The Second Leg Down of America’s Death Spiral
by Gonzalo Lira
I swear to God Almighty: Mortgage Backed Securities are America’s Herpes – the gift that keeps on oozing.
Last Friday, Bank of America announced that it was suspending all foreclosure proceedings, presumably until further notice. Other banks have already suspended foreclosures in a whole truckload of states. A nationwide moratorium on foreclosures might soon happen – which would be a big deal: Global Financial Crisis, Part II – Longer, Wider and Uncut.
But the mainstream media – surprise-surprise – has downplayed the whole shebang. They’re throwing terms out there into the ether, but devoid of context or explanation: “Robo-signings,” “foreclosure mills,” forged signatures, “double booking,” MERS – it’s confusing as all get-out.
So the mainstream media just mentions it casually – “and in other news tonight . . .” – like it’s no big deal: A couple-three lines, lots of complicated, unfamiliar terms, an attitude like it’s a brouhaha over paperwork of all things! – and then zappo-presto-change-o!: They’re showing video footage of a cute koala nursing in the arms of a San Diego zookeeper.
But even the koalas know that something awful is heading America’s way. Smart little critters, they’re heading for the treetops, to get away from this mess.
So what the hell is going on with the God forsaken mortgage mess in the United States?
It’s got a lot of bells and whistles, but it’s basically quite simple: It’s all about the fucking Mortgage Backed Securities (MBS). Again.
So this is what happened, more or less – the short version:
In the crazed frenzy to get as many mortgages securitized during the Oughts, banks took shortcuts with the paperwork necessary for the Mortgage Backed Securities. The reason was because everyone in the chain of this securitization mania got a little piece of the action – a little slice of the MBS pie in the shape of commissions.
So in the name of “improved efficiencies” (and how many horror stories are we finding out, carried out in the name of “improved efficiencies”), banks digitized the mortgage notes – they didn’t physically endorse them, like they were supposed to by the various state and Federal laws.
Plus – once the wave of foreclosures broke, and the holes in this bureaucratic paperwork became evident and relevant – some of the big law firms handling the foreclosures for the banks started doing some document fabrication and signature forgery, in order to cover up the mistakes – which is definitely illegal.
Long story short (since this is the short version): A lot of the foreclosed properties might not have been foreclosed legally. The people evicted might still have a right to their old houses. The new buyers might not actually own the REO’s they bought off the banks. The banks could be on the hook for trillions of dollars, and in the sights of literally millions of lawsuits.
In short: This could become another massive oozing sore, complete with yellow-green pus drip-drip-dripping out of some unmentionable places on the Body Economic.
Now – the long version:
Homeowners can only be foreclosed and evicted from their homes by the person or institution who actually has the loan paper – only the note-holder has legal standing to ask a court to foreclose and evict. Not the mortgage – the note, which is the actual IOU that people sign, promising to pay back the mortgage loan.
Before Mortgage Backed Securities, most mortgage loans were issued by the local Savings & Loan. So the note usually didn’t go anywhere: It stayed in the offices of the S&L down the street.
But once mortgage loan securitization happened, things got sloppy – they got sloppy by the very nature of Mortgage Backed Securities.
The whole purpose of MBS’s was for different investors to have their different risk appetites satiated with different bonds. Some bond customers wanted super-safe bonds with low returns, some others wanted riskier bonds with therefore higher rates of return.
Therefore, as everyone knows, the loans were “bundled” into REMIC’s (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then “sliced & diced” – split up and put into tranches, according to their likelihood of default, their interest rates, and other characteristics.
This slicing and dicing created “senior tranches,” where the loans would likely be paid in full, if past history of mortgage loan statistics was to be believed. And it also created “junior tranches,” where the loans might well default, again according to past history and statistics. (A whole range of tranches were created, of course, but for purposes of this discussion, we can ignore all those countless other variations.)
These various tranches were sold to different investors, according to their risk appetite. That’s why some of the MBS bonds were rated as safe as Treasury bonds, and others were rated by the ratings agencies as risky as junk bonds.
But here’s the key issue: When an MBS was first created, all the mortgages were pristine – none had defaulted yet, because they were all brand new loans. Statistically, some would default and some others would be paid back in full – but which ones specifically would default? No one knew, of course. If I toss a coin 1,000 times, statistically, 500 tosses the coin will land heads – but what will the result be of, say, the 723rd toss specifically? I dunno.
Same with mortgages.
So in fact, it wasn’t that the riskier loans were in junior tranches and the safer mortgage loans were in the senior tranches: Rather, all the loans were in all the tranches, and if and when a mortgage in a given bundle of mortgages defaulted, the junior tranche holders would take the losses first, and the senior tranche holder take the loss last.
But who was the owner of the junior tranche bond and the senior tranche bond? Two different people. Therefore, the mortgage note was not actually signed over to the bond holder. In fact, it couldn’t be signed over. Because, again, since no one knew which mortgage would default first, it was impossible to assign a specific mortgage to a specific bond.
Therefore, how to make sure the safe mortgage loan stayed with the safe MBS tranche, and the risky and/or defaulting mortgage went to the riskier MBS tranche?
Enter stage right, the famed MERS – the Mortgage Electronic Registration System.
MERS was the repository of these digitized mortgage notes that the banks originated from the actual mortgage loans signed by homebuyers. MERS was jointly owned by Fannie Mae and Freddie Mac (yes, those two, again, I know, I know: Like the chlamydia and the gonorrhea of the financial world – you cure ‘em, but they just keep coming back).
The purpose of MERS was to help in the securitization process. Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially the operating table where the digitized mortgage notes were sliced and diced and rearranged so as to create the Mortgage Backed Securities. Think of MERS as Dr. Frankenstein’s operating table, where the beast got put together.
However, legally – and this is the important part – MERS didn’t hold any mortgage note: The true owner of the mortgage notes should have been the REMIC’s.
But the REMIC’s didn’t own the note either, because of a fluke of the ratings agencies: The REMIC’s had to be “bankruptcy remote,” in order to get the precious ratings needed to peddle Mortgage Backed Securities to institutional investors.
So somewhere between the REMIC’s and the MERS, the chain of title was broken.
Now, what does “broken chain of title” mean? Simple: When a homebuyer signs a mortgage, the key document is the note. As I said before, it’s the actual IOU. In order for the mortgage note to be sold or transferred to someone else (and therefore turned into a Mortgage Backed Security), this document has to be physically endorsed to the next person. All of these signatures on the note are called the “chain of title.”
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