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.