1. 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
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
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
side had intended. But they were making the best of an
unfortunate situation. And the truth was, it was going
pretty well.
The Lenders had control. In trust deed states like
California, foreclosures took place largely outside the
BY RICHARD ZAHM court system. Silently, efficiently. Many of the houses
being seized were there, thankfully.
In states requiring judicial involvement, the biggest
I. Land War. problem wasn’t getting title—it was getting through the
F
or the past two years they’d been kept outside the queue just to get a judge’s signature on the docs. Courts
perimeter. There had been attempts to break were overwhelmed by the sheer volume of cases, piles
through, to be sure. But isolated, dejected— of file folders stacked in corridors and spare offices like
unarmed—they’d been kept at bay, effortlessly. Borrow- cord wood. Thousands of them. But the system was still
working. The foreclosure blades were whacking. Ker-
chunk. Another family out, another unit into the dis-
Richard Zahm is a direct lender and portfolio tressed portfolio.
manager based in Connecticut and Califor- The problem wasn’t really in the mechanism. The
nia. He may be reached at richzahm@ number of foreclosures had clogged up the blades, but
gmail.com. increased documentation efficiencies had alleviated
some of the pressure. In many ways, the entire system
COPYRIGHT 2011 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 1944-9453

2. 2
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- There was no subtlety behind the perception. It was a
nition with them: judges. 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 So if the Borrowers deserved to be tossed out, docu-
servicer employee, a guy with a mullet who carried mul- ments required to complete the task were basically a
tiple VP titles, but who couldn’t describe the basics of formality. Irregularities in their paperwork were techni-
the company he was representing—MERS [Mortgage calities, easily remedied by filing amended pleadings.
Electronic Registration Systems]. He could describe They were all just actions resulting in a kill. Whatever.
how he signed thousands of foreclosure documents and Legal pleadings can be amended according to state
was quite open about having no idea of what they con- and local law and rules. But local judges can choose not
tained. to accept new or amended affidavits. New affidavits suf-
The press caught wind and they attached a catchy fer from an inherent disadvantage—they have to com-
term: ‘‘robo-signers.’’ pensate or explain why the first ones were wrong, or
how they violated court rules. And even if judges do ac-
They were inside. Robo-signers were an unfortunate cept them, they don’t necessarily override the original
weapon for Lenders. They released flechettes across the documents.
spectrum of operations. Easy to deploy, they forced Most important for homeowners, they don’t prevent
Lenders’ heads down. Worse, they were emblematic of the argument that the Lender doesn’t have the right to
tools that were in common use in the industry. They in- bring a case against a borrower in the first place.
cluded false affidavits of indebtedness, lost note affida-
vits, lost summons affidavits, backdated mortgage as- Strategic Defaulters. The Viet Cong of the Borrowers
signments, counterfeited notes, mortgages and assign- were the Strategic Defaulters. Nimble, educated, effec-
ments. tive, they’d pushed back on a portion of the perimeter
The initial flurry focused on the attestations con- with minimal casualties. They’d received some press
tained in the signed affidavits. Affidavits carry the same attention—mainly as cultural oddities, soulless merce-
weight in foreclosure proceedings as testimony. They’re naries gaming the system. Absorbing hits to their credit
relied on by the courts to describe the foreclosing par- scores, moving on, minimizing collateral damage to
ty’s ownership interests in the properties, as well as the their finances and families, their actual numbers were
calculation of amounts owed. Robo-signing undercut far less than their potential—about 20 million. Even if
both of these elements. one in four homeowners were underwater, not every-
Here was evidence that servicers were basically fab- one was cut out to be a guerrilla.
ricating testimony, and that it was industry practice not The bigger cuts in the wire came from the AGs. Bet-
only to sign documents by the thousands, but to back- ter equipped than the Borrowers (few of whom even
date them and, when needed, recreate originals them- showed up to contest their foreclosures), they brought
selves. considerable firepower.
The import of this would become apparent several Lenders dropped into their bunkers and responded in
weeks later. It was discovered that robo-signing was not force. Foreclosures were halted by The Big Four: Bank
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3. 3
of America, JPMorgan Chase, Wells Fargo, and Citi. In- Despite the dynamic growth potential of the industry,
vestigations were announced. Days later, the foreclo- casualties were not unknown. State investigations of
sure machines, well-oiled, started up again. ‘‘Paper- foreclosure mills resulted in peremptory firing squads
work errors’’ had been corrected (in their hundreds of by Lenders. In late October the Law Offices of David J.
thousands). Lenders reiterated that Borrower attacks Stern, Florida’s premier foreclosure firm, laid off more
only served to extend the economic discomfort being than 500 workers, 70 percent of its staff, in a single day.
experienced by all. They were notified of their loss by e-mail.
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
Why the War? The root problem stemmed from an in- defense.
herent disconnect within the securitization process it- They used MERS as their lever. If they could only get
self. Securitized mortgages—the vehicles—were de- legislation passed affirming MERS’s legitimacy—or at
signed according to meticulous standards. Documenta- least blocked legislation denying it—there was hope for
tion and transferal accuracy were central to its slowing the rout. The effort was nothing new, but it had
operation. To its designers—and to the investment never been viewed as vital. Since 2008, a million dollars
bankers, rating agencies, and investors—the model had been allocated to lobbying, plugging holes punched
worked. into MERS by lower courts ruling against its primacy.
The calculation that wasn’t made was this: The pro- MERS was the creation of the Lenders, a VIN system
cess doesn’t scale, particularly under time pressure. for mortgages that was designed to supplant traditional
Lawyers had designed and created intricate machines— county recording office methods of tracking ownership
which were then shipped off to assembly plants. of mortgages.
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.
And the ultimate stake was much higher—the valid-
Production was geared in one direction: intake and ity of MERS transfers brought into question the entire
sale. And solid faith was placed in automation. Automa- securitization process. Some 66 million mortgages
tion to assess borrowers, automation to generate loans could conceivably be foreclosure-proof.
and to track them through an (automated) recording The lobbyists argued that rulings against it were
system. In the end, automation could correct documen- merely local, and that MERS offered a wonderful base
tation oversight, and late dates and, finally, human re- to establish one unambiguous, centralized, computer-
view and signatures. ized tracking system. States would have to lose their
It hadn’t always been this way. Before the securitiza- power over property law, unfortunately. MERS would
tions, before the models and algorithms, a Lender had receive a hall pass from the feds.
to know a Borrower. Lending decisions weren’t based The argument overlooked two elements. First, MERS
on the poor judgment of loan officers and easily ma- was viewed in a negative light at the time. Second, re-
nipulated automated origination software. A loan cording issues are firmly rooted in state, not federal
wasn’t a mass production item churned out by data pro- law. U.S. Supreme Court cases have repeatedly found
cessing factories. It was a considered investment deci- real estate transactions to be beyond the reach of the
sion, a relationship that could continue for decades. Commerce Clause, and not subject to federal interven-
Foreclosures without knowledge of underlying cir- tion.
cumstances didn’t happen. Before you ‘‘offed’’ a Bor- The most damning argument against MERS centers
rower, you had to see the whites of his eyes. You had to on its claim that it acts as a mortgagee of record. Mort-
listen to his breathing on the other end of the phone gages registered in its name in local courthouses repre-
when you told him he was done. Now everything was sent that MERS is both the nominee of the mortgage
performed at a distance, on computer screens, auto- and the mortgagee—something that’s not possible, akin
mated. to being a principal and an agent at the same time.
Lender foot soldiers were no longer the grizzled col- In 45 states, a mortgagee must be a creditor. The note
lections veterans of earlier times. They were now ‘‘fore- is the critical document and is accompanied by the
closure specialists,’’ working in shifts around the clock. mortgage, which is deemed an ‘‘accessory’’ to the note.
High school graduates or GED certificate holders were MERS doesn’t lend money or collect interest payments,
preferred, and fast typing skills were a plus. Drawing and it maintained that the note and the mortgage could
from the ranks of fast food restaurants and hair salons, be separated—and then reunited.
pay ranged from $10 to $12 per hour. Case law in virtually every state follows Carpenter v.
They had one goal: speed. Some—those had worked Longan 83 U.S.271, 21 L.Ed.313 (1873): ‘‘The note and
in the mortgage industry previously—brought with mortgage are inseparable; the former as essential, the
them the practices and ethics that had enabled the latter as an incident. An assignment of the note carries
origination of the types of loans they were now shutting the mortgage with it, while an assignment of the latter
down. alone is a nullity.’’
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4. 4
MERS itself has a bizarre structure. The mortgage . . . and the Lenders, it appeared, had simply ignored
and servicing database has no employees; its parent, them.
MERSCORP, has around 50 employees. But the em-
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.
But while strategic defaults created focused losses on
Bullets. Loan files were the basic component of the Lenders’ balance sheets, bank walkaways created col-
war. If the property—and the equity and cash flows— lateral damage, intensifying the deteriorzation of the
were what was being fought over—the documentation market and complicating stabilization efforts. Neigh-
served to provide the goal. And yet, little was known bors were being impacted in colorful ways that at-
about them. tracted the press. With the passage of time, vacant
Home mortgages consist of three different file types. homes generated more than overgrown lawns and lime-
There is an origination file, consisting of the mortgage green swimming pools. Pipes burst. Roofs separated.
application, appraisal, employment verification, bank Windows shattered. Houses began to grow mold.
statements, etc. There is a servicing file, which includes
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.
took place with note allonges: multiple signatures, elec- About half of associations polled said they lacked the
tronically forged. funds to carry out their responsibilities and were bor-
rowing, levying special assessments and restricting ser-
Parallel Foreclosures. It was Lender industry practice vices.
to simultaneously pursue foreclosure while negotiating Florida courts offered some relief to HOAs, allowing
loan modifications with Borrowers. While ostensibly ‘‘Mortgage Terminator’’ suits against Lenders. Quiet
parleying under a white flag—a truce—Lenders contin- title actions required Lenders to pay up. If they didn’t,
ued to tunnel under Borrowers’ defenses. associations could take title to the property and then
The practice was endorsed by the government- force the primary lien holder to initiate its own foreclo-
sponsored housing enterprises (GSEs) Fannie Mae and sure proceeding, or release its mortgage to the associa-
Freddie Mac. The justification, as with so much of the tion so that it could sell the unit itself. The legal theory
Mortgage War, was speed. Loan modification programs is that the Lenders had abandoned their mortgages-
required time, and the passage of time increased the . . . and their claims.
cost of what was the generally inevitable outcome: fore-
closure. Parallel tracking was an efficient method of The Corps: Servicers. The last wars are the ones pre-
placating Borrowers as they stood in line for the firing pared for and this one was no different. The foot sol-
squad. diers of investors and banks were the servicers. Servic-
The curious factor was that the government’s loan ing was traditionally a low margin/high volume line of
program had always banned banks and others from business, the role being relatively straight-forward.
foreclosing on Borrowers attempting to obtain modifi- Mortgage statements were sent out, mortgage pay-
cations. The GSEs just hadn’t adopted these measure- ments were collected, and the proceeds pushed up-
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5. 5
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
values. As a result, the most efficacious solution to the called to request some type of loan assistance, the rec-
housing crisis was actually placed out of reach. Princi- ommended course was to not make their mortgage pay-
pal balance reductions (the only viable solution: do the ment for a series of months. This served to remove lin-
math), were exactly what servicers didn’t want. This gering doubt.
route only served to cut into servicers’ profits: their own Limitations were in place in order to protect a range
fees were based on principal balances. of interests having little to do with actual loans. These
Loans defaulting en masse required exactly the oppo- included maintaining off balance sheet status; pass
site types of skill sets and processes servicers pos- through tax treatment to avoid double-level taxation;
sessed. Loss mitigation entails negotiation, the creation and the need to match the timing of a trust’s income
of repayment plans, loan modifications, short sales and from mortgages with the timing of the payment to the
deeds-in-lieu. It requires sensitivity to all parties’ needs, trusts.
determining the least-worst solution for frantic home- PSAs—the governing documents between servicers
owners. It requires trained employees. Instead, ‘‘loss and investors—vary in the types of modifications al-
mitigation’’ was treated as a factory process allowing lowed. Some allow only interest rate reductions. Some
use of low-skilled personnel: this was the exact opposite cap the number of loans that can be modified within a
of what was needed. pool without consent from a third party (often 5 percent
Worse, loss mitigation labor expenses are considered of the pool). Some limit the amount of the interest rate
overhead, non-reimbursable expenses to the servicers. reduction, require a particular capitalization method for
Worse still, it cut across the real profit center available amounts past due, or limit the number of loan modifica-
to them: default fees. tions that can be made within a given year.
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6. 6
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
Center report listed 36,000 complaints of lost docu- about half the cases handled by foreclosure defense
ments and inability to get a servicer response. lawyers. The irony was that with the ocean of foreclo-
HAMP applications stacked up. Treasury guidelines sures taking place, they went largely unnoticed.
called for a response and action within 30 days. The av- There were even more egregious foreclosures, horror
erage length of time homeowners sought HAMP modi- stories from homeowners facing foreclosure who didn’t
fications was 14 months. even have a mortgage; homeowners facing foreclosure
If they didn’t qualify—and had been paying a lesser from two different Lenders, simultaneously.
amount during this period—they were billed the differ- As more investigators entered the fray, patterns were
ence, with fees plus interest, in one lump sum. discerned. There were ‘‘Linda Green,’’ signatures.
A variation on this was for servicers to advise Bor- Green had worked for document processing company
rowers not to make their mortgage payments while they LPS and had been listed, variously, as an executive for
were being qualified for modifications. This approach BofA, Wells Fargo, US Bank, American Brokers Con-
would often be coupled with two tracks: while the loan duit, National City . . . and dozens more. The amusing
modification possibilities were being explored, foreclo- part was that the ‘‘Linda Green’’ signatures bore little
sure proceedings would be initiated (in the interest of resemblance to each other. Forged signatures, imper-
saving time). sonation of an officer of a bank, improper conveyance
But the most egregious traps were coming to light: of a mortgage into a trust: the charges mounted.
Foreclosures occurring even when Borrowers had made And these all pointed to what had proven to be the
every single mortgage payment. The seemingly safe most effective weapon against Lenders: requiring them
terrain—pay the mortgage on time, keep the house— to prove that they actually had standing to foreclose.
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7. 7
It had become a rallying point for Borrowers, a battle on their seconds. And from a Borrower’s point of view,
cry: ‘‘Show me the note.’’ this reverse order makes perverse sense. Seconds have
higher interest rates and are smaller, more manageable.
Friendly Fire on Foreclosures. Lenders managed to fire They also take a more liquid form, as HELOCs. Borrow-
on their own position, selling homes that they had fore- ers’ loan payment priorities had emerged: car payments
closed on—but didn’t own. Likely as a result of title first, then credit cards, then HELOCs. Mortgages could
chain verification errors—the spawn of MERS—Fannie wait. Like crying infants, the loudest and smallest are
Mae was reported to have sold homes that it had not ob- fed first.
tained title to. Here was a simple story for the press. An astounding figure: in 90 percent of the instances
‘‘Foreclosure sales,’’ a commercial broker com- where a first was in default, the dollar amount of out-
mented, ‘‘are like catching a falling knife.’’ standing HELOCs remained the same. Borrowers could
Foreclosure sales are final. The risk falls not on the be not paying on their firsts, but the amount available
home buyer, but on the foreclosing Lender. Deeds ob- to them to borrow on their seconds was not reduced.
tained through foreclosure sales are strongly protected. Six percent of borrowers actually had their lines in-
The problems escalate when the underlying foreclosure creased after they went into default, by an average of 20
is flawed—as in the case where false affidavits have percent. Often, the firsts and seconds were held by the
been introduced and accepted. same bank.
The situation then becomes: Wrong Lender fore- And in the distance, watching this all, are the regula-
closes on Borrower, but can’t take title. Wrong Lender tors. Although they have the power to force banks to re-
sells to innocent buyer, who could be sued by the origi- serve against the loans, they often choose not to. Perfor-
nal Borrower. mance of the loans is what is crucial, not the value of
Making matters worse, more accounts appeared of the underlying property. Besides, there isn’t enough
Lenders selling foreclosed houses twice, to two sepa- money in the economy to write them all down anyway.
rate buyers closing on homes Lenders didn’t have title
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-
see servicers, but carveouts and indemnifications
Wrongful foreclosures had in fact been taking within PSAs limit the risk entailed by their supervisory
role.
place for years. But as always, Borrowers had In the rear with the gear, trustees could be suddenly
called up and shoved into fighting holes. Reason: they
been too beleaguered, too isolated, to mount certified to investors that the trusts contained the mort-
gage securitizations—that they contained the trust as-
a coordinated defense. sets. If the loans were not properly conveyed to the
trust, the certifications they made were untrue. Inves-
tors who relied on the certifications could be under-
standably chuffed.
The Battle of the Seconds. Banks held a disproportion- The biggest mortgage securitization trustees were
ate number of second liens—home equity lines of credit
Bank of New York, Deutsche Bank, Wells Fargo, and
(HELOCs)—the part of Borrowers’ indebtedness that
U.S. Bank. There was some shifting of blame to ser-
most often had been used for discretionary purchases.
vicers, but it was never the servicers’ duty to get the
In order to get to the starting point of a first mortgage,
loans into the trust.
the second had to be written down entirely. Terminated.
So, if the notes weren’t conveyed to the trust, and
In 2009 about 90 percent of residential mortgages were not endorsed over to the trust, the trustees failed
originated were securitized; over 75 percent of all resi- to perform their duties. Servicers need only say that
dential firsts are securitized. Most second liens, how- they were doing their job . . . and being managed by the
ever, were not: 86 percent fall into this category. Banks trustees.
keep HELOCs in their own portfolios. Banks with ser-
vicing subsidiaries own 10 percent to 15 percent of the Shock Troops: Attorneys General. The best equipped
second mortgages on the firsts they service. So there is force for the attack were the attorneys general of the 50
a strong incentive for servicers to modify the firsts to states. They were precise, professional, and very, very
free up money for Borrowers to pay on the seconds. fast: black-pajama warriors pouring out of under-
For banks, the numbers were huge, and concen- ground tunnels, whistles sounding. The Lenders were
trated. The Big Four (BofA, Wells Fargo, JPMorgan immediately rocked back.
Chase, Citi) held $423 billion of HELOCs with $151 The remarkable aspect is how long it took them to or-
billion—more than a third—of this amount to Borrow- ganize themselves into an effective task force, and then
ers who were underwater, or close to it. The loans were, deploy. They had spotted blood trails and had tried to
in effect, unsecured. sound the alarm as early as 2003, but the Office of
If the seconds had loan-to-value (LTV) ratios greater Comptroller of the Currency had denied their requests
than 100 percent, it would stand to reason that the loans for assistance in getting national banks to provide de-
would be written off. tails of their foreclosure operations. Maintaining that
But this would be wrong. BofA—with $41 billion of national banks should only answer to inquiries from
underwater seconds—estimates that even if all of these federal regulators, state involvement, said the feds,
loans defaulted, it would still be able to collect 85 cents would only confuse matters.
for every dollar loaned. Foreclosure operations were reviewed. Banks pro-
Rationale: Even after defaulting on a first mortgage, vided their own in-house assessments of their own
more than half of Borrowers continue to make payment practices: they graded themselves.
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8. 8
There were early rumors that the AGs sought only to required to demonstrate a chain of proper endorse-
soften the Lenders sufficiently to encourage a greater ments dating from the inception of a loan. It went to the
focus on loan modifications. Or, they wanted to create a basic feature of negotiable instruments. Mortgage notes
fund to compensate homeowners who had been wrong- are transferred by delivery, not by contract or assign-
fully foreclosed, a sop modeled after the BP gulf oil spill ment. The party making the transfer must endorse the
fund of the Summer of 2010. There was talk of the force instrument so that it’s payable to the recipient [or en-
losing some of its leaders in the aftermath of midterm dorsed in blank].
elections. 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-
It was telling that the action came from the states, not diately following the midterm elections, both the House
the Treasury. The violations took place in connection and Senate held hearings on the mortgage industry,
with HAMP, but Treasury remained passive, maintain- foreclosure practices and regulatory oversight. Rep.
ing that it had little power to require banks to behave in Maxine Waters (D-Calif.), chairman of the House Fi-
certain ways under its own program. At this same time, nancial Services Subcommittee on Housing and Com-
there were calls for some type of federal standardiza- munity Opportunity, grew exasperated with regulators’
tion of foreclosure processes. There were also calls for replies to basic questions, which reiterate the theme
criminal indictments . . . that they were focused on banks’ loan modification pro-
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
their way. Audits performed by Office of the Comptroller of the
Currency (OCC), Office of Thrift Supervision (OTS),
Judges. Courts had traditionally tended to side with and Federal Deposit Insurance Corporation (FDIC) and
Lenders, servicers and trusts in foreclosure cases. Part the Federal Reserve found that 95 percent of servicers
of this could have been because of power dynamics— didn’t meet performance standards. None had been
big banks vs. defaulting Borrowers. Part could have fined or penalized. The Big Four were directed to
been because in around 94 percent of all cases, Borrow- change their processes.
ers failed to even appear at proceedings to defend them- FHA followed a different route, withdrawing ap-
selves. proval from 1,500 lenders and servicers and levying
These helped to give birth to high-volume foreclosure $4.25 million in fines. The suspensions overwhelmingly
‘‘rocket dockets,’’ the judicial corollary to automated involved small firms.
mortgage foreclosure systems. The regulators’ testimony followed Lender talking
By late 2010, however, judges were becoming more points. Lenders maintained that they were doing every-
circumspect. Consistently holding for servicers and thing they could to avoid foreclosures; that foreclosures
trustees in cases with poor, missing, or questionable held no benefit to them; that second mortgage portfo-
documentation served to create problematic precedents lios had no influence on their decisions; that only
extending real property law concepts into other types of people who were delinquent had been foreclosed; and
notes and contracts. if the Lenders ever learned of any mistakes, they
Judges were heeding the calls of their attorneys gen- quickly fixed matters.
eral and backing away from peremptory findings that One Lender went on to say that customer satisfaction
were at odds with the UCC, prior precedents, and com- was their paramount concern. This was answered by
mon sense. Speed took a back seat to the consideration shouts of ‘‘Liar!’’ from members of the audience, who
of facts. were escorted from the hearing room.
The facts were straight-forward, echoing Borrowers’ More House members were predisposed towards
‘‘Show me the note.’’ Trustees were increasingly being banks, and they had fewer policy staffers than the Sen-
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9. 9
ate. But the hearings found the Lenders’ range and they the securitization, Bank of New York, had the right to
hammered it. This was: all foreclosures are warranted, foreclose. But for this to happen, the trust must have
and therefore all foreclosure problems are simply pa- had both the note and the mortgage. Countrywide still
perwork matters. had the note.
By the beginning of December regulators appeared to BofA tried to file an assignment of the mortgage and
be taking action. The OCC ordered servicers under its note to BofNY in 2007. But under the strict rules of se-
purview to stop dual tracking foreclosure proceedings curitization, late assignments don’t count—they’re void.
and loan modifications. The next attempt took the form of an allonge,
Municipalities weighed in with various strategies. custom-made a few weeks before especially for the
Chicago and surrounding suburbs in Cook County de- Kemp trial. Allonges are pieces of paper that are sup-
clared de facto foreclosure-free zones when their front posed to be used when the note runs out of room for
line refused to fire. The sheriff’s office, responsible for endorsements—including margins and reverse sides.
physically evicting borrowers, announced in late Octo- When used, they’re supposed to be firmly attached to
ber that its officers would ‘‘no longer be doing the the original note. Allonges suddenly were being discov-
banks’ work for them.’’ ered at custodians’ offices, separate from the notes.
Cook County Sheriff Thomas Dart explained that, ‘‘I Again, the court held the note hadn’t been delivered.
can’t possibly be expected to evict people from their A final attempt was made: a ‘‘lost note affidavit’’ was
homes when the banks themselves can’t say for sure ev- filed, claiming the original note had been lost. The
erything was done properly.’’ Dart had asked Lenders’ move failed: BofA later ‘‘discovered’’ the note.
attorneys to personally sign documents confirming that Standing defenses were rolled out. Example: The
the evictions were justified. None did. bulk of BofA’s mortgages were originated by Country-
Dart was not alone. Judges, sheriffs, and attorneys wide, which BofA had acquired. BofA increased the
general began to push the limits of their powers to slow number of foreclosures in its own [Countrywide’s]
down the pace of foreclosures. Like infantrymen before name. In effect, BofA was claiming that it owned the
them, they might not be able to refuse to fire their loans and had never securitized them.
weapons. But they could ensure that they fired high. The trouble was, Countrywide had said in SEC filings
The Kemp Salient. In late November The New York that 96 percent of its loans were securitized.
Times reported on Kemp v. Countrywide, a bankruptcy This raises some intriguing questions. The loans may
case in New Jersey. A Countrywide employee testified never have been on BofA’s books. Or, Countrywide mis-
that it was standard practice there not to deliver the represented the truth in its SEC filings. Or, Country-
note to trustees. In the Kemp instance, the trustee to the wide didn’t complete the steps to convey the loans to
securitization had attempted to file a proof of claim in the trust; or the trust doesn’t own the note because it
Kemp’s bankruptcy. Kemp argued that the trustee wasn’t conveyed according to the terms of the PSA. If
lacked standing because it didn’t have possession of the these were in fact the case, BofA could be seen as hav-
note. ing committed fraud on the state court in the foreclo-
Countrywide didn’t just fail to convey title to the sure process and in federal bankruptcy court, where
mortgage loan: it didn’t even deliver it. If this was in Chapter 13 claims following foreclosures are landing.
fact common practice, the situation cascades through It had gone beyond mere cost-cutting-robo-signing-
the entire securitization chain: paperwork-technicalities. Multiple cover-ups were com-
s Trustees would have problems proving they have ing to light, in what could be viewed as a deliberate ef-
standing for foreclosures and bankruptcies. fort for a Lender to prevail.
s Trustees are open to claims by investors that they For Kemp, the result was that the bankruptcy judge
failed to perform and misrepresented their transactions disallowed BofNY’s claim (via BofA) to be paid sums
with investors. due under Kemp’s mortgage. Neither bank was able to
If mortgages aren’t transferred during securitization, foreclose, and Kemp’s mortgage debt became
mortgage-backed securities would actually not be unsecured—the banks had to get in line with the other
backed at all. A failure of a transfer of mortgages into creditors.
trusts could cloud titles on millions of properties. Con- Kemp raised crucial issues for participants across the
tract rescission/putback liabilities could run into the spectrum. Federal regulators were faced with the pros-
trillions of dollars--more than the capital of the major pect of systemic risk spanning the entire financial seg-
U.S. banks. ment.
If what investors purchased were in fact non- Targeted exams of banks’ collateral files could
mortgage backed securities, they could claim rescis- quickly bring answers--simply count the missing chains
sion, unwind the securitization, and receive back their of endorsements or those lacking signatures. The con-
original payments at par. Losses would go to the secu- cern here was that regulators might find something that
ritization sponsor. could be a land mine under the still-fragile economy.
BofA (which had purchased Countrywide) made
three separate attacks in an effort to solve its note prob- The second part of Richard Zahm’s analysis will
lem. In order to prove it had the right to foreclose on appear in the Jan. 25 issue of Real Estate Law
Kemp’s house, it first needed to show that the trustee of & Industry Report.
REAL ESTATE LAW & INDUSTRY REPORT ISSN 1944-9453 BNA 1-11-11