The inter-regulator fight over the proper parameters of a foreclosure fraud settlement are really highlighting the changes in the financial regulatory world. What we’re told is that the OCC and Fed are urging a weak settlement, while FDIC, the state AGs, and the Consumer Financial Protection Bureau (CFPB) are pushing for a serious settlement.
Parts of this line up look quite familiar, but parts are new and exciting.
There’s nothing new or surprising about the OCC protecting (rather than regulating) the banks. Similarly, it’s not surprising to see the Fed back the banks, although, the Fed tends to be less gung-ho than OCC in these matters (and I would note that there isn’t necessarily unanimity within any agency on these issues). It’s also no surprise to see the state AGs on the other side, pushing for regulation. Gosh, this just sounds like a Wachovia v. Watters redeux (one of OCC’s most shameful moments in recent years—putting its preemption agenda ahead of consumer protection in the mortgage space. Now where did that get us?)
The Ibanezforeclosure decision by the Massachusetts Supreme Judicial Court has gotten a lot of attention since it came down on Friday. The case is, not surprisingly being taken to heart by both bulls and bears. While I don’t think Ibanez is a death blow to the securitization industry, at the very least it should make investors question the party line that’s been coming out of the American Securitization Forum. At the very least it shows that the ASF’s claims in its White Paper and Congressional testimony are wrong on some points, as I’ve argued elsewhere, including on this blog. I would argue that at the very least, Ibanez shows that there is previously undisclosed material risk in all private-label MBS.
The Ibanez case itself is actually very simple. The issue before the court was whether the two securitization trusts could prove a chain of title for the mortgages they were attempting to foreclose on.
There’s broad agreement that absent such a chain of title, they don’t have the right to foreclose–they’d have as much standing as I do relative to the homeowners. The trusts claimed three alternative bases for chain of title:
(1) that the mortgages were transferred via the pooling and servicing agreement (PSA)–basically a contract of sale of the mortgages
(2) that the mortgages were transferred via assignments in blank.
(3) that the mortgages follow the note and transferred via the transfers of the notes.
The Supreme Judicial Court (SJC) held that arguments #2 and #3 simply don’t work in Massachusetts. The reasoning here was heavily derived from Massachusetts being a title theory state, but I think a court in a lien theory state could easily reach the same result. It’s hard to predict if other states will adopt the SJC’s reasoning, but it is a unanimous verdict (with an even sharper concurrence) by one of the most highly regarded state courts in the country. The opinion is quite lucid and persuasive, particularly the point that if the wrong plaintiff is named is the foreclosure notice, the homeowner hasn’t received proper notice of the foreclosure.
Regarding #1, the SJC held that a PSA might suffice as a valid assignment of the mortgages, if the PSA is executed and contains a schedule that sufficiently identifies the mortgage in question, and if there is proof that the assignor in the PSA itself held the mortgage. (This last point is nothing more than the old rule of nemo dat–you can’t give what you don’t have. It shows that there has to be a complete chain of title going back to origination.)
On the facts, both mortgages in Ibanez failed these requirements. In one case, the PSA couldn’t even be located(!) and in the other, there was a non-executed copy and the purported loan schedule (not the actual schedule–see Marie McDonnell’s amicus brief to the SJC) didn’t sufficiently identify the loan. Moreover, there was no proof that the mortgage chain of title even got to the depositor (the assignor), without which the PSA is meaningless:
Last week the US Bankruptcy Court for the District of New Jersey issued an opinion in a case captioned Kemp v. Countrywide Home Loans, Inc. This case looks like the first piece of evidence in what might turn out to be the Securitization Fail or, in homage to Michael Lewis, The Big Fail.
Briefly, Countrywide as servicer filed a proof of claim for a mortgage in a bankruptcy case on behalf of Bank of New York as trustee for a securitization trust. The bankruptcy court denied the claim because there was no evidence that Bank of New York ever owned the mortgage. The mortgage note had never been negotiated or delivered to Bank of New York, despite the requirement to do so in the Pooling and Servicing Agreement (PSA) that governed the securitization of the loan. That meant that Bank of New York as trustee had no interest in the loan, so the proof of claim filed on its behalf was disallowed.
This opinion could turn out to be incredibly important. It provides a critical evidence for the argument that many securitization transactions simply failed to be effective because non-compliance with the terms of the transaction: failure to properly transfer the mortgage meant that the mortgages were never actually securitized. The rest of this post explains the chain of title issue in mortgage securitizations and how Kemp fits into the issue.
Note and Mortgage Transfers in Securitizations
A residential mortgage securitization is a transaction that involves a series of transfers of two types of documents: mortgage notes (the IOUs made by mortgage borrowers) and mortgages (the security instrument that says the lender may foreclose on the house if the borrower defaults on the note). Ultimately, both the notes and mortgages need to be properly transferred to a trust that will pay for them by issuing securities (backed by the mortgages and notes, hence residential mortgage-backed securities or RMBS). If the notes and mortgages aren’t properly transferred to the trust, then the securities that the trust issues aren’t mortgage-backed and are worthless.
So the critical issue here is whether the notes and mortgages were properly transferred to the securitization trusts. To determine this, we need to figure out two things. First, what is the proper method for transferring the notes and mortgages, and second, whether that method was followed. For this post, I’m going to focus solely on the notes. There are issues with the mortgages too, but that gets much, more complicated and doesn’t directly connect with Kemp.
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