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Congressional testimony of Katherine Porter, Professor of Law, on the mortgage transfer issue [ClearOnMoney]
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Congressional testimony of Katherine Porter, Professor of Law, on the mortgage transfer issue

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Commentary

Congressional testimony of Katherine Porter, Professor of Law, on the mortgage transfer issue

27 Oct 2010 by Jim Fickett.

Today the Congressional Oversight Panel had a hearing on TARP Foreclosure Mitigation Programs. COP also asked for input on “the problems with foreclosures processes and loan paperwork”. I found the testimony of Katherine Porter, a professor at the University of Iowa, and visiting professor at Harvard, to be quite illuminating.

She

  • gives a more nuanced view than most concerning what, exactly, is involved in the transfer of ownership
  • emphasizes that the problem is a longstanding one, and that it could have very serious repurcussions
  • gives considerable circumstantial evidence that serious problems are widespread
  • strongly criticizes the banks for trying to sweep it under the rug
  • several times emphasizes that we need a strong independent audit, perhaps from the COP
  • suggests that the likely outcome of the the attorneys general efforts might be to force servicers to do more aggressive loan modifications

The whole testimony is very well reasoned and written, and is a pleasure to read. I include a longish extract:

The largest and most complex harm that may exist with the loans in default or foreclosure today is that the paperwork for the loans was not transferred correctly. I emphasize that what constitutes a correct transfer is a gray area; we need more direction from courts and legislatures on this subject. But there are plausible legal claims that the transfers of the notes and mortgages were not effective to give the trust full enforcement rights. These issues are complex but to summarize: First, what we commonly call a “mortgage” normally consists to two documents: a note and a mortgage or deed of trust. The note creates a debt obligation, the borrower owes the lender a specified number of dollars payable in a specified way. If certain requirements are met, this note may be a negotiable instrument, a term of art under the Uniform Commercial Code. If the note is not a negotiable instrument, it is commercial paper, another term of art. Generally, the law governing notes is Article 3 of the Uniform Commercial Code and general contract law. The mortgage or deed of trust is effectively a grant to the lender of a security interest in the property. Like the note, there are requirements that must be met to create a mortgage (for example, it must be in writing, and in some states, must be notarized). Generally, the law governing mortgages is non-uniform state real estate law, although when mortgages are securitized Article 9 of the Uniform Commercial Code, which is the law in every state, may also be relevant.

The concern being raised is that during the securitization process that the transfers from originator to sponsor to depositor to trust (to generalize the parties in a typical process) were not performed or were not performed correctly. A related issue is whether the physical paperwork or electronic records can be located and are accurate. These records are needed to sort out whether the transfers were completed and valid.

I believe the law is somewhat unsettled on what actually must be done via a securitization to complete the transfers correctly. Some have argued that the traditional processes govern. This would mean the note must be negotiated (if a negotiable instrument) or endorsed (if bearer paper) and that the mortgage must be assigned to each party in the securitization process. The latter issue implicates MERS, the Mortgage Electronic Recording System and whether its efforts to declare itself the nominee for the mortgagee and not make public recordation of the assignments are valid. Others believe that the primary issue is whether the note was transferred correctly, on the theory that the “mortgage follows the note” (but it is not clear whether the same rules applies for a deed of trust). But even here, there is disagreement on whether the transfer of the notes needed to have occurred individually, by endorsement (negotiable instrument) or by transfer of possession (bearer paper), or whether the pooling and servicing agreement somehow suffices to effectuate the transfer of the notes to the trust.

The implications of problems with transfer are serious. If the trust does not have the loan, homeowners may have been making payments to the wrong party. If the trust does not have the note or mortgage, it may not have standing to foreclose or legal authority to negotiate a loan modification. To the extent that these transfers are being completed retroactively, it raises issues about honesty in creating and dating the assignments/transfers and about what parties can do, if anything, if an entity in the securitization chain, such as Lehman Brothers or New Century, is no longer in existence. Moreover, retroactive transfers may violate the terms of the trust, which often prohibit the addition of new assets, or may cause the trust to lose its REMIC status, a favorable treatment under the Internal Revenue Code. Chain of title problems have the potential to expose the banks to investor lawsuits and to hinder their legal authority to foreclose or even to do loss mitigation. …

Due process does not disappear merely upon the assertion by one party that the other is clearly liable. The allegations of problems in mortgage servicing should, if anything, only heighten the due process requirements on consumers. For example, in light of the lack of verification procedures for affidavits to support requests for judgments in judicial foreclosures, it may be reasonable to be concerned that there is absolutely no verification of the facts in the non-judicial foreclosure context. Thus, we might argue that states or the federal government ought to increase the legal requirements for foreclosures across the board, at least for loans initiated in the last five to ten years when widespread allegations of paperwork and procedural problems have existed. The banks’ arguments that we can ignore possible systemic wrongdoing by the banks because as a systemic matter, homeowners are in default on their loans, is unpersuasive. Indeed, it seems to reflect a fundamental misunderstanding of the obligations of any party wishing to invoke the aid of the law in enforcing its rights.

The most pressing issue is to assess the extent of the wrongful or problematic foreclosures. This assessment needs to have two fundamental parts. First, how many loans or foreclosures have any defect? Second, what kinds of defects do the troubled loans or foreclosures have? Without an answer to these questions, it is nearly impossible for anyone to do more than speculate about the key questions before this panel about the impact of these troubled loans or foreclosures on the government’s foreclosure mitigation efforts and the well-being of financial institutions.

The immediate need is to know the extent to which the problems in mortgage servicing occur sporadically or are endemic. As a preliminary matter, I note that it is simply not credible to believe that the lenders have made no errors in their foreclosure procedure. Because they are being allowed to control the definition of error and are being allowed to audit themselves, we cannot have confidence in such reports. The question is then is whether the rate of troubled loans is nearly 100% as some have alleged, or rather is a smaller fraction of loans, such as 5%. …

The Panel asked in its written invitation to me that I address the question of whether I believe the problems with foreclosures processes and loan paperwork are endemic in the industry. … The Congressional Oversight Panel should urge regulators and financial institutions to immediately outline a plan for auditing a sample of loans at each servicer …

I do think that the structure of the mortgage servicing industry and the lack of accountability by financial institutions in the securitization process make it a fair inference that the problems from flawed foreclosure are not isolated incidents. … mortgage servicing is a high-volume industry. Its personnel have relatively little training, weak supervision, and are under pressure to cut costs and boost profits. These structural qualities of mortgage servicing make it likely that procedural problems need to be treated as part of a pattern or practice of illegal behavior and not as isolated incidents.

Finally, I want to share with the Panel that the lawyers that I have met over years of my research on mortgage servicing—both creditor lawyers and debtor lawyers—have nearly universally expressed that they believe a very large number (perhaps virtually all) securitized loans made in the boom period in the mid-2000s contain serious paperwork flaws, did not meet underwriting or other requirements of the trust, and have not been serviced properly as to default and foreclosure. I trust and respect these individuals; they are in the trenches, reviewing paperwork and litigating these cases. I trust and respect the courts around the country that have devoted time and resources to identifying such problems and preparing published opinions to explain the legal consequences of such problems. In the wake of these parties’ longstanding allegations and findings of inappropriate and illegal practices, I am unable to give weight to recent statements by banks such as Bank of America that only 10 to 25 of the first several hundred loans that it has reviewed have problems. … The need for outside audit and verification of loans and foreclosure procedures remains urgent. …

The most aggressive, and seemingly well- coordinated, response to date is from the 50 states’ Attorney Generals. … The most likely outcome … is that the Attorneys General gain concessions from servicers about their willingness to do mediation before foreclosure or to relax their rules about who may receive a loan modification. …

the housing market faces a grave risk of near complete shutdown if the concerns about correct transfer of loans should cause title insurers to refuse to write new policies on foreclosed homes. This would leave banks saddled with REO properties and would not permit the housing market to find its bottom by processing the pending foreclosures and returning the properties to the market. …

The concerns about shortcomings in documentation, procedure, and substantive rights are not new. In fact, the current “crisis” has existed for years, as homeowners’ and investors’ rights have been ignored in the foreclosure process. It is very likely that there are thousands, and possibly hundreds of thousands, of families who already have lost their homes were deprived of procedural or substantive rights.