Shutting Down the Big Banks

Economists William Black and Randall Wray argue that several big banks should be foreclosed on, starting with Bank of America, for engaging in a pattern of criminal fraudulent behavior first in its mortgage lending practices and now in the foreclosure processes. To read how and why Black and Wray believe that Bank of America should be forced into receivership see:

Foreclose on the Foreclosure Fraudsters, Part I: Put Bank of America in Receivership; and

Foreclose on the Foreclosure Fraudsters, Part II: Spurious Arguments Against Holding the Fraudsters Accountable

If Bank of America and other Wall Street banks had been taken over in 2009 when they were nearly insolvent and desperate for a lifeline, everything would be much different now both on Wall Street and on Main Street. Instead, the big banks have continued "rewarding" their executives with enormous bonuses as they continue to be silently buoyed by the Fed.

Are the Megabanks Insolvent?

Three trillion dollars in uninsured mortgage exposure? Nine hundred billion in home equity loans (probably better termed no-equity loans)? Plus, 1.7 trillion dollars in suspect commercial loans? "The collateral for these loans is definitely worth less than the loan balance." What a nightmare.

Add in any realistic valuation adjustments for MERS related losses, lost note losses, and the fact that residential real estate sales are still declining and it gets really hard to see how the banking sector can be fully solvent.

The Obama administration needs to do new stress tests, with a specific focus on foreclosure fiasco issues, and then assess which banks are viable and which ones are not. Those that are not viable must be shuttered immediately--before they can do more damage or become even more insolvent.

Can All The King's Men Put MERS Back Together Again?

If I weren't crying so much about the doings of the lame duck Congress I would bust out laughing (or maybe its vice versa).

Nowhere does the great sausage machine seem more out of kilter than on the issues surrounding the mortgage foreclosure crisis. They seem utterly clueless on what to do. And, as the Congressional Research Service highlights this week, lawmakers really have no way to untangle how any putative bailout legislation would impact the various federal interests in the residential real estate market:

Another interesting wrinkle is that the federal government is an active participant in multiple, and sometimes conflicting aspects, of the mortgage market. For instance, the Department of the Treasury (Treasury) has used Troubled Asset Relief Program (TARP) funds to acquire stock and warrants to purchase stock in banks with significant mortgage-related assets (e.g., CitiGroup) and to implement the Making Home Affordable Program; the Treasury also has used funds from the Housing and Economic Recovery Act (HERA, P.L. 110-343) to purchase millions of dollars worth of mortgage-backed securities from Fannie Mae and Freddie Mac; the Federal Housing Finance Agency (FHFA) is acting as conservator of Fannie Mae and Freddie Mac; and the Federal Deposit Insurance Corporation (FDIC) holds interests in mortgage assets as conservator and receiver over failed commercial banks and thrifts. As a result, the government will be directly impacted by, and at times, will be actively involved in, mortgage-related legal disputes.

So, as I posited in earlier posts, lawmakers should move cautiously in this area, as the possible unintended consequences of any law could prove devastating.

Perhaps the first thing lawmakers must insist upon is that the banks come clean on the depths of the problem. Recent evidence suggests that it is far worse than the banks have portrayed. For example, the Washington Post reports this morning that the banks have launched a major lobbying effort in the halls of Congress which belies their position that this is all about mere legal technicalities and everything will be all right. Similarly, the lawyers in the trenches report with seeming unanimity that none of them ever sees foreclosure cases where the paperwork is in order:

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Matt Taibbi reports the same in a recent Rolling Stone story on this whole mess. This quote represents my worst fears concerning the depths of this crisis underlying the thousands of fraudulently prepared lost note affidavits:

It turns out that underneath that little iceberg tip of exposed evidence lies a fraud so gigantic that it literally cannot be contemplated by our leaders, for fear of admitting that our entire financial system is corrupted to its core — with our great banks and even our government coffers backed not by real wealth but by vast landfills of deceptively generated and essentially worthless mortgage-backed assets.

So, my point is simply that before Congress takes a leap in favor of the megabanks they should at least try to figure out who they are tossing under the bus to save their precious megabanks and just how much money its going to cost the government.

Similarly, they seem powerless to me to change UCC section 3-309 regarding lost notes. That must happen on a state by state basis, and would virtually revolutionize he law of commercial paper which has always made it difficult if not impossible to recover on lost notes except in relatively narrow circumstances.

Congress must wait to define the scope of the problem, its powers, and the interests of the government itself before leaping into the tsunami created by the megabanks to attempt what may well be an impossible rescue. Instead, the administration should fire-up the Dodd-Frank Orderly Liquidation Authority, scatter the megabanks to the four winds, fire and investigate the reckless bank managers, and quickly undertake a massive loan modification program to save consumption and reestablish the rule of law in our economy.

COP on Foreclosure Crisis and Bank Solvency: "Severe Threats Remain"

The TARP Congressional Oversight Panel (COP) today released "Examining the Consequences of Mortgage Irregularities for Financial Stability and Foreclosure Mitigation." The above video is a very helpful summary of the full report.

The findings of the COP on this issue now represent the most comprehensive and detailed analysis of the foreclosure crisis I have seen to date. I whole-heartedly agree with the report, and I was pleased to see the COP call for further stress tests of the banks to find-out the depths of the the threat the foreclsoure crisis is likely to present to our financial system.

Yet, I am troubled by one loose end raised by the report. The TARP COP has vastly more resources than any blogger to drill down and find out whether the banks have the notes or not for the millions of mortgage loans packaged during the real estate bubble. I am baffled that weeks are flying by and we still have no authoritative guidance on how big the missing note problem is.

That seems antithetical to a well-functiong system of capitalism backed by the rule of law. Is it really the case that virtually the entire global financial system must fly blind on this rather crucial issue? Can someone please tell us if the bankers have the notes?

Does the Use of MERS Constitute Consumer Fraud?

One major issue facing those hoping for a federal solution (aka yet another bank bailout) to the MERS controversy is the fact that MERS implicates a wide range of state law issues that are simply not conducive to broad brushed federal intervention or defacto guarantees. We are talking basic property rights, contract law and recording regimes which have been left to states for centuries. Any "federal solution" should be viewed with deep suspicion because the only real reason for Congressional meddling with these traditional state law functions would be to once again shield the banks from unpleasant legal and competitive outcomes. Further, because 50 state law regimes are at issue it would be very difficult for Congress (or bank lobbyists) to craft legislation without potentially serious unintended consequences.

Consider, for example, the recent DC Attorney General Determination that the use of MERS as the original mortgagee to evade recording fees constitutes consumer fraud under DC law. According to the DC Attorney General: "A noteholder’s security interest in a DC home should normally be reflected in the public land records maintained by the District’s Recorder of Deeds. Under District law, in contrast to the laws of many states, each deed or other document transferring a mortgage interest must be recorded with the Recorder of Deeds within 30 days of execution. This requirement is not satisfied by private tracking of mortgage interests through the Mortgage Electronic Registration Systems (MERS)." Thus, a foreclosure proceeding against a homeowner is deceptive to the extent the party seeking foreclosure has no recorded right to do so.

Many jurisdictions would follow this basic approach. Thus, for example, in Illinois, a mortgage must identify the grantee. The mortgage "shall" be recorded and is effective as a lien, generally, only when recorded. And, in Illinois, deceptive practices are statutorily defined to include any misrepresentation of a material fact, in any consumer transaction. In my view, Illinois should therefore also find that the use of MERS constitutes consumer fraud. The same likely holds true in many other jurisdictions.

The basic idea is that a consumer is entitled to know the identity of the mortgagee of their property, and should be able to assess the validity of the mortgage based upon readily available information. It is hard to argue that these facts are not material to a consumer, either faced with foreclosure or otherwise. For example, as stated in the DC Attorney General's opinion how can a homeowner accurately assess a lender's right to foreclose if a lender's mortgage is not duly recorded in the recorder's office. Similarly, if a mortgagor is underwater on their property they should be able to contact the mortgagee without relying on the good graces of their servicer who very often has incentives to pursue foreclosure instead of a loan modification. It is a material fact to know the actual holder of the mortgage.

The upshot of all this means that the great destabilization of property rights associated with the use of MERS is not the only legal problem that courts must address. They also need to think hard about whether consumers have a right (protected by the state consumer fraud statutes) to be able to discern the identity of their mortgagee through public records, independently of the determination of the loan servicer's calculation of its profit interest.

Underlying this judicial determination is an important policy consideration: do courts want to empower consumers to plead their case for loan modifications or forbearance directly with the end lender, or do they want to empower servicers to maximize their ability to generate profits from fees associated with foreclosures? If they choose servicers over homeowners, they will essentially encourage more foreclosures along with associated macroeconomic carnage in the form of devastated families (hurting consumption today and human capital formation long term), massive continued price depreciation nationwide from the downward pressure exerted from foreclosures, and continued losses to the MBS investors from real estate depreciation nationwide. The only beneficiaries will be three or four megabanks that dominate the servicer market.

Congress faces a more complicated calculus. It is a lame duck Congress. The job market sucks. Certainly, those who will not return can be forgiven if they have their eyes on the job market--and the megabanks control more wealth than virtually anyone else in our society. Moreover, since they enjoy a government guarantee the megabanks can pay employees above market wages regardless of their performance or the performance of the economy.

Still the ultimate point of this blog entry is that it would highly inappropriate and macroeconomically devastating for the federal government to once again give the megabankers legal indulgences to allow the senseless foreclosure machine to continue unabated. Further, this time such indulgences would involve a massive extension of federal power into traditional areas of state law ranging from property rights definition, recording statutes, foreclosure rights, mortgages, contracts and consumer fraud.

Let's hope Congress makes the right call and allows our preexisting legal system to dole out incentives and disincentives without political interference on behalf of the most outlaw elements of our society.

Citizens United and the 2010 Mid-term Election

With the 2010 mid-term election in the rear view mirror, the impact of Citizens United can now be practically assessed. For those that spent any time watching television in October 2010, the impact of Citizens United was on full display during this election advertising cycle. 2010 saw a new record set on the amount of money spent on election advertising and electioneering, with some estimates coming in at more than $3 billion being spent, much of it on television spots. Some argue that the ads this election cycle were more vicious than ever before. Without question, they were more plentiful. Of course, Citizens United is the U.S. Supreme Court decision that allows unfettered (and in some cases anonymous) contributions from corporations to specific political and judicial candidates.

A couple of important points to consider:

First, when judges are elected, particularly in partisan contested elections, the potential for nefarious outcomes is elevated. To this point, see this Washington Post editorial entitled "Putting a Halt to Judicial Elections." Further, I have recently dropped an essay with the Iowa Law Review, where i discuss recent empirical evidence that finds that judges that are elected in partisan contests are significantly more likely to find for corporate defendants and interests than are those judges that are appointed. The essay is entitled: "Procuring Justice: Citizens United, Caperton, and Partisan Judicial Elections" and can be accessed at the Iowa Law Review Bulletin.

Second, much of the corporate electioneering is being steered into state local elections by prominent out-of-state groups and organizations, that are crypticly named "Americans for Safety and Strength" or "Americans for Fiscal Responsibility," etc. These organizations provide no ideological affiliation, but do provide cover for many corporate contributions that remain undiscoverable in many instances. Professor Atiba Ellis hosted a Citizens United conference at the West Virginia University College of Law, wherein he and law professors from the University of Akron discussed the impact of Citizens United on this 2010 election cycle.

Citizens United, as described many times in this blogspace, enables an atmosphere of diabolical electioneering, and we have just now begun to see its impacts.

Prof. Christopher Peterson (and myself) Will Present a Webcast on the Mortgage Morass Tomorrow

As I previously emphasized, Professor Christopher Peterson recently posted an outstanding update to his outstanding law review article in the Cincinnati Law Review.

Tomorrow the University of Utah, Quinney College of Law, will host a webcast (available here) presentation by Professor Peterson and myself entitled “Foreclosure Fiasco? Lost Promissory Notes and the Mortgage Electronic Registration System.” The webcast will run from 12:15 to 1:30 p.m., Utah Time or 1:15 to 2:30, Chicago time.

I will comment and try to put Professor Peterson's outstanding work in perspective, as I have tried to do here, here, here and here.

We will also address the problem of lost and destroyed notes, which along with MERS casts a pall over the residential real estate market today. Indeed. most real estate experts attribute renewed weakness in the real estate market to the mortgage morass.

Professor Peterson displays uncommon scholarly courage as the messenger of bad news for the megabank sector. I urge anyone concerned about the power of the megabanks or the economy in general to tune-in as I predict the banks will soon beseech our elected representatives to relieve them from the legal and economic consequences of the recklessness of their senior managers. My argument is that some megabanks may already be insolvent and should be escorted into the Dodd-Frank Orderly Liquidation Authority Regime.

Late last Friday afternoon, for example, Bank of America disclosed that it faces $375 billion (although much less in light of this ruling which is not final) in claims that the mortgage backed-securities sold by it and its affiliates included such deep-seated flaws that BOA must repurchase the private label securities. This exposure certainly does not boost their financial solvency. The full BAC 10-Q is available here. Similarly, the Attorney General of the District of Columbia just issued an innovative, even pioneering, opinion that the use of MERS may violate the DC consumer protection statute. This too carries the potential, if followed in other jurisdictions, to severely impact the capital of the megabanks.

I cannot imagine a more timely issue.

THE GREAT DESTABILIZATION OF US PROPERTY RIGHTS AND THE "ELECTION" OF 2010

For purposes of this blog post let us assume that the election tomorrow is irrelevant. Let's assume that whether the Democrats win or the Republicans win, big money definitely wins--and they are perfectly hedged insofar as election outcomes are concerned. Let us further assume that the use of money to influence elections is only one channel by which big money wins in America. Let's assume that jobs, revolving doors and social affinity all play a role in cognitive capture as well as raw economic power.

Based upon the forgoing, I posit that shortly after the election the lame duck Congress will cobble together some bill (which President Obama will sign) that attempts to protect the bankers from MERS Madness, Robo-signed affidavits, mortgage bond putbacks and lost notes. I am not the first to so argue: John Carney of CNBC brazenly argues that "The politicians will not let the financial stability of the largest bank in the nation to be threatened by contractual rights." So now the working assumption is the megabanks are too big to enter into enforceable contracts? Too big to bother with proving their claims in a court of law? We should apparently just let banks file whatever paperwork they deem appropriate and then seize whatever property they want? Not even a completely runaway Congress can go that far.

What would such a bill look like? Almost certainly the bill will give huge windfall benefits to the megabanks and create huge costs down the road for the vast majority of the 99.9 percent of the population that does not occupy the executive suites of Wall Street. Yet, even that will not be enough to rescue the megabanks now. Here is why:

i) The bill would have to legalize, ex post, a huge number of illegal foreclosures. Obtaining an eviction based upon a fraudulent affidavit is illegal, and probably constitutes perjury, consumer fraud, mail fraud, wire fraud, and racketeering. Such misconduct constitutes sanctionable conduct in a court of law and may give rise to civil and criminal causes of action. Moreover, the victims of this misconduct may now have rights to reclaim their homes, pending the banks' ability to exercise lawful rights in a lawful manner. So how could Congress put this rather messy toothpaste back in the tube? They would have to give federal exemptions to fraud, perjury, mail fraud, wire fraud, racketeering and court levied sanctions. They would have to extinguish state recognized property claims of evicted homeowners and in order to make it more profitable going forward to foreclose, they would have to approve a Kafkaesque judicial process for foreclosures that would make a mockery of the rule of law. Would Congress and the President really have the audacity to undermine property and contract rights in a such an unprecedented and pervasive manner? Would even a lame duck Congress go to these extremes?

ii) Consider MERS. MERS has carved-out a legal status that is incoherent to all but (perhaps) itself. MERS does not hold the notes to underlying notes so it cannot foreclose. To fix this Congress would need to change basic property law to provide that a mere mortgage "nominee" can foreclose with no beneficial interest in the underlying note. Then there is the problem that MERS has no beneficial interest in the mortgage. As such it cannot transfer any rights. Thus, it appears that Congress would have to empower a non-beneficial "holder" of the mortgage to foreclose or transfer rights it does not have. This would require deep federal legislative disruption of long-standing state property rights and theory. Indeed, the idea that a mortgage that is assigned without the note is "nullity" is rooted in an 1872 US Supreme Court decision, Carpenter v. Longan. The idea is simply that the mortgage and note should be held by a unified plaintiff with the power to achieve just one recovery.

And if Congress wants to empower this legal ghost to play a central role in our system of tracking, prioritizing and recording property rights, it would need to answer difficult questions. For example, is the federal government willing to guarantee the perpetual existence of MERS? That is precisely what would be needed for a private mortgage registry to track and prioritize property claims on a permanent basis. Is the federal government going to mandate that MERS have the power and obligation to release mortgages when loans are repaid years down the road? Right now, if MERS is mortgagee it is unclear to say the least whether they can release mortgages if they are beneficially owned by others. What economic incentives does MERS have to release mortgages and record the release so that sales may proceed without the cloud preexisting mortgages. And, when this private actor neglects its duties to get tracking right, what recourse do victims have? Simply stated, it is unclear how Congress could legitimize MERS without throwing our entire system of property rights into chaos.

iii) Lost notes. Under the UCC mortgage notes are treated as negotiable instruments. That means like a check, you need the original to get paid. Is Congress really prepared to repeal the UCC insofar as the megabanks and lost notes are concerned? This would expose borrowers to the prospect that they could get sued by a megabank claiming the note is lost, and then get sued again when another holder in due course shows up with the note. Frankly, from a legal point of view, if Congress can change the law of negotiable instruments to save their precious megabanks, they can simply confiscate all retirement assets and hand them over to the banks. That is the essential meaning of lawlessness, folks, it is living in a society where everything is up for grabs at the behest of those holding the most power.

For Congress to jump in and fix these deep-seated legal issues would require it to "bulldoze" on a wholesale basis longstanding state law from contracts to property to negotiable instruments. It would also shred the last semblance of the rule of law in our economy, and thereby doom the US to a second or third world economy.

Certainly the wholesale preemption of state law and retroactive modification of contract and property rights would trigger a major constitutional challenge. It is hard to imagine that the Supreme Court would approve.

But, just in case: when you vote tomorrow, vote for the candidate most likely to hold the banks to account under law, and most likely to impose the Dodd-Frank Orderly Liquidation Authority. That may require thinking outside of the box.