be written off.
resemblance to each other. Forged signatures, imper-
sonation of an officer of a bank, improper conveyance But this would be wrong. BofA—with $41 billion of
of a mortgage into a trust: the charges mounted. underwater seconds—estimates that even if all of these
And these all pointed to what had proven to be the loans defaulted, it would still be able to collect 85 cents
most effective weapon against Lenders: requiring them for every dollar loaned.
to prove that they actually had standing to foreclose. Rationale: Even after defaulting on a first mortgage,
It had become a rallying point for Borrowers, a battle more than half of Borrowers continue to make payment
cry: ‘‘Show me the note.’’ on their seconds. And from a Borrower’s point of view,
this reverse order makes perverse sense. Seconds have
Friendly Fire on Foreclosures. Lenders managed to fire higher interest rates and are smaller, more manageable.
on their own position, selling homes that they had fore- They also take a more liquid form, as HELOCs. Borrow-
closed on—but didn’t own. Likely as a result of title ers’ loan payment priorities had emerged: car payments
chain verification errors—the spawn of MERS—Fannie first, then credit cards, then HELOCs. Mortgages could
Mae was reported to have sold homes that it had not ob- wait. Like crying infants, the loudest and smallest are
tained title to. Here was a simple story for the press. fed first.
‘‘Foreclosure sales,’’ a commercial broker com- An astounding figure: in 90 percent of the instances
mented, ‘‘are like catching a falling knife.’’ where a first was in default, the dollar amount of out-
Foreclosure sales are final. The risk falls not on the standing HELOCs remained the same. Borrowers could
home buyer, but on the foreclosing Lender. Deeds ob- be not paying on their firsts, but the amount available
tained through foreclosure sales are strongly protected. to them to borrow on their seconds was not reduced.
The problems escalate when the underlying foreclosure Six percent of borrowers actually had their lines in-
is flawed—as in the case where false affidavits have creased after they went into default, by an average of 20
been introduced and accepted. percent. Often, the firsts and seconds were held by the
The situation then becomes: Wrong Lender fore- same bank.
closes on Borrower, but can’t take title. Wrong Lender And in the distance, watching this all, are the regula-
sells to innocent buyer, who could be sued by the origi- tors. Although they have the power to force banks to re-
nal Borrower. serve against the loans, they often choose not to. Perfor-
Making matters worse, more accounts appeared of mance of the loans is what is crucial, not the value of
Lenders selling foreclosed houses twice, to two sepa- the underlying property. Besides, there isn’t enough
rate buyers closing on homes Lenders didn’t have title money in the economy to write them all down anyway.
to.
‘Trustees, Up!’ Trustees, like most poags (posted on a
garrison), in theory have great responsibility, when in
practice they do very little. They were supposed to over-
Wrongful foreclosures had in fact been taking see servicers, but carveouts and indemnifications
within PSAs limit the risk entailed by their supervisory
place for years. But as always, Borrowers had role.
In the rear with the gear, trustees could be suddenly
been too beleaguered, too isolated, to mount called up and shoved into fighting holes. Reason: they
certified to investors that the trusts contained the mort-
a coordinated defense. gage securitizations—that they contained the trust as-
sets. If the loans were not properly conveyed to the
trust, the certifications they made were untrue. Inves-
The Battle of the Seconds. Banks held a disproportion- tors who relied on the certifications could be under-
ate number of second liens—home equity lines of credit standably chuffed.
(HELOCs)—the part of Borrowers’ indebtedness that The biggest mortgage securitization trustees were
most often had been used for discretionary purchases. Bank of New York, Deutsche Bank, Wells Fargo, and
In order to get to the starting point of a first mortgage, U.S. Bank. There was some shifting of blame to ser-
the second had to be written down entirely. Terminated. vicers, but it was never the servicers’ duty to get the
In 2009 about 90 percent of residential mortgages loans into the trust.
originated were securitized; over 75 percent of all resi- So, if the notes weren’t conveyed to the trust, and
dential firsts are securitized. Most second liens, how- were not endorsed over to the trust, the trustees failed
ever, were not: 86 percent fall into this category. Banks to perform their duties. Servicers need only say that


8

they were doing their job . . . and being managed by the Judges. Courts had traditionally tended to side with
trustees. Lenders, servicers and trusts in foreclosure cases. Part
of this could have been because of power dynamics—
Shock Troops: Attorneys General. The best equipped big banks vs. defaulting Borrowers. Part could have
force for the attack were the attorneys general of the 50 been because in around 94 percent of all cases, Borrow-
states. They were precise, professional, and very, very ers failed to even appear at proceedings to defend them-
fast: black-pajama warriors pouring out of under- selves.
ground tunnels, whistles sounding. The Lenders were These helped to give birth to high-volume foreclosure
immediately rocked back. ‘‘rocket dockets,’’ the judicial corollary to automated
The remarkable aspect is how long it took them to or- mortgage foreclosure systems.
ganize themselves into an effective task force, and then By late 2010, however, judges were becoming more
deploy. They had spotted blood trails and had tried to circumspect. Consistently holding for servicers and
sound the alarm as early as 2003, but the Office of trustees in cases with poor, missing, or questionable
Comptroller of the Currency had denied their requests documentation served to create problematic precedents
for assistance in getting national banks to provide de- extending real property law concepts into other types of
tails of their foreclosure operations. Maintaining that notes and contracts.
national banks should only answer to inquiries from Judges were heeding the calls of their attorneys gen-
federal regulators, state involvement, said the feds, eral and backing away from peremptory findings that
would only confuse matters. were at odds with the UCC, prior precedents, and com-
Foreclosure operations were reviewed. Banks pro- mon sense. Speed took a back seat to the consideration
vided their own in-house assessments of their own of facts.
practices: they graded themselves. The facts were straight-forward, echoing Borrowers’
There were early rumors that the AGs sought only to ‘‘Show me the note.’’ Trustees were increasingly being
soften the Lenders sufficiently to encourage a greater required to demonstrate a chain of proper endorse-
focus on loan modifications. Or, they wanted to create a ments dating from the inception of a loan. It went to the
fund to compensate homeowners who had been wrong- basic feature of negotiable instruments. Mortgage notes
fully foreclosed, a sop modeled after the BP gulf oil spill are transferred by delivery, not by contract or assign-
fund of the Summer of 2010. There was talk of the force ment. The party making the transfer must endorse the
losing some of its leaders in the aftermath of midterm instrument so that it’s payable to the recipient [or en-
elections. dorsed in blank].
Judicial activism has limitations—in the United
But as more evidence of wrongdoing surfaced, and
States, judges are the finders of fact, not investigators.
AGs steadily gained ground, it became apparent that As Lenders and servicers increasingly requested that
the battle would go on, bank to bank, house to house. foreclosure sales be cancelled and judgments vacated,
Midterm elections held in November replaced some at- judges found themselves in an uncomfortable position.
torneys general, but their replacements took their place Many were of the opinion that procedural abuses had
on the line and continued their measured advance. been occurring. The issue wasn’t so much whether to
A homeowner’s group met with Iowa’s attorney gen- grant Lenders’ motions to vacate. It was what to do with
eral, Tom Miller, the leader of the coordinated attor- defective foreclosure affidavits that weren’t being
neys general. They asked him to prosecute bank execu- brought to their attention. And by extension, what to do
tives for mortgage fraud. ‘‘Your investigation is the best with cases that had already passed through their court-
hope . . . we seek justice for the millions of families who rooms . . . carrying falsehoods with them.
have lost their homes . . . now is the time for leadershi- Judges held greatest sway in the 23 judicial foreclo-
p . . . Americans are watching,’’ the group said in a let- sure states. About 38 percent of foreclosure filings and
ter. 41 percent of the foreclosure inventory nationwide were
Shortly before Christmas, Arizona and Nevada filed there.
lawsuits against BofA charging consumer fraud and de- In addition to controlling the fate of affidavits, judges
ceptive mortgage servicing practices, particularly in had another weapon: filing and re-filing fees. These var-
mortgage modifications and foreclosures. Seeking res- ied by county and by state, and could range from $475
titution to consumers and fines of $25,000 for each vio- in Ohio to $2,000 in Broward County, Fla. Multiplied by
lation, the language was scathing: ‘‘misleading and de- thousands of cases, the figures could become signifi-
ceiving consumers . . . callous disregard. . .truly egre- cant . . . and these were before legal costs.
gious,’’ the Nevada attorney general said in a statement
that accompanied the complaint.
The Attack of the Regulators. In mid-November, imme-
diately following the midterm elections, both the House
It was telling that the action came from the states, not and Senate held hearings on the mortgage industry,
the Treasury. The violations took place in connection foreclosure practices and regulatory oversight. Rep.
with HAMP, but Treasury remained passive, maintain- Maxine Waters (D-Calif.), chairman of the House Fi-
ing that it had little power to require banks to behave in nancial Services Subcommittee on Housing and Com-
certain ways under its own program. At this same time, munity Opportunity, grew exasperated with regulators’
there were calls for some type of federal standardiza- replies to basic questions, which reiterate the theme
tion of foreclosure processes. There were also calls for that they were focused on banks’ loan modification pro-
criminal indictments . . . grams, not foreclosures. ‘‘Why,’’ asked Waters, ‘‘is it
Class actions were filed: Florida, Maine, Indiana, you don’t know how these systems work that you
Kentucky, Maryland, and New Jersey. Lenders slowly regulate? Why should we take you seriously?’’
began to realize that a new kind of war was coming Audits performed by Office of the Comptroller of the
their way. Currency (OCC), Office of Thrift Supervision (OTS),


9

and Federal Deposit Insurance Corporation (FDIC) and s Trustees are open to claims by investors that they
the Federal Reserve found that 95 percent of servicers failed to perform and misrepresented their transactions
didn’t meet performance standards. None had been with investors.
fined or penalized. The Big Four were directed to If mortgages aren’t transferred during securitization,
change their processes. mortgage-backed securities would actually not be
FHA followed a different route, withdrawing ap- backed at all. A failure of a transfer of mortgages into
proval from 1,500 lenders and servicers and levying trusts could cloud titles on millions of properties. Con-
$4.25 million in fines. The suspensions overwhelmingly tract rescission/putback liabilities could run into the
involved small firms. trillions of dollars--more than the capital of the major
The regulators’ testimony followed Lender talking U.S. banks.
points. Lenders maintained that they were doing every- If what investors purchased were in fact non-
thing they could to avoid foreclosures; that foreclosures mortgage backed securities, they could claim rescis-
held no benefit to them; that second mortgage portfo- sion, unwind the securitization, and receive back their
lios had no influence on their decisions; that only original payments at par. Losses would go to the secu-
people who were delinquent had been foreclosed; and ritization sponsor.
if the Lenders ever learned of any mistakes, they BofA (which had purchased Countrywide) made
quickly fixed matters. three separate attacks in an effort to solve its note prob-
One Lender went on to say that customer satisfaction lem. In order to prove it had the right to foreclose on
was their paramount concern. This was answered by Kemp’s house, it first needed to show that the trustee of
shouts of ‘‘Liar!’’ from members of the audience, who the securitization, Bank of New York, had the right to
were escorted from the hearing room. foreclose. But for this to happen, the trust must have
had both the note and the mortgage. Countrywide still
More House members were predisposed towards had the note.
banks, and they had fewer policy staffers than the Sen-
BofA tried to file an assignment of the mortgage and
ate. But the hearings found the Lenders’ range and they
note to BofNY in 2007. But under the strict rules of se-
hammered it. This was: all foreclosures are warranted,
curitization, late assignments don’t count—they’re void.
and therefore all foreclosure problems are simply pa-
perwork matters. The next attempt took the form of an allonge,
custom-made a few weeks before especially for the
By the beginning of December regulators appeared to Kemp trial. Allonges are pieces of paper that are sup-
be taking action. The OCC ordered servicers under its posed to be used when the note runs out of room for
purview to stop dual tracking foreclosure proceedings endorsements—including margins and reverse sides.
and loan modifications. When used, they’re supposed to be firmly attached to
Municipalities weighed in with various strategies. the original note. Allonges suddenly were being discov-
Chicago and surrounding suburbs in Cook County de- ered at custodians’ offices, separate from the notes.
clared de facto foreclosure-free zones when their front Again, the court held the note hadn’t been delivered.
line refused to fire. The sheriff’s office, responsible for A final attempt was made: a ‘‘lost note affidavit’’ was
physically evicting borrowers, announced in late Octo- filed, claiming the original note had been lost. The
ber that its officers would ‘‘no longer be doing the move failed: BofA later ‘‘discovered’’ the note.
banks’ work for them.’’ Standing defenses were rolled out. Example: The
Cook County Sheriff Thomas Dart explained that, ‘‘I bulk of BofA’s mortgages were originated by Country-
can’t possibly be expected to evict people from their wide, which BofA had acquired. BofA increased the
homes when the banks themselves can’t say for sure ev- number of foreclosures in its own [Countrywide’s]
erything was done properly.’’ Dart had asked Lenders’ name. In effect, BofA was claiming that it owned the
attorneys to personally sign documents confirming that loans and had never securitized them.
the evictions were justified. None did. The trouble was, Countrywide had said in SEC filings
Dart was not alone. Judges, sheriffs, and attorneys that 96 percent of its loans were securitized.
general began to push the limits of their powers to slow This raises some intriguing questions. The loans may
down the pace of foreclosures. Like infantrymen before never have been on BofA’s books. Or, Countrywide mis-
them, they might not be able to refuse to fire their represented the truth in its SEC filings. Or, Country-
weapons. But they could ensure that they fired high. wide didn’t complete the steps to convey the loans to
the trust; or the trust doesn’t own the note because it
The Kemp Salient. In late November The New York
wasn’t conveyed according to the terms of the PSA. If
Times reported on Kemp v. Countrywide, a bankruptcy
these were in fact the case, BofA could be seen as hav-
case in New Jersey. A Countrywide employee testified
ing committed fraud on the state court in the foreclo-
that it was standard practice there not to deliver the
sure process and in federal bankruptcy court, where
note to trustees. In the Kemp instance, the trustee to the
Chapter 13 claims following foreclosures are landing.
securitization had attempted to file a proof of claim in
Kemp’s bankruptcy. Kemp argued that the trustee It had gone beyond mere cost-cutting-robo-signing-
lacked standing because it didn’t have possession of the paperwork-technicalities. Multiple cover-ups were com-
note. ing to light, in what could be viewed as a deliberate ef-
fort for a Lender to prevail.
Countrywide didn’t just fail to convey title to the
For Kemp, the result was that the bankruptcy judge
mortgage loan: it didn’t even deliver it. If this was in
disallowed BofNY’s claim (via BofA) to be paid sums
fact common practice, the situation cascades through
due under Kemp’s mortgage. Neither bank was able to
the entire securitization chain:
foreclose, and Kemp’s mortgage debt became
s Trustees would have problems proving they have unsecured—the banks had to get in line with the other
standing for foreclosures and bankruptcies. creditors.


10

Kemp raised crucial issues for participants across the cern here was that regulators might find something that
spectrum. Federal regulators were faced with the pros- could be a land mine under the still-fragile economy.
pect of systemic risk spanning the entire financial seg-
ment. The second part of Richard Zahm’s analysis will
Targeted exams of banks’ collateral files could appear in the Jan. 25 issue of Real Estate Law
quickly bring answers--simply count the missing chains & Industry Report.
of endorsements or those lacking signatures. The con-

Richard Zahm is a direct lender and portfolio manager based in Connecticut and California. He may be reached at
richzahm@gmail.com.


Mortgage Wars Zahm Bna

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