Friday, October 29, 2010

War On . . . Symposium

The Journal of Gender, Race & Justice is now calling for papers for its 15th anniversary symposium.

The symposium, “War on: The Fallout of Declaring War on Social Issues,” will explore the consequences of declaring war on society’s problems.

From the War on Poverty, to the War on Crime, to the Wars on Drugs and Terror, by utilizing the "War on" rhetoric, policy and lawmakers unite the public against a common enemy and authorize themselves to act more aggressively against a group of people. Our symposium will examine who gets swept into this class of enemies, and how the practice of declaring wars on social issues affects marginalized communities.

Please see the call for papers for submission instructions. Paper proposals must be submitted by November 15th, 2010.

Thursday, October 28, 2010

Time to Fire-up the Dodd-Frank Orderly Liquidation Authority

Even before the lawlessness of the banks caused the mortgage morass, the megabank sector seemed inadequately capitalized. In late August of this year, I summarized the problems facing the banking industry:

"bank capital remains under siege. European debt could explode at any moment and the bailout of last spring appears inadequate. Student loans will inexorably erode bank capital because of the dearth of job opportunities for graduates. The residential real estate market continues to meltdown, with the commercial real estate market now inflicting comparable losses on the financial sector. One trillion dollars of consumer debt suffers from serious delinquency. Consumer deleveraging will continue to suppress demand for quite some time. This will continue to mean employment problems that will lead to more losses on debt."

Things have not improved lately. The latest Case-Shiller index on home prices continues to decline and sales are stagnant at best. Economist Robert Shiller sounds more bearish than ever regarding the real estate market.

So, tack on the mortgage morass, and its time to face up to another looming spate of bank insolvencies on Wall Street. Consider the litigation costs if the banks need to litigate for equitable (assuming the banks can show clean hands) mortgages (which may be discharged in bankruptcy); litigate to enforce notes they do not hold (also dischargable in bankruptcy); and litigate all defenses borrowers may have against the original lenders (because you cannot be a holder in due course for a note you do not hold). Then the banks need to seek monetary recovery against highly distressed property with clouded title and highly distressed borrowers that probably can enter bankruptcy. It is entirely possible that the costs of recovery exceed the recovery on many thousands of mortgages.

We need to get our minds around the concept that many billions of dollars worth of mortgage backed securities could prove worthless. Professors Katherine Porter and Christopher Peterson each wrote outstanding law review articles that together lead to that logical conclusion, which I have previously highlighted.

Economist Simon Johnson hit the bull's eye with this post
. We need to determine whether the losses are containable (in the $120 billion range on put back exposure alone) as mainstream financial analysts claim, or whether they are far more legally problematic, as others suggest. If, as I strongly suspect, many of our large banks are insolvent we should immediately place them in receivership under the Dodd-Frank Orderly Liquidation Authority.

Under section 203 of the Dodd-Frank Act if a systemically risky megabank is insolvent then the Secretary of the Treasury (along with 2/3 votes of the Fed and the FDIC) may appoint the FDIC as receiver of the firm.

Section 210 authorizes the sale of assets of the firm--meaning the FDIC can sell off all the operating divisions of the firm separately--i.e., break the firm up. This section also empowers the FDIC to takeover all the powers of senior managers--i.e., prior management is terminated. Section 210(f) provides for the liability of directors and officers for gross negligence plus any other claims (like the duty of ordinary care applicable to agents such as senior managers) that the FDIC holds as it steps into the shoes of failed firm.

Dodd-Frank certainly is not perfect. And, the above summary is necessarily incomplete. Nevertheless, the government now has explicit power to put insolvent megabanks into receivership, break them up, terminate managers, and investigate and pursue civil claims against reckless (or even negligent) managers.

In addition, once the FDIC is in control of the firm the burden of CEO primacy is lifted and the FDIC can direct the firm to negotiate sensible loan modifications with borrowers. This would stop the foreclosure fraud madness in its tracks and create loan modifications that can be duly recorded in the recorder of deeds office to restore certainty in our system of property rights.

My working hypothesis is the great and irrational resistance to loan modifications now holding sway in the banks is mostly about senior manager bonuses--massive loan write-downs mean losses now for the banks and no bonuses for the CEO and other senior managers. It is the corollary to hoarding capital.

So again, if we follow the law then solutions are available. If we do not follow the law, and instead allow the reckless bankers to maintain control of the financial sector, the most likely out come seems to me to be this scenario--a long and protracted period of economic pain and misery.

Wednesday, October 27, 2010

The Greatest Election Issue Never Discussed: What to do with Insolvent Megabanks?

The above chart shows that Bank of America stock swooned in mid-October after getting hammered over the last six months. The stock (like the entire megabank sector) woefully underperformed the market as whole, particularly recently. As the news of the banks' reckless practices slowly seeps into the marketplace, expect more price declines and eventually an overall market reaction to the expected losses that could prove violent and dramatic.

Indeed, after looking at the intensifying trouble in the mortgage market, after ruminating on the Robo-signing scandal, after reflecting on MERS Madness, after looking at the possibility of a mortgage bond meltdown, and, after recovering from the shock of lost and destroyed notes, I conclude that the market vastly underestimates the trouble ahead. While some analysts and economists certainly see the gravity of the problem, for the most part a full reckoning of costs is now impossible, particularly without in-depth legal analysis. Thus, the financial markets remain in deep denial. And, the banks insist that all (or nearly all) is well. Which banks will suffer what losses is not known; still, large losses to the system as a whole are virtually certain.

Let me be clear: this foreclosure fiasco is fundamentally a legal problem. The law must finally be followed with respect to bank misconduct and if it is followed here the banks will take massive (but ultimately unknowable) hits to their capital. In fact, just today the Florida court of appeals ruled (in a rather pedestrian application of the law) that a bank must produce the original note before a court may order a foreclosure as required under the UCC. The Attorney General of the District of Columbia has issued an interpretive release under DC law that appears to prohibit foreclosures in the name of MERS. The Maryland courts recently revised foreclosure rules to clarify that fraudulent affidavits can no longer support a foreclosure and instead the foreclosing bank bears the burden of demonstrating the authenticity of documents supporting foreclosure. Meanwhile, investors continue to organize and retain counsel to press rights for put-backs to banks of defective MBS.

All of this means the banks' jig is up. They are not going to be able to steamroll courts into wrongful foreclosures. Thus, hopefully the law can now function to prevent the kinds of travesties of justice that are now manifest. The banks need to put up or shut up: stop soft-peddling the huge mistakes that have been made and start producing legally enforceable notes and mortgages under law.

This is what a well-functioning rule of law looks like. It means that legal rights and remedies are enforceable even against the most economically powerful in a given society--like the megabanks. It means that even megabanks cannot achieve judicial remedies through pervasive fraud. Even megabanks must show they are entitled to foreclosure before seizing homes.

We should now expect the bank apologists to claim the banks need special exemptions from the rule of law and competitive markets. That somehow we need the megabanks to strangle our economy and hoard capital. They will claim we again have no choice but to bailout the megabanks and permit them to continue to pay megabonuses to their senior managers. The greatest risk to our economy right now is the continued control of the reckless bankers over far too vast a hoard of precious capital.

Do not believe for a moment that bailing out the senior managers is needed. As I will explain in my next post, it is time to fire up the Dodd-Frank Orderly Liquidation Authority to take down these megabanks through receivership, shatter them into 10,000 pieces and terminate the reckless managers--and in appropriate cases sue managers for gross negligence. That will restore proper incentives and end the infinite recklessness at the apex of our economy. And it vindicates the rule of law--finally.

The decision to apply the full force of the law is the greatest economic decision now facing the nation. It will determine the course of our economy for years to come. Unfortunately this issue remains completely unaddressed in this election.

Tuesday, October 26, 2010

Dodging Fence Posts and Whacking Moles

Earlier this year, Bill Maher invited Elizabeth Warren, the new Chair of the Consumer Financial protection Bureau (much to the dismay of Republicans), to appear on his HBO show “Real Time” to talk about recent legislation regarding financial practices by banks and credit card companies. An interesting and funny exchange took place between the two. Speaking of the Dodd-Frank bill, which was being debated at the time, Warren said:

“I really thought . . . that we were on the brink of real financial reform, that we were going to change the system, that we were going to have a consumer agency to make sure that we rolled back the crazy abuses and the tricks and the traps.” Maher looked puzzled and interrupted her,

“You thought that? Boy, what do you smoke before the show?”

Warren, unamused, continued:

“I also thought that we would change the rules on things like derivatives and that we were going to change the rules on resolution authority, what we do with these big banks, that we were going to get rid of too big to fail. The problems could not be more obvious, and quite frankly, the solutions are just about that obvious but we can’t seem to get the two together.”

That the Dodd-Frank legislation and other attempts at corporate reform do not go near far enough has been well documented on this blog. CNN recently compared the corporate response to these new reforms as a game of “Whac-a-Mole,” that the minute one set of bank fees or practices is banned, a whole new creative set pops up in its place.

Similarly, the Credit CARD Act that went into effect earlier this year established a credit card holder’s Bill of Rights by outlawing 10 egregious practices by credit card companies that padded their bottom lines. However, as Elizabeth Warren pointed out in her interview with Maher, it doesn’t take much to get around these 10 regulations:

“The problem with the approach . . . is that it’s like putting fence posts on an open prairie. You’ve got 10 of them now and if you smack straight into one, you really will get hurt. But if you want to hire just one lawyer, much less an army of lawyers, you could just run a little to the left of it, or a little to the right of it, and it’s business as usual.”

A report by the Center for Responsible Lending confirms that as some credit card abuses are outlawed, new ones inevitably proliferate.

Below is a parody of how commercial banks are responding to the new regulations imposed by the Credit Card Accountability, Responsibility and Disclosure Act that Warren refers to as "fence posts on an open prairie":

Sunday, October 24, 2010

The Banks Lost the Notes: This is no Joke!

What kind of banker loses promissory notes? "A damn careless one," according to Law Professor Douglas Whaley, who spent 40 years teaching Commercial Paper at Ohio State University.

What kind of banker destroys promissory notes? A "really stupid" one, says Professor Whaley.

And yet, it is now clear that promissory notes underlying mortgage backed securities were lost or destroyed on a systematic basis, in what can only be termed yet another exhibition of the infinite recklessness (or corruption) of the bankers running the US economy. How bad was it?

The Florida Bankers Association told the Florida Supreme Court that banks routinely destroyed notes after e-recording the notes to "avoid confusion." The Florida bankers told the Supreme Court that this was the "industry standard." Professor Katherine Porter wrote a 2008 Texas Law Review article that looked at the loan documentation from 1700 bankruptcy cases. A stunning 41.1 % of the files reviewed lacked a promissory note to support the mortgage claim. Yves Smith, the high profile author and economics blogger, states that her sources indicate the notes were "never" transferred to the MBS trust. This certainly will prove to be a major problem, as demonstrated by the recent rescission claim being pressed by (among others) the New York Fed which claims that MBS were plagued by "shoddy paperwork."

On some levels losing the note is worse than blowing the mortgage (due to MERS Madness, for example). Because promissory notes are negotiable instruments generally only the original (and not any copy) is enforceable against the borrower. Under the UCC (a uniform commercial code in place in most all jurisdictions in one form or another), section 3-309, a lost note may not be fatal to recovery by the owner of the note. But the requirements of proof under this section are quite demanding; most notably, the section requires that possession and ownership of the promissory note be vested in the plaintiff at the time of loss. It appears that many MBS notes disappeared before transfer to the trust that now holds the note, which would defeat recovery under this section. Moreover, in order to enforce a lost note under the UCC, the court must assure that "the person required to pay the instrument is adequately protected against loss that might occur by reason of a claim by another person to enforce the instrument." That sounds like an indemnity bond to me (particularly given the transitory nature of the banks holding these notes, as I will show in my next post). And, that could prove costly. These are serious impediments to enforcement of lost promissory notes in this context.

Moreover, analysis of the ability to enforce lost notes is made more difficult by the fact that each state may have quirks in their version of the UCC. Some states have amended their UCC statutes like this version in Florida which is less demanding than most states. It could take years for the courts across the country to work out these issues.

Again, these issues are not technicalities. Instead, they are integral parts of a statutory scheme designed to balance commercial certainty and enforcement of contracts against protecting the borrower from multiple claims. The ultimate protection of the borrower is an original canceled note. Once a borrower pays a note obligation he is entitled to a canceled note. If the lender loses the note he has in a real sense deprived the borrower of this basic right. So courts are rightly suspect of efforts to enforce lost notes, and courts should take appropriate steps to give borrowers that same level of protection--i.e., an indemnity bond or better. Thus, courts have not hesitated to refuse to enforce lost notes despite efforts by claimants to avail themselves of 3-309, as illustrated in this case, and those cited therein.

Even if courts allow enforcement of missing and lost notes, therefore, this will require more proof and costly hearings, not to mention the cost of indemnity bonds. It is probably true that few have been wrongfully subject to foreclosure proceedings; on the other hand, it appears very likely that many, many homeowners were evicted through flawed proceedings where the bank failed to prove its entitlement to foreclosure properly. Figuring out how to manage these grim outcomes will also require extensive litigation--largely due to the ineptitude of the banks and their failure to follow the law. At best, from the point of view of the banks, this will slow down foreclosures, increase foreclosure costs, and further impair the value of MBS, leading to more bank losses.

So, here we go again. The banks failed to see to it that this reckless subprime lending entailed any semblance of basic and prudent documentation practices. I can think of no more powerful indicator of gross ineptitude than this: they lost and destroyed promissory notes. These are the bankers that we bailed out and left in control of a huge chunk of our financial sector.

Friday, October 22, 2010

SEC Smacks Angelo Mozilo with 67.5 Million Fine

Just four days before Angelo Mozilo’s securities fraud and insider trading trial was to begin in Los Angeles, the former CEO of now-defunct Countrywide, settled the SEC’s claims against him for 67.5 millions dollars, resulting in the first personal punishment for a prominent executive who engaged in reckless and grossly negligent behavior during the subprime mortgage boom and bust. Mozilo raked in hundreds of millions of dollars in ill-gotten gains during his company’s foray into the subprime mortgage markets.

The settlement consists of 45 million to disgorge ill-gotten profits and 22.5 million as a penalty. Despite the hefty sound of the fine, the total settlement represents a drop in the bucket of what some have deemed obscene profits earned by Mozilo during 2000 to 2008. Countrywide’s bread and butter during the subprime boom was the incredibly risky zero-down, negative amortization, adjustable rate mortgages. Mozilo earned 500 million during this 8 year period. Amazingly, of the 67.5 million penalty, Mozilo will only be responsible for paying the 22.5 million in ill-gotten profits. Insurance and Bank of America (successor to Countrywide) will pay the remaining 45 million, based on various indemnification agreements. So, at bottom, Mozilo received more than $500 million in compensation and bonuses while driving Countrywide into the ground and defrauding shareholders, yet will only be forced to disgorge 22.5 million of his personal fortune, and agreeing to a ban from ever serving again as a corporate executive. A small price to pay for recklessly leading Countrywide into bankruptcy.

The record-setting default rates for these terrible mortgage products caused not only the demise of Countrywide, but contributed significantly to the near collapse of U.S. financial markets. Mozilo himself described these loan products as, “poison” and “toxic” in emails to other Countrywide execs in 2006, signaling that he could readily foresee the collapse of the company that he was leading, but Mozilo chose to continue to enrich himself by defrauding investors and shareholders recklessly.

Bank of America eventually acquired Countrywide in 2008 in a fire sale.

Thursday, October 21, 2010

The Federal Reserve We Need

Professor Timothy Canova has recently published “The Federal Reserve We Need” in The American Prospect. Therein, Professor Canova details, painstakingly, the path that The Federal Reserve has taken from a governmental agency charged with safeguarding the American economy through sound monetary policy to an organization that has simply adopted the private banking interests and agenda as its own. Professor Canova highlights the groundbreaking work of former Fed Chair Marriner Eccles during and after the Great Depressions and juxtaposes the role that Eccles played in assisting the American economy with that of Alan Greenspan and Ben Bernanke and argues that Greenspan and Bernanke have co-opted the private interests of banks rather than safeguarding the best interests of the American economy. Read his excellent article here: The Federal Reserve We Need

Additionally, Reuters has just published an investigative report, entitled “Cozying Up to Big Investors at Club Fed,” that details the many conflicts of interest that continue to exist at the Federal Reserve, including what amounts to very nearly insider trading engaged in by members of the Federal Reserve and the clients that subscribe to a specific member’s consulting services. The full article can be read here: Club Fed

Wednesday, October 20, 2010

Is A Mortgage Bond Meltdown Imminent?

The above charts show that our mega-banks suffer from higher perceived risk of default, as the market prices of credit protection have soared--in response to the threat to bank capital from MERS Madness and the Robo-signing fraud. Many commentators, however, believe that these scandals pale in comparison to a fast-approaching meltdown in the entire private label mortgage bond market. Essentially, we appear to be on the brink of a flood of claims that the mega-banks simply did not package and sell loans in accordance with their representations and warranties at the time of sale and withheld material information.

Today, the New York Fed announced that they and other major investors are seeking $47 billion from Bank of America for precisely this kind of claim and credit default protection on BOA bonds has now soared to 15 month highs. Chase analysts estimate that the mortgage bond buybacks could cost the banks $120 billion.

But so far, the claims seem to me to be the tip of the iceberg. For example, here is the gist of the claim brought by the FHLB of San Francisco:

In its amended complaints, the Bank is seeking to rescind its purchases of 136 securities in 116 securitization trusts, for which the Bank originally paid more than $19.5 billion.

The amended complaints reflect the Bank's further investigation of specific loans in the 116 trusts. The amended complaints allege, on a trust-by-trust basis, that the defendant dealers made untrue or misleading statements about the loan-to-value ratios of the mortgage loans in the trusts, the percentage of those loans that were secured by the primary residence of the borrower, and the extent to which the originators of those loans departed from their disclosed underwriting standards in making the loans.

Similar suits have been brought by the FHLB of Seattle, the FHLB of Chicago and no doubt many others will emerge. But perhaps the biggest suits will be those arguing that when you sell mortgage-backed securities you need to include mortgages--enforceable mortgages, no less. In other words, the MERS Madness also rears its ugly head here, in the form of yet another basis for investors to pursue claims against the mega-banks. Given that MERS infects 60 percent of all mortgages and that there over two trillion dollars of private label securitizations outstanding it is really hard to imagine that this is only a $120 billion problem. Similarly, the lawyer at ground zero of this particular fiasco states that 50% of all loans tested did not meet the representations and warranties made by the issuer. So the Chase estimate reminds me of the false confidence displayed in the early stages of the last crisis. Perhaps global capitalism will survive, but more than $120 billion in losses will hit bank capital as a result of this meltdown; indeed, BOA may take a $74 billion hit alone.

Now some pundits claim that the US Government will come to the rescue. And, I do not want to underestimate the power of money in politics. But if the Democrats lose control of either House we are facing deep gridlock. There will be no rescue.

Dodd-Frank does authorize Fed and FDIC bailouts. It also authorizes a reasonable Orderly Liquidation Authority. Nevertheless, the bankers defanged the OLA, and the Fed and the FDIC may actually lack the firepower to pull off another bailout without a sentient Congress. This will be a forthcoming blog topic.

Monday, October 18, 2010

MERS Madness!

What is MERS?

According to Professor Christopher Peterson, over 60 percent of all American mortgages are recorded in the name of MERS, even though they do not own the mortgages or underlying notes. This was apparently done to avoid paying recording fees when mortgages were transferred. Here is what MERS does, from the MERS website:

MERS was created by the mortgage banking industry to streamline the mortgage process by using electronic commerce to eliminate paper. Our mission is to register every mortgage loan in the United States on the MERS® System.

Beneficiaries of MERS include mortgage originators, servicers, warehouse lenders, wholesale lenders, retail lenders, document custodians, settlement agents, title companies, insurers, investors, county recorders and consumers.

MERS acts as nominee in the county land records for the lender and servicer. Any loan registered on the MERS® System is inoculated against future assignments because MERS remains the nominal mortgagee no matter how many times servicing is traded. MERS as original mortgagee (MOM) is approved by Fannie Mae, Freddie Mac, Ginnie Mae, FHA and VA, California and Utah Housing Finance Agencies, as well as all of the major Wall Street rating agencies.

Mortgages are held by MERS as "nominee" no matter who actually holds the beneficial interest? As Professor Peterson shows in his outstanding work on this issue, there are serious problems with this means of managing mortgages. First, the mortgage (as well as any assignment) must be recorded with public recorders of deeds to maintain priority over subsequent transferees of any interest in the underlying real estate. (pp. 3, 13). Second, under the statute of frauds the name of the owner of the mortgage must be listed on the face of the mortgage. (pp. 16-19). Third, mortgages cannot be split, transferred or assigned away from the underlying note and MERS does not retain any beneficial interest in the notes. (pp. 5-7). Fourth, only the owner of the mortgage may enforce the mortgage. (p. 5). Finally, it is "extremely unclear" that a mortgage can be held in the name of an agent or nominee. (p. 5). All of this means that there may be very serious flaws in millions of mortgages across the nation, that likely renders many such (perhaps millions) mortgages unenforceable. MERS has thus met skepticism in the courts to say the least. (pp. 8-11). Recent cases fully support the upshot of this analysis.

Professor Peterson suggests that these flaws render the mortgage debt unsecured debt. This would naturally greatly erode the value of all mortgage backed securities infected with the MERS flaws. Peterson also suggests that perhaps courts could impose equitable mortgages in place of legal mortgages; but in equity the mortgages would be unlikely to retain some of their more predatory features. Moreover, equitable mortgages can be discharged in bankruptcy and the ability of lenders to pursue deficiency judgments may well be reduced. In short, this is a costly and uncertain road, and lenders would be well advised to negotiate and reduce their principal than to litigate endlessly in hope of equitable relief. (pp. 20-22).

Obviously, this MERS madness could have serious adverse effects on the continued solvency of our financial sector. But, it is worth noting that these time-honored rules are not technicalities. They exist to assure that a borrower does not have to pay, again and again. By requiring that the mortgage and note stay together in the same person, the borrower can only be sued once on the same debt. In fact, there is already much evidence that some debt has led to exactly this problem with MERS. So requiring the plaintiff in a foreclosure action to show up with the original signed note and mortgage (or to account for same), is a basic protection of homeowner rights.

Professor Peterson highlights other policy ramifications from this fiasco. "For the first time in the nation's history, there is no longer an authoritative, public record of who owns land in each county." (p. 4). Because MERS did not in fact have any claim to the mortgages, its mortgage recordings were false documents. "Using false documents to avoid paying fees to the government sounds a lot like tax fraud." (p. 25). But perhaps most importantly, "the lives and fortunes of generation after generation [of] America's middle class turn more on their ownership of land than any other asset." (p. 18). The massive destabilization of middle class property rights (the rich can hire teams of lawyers) implicit in this MERS madness will impose costs and uncertainty at the heart of the American economy for years to come. Once a mortgage goes into the MERS black hole, there is no tracing the actual owner of the mortgage for purposes of negotiations, payment certainty, or history of the loan. If MERS holds the mortgage there is literally no way to know for sure whom should be paid. Ten years from now these problems will be even worse.

Frankly, this is outrageous. Doing this right is simple: the original lender is named on both the mortgage and the mortgage note; these documents are recorded at the recorder of deeds office; when these interests are pooled (into a trust or some other entity) for purposes of securitization, then the mortgages and notes are assigned to the securitization vehicle; and, the assignment is recorded to preserve priority. This is simple and time tested. It conforms to law. Yes, it could cost a bit more, but these guys sucked the economy dry with their blasted bonuses, and recording costs about 40 bucks. Our system of property rights is looking like some Banana Republic for a few pieces of silver.

One more time: the apex of our economy is dominated by the most inept, if not corrupt, financial elites in the history of financial elites. Its as if the entire Wall Street culture decided the world was going to end in just a few weeks. It is (way past) time to fragment these banks into 10,000 pieces and terminate all of the senior managers of these unbelievably reckless entities.

The MERS madness shows that these people really think they above the law.

So far, the markets have had an apparently mixed reaction to the foreclosure crisis, but the cost of credit default insurance against major banks is climbing higher. Perhaps the hope is that these legal problems can somehow be resolved over time. If these problems persist I doubt the market will not suffer.

ADDENDUM: Here is the best case for MERS, as stated by their spokesperson.

Saturday, October 16, 2010

Ruminations on Robo-signing and Our Corrupt Financial Elite

Every American should be outraged by the subversion of middle class property rights now underway in courthouses across America where massive fraudulent foreclosures appear to be occurring. The video above provides an overview of the problem. As Paul Krugman puts it: "the mortgage mess is making nonsense of claims that we have effective contract enforcement -- in fact, the question is whether our economy is governed by any kind of rule of law."

So far, Wells Fargo, JP Morgan Chase, Ally (GMAC), Citi, PNC, Bank of America and Goldman Sachs among others have each been caught up in the robo-signing fraud. Apparently our major banks decided to kick-out homeowners through the cheapest and fastest means they could get away with regardless of illegality. Basically, according to one attorney who has deposed 150 "robo-signers," this was "an industry wide scheme designed to defraud homeowners."

This started to unravel when Attorney Thomas Cox discovered that GMAC hired a "limited signing agent" to execute 10,000 affidavits a month in support of foreclosures--a veritable dispossession machine. Obviously, such a pace makes it impossible to testify based upon personal knowledge and to assure that the bank actually has the right to foreclose. Now attorneys have admissions from agents of major banks that they had no personal knowledge of the facts they swore to, they did not understand the affidavits they signed, and they had not searched for basic documents like notes and mortgages that would prove the right to foreclosure. A paralegal at one foreclosure mill testified that signatures were forged, documents backdated, and social security numbers swapped to support faster foreclosure actions.

Maryland now appears poised to conduct a massive audit of foreclosure actions in its courts. The SEC is investigating publicly held firms involved in this entire sordid affair, and the DOJ, FDIC and OCC are also conducting their own inquiries. These actions have been announced since I posted my first blog on this topic which was triggered by the coast-to-coast investigation of our 50 state attorney generals. Class action attorneys will no doubt file massive claims. This fraud in foreclosures amounts to a massive assault on the judicial process and the rule of law in America and should lead to convictions, judicial sanctions and the imposition of massive legal liabilities.

According to one bank analyst the litigation losses to the banks from this pattern of fraud could mount to $80 billion. Another analysis suggests a $6-10 billion loss from the delay in foreclosure recoveries. For now, at least, it appears that the value of MBS has not suffered much. So, standing alone, these losses ought not to lead to another Lehman meltdown. But, the mortgage bond meltdown (which I will cover in more detail soon) may lead to even larger losses. In a fundamentally weak economy, the combined problems in the mortgage market could easily trigger another financial crisis, complete with federal bailouts of our banks, again.

I became a lawyer in 1986, shortly after graduating from Saint Louis University School of Law. Since then I worked for large corporate firms, small firms, the SEC, the FDIC and as a teacher at two different law schools in Chicago and Topeka, Kansas. Nothing in my experience prepared me to understand the robo-signing scandal now gripping the banking sector. In my opinion the systematic submission of fraudulent documentation to support residential foreclosures was impossible. Lawyers cannot participate in fraud and owe a duty of candor to courts. CEOs and directors would never approve such a brazen method of generating revenues now while exposing their firms to massive legal liabilities down the road. Under Model Rule 1.13 any in-house attorney as well as outside counsel would be duty bound to alert corporate authorities to the fraud and would even confront the possibility of reporting wrongdoing within publicly held banks to the SEC. Fraud ought not to pay, and the system really does punish fraudfeasors (other than securities fraudfeasors which benefit from special legal protection).

Nevertheless, I was clearly wrong. We are seeing the most massive legal fraud in US history, right before our very eyes, right now. This all makes a mockery of the rule of law in America, which already was suffering from excessive elite subversion, as I argue in my forthcoming book Reimaging Capitalism.

We should have expected this. When we bailed out the banks we permitted the reckless bankers to remain in control, even though they had proven themselves inept, at best, and corrupt at worst. According to Professor Emma Jordan Coleman, 92% of the senior bank managers who caused the crisis remain in control of their firms. They sunk global capitalism in the name of short term profits. Now they are so anxious to generate revenue from foreclosures they seem to be utterly unconcerned about committing fraud on the courts, fraud on homeowners, and fraud on buyers of tainted properties. It is now past time to oust the managers of these "zombie" banks that do not lend and instead "suck the lifeblood out of our economy." That is why I argued here, here, here, and here that any bailout should require dismissal of the senior managers who recklessly crashed the economy.

Otherwise, the managers will simply be emboldened by their ability to foil legal accountability to pursue even worse misconduct--like judicial fraud.

Wednesday, October 13, 2010

Trouble with Foreclosures Intensifies: "Where Were all The Lawyers?"

For some time, there have been signs of trouble with real estate foreclosures because issuers of securitizations apparently failed to assure that loans could be foreclosed upon in the event of default on the underlying mortgage debt. So, for example, in Cleveland, in 2007, a judge dismissed a number of foreclosure actions brought by Duetsche Bank because the bank's ownership of the mortgage documents had vaporized and could not be proved in court.

I am frankly amazed that these problems have emerged because it seems to me that the lawyers representing the issuers of these securitizations owed professional obligations to undertake due diligence. This due diligence would require, at a minimum, to see to it that the notes and mortgages being pooled were valid under state law; that the mortgage was perfected, recorded and could be enforced through foreclosure in the event of default; and, that the foreclosure proceedings would not entail excessive cost. These mortgage interests in real estate then must have been transferred to investment vehicles in writing, in accordance with the Statute of Frauds, and through a recorded transfer that would preserve priority against subsequent transferees. A lawyer cannot be willfully blind to a client's reckless misrepresentations and must exercise due diligence to avoid participating in a fraud. Thus, a mortgage securitization must include enforceable mortgages. This entire process would then be preserved through the retention of appropriate documentation.

So, in 2007, when these issues first appeared, I was certain that they must be the result of isolated aberrations. In fact, the recklessness (or worse) of the private label securitizers now appears to be systemic and has triggered a coast-to-coast investigation of foreclosures by all 50 state attorney generals. There are three major problems.

First, there is certainly a procedural problem spawned by so-called robo-signers who were used to short-cut court procedures by signing affidavits in support of foreclosure actions without any factual basis or investigation. Some robo-signers executed 6000 affidavits in support of foreclosure per week. This systemic effort for cheap foreclosures simply reiterates the fundamental recklessness of the financial sector. This is fundamentally fraudulent. By raising the costs of foreclosure, here it appears that the state attorney generals seek massive loan write-downs, meaning massive loan losses to banks.

Second, many key loan and mortgage documents were not recorded in a proper way and instead used a nominee of dubious legal standing--in particular an outfit called MERS. This means of tracking mortgages seems to be a colossal failure because the courts are increasingly refusing to enforce mortgages held in nominee names. Consequently, there is some chance that a significant portion of the 64 million mortgages held in the name of MERS will be unenforceable leading to massive financial losses. Professor Chris Peterson suggests that MERS grew from hubris that exalted short tern profits over long term legal risks.

Third, it appears that many mortgage documents simply cannot be located. This one really baffles me. According to Professor Katherine Porter this is very common. Basically it appears that investors were induced to buy mortgage pools without enforceable mortgages. This will spawn years of litigation and accompanying losses for the financial sector. And, it is likely to require massive loan write-downs as banks renegotiate loans in the shadow of missing documents.

One financial expert calls this "the biggest fraud in the history of capital markets." According to Professor Georgette Phillips of the Wharton School of Finance: "This entire debacle is a symptom of the Wild West, shoot first and ask questions later, attitude of the securitization industry." My friend Christian Johnson puts it more succinctly: "This is all unbelievably bad."

Where does this all lead? Undeniably, this will mean a major loss of bank capital in a context where both the banking sector and the economy generally are already vulnerable, as Nouriel Roubini (48 minute mark) and Chris Whalen (1:07) make clear in this video. Moreover, this will hardly help the residential real estate market recover. So this will likely extend our economic problems, at best, and has the potential to trigger a major financial crisis, at worst.

The magnitude of the problem is betrayed by the banks' resort to congressional fixes. President Obama just vetoed legislation that would have eased many of the banks' documentation problems. The banks would not have sought such legislation unless they needed it to resolve a serious problem. Only the banks know the magnitude of this problem with certainty, but there is simply no doubt that is is now a major economic problem.

For me, however, the question is: where were all the lawyers when these securitization deals came down?