[This is the second post in a 2-part series in which we take a not-so-nostalgic stroll down Memory Lane, revisiting the events that linger with us today – almost exactly five years after the collapse of the lender credit markets and the resulting cliff dive in housing prices. The first post can be found here. PCQ]
Loan Documentation – The Promissory Note. The promissory note is commonly referred to as the “debt instrument,” meaning it is the legal document that contains the promise to repay the loan. As discussed later, promissory notes may be transferred between various banks for various reasons. It is less clear why banks transfer promissory notes that appear to be non-performing at the time of transfer [i.e., suggesting that the note had been “written off” by the holder and then transferred at a significant discount to a company that would either try to collect, or aggregate notes for assignment out for third-party collection.] Nevertheless, it does appear that there has been an active market for the sale and transfer of promissory notes.[3] In order to transfer a promissory note, Section 3-203 of the Uniform Commercial Code (“UCC”) is triggered. The UCC is a set of uniform laws applicable between the states that govern non-real estate commercial transactions. To fully understand the legal issues raised by multiple transfers of promissory notes, it is essential to have a working knowledge of Articles 3 and 9 of the UCC. This subject is beyond the scope of this post.
Loan Documentation – Trust Deeds and Mortgages. Trust deeds and mortgages perform essentially the same function, i.e. securing repayment of the promissory note. Trust deeds and mortgages differ primarily in their nomenclature:
- Mortgagee (lender in mortgage) = Beneficiary (lender in trust deed)
- Mortgagor (borrower in mortgage) = Grantor (borrower in trust deed)
- Trustee – There is no such thing in mortgage law, since mortgages are a two-party instrument. Mortgages are a creature of the Common Law. Trust deed law is a creature of statute, and is in derogation of the Common Law. The trustee fictionally[4] “holds title” to the property in trust until the loan is either paid off, or falls into default.
- If paid off, the beneficiary notifies the Trustee, who executes and records a “Deed of Reconveyance” (fictionally re-conveying “title” in the property back to the Grantor). The Deed of Reconveyance is the functional equivalent of the “Satisfaction of Mortgage” that, once recorded, effected a removal of the mortgage from the county records.
- If the loan falls into default, the Beneficiary notifies the Trustee. Since most trustees identified in trust deeds are an institution, such as title insurance companies, they typically are replaced by a Successor Trustee, who is appointed by the Beneficiary.
- The successor trustee then records a Notice of Default (“NOD”) in the county records where the property is located. This process occurs outside of court; ergo, “non-judicial foreclosure.” See, ORS 86.705-86.990.
- Then the trustee sends or serves [or both] a Notice of Sale to the borrower (“Grantor”) containing information about the default, the sum necessary to cure it, and the date, time, and place of sale.
- The sale can occur no sooner than 120 days after the Trustee mails the Notice of Sale. The borrower may “cure” the default by paying the amount then due [as if no acceleration occurred]. This sum must be paid prior to 5 days before the scheduled sale date. If it is not, then the entire unpaid indebtedness becomes immediately due and payable. The Grantor (borrower) has no right of redemption after the sale and the Beneficiary (lender) has no right to a deficiency judgment against the borrower.
[Note that effective on July 11. 2012, SB 1552 will go into effect. It requires that following the recording of the NOD, and not less than 60 days before the mailing or service of the Notice of Sale, a borrower being non-judicially foreclosed in Oregon has a right to require the bank/servicer, mediate one-on-one, to determine if they parties can agree upon a satisfactory “foreclosure avoidance measure.” For more on this new law, see my posts here and here.
Judicial vs. Non-Judicial Foreclosure Foreclosures. Foreclosure is governed by state law. States are divided generally into (a) judicial and (b) non-judicial foreclosure states. It appears they are about equally divided.
Judicial Foreclosure States. In order to foreclose in these states, the lender must actually file a lawsuit. This entails filing a complaint for foreclosure in the county in which the property is located. Although most foreclosures are not contested, when they are, the primary tool used by the plaintiff/lender is to file for “summary judgment” in which the lender presents affidavits from persons “ostensibly” familiar with the loan, saying that: (a) The bank holds the note and trust deed; (b) The promissory note is in default; and, (c) The bank is entitled to a decree of foreclosure.
The only way for a homeowner to contest the summary judgment is to deny these allegations contained in the affidavits. But a simple denial does not create an “issue of fact,” which is necessary for the court to deny the bank’s motion for summary judgment and move the case forward to trial.
However, as we have seen in Florida over the early years of the foreclosure crisis, contesting a foreclosure in judicial states gives the homeowner the advantage that they can obtain, through the discovery process, much of the banks’ documentation that led up to the foreclosure. It was through this discovery process that it became apparent that banks, servicers, and their attorneys were engaged in “shady” – if not outright illegal – practices; Robo-signing being the most notorious of these practices.
Non-Judicial Foreclosure States [Including Oregon]. It is much easier for banks to foreclose in these states, since there is no public filing in court. As such, the homeowner merely receives a Notice of Default and Election to Sell (“NOD”), which is mailed, served and posted at the residence. The NOD is advertised in a newspaper of general circulation for a fixed period of time. The Notice of Sale must also be sent and/or served on the borrower, and this step must precede the actual sale date by at least 120 days. In order for a borrower to contest a non-judicial foreclosure, one must file for a temporary restraining order or preliminary injunction to have a court halt the sale. To do so requires a showing of, among other things, the likelihood that the borrower will prevail in court. This is not an attractive alternative for most homeowners who do not have the money or appetite for filing lawsuits.
MERS® and the Assignment Dilemma. The one thing judicial and non-judicial foreclosure states have in common is the requirement that before the foreclosure can be granted, there must be a recorded trust deed or mortgage in the name of the party seeking to foreclose. During the years of easy credit, rising home prices, and the securitization boom, trust deeds and mortgages were routinely assigned multiple times. With millions of loans being made and securitized, and lender-borrower documents passing hands at warp speed, the expenditure of time and money to properly publicly record trust deeds was eclipsed by the need for speed – hence the birth of MERS®, the Mortgage Electronic Registration System.
Before MERS®, which was created in the 1990s, when one checked the public records at the county courthouse, they could track the successive assignments (if any) from the original lender all the way to the present owner. Thus, the continuous, unbroken recorded chain of successive transfers left little question about the identity of the true owner of the mortgage.
MERS® is the child of the mortgage industry’s biggest players. Its current owners include: Fannie Mae, Freddie Mac, Wells Fargo, AIG, GMAC, Citigroup, HSBC, and Bank of America. Today, MERS® members consist of almost all 3,000 mortgage lenders in the country and tracks approximately 31,000,000 active loans.
The MERS® business model was based upon the concept that it would act as the “nominal” beneficiary or mortgagee for all of its members [which is estimated to be approximately 60% of all banks in the country]. This meant that rather than recording the original lender’s name on the county records, the mortgage or trust deed would identify MERS® as the mortgagee or beneficiary. [Alternatively, the trust deed could be recorded in the original lender’s name and then promptly assigned to MERS® as the “nominal” beneficiary or mortgagee.]
Once a mortgage or trust deed became “registered” with MERS®, all future assignments of the security document were “off the public record.” [Note, once a lender’s priority is established by publicly recording the mortgage at the time of closing, all subsequent off-record assignments of that mortgage still retain their original priority.]
But once mass foreclosures began in 2007, banks had to scramble to find out who currently owned the trust deed. The reason: not all banks were MERS® members, and not all MERS® members registered their assignments in the MERS Registry. Once the current owner of a nonperforming loan was determined, the original beneficiary [i.e. either MERS® in its nominal capacity, or the MERS® member bank itself] would execute an assignment of the trust deed to the bank ostensibly having the current right to foreclose – presumably the last one to purchase the loan.
All of the paperwork signing was all performed by MERS® “Certifying Officers.” A review of most Oregon non-judicial foreclosures over the last few years that involve MERS® members, reveal the following:
- When it became necessary for the MERS® assignment document to be signed [e.g. the Assignment of Trust Deed] they were normally signed by a “Vice President” or “Assistant Secretary.”
- However, MERS® Certifying Officers were not actually “officers” in any conventional sense. Nor were they employees or contractors hired by MERS®. They were not compensated by MERS®.
- In short, Certifying Officers had no direct relationship with MERS®. Rather, in accordance with its rules, MERS® merely “lent” them an official title solely for purposes of signing assignments of trust deeds and mortgages. Frequently, they were low-level bank employees.
- According to congressional testimony, MERS® has approximately 20,000 Certifying Officers.
- But these assignments that were recorded shortly before foreclosure, ignored all of the intervening “off-record” assignments of the trust deed that had occurred between the date of the original loan and the date of the original foreclosure.
Oregon’s non-judicial foreclosure law requires that all successive transfers of a trust deed [and appointments of successor trustees] must be recorded prior to foreclosure. See, ORS 86.735(1). In this way, the entire chain of successive assignments from the original lender to the foreclosing lender, are accounted for, and there can be no question that the lender conducting the foreclosure is the one having the legal right to do so. [This has sometimes been referred to as “standing” by some courts ruling on the issue. – PCQ]
The Robo-Signing Controversy. Rather than the banks using their own employees to act as MERS® certifying officers, they hired third party vendors to do the signing. And when the vendors couldn’t find the necessary documents, they hired other providers to make them up. Lender Processing Services or “LPS” and its former affiliate, DocX, are two such examples, respectively. Most of these practices have been discontinued today.
These robo-signers had no familiarity with the documents they were signing, and their notaries made no effort to actually witness signatures, as required by state law. Frequently, robo-signers signed the names of other robo-signers [a practice that became known as “surrogate signers”].
The practice of robo-signing did not necessarily occur in a proper chronological order. This is because boilerplate forms were prepared for groups of robo-signers to sign en masse. There were blanks left in the documents for the identity of the signer and the identity of the notary to be filled in. Blanks were left for dates and official designations to be completed. The result was predictable; many documents in the chain of title leading up to a non-judicial foreclosure were signed and dated out of order, by persons whose signatures varied dramatically over time.
Invalid Foreclosures. The result of these sloppy practices was that some courts ruled that a non-judicial foreclosure conducted without the proper recording of all trust deed assignments were invalid. Some courts have enjoined foreclosures because the lender seeking to do so did not appear to be the current owner of the loan.[1] Some courts have refused to evict foreclosed borrowers from their homes, since the underlying foreclosure was invalid.
Unmarketable Title. Based on some if the court rulings, title companies have become cautious when asked to insure title out from a bank to a new buyer, fearful that the prior owner might later contest the bank’s right of ownership due to an earlier invalid foreclosure.
Conclusion. Thus, beginning with the rampant securitization of residential mortgages circa, 2005, we can connect the following dots to where we are today:
- Securitizations encouraged the making of more and more residential loans;
- The high volume of lending and securitization led to poor paperwork and recordkeeping practices;
- MERS® and the MERS® Registry, came into existence to reduce the burden and cost of having to publicly record assignments;
- The rampant securitization and the need for speed, led to poor lender underwriting, since the bad loans became someone else’s problem – i.e. the investors;
- Almost everyone that could fog a mirror, could get a loan;
- But poor underwriting also meant that eventually, these loans would fail;
- In the third quarter of 2007, the ratings agencies woke up, realized what they were rating straw, not gold, and made mass downgrades to the securitized loan pools. The immediate result was that residential borrowing and refinancing became – almost overnight – increasingly difficult to obtain;
- The drop-off in lending continued for the next twelve months, during which time, the big money securitization business collapsed, affecting those banks heaviest into that line of business, e.g. Bear Stearns and Lehman; word hit Wall Street, confidence in these banks’ ability to repay collapsed, and accordingly,their access to the Repo Market[5] froze up; they could no longer conduct business;
- Housing supply – especially new construction – began to exceed demand;
- Housing prices began to plummet;
- Borrowers who had taken out imprudent – too good to be true – loans found that they could not escape by re-selling the home or refinancing the loan;
- This resulted in millions of foreclosures;
- The combination of MERS®, poor paperwork, poor record-keeping, and millions of bad loans, resulted in banks having to scramble to locate and record the necessary legal documents to process their foreclosures;
- Housing prices continued to collapse as foreclosures and short sales increased;
- But the increase in foreclosures led to legal problems due to sloppy foreclosure practices;
- Banks began to slow down their foreclosures in an effort to get control of the paperwork problem;
- The result today is that housing prices are still sliding, since the inventory of homes waiting to be foreclosed, coupled with those already in foreclosure, continues to increase and depress prices further;
- This loss in value has crept up the demographic chain with the result that homeowners who made prudent loans now find themselves without equity, and in many cases, are awash in negative equity, thus preventing them from selling and/or refinancing.
Voila! Here we are, five years later, wondering when it will all end.
[3] Although not a topic for detailed discussion here, it appears that for several years leading up to the credit and real estate crisis [and likely THE tipping point resulting in the collapse of Bear Stearns [2007] and the later bankruptcy of Lehman Bros. [2008] – two of Wall Street’s most well-regarded investment banks] was the little known “Shadow Banking System.” This was a totally unregulated system by which banks funded their daily operations by obtaining short term loans from each other secured by the toxic mortgage backed securities they owned. [This borrowing facility is known as the “Repo Market” which refers to the obligation the short term borrower has to “repurchase” the security it obtained from the short term lender. It’s not dissimilar to going to a pawn shop on a serial basis, using the same security over and over again.] This worked fine as long as the market was willing to price these securities at unrealistic values, which continued until August, 2007, when some banks began to re-price the assets securing the short term “repo” loans they were making. This re-pricing, along with the contemporaneous massive downgrades by the ratings agencies, combined to cause the “Repo Market” to freeze up. Once lender banks began to lose confidence in the value of the assets backing the short term “repo” loans they were making, it undermined their confidence in one another; no one knew how much toxic assets each other was sitting on. The result was that credit began to freeze up and those banks that relied most heavily on these assets for “repo” security found they could no longer get the same extensions of credit needed for their daily operations. The more a bank has to dig into its own capital to fund its daily operations, the more restrictive its daily operations become, since federal regulations require that they maintain strict debt-to-equity ratios.
[4] I say “fictionally” because if one reads some trust deeds, it would sound as if the borrower is delivering the actual title – as if they were pledging it – to the trustee to physically hold, pending repayment or default of the loan. In reality, Oregon, like most – but not all states – says that the borrower holds legal title to the property and the lender merely has a “lien”. A “lien” is a charge against real property, the nonpayment of which gives the lien holder the right to foreclose to satisfy the debt. This is what is meant when it is said that Oregon is a “lien theory state” – i.e. the lender holds a “lien” and does not hold title.
[5] For those interested, go back to Footnote 3, above. The “Repo Market” i.e. the bank-to-bank lending market where they made overnight loans to each other pledging security via “Repurchase Agreements” collapsed. This was in 2008, when we saw Bearn Stearns and Lehman Bros. collapse. Without government intervention, it is likely the fallout would have been much, much, worse. [But as with all things, our government could not resist the temptation to do more, and more, and more…. Today, we are now seeing the effect of layer upon layer of new laws, rules and regulations that continue to destroy business confidence and hamper free market growth. – PCQ]
