1. A BNA, INC.
REAL ESTATE !
LAW & INDUSTRY
VOL. 4, NO. 2 REPORT JANUARY 25, 2011
MORTGAGES
In this second of a two-part series, the author shifts from the Ground War of home mort-
gage Lenders, who have engaged in a pitched battle with Borrowers for America’s housing
stock to the War at Sea, involving armadas of mortgage securities investors. He notes that
in spite of Obama administration efforts to intercede, homeowners continue to suffer losses
to foreclosure, while Investors continue to trade blows with Lenders. The outcome for all
combatants, as well as for the U.S. economy, remains in doubt.
In Its Self-Destructive Housing Conflict, America Finds the Enemy Close to Home
II. The War at Sea
F
or all the drama taking place on courthouse steps
and neighborhoods, the penultimate battle was lin-
ing up over the horizon, out of sight of land, far
from people and the press. The massive battleships of
investors, trustees and banks were taking position.
Their fight paralleled the land water and originated
from the same source: flaws in mortgage creation. In-
vestors found themselves in a mirror position to Bor-
rowers. But unlike Borrowers, clinging to their indi-
vidual homes, Investors had the firepower to force the
biggest issue: Their claims went to the core of the en-
tire securitization market—the validity of the pools
themselves.
BY RICHARD ZAHM Investor frustration had been mounting for years.
Continued loan losses, unexplained bond write-downs,
inequitable treatment of first- and second-lien mort-
Richard Zahm is a direct lender and portfolio gages, ineffective loan modifications. . .
manager based in Connecticut and Califor- An initial claim made by Pimco, Blackrock, and the
nia. He may be reached at richzahm@ New York Federal Reserve against BofA sought $47 bil-
gmail.com. lion in putbacks. JPMorgan Chase calculated that total
Lender exposure could range between $55-$120 billion.
COPYRIGHT 2011 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 1944-9453

2. 2
Direct hits of this magnitude could, conceivably, send This doesn’t work. Reasons: It’s too late by a long
the banking behemoths to the bottom. shot; it bypasses the required intermediaries, and it oc-
curs after the default—violating the requirement the
Mortgage Artillery Shells: Duds. Artillery consist of loans be performing. Mortgage securitization trusts are
four components. There is some type of explosive—the organized under New York trust law, which is un-
propellant. There is the shot itself. There is a catalyst, a equivocal: transferring non-performing loans—late—is
primer, something that ignites the explosive. And there void.
is the barrel that directs the shot to its destination. All
components need to be present. The upshot is that the mortgage-backed securities
that were purchased by Investors could actually be
Securitized mortgages take the same form. The pow-
backed by nothing at all.
der consists of a note (an IOU from a borrower), and a
mortgage, which describes the details of the collateral When a Borrower defends himself against a Lender
backing the note. These include the terms of the at a foreclosure hearing, the most common challenge is,
amount being borrowed, the interest rate, the payment ‘‘Show me the note.’’ It demands the simple production
schedule, etc. of a simple document. When Lenders pull the foreclo-
There is the shot: this is the property itself. A house, sure trigger, and they can’t produce the note, there is a
an office building, raw land. single sound. Click.
Catalysts for secured mortgages take the form of For Investors, this sound could be much, much
delivery—a chain ‘‘reaction’’ of transferal through dif- louder.
ferent parties (loan originator to sponsor to trustee). As Investors prepared for battle, the Securities and
Finally, there’s recordation—the barrel. This takes Exchange Commission (SEC) assisted on their flank,
the form of county recorders and their erstwhile substi- bringing its own investigation on servicers and Lenders.
tute, the Mortgage Electronic Registration Systems Sending in waves of subpoenas in December to BofA,
(MERS). Citi, JPMorgan Chase, Goldman Sachs, and Wells
In securitizations, the snap of the primer requires Fargo, the probe was focused on the roles they played—
precise transferals taking place within exact time- and the representations they made—in the securitiza-
frames. The process is governed by Pooling and Servic- tion process.
ing Agreements (PSAs) that are in turn governed by
Grounded Air Wing. The Obama administration
New York trust law, which is particularly strict. Trans-
wanted the fighting to just go away, quickly. Tradition-
ferals may also be governed by Articles 3 & 9 of the Uni-
ally backing the Lenders, it knew that the housing mess
form Commercial Code (UCC), but in the strict world of
could only prolong the recovery and undermine con-
PSAs, the actual wording of the PSAs prevails.
sumer and voter confidence. As other sectors of the
PSAs have two basic requirements. First, notes and economy improved, housing languished. . .pulling the
mortgages have to be transferred to a trust. Second, the others down and threatening to draw the country into a
original notes have to be delivered. The original notes double-dip recession.
each must contain a complete chain of endorsements
showing the ownership of the loan. A final endorsement The federal government was up to its eyeballs in the
is left blank. mortgage market—and on
The note—like an IOU—has to be endorsed, like a both sides of the wire. The Treasury Department
check, from one party to another. The chain of convey- used the Troubled Asset Relief Program (TARP) funds
ance has to be from originator to sponsor to depositor to buy stock in the Big Four, and to implement the
to trust. All of the steps had to be completed within a set Home Affordable Modification Program (HAMP), and
time period, usually 90 days after the trust closed. All of to buy paper from govenment-sponsored housing enter-
the loans had to be performing: the loans had to be prises Fannie Mae and Freddie Mac. The Federal Hous-
‘‘seasoned.’’ ing Finance Agency (FHFA) was a conservator of the
The reason for having the full chain of title in the en- two GSEs. The Federal Deposit Insurance Corporation
dorsement is this: It ensures bankruptcy remoteness of (FDIC) held mortgage assets and served as a receiver
the trust’s assets. It protects Investors from taking on for failed banks that had sold loans to Fannie and Fred-
the credit risk of the originators and securitizers. A ‘‘re- die.
cital of sale’’ isn’t sufficient. There has to be actual de- Air cover has always been dependable. Federal gov-
livery. And it has to be within a prescribed time period, ernment inaction had kept the states on the ground, and
usually 90 days. allowed the Lenders to control the field. Antiaircraft
Banks—the securitization sponsors—could find that flak from the press might have briefly lit up the sky, but
the loans that were believed to have been transferred to the stories they told were always local, isolated, and
securitization trusts actually weren’t. The loans could quickly forgotten. Borrower claims of Lender duplicity
still be on the banks’ balance sheets. They were like were easily deflected, and even more easily ignored.
grenades with their pins pulled, rolling back at them. Banking is a government-sanctioned cartel. Govern-
Loan losses would go to the banks and the banks would ment extends banking licenses and regulates and sanc-
have to increase their capital against the loans that tions banking activities. When banks engage in unsafe
hadn’t gone into foreclosure. practices, they put the economy at risk—regulators are
By the end of the year it was becoming increasingly supposed to be on top of this.
apparent that basic transferal and delivery require- As late as November, at the height of the robo-
ments had been ignored. Necessary steps to convey signing discoveries, the Department of Housing and Ur-
loans to a trust created to hold them hadn’t been taken. ban Development (HUD) still maintained that there was
The notes couldn’t be located and they very often no evidence of any systemic issues. Treasury had qui-
weren’t conveyed to the trust until immediately before etly deployed an investigative task force. Comprised of
a foreclosure. 11 separate agencies and hundreds of investigators, it
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3. 3
was more sound than fury. It was thin on the ground Body Count. Since mid-2007 8 million homes have
and inexperienced in the mortgage industry. been placed in foreclosure. This includes 2.5 million
The investigation was crammed into the end of the that were foreclosed in 2010; 7.04 million loans are non-
year, along with holidays and other year-end tasks. current. Another 6.5 million are forecast to be fore-
There didn’t appear to be much attention paid to an is- closed within the next two years. At 2.3 people per
sue highlighted by Borrowers’ attorneys—the high per- household, around 33 million Americans would be
centage of foreclosures resulting from servicer errors wounded in these four years of the Mortgage War.
and misapplication of payments, resulting in com-
pounding fees and charges that were tipping Borrowers Lenders Dig In. In the mean time, Lenders pursued a
into default. Over 50 percentage of defaults have been strategy of reviewing their pending foreclosure cases in
ascribed to this practice. The task force’s findings were the 23 judicial states, variously halting foreclosure ac-
delayed, missing the congressional panels held the tions in different markets. Initially claiming that they
week of Nov. 15. found no problems with their processes, by mid-
December they were approaching completion of an af-
It released its findings two weeks later. It found fidavit resubmission project of staggering proportions.
‘‘widespread and inexcusable breakdowns’’ in basic Wells planned to resubmit 55,000 cases where its ser-
controls of the foreclosure process. It also found that vicers failed to ‘‘strictly adhere’’ to processes; BofA was
regulators hadn’t imposed fines or sanctions on banks doing the same with 102,000 cases. Everything was A.J.
for known problems. Squaredaway.
It was in Treasury’s interest to minimize elements There were still decent kills to be had.
that may have created systemic risk, because this was
its mantra: the banking system is sound, no matter The Homefront. ‘‘Homebuilding,’’ intoned the experts,
what. It was also announced that Treasury Assistant ‘‘will lead the U.S. out of the recession, same as it has
Secretary for Financial Institutions Michael Barr would before.’’ Well, no. It was never homebuilding that
be leaving his post to return to his academic career. . . chopped through the jungle—it was the availability of
At year’s end, the Obama administration had spent financing. And new homes were the last thing the coun-
just $12 billion of the $50 billion promised to help try needed.
homeowners avoid foreclosure. Barely 16 percentage— In earlier times, a housing inventory of six to seven
483,000 distressed homeowners—were making reduced months signaled a balanced market.
payments as the result of government loan modification By late 2010, the national inventory was four times
programs. More than 755,000 Borrowers had been this amount. Adding homes listed on the Multiple List-
tossed from the programs, either because they were un- ing Service (MLS) to the shadow inventory of loans on
able to make the smaller payments or because of docu- homes that were more than 90 days late, homes in fore-
ment issues or bank blunders. closure and REO not listed, inventory stood at around 7
million homes. (This didn’t take into account properties
Administration Palliatives. The Obama administration of owners who wanted to sell, but who were underwa-
continued to chum the water to induce banks to trim ter in their loans. Twenty-five percent of all homes were
loan balances through several programs: worth less than their loan amount.)
In some regions, existing inventory was calculated at
s HAMP-PRA required Lenders to ‘‘consider’’ re-
over 10 years.
ducing principal for Borrowers underwater by at least
There was also the question of who would sop up the
15 percent.
inventory, even after prices found a bottom. Demo-
s Hardest Hit Fund: CA, NV and AZ required a graphics weren’t encouraging. Aging baby boomers
dollar-for-dollar match by Lenders for amounts paid for were seeking to downsize, but their equity had been se-
principal reductions by the sates under a federal pro- verely eroded by falling prices. Forty percent of Ameri-
gram. cans had mortgages with rates higher than 6 percent-
s FHA Short-Refinance: Principal reductions age, when the current 30 year fixed rate is in the 4 per-
coupled with refinancing through the Federal Housing centage range. Reason: many couldn’t refinance
Administration (FHA). because they were underwater.
Younger would-be buyers were in similar straits,
But as the administration encouraged Lenders to par- made worse by high rates of unemployment.
ticipate in these programs, the two biggest Investors re- The youngest cohort of potentials carried its own spe-
mained on the sidelines: Fannie Mae and Freddie Mac. cial burden: student loan debts. College graduates of
Collectively holding nearly a third of all seriously delin- the Class of 2008 were saddled with an average debt
quent mortgages, their implementing reductions could load of $23,000. Worse, they were contending with a job
have brought significant impact on the market. But they market skewed against them: up to 24 percentage un-
couldn’t. Their regulator, the FHFA, wouldn’t let them. employment for ages 18 to 24.
FHFA was charged with two conflicting roles. It was The actual value of their education investment was
responsible for overseeing the broad U.S. housing mar- questionable: the Government Accountability Office
ket: principal reductions could provide some stability, it (GAO) reckoned that half the holders of bachelor’s de-
was thought. At the same time, the agency was respon- gree were working in jobs that didn’t require a degree.
sible for ensuring that the GSEs conserve their funds in The combination of debt, unemployment and low wages
order to wean themselves from government support. caused student loan default rates to soar 300 percent-
The question was one of selecting the least-worst op- age between 2008 and 2009: $51 billion of student loans
tion, of the tension between short-term and long-term were nonperforming.
demands, of helping homeowners avoid foreclosure, Starting out in the hole, credit trashed, glad to have a
while protecting taxpayer interests and avoiding creat- job—any job—the sight of young-people-moving-in was
ing moral hazard. becoming a rarity.
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4. 4
Viewed from another angle, the U.S. poverty level percentage were delayed or cancelled due to REO title
was at 14.3 percentage, a 50-year high. issues.
The average number of days that would pass between The growing consensus was that distressed invest-
nonpayment of a mortgage and eviction was 492. This ment wasn’t worth the delays, the headaches, and the
was an increase over 2009 (382 days) and 2008 (244 uncertainty.
days). In New York and Florida, the time period was Home prices continued to decline in nearly half the
closer to 20 months. In November 700,000 more Bor- metro areas of the country.
rowers entered the more-than-90-days-late category, a
position few exit without losing their house. Walking Wounded Return. As the New Year started,
Millions of homeowners were still living in houses the general consensus was that some type of housing
that they were no longer making mortgage payments market recovery would take place. The dates for this oc-
on, in effect squatting in their own homes. Sixty-three curring were consistently pushed back: they stood at
percent of them knew Borrowers in the same straits. 2012 or 2013. The recovery was no longer described as
Only one in four believed that Lenders would pursue a return to prices seen in 2005. There was grudging ac-
their assets beyond their house. Their credit damaged, ceptance of equilibrium being found at levels of a de-
they were applying their unpaid mortgage amounts to cade before.
other bills, stashing it in savings, or spending it at the Congress and regulators continued their advance.
mall. Hearings continued; the Office of the Comptroller of the
Minimum credit scores were raised in late November Currency (OCC) banned servicers from following the
for Borrowers seeking Federal Housing Administration two-track modification/foreclosure strategy it had been
(FHA) loans. It would take a FICO score of 640 to employing. The mortgage interest deduction—long a
qualify, up from 620. About 6.3 million people fall into sacred cow—had been put on the block as a revenue
this range. The pool of potential buyers continued to saving device.
shrink. What had started out as a regrettable police action
Other fundamentals pointed to a lengthy wait for had turned out to become an outright war. And as with
good times to return to the housing market. Unemploy- so many wars, the basic question arose: Were we fight-
ment appeared to have peaked, but remained high. Low ing on the wrong side? There had been a heroic time be-
interest rates had only one way to go in the future: up. fore, a time of belief. Now there were empty houses.
This would dampen home prices. The large shadow in- Outcomes in the years to come were relatively clear:
ventory remained, and there were growing questions as s Principal modifications;
to whether existing homes—especially those in far s Putbacks;
flung exurbs—actually met changing homeowner
s Accounting rule changes for second-lien write
needs.
downs;
The pace of foreclosures varied, with different Lend-
ers, and Fannie and Freddie freezing and unfreezing s Shared equity appreciation and owners equivalent
their machines on a weekly basis. Some states were rent programs; and
able to stop foreclosure proceedings by individual s Tax write offs of equity losses.
banks (Maine) or altogether (Connecticut). What was less clear was what form these war repara-
The slowed pace cut down on the foreclosure carrion tions would take, and to what extent war criminals
available in the most hard-hit regions. As judges began would be indicted and punished. This had been a war
to review facts of cases before them, house flippers, without valor, a war on ourselves. We who have seen
renovators, and Realtors started to chafe. war will always have it in our dreams.
The toxic cloud surrounding deficiencies in foreclo- As for homeowners—past, current, and future—the
sure documentation kept home shoppers away from issue would be the same as it is after any war. When
distressed properties, pushing down prices further. Al- would life return to normal, and what would the new
though servicers pulled REO properties off the market, normal be? When would the wounds heal? Trust had
owner-occupant buyers and Investors increasingly been lost. Trust in banks, trust in government, trust in
shied away from short-sales. the value of an investment in a home.
One out of four closings was delayed or cancelled in Borrowers would slowly make their way back home.
October due to issues surrounding short sales. Twelve Wherever—and whatever—that might be.
1-25-11 COPYRIGHT 2011 BY THE BUREAU OF NATIONAL AFFAIRS, INC. REAL ISSN 1944-9453