Foreclosure Fraud For Dummies (DOC)

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					Foreclosure Fraud For Dummies, 1: The
Chains and the Stakes
Posted on October 8, 2010 by Mike

(This is a series giving a basic explanation of the current foreclosure fraud crisis: This is Part
One. Here is Part Two, Part Three, Part Four, and Part Five.)

The current wave of foreclosure fraud and the consequences for the economy are difficult to
follow. As such, I’m going to write a few posts to simplify what is going on so you can follow
stories as they unfold. This is very 101 level, and will include a reading list of blog posts and
articles at each stage to help provide depth. (Special thanks to Yves Smith and Tom Adams for
walking me through much of this.) Let’s make three charts of the chains involved in the process.
The first is what is currently going on with foreclosure fraud (click through for larger).

As you can see, in judicial review states like Florida the courts require that servicers, or those
who administer the bonds that are full of mortgages (securitization, residential mortgage backed
securities, RMBS, are all phrases for them), say that they have everything necessary in order to
have standing to bring a foreclosure. They need to have the note for a mortgage, which is
supposed to be in the trust – part of the mortgage backed securities – that they administer.

What is breaking down here? In Florida, a judicial review state, it was found that one person was
notarizing documents far faster than anyone could reasonably have. Forged documents necessary
for the foreclosure process like the note were found. A separate court system was set up to
resolve these foreclosures faster at the expense of allowing serious challenges to the documents.
Here’s Smith on how kangaroo these courts look up close. Here’s WaPo on one individual and
the nightmare of trying to challenge an invalid foreclosure. Keep him in mind when you hear
about deadbeats and whatnot: the current system is designed to make it difficult for anyone to
challenge their case.

Meet the robo-signer who kicked it off here at this WaPo story. I almost feel bad for this patsy;
the real battle here is between junior and senior tranche holders, and this doofus could end up in
jail in order to keep John Paulson rich. After reading about this guy I’m asking our elites to take
care of their patsies better. (Can we get a Financial Patsy Fordism social contract movement
going? If you are going to be a patsy for GMAC, you should be paid enough able to be able to
buy GMAC’s services or something.)

Why would servicers do this? One story would be that the more foreclosures they process, the
more fees they get, so there is an incentive to cut as many corners to speed through the process as
possible. Hence the term foreclosure mills. You can read more about this from Andy Kroll’s
excellent work for Mother Jones (start here).

There’s another problem though – what if servicers are behaving this way because the actual
notes aren’t in the trust? Let’s go back to the creation of these instruments.

I take a mortgage out at Joe’s Lending, a mortgage originator. A mortgage consists of two parts.
The first is the note, or the IOU, which is the borrower’s promise to pay. The second is the
mortgage, which is the security, or the lien, or the actual interest.

Joe’s lending takes the mortgage note to a sponsor to turn these mortgages into a bond. The
sponsor was often an investment bank like Bear Sterns. Now that investment bank puts an
intermediary in between itself and the trust. This intermediary is usually called a depositor, and
sometimes there are several of them in the chain.

What’s the worry here? Well many of these mortgage originators were fly-by-night shops, shady
enterprises that collapsed the moment they hit trouble. And many of them cut corners and one of
the corners they may have cut would have been to send the note to the trust. Specifically, there is
worry that many mortgage originators never sent the notes to the depositors. Originators wanted
volume to get fees and may not have done all the paperwork correctly. There are a lot of things
that have to end up in the trust when I take out a mortgage, things like the note, title insurance,
supporting documents. But the note is the most important.

Why is this important? Well the trustees usually sign several certificates saying that they have
verified all the documentation in these trusts. Many of these trusts are under New York trust law
which is particularly clear and strict when it comes to these matters. With this in mind, tackle
these three posts by Yves Smith (one two three).

So connect the two together, and you can see why we might have a systemic crisis on our hands:

There are roughly $2.6 trillion dollars in mortgage backed securities. The Wall Street Journal
starts to explain how this will be a battle between holders of junior and senior tranches of debt. It
also exposes the servicers, which include the four largest banks, to extensive legal liabilities by
those who bought these securitizations that were signed off as being properly administered and

One result is that this has lead homeowners to reasonably demand to see the proper
documentation before they and their families are put out on the street. Read Ryan Grim and
Shahien Nasiripour from June, Who Owns Your Mortgage? “Produce The Note” Movement
Helps Stall Foreclosures.

Katie Porter is an expert who has done extensive research into this area and often blogs about it
at credit slips. See the blog posts: How to Find the Owner of Your Mortgage and Produce the
(Bogus?) Paper. Porter found that this was extensive in her research, see Misbehavior and
Mistake in Bankruptcy Mortgage Claims (“A majority of mortgage claims are missing one or

more of the required pieces of documentation for a bankruptcy claims. Fees and charges on
claims often are poorly identified and do not appear to be reasonable. The bankruptcy data
reinforce concerns about the overall reliability of the mortgage service industry to charge
homeowners only the correct and legal amount of the debt and to comply with applicable
consumer protection laws”). By rushing the process, unreasonable and excessive foreclosure
fees can get applied to homeowners when there may not even be the proper documentation to
have the standing to bring foreclosure at all.

So keep these frameworks in mind when you see the debate unfold in the next weeks. It is a
problem of systemic risk, and it is a problem for the currently cratered securitization market. It
will need to be addressed, the sooner the better. But how?

Foreclosure Fraud For Dummies, 2: What is
a Note, and Why is it So Important?
Posted on October 11, 2010 by Mike

(This is a series giving a basic explanation of the current foreclosure fraud crisis: Here is Part
One. This is Part Two, Part Three, Part Four, and Part Five.)

The SEIU has a campaign: Where’s the Note? Demand to see your mortgage note. It’s worth
checking out. But first, what is this note? And why would its existence be important to struggling
homeowners, homeowners in foreclosure, and investors in mortgage backed securities?

There’s going to be a campaign to convince you that having the note correctly filed and produced
isn’t that important (see, to start, this WSJ editorial from the weekend). This is like some sort of
useless cover sheet for a TPS form that someone forgot to fill out. That is profoundly incorrect.

Independent of the fraud that was committed on our courts, the current crisis is important
because the note is a crucial document for every party to a mortgage. But first, let’s define what a
mortgage is. A mortgage consists of two documents, a note and a lien:

The note is the IOU, it’s the borrower’s promise to pay. The mortgage, or the lien, is just the
enforcement right to take the property if the note goes unpaid. The note is crucial.

Why does this matter? Three reasons, reasons that even the Wall Street Journal op-ed page needs
to take into account. The first is that the note is the evidence of the debt. If it isn’t properly in the
trust then there isn’t clear evidence of the debt existing.

And it can’t be a matter of “let’s go find it now!” REMIC law, which governs the securitization,
is really specific here. The securitization can’t get new assets after 90 days without a tax
penalty, and it can’t get defaulted assets at all without a major tax penalty. Most of these notes
are way past 90 days and will be in a defaulted state.

This is because these parts of the mortgage-backed security were supposed to be passive entities.
They are supposed to take in money through mortgage payments on one end and pay it out to
bondholders on the other end, hence their exemption from lots of taxes; the tradeoff is that they
can’t be de facto managers of assets, and that’s what going to find the notes would require.

For Distressed Homeowners

The second is that it also matters a great deal for homeowners who are distressed. The note lays
out the terms of late fees and other penalties. As we will discuss in the next section about
mortgage servicers, the process of trying to get people behind on their payments current instead
of driving them into bankruptcy has broken down. But for now it’s clear that mortgage servicers
don’t have great incentives to get distressed homeowner’s records correct.

There’s well-documented evidence that extra fees are tacked on to mortgages that have fallen
behind, fees that aren’t following the terms of the note. This is usually only found out in
bankruptcy where there is a lawyer (and multiple parties), not in foreclosure cases. But if
homeowners wants to challenge whether what the servicers claim is the correct final due amount,
the terms of the note are necessary for the court.

This will matter a great deal for many homeowners. Small, marginal differences in the total
owed could allow for a short sale. It could determine if the homeowner has any equity in their
home. And this can only be determined by producing the note.

For Investors, Who Took This Seriously at the Beginning

Last reason: you can tell it’s important because all the smartest finance guys in the room thought
it was important. Let’s look at a Pooling and Service Agreement form from 2006 between “GS
COMPANY, Trustee.” (h/t Adam Levitin for this example.) Let’s reproduce the chart from part

1 to see the chain between depositors and trustees who oversee the trust:

So what agreement did they come to when it comes to the proper handling of notes in
securitization? Did they think this was no big deal, or that it is something serious? From the PSA
(my bold):

(b) In connection with the transfer and assignment of each Mortgage Loan, the Depositor has
delivered or caused to be delivered to the Trustee for the benefit of the Certificateholders the
following documents or instruments with respect to each Mortgage Loan so assigned:

(i) the original Mortgage Note (except for up to 0.01% of the Mortgage Notes for which
there is a lost note affidavit and the copy of the Mortgage Note) bearing all intervening
endorsements showing a complete chain of endorsement from the originator to the last
endorsee, endorsed “Pay to the order of _____________, without recourse” and signed in the
name of the last endorsee…

The Depositor shall use reasonable efforts to cause the Sponsor and the Responsible Party to
deliver to the Trustee the applicable recorded document promptly upon receipt from the
respective recording office but in no event later than 180 days from the Closing Date….

In the event, with respect to any Mortgage Loan, that such original or copy of any document
submitted for recordation to the appropriate public recording office is not so delivered to
the Trustee within 180 days of the applicable Original Purchase Date as specified in the
Purchase Agreement, the Trustee shall notify the Depositor and the Depositor shall take or cause
to be taken such remedial actions under the Purchase Agreement as may be permitted to be taken
thereunder, including without limitation, if applicable, the repurchase by the Responsible
Party of such Mortgage Loan.

Read that again through to the end and use the chart to follow the chain. If more than 0.01% (!)
of mortgage notes weren’t properly transferred, the trust can force the sponsor (in this case,
Goldman Sachs) to repurchase the bad mortgages. And this is just one contract for one part of
the ~$2.6 trillion dollar mortgage backed securities market. How’s that for systemic risk?
 Especially if this is found to be widespread….

Looking at the documents you see that the smart guys who created these mortgage-backed
securities put large poison pills into them to try and prevent the kind of note fraud we are
currently experiencing as a country. They took the policing and legal recourse (and legal ability
to cover their ass) very seriously on this issue. So seriously they can force repurchases of this bad

So don’t believe the hype of anyone who says these are just technicalities; the people who wrote
the contract didn’t believe they were.

(Special thanks to Katie Porter and Adam Levitin, who you can read at credit slips, as well as
Tom Adams and Yves Smith, who you can read at naked capitalism, for in-depth discussions on
this material.)

Foreclosure Fraud For Dummies, 3: Why Are
Servicers So Bad At Their Job?
Posted on October 11, 2010 by Mike

(This is a series giving a basic explanation of the current foreclosure fraud crisis: Here is Part
One, Part Two,, and this is Part Three.)

Whenever I hear about how there wouldn’t be a problem with foreclosures if people just paid
their mortgages on time, I’m reminded of Alan Grayson’s paraphrase of the Republican Health
Care Plan: “Don’t Get Sick. If You Get Sick, Die Quickly.” Yes, the world would be an easier
place if people never got sick, or credit risk didn’t exist, and people made payments perfectly all
the time. But they don’t, and we need a system of rules and a process for collecting and

presenting evidence in order to kick a family out of their home. And we need a system where this
process sets the ground rules that in turn allow for lenders and borrowers coming together and
negotiating a situation that is best for both of them.

Because the first rule of mortgage lending is that you don’t foreclose. And the second rule of
mortgage lending is that you don’t foreclose. I’ll let Lewis Ranieri, who created the mortgage-
backed security in the 1980s, tell you: “The cardinal principle in the mortgage crisis is a very old
one. You are almost always better off restructuring a loan in a crisis with a borrower than going
to a foreclosure. In the past that was never at issue because the loan was always in the hands of
someone acting as a fudiciary. The bank, or someone like a bank owned them, and they always
exercised their best judgement and their interest. The problem now with the size of securitization
and so many loans are not in the hands of a portfolio lender but in a security where structurally
nobody is acting as the fiduciary.”

In the past you had Jimmy Stewart banks. The mortgages were kept on the books of the bank.
You had someone who you could go to and renegotiate your mortgage. With mortgage-backed
securities, the handling of payments and working-out of troubles moved to servicers. If you are
learning about this crisis for the first time, understanding what is broken here is very important.

This is Not a New Problem With Servicing

Let’s get some quotes from bankruptcy judges in here:

“Fairbanks, in a shocking display of corporate irresponsibility, repeatedly fabricated the amount
of the Debtor’s obligation to it out of thin air.” 53 Maxwell v. Fairbanks Capital Corp. (In re
Maxwell), 281 B.R. 101, 114 (Bankr. D. Mass. 2002).

“[t]he poor quality of papers filed by Fleet to support its claim is a sad commentary on the record
keeping of a large financial institution. Unfortunately, it is typical of record-keeping products
generated by lenders and loan servicers in court proceedings.” In re Wines, 239 B.R. 703, 709
(Bankr. D.N.J. 1999).

“Is it too much to ask a consumer mortgage lender to provide the debtor with a clear and
unambiguous statement of the debtor’s default prior to foreclosing on the debtor’s house?” In re
Thompson, 350 B.R. 842, 844–45 (Bankr. E.D. Wis. 2006).

(Source.) Notice that consumer rights groups were flagging this as a major problem back in 1999
and 2002 because judges were noticing it was a major problem in their bankruptcy courts. If the
late 1990s to 2006 period is a Renaissance period of servicer fraud then we can contrast it with
the period we live in now, the Baroque period of servicer fraud. Whatever unity there used to be
between the forms and functions of the sloppy documentation and outright fraud in the art of
servicing have become detached.

The forms of fraud have gone high art: serving documents on people who could never have been
served, signing 10,000 affidavits a month, etc. They are all well covered, and we’ll list more later

perhaps. Here are some of my favorites from last year, the reading list in Part One has even
more. But what I want to focus on is the function of servicer fraud.

What Do Servicers Do? A Case Study in Bad Design and Worse Incentives

Servicers in a mortgage-backed security have two businesses. The first is transaction processing.
This means taking in your mortgage money on one end and walking it over to the crazy tranches
and payment waterfalls on the other end. This is clean, efficient, largely automated, requires little
discretion and works very well, and implicit in it is that it is most profitable when you can
harness economies of scale.

It’s considered a “passive entity” in fact, so there are no taxes applied in this passthrough
mechanism. If servicers went “active”, say by looking for mortgage notes not in the trust 90 days
after the fact or mortgage notes that are not in the trust that have defaulted, which is what they’d
likely have to do to get out of this foreclosure fraud crisis, they’d face very severe tax penalties.

Their other business is to handle default situations. In addition to the fixed fee they get for
servicing each individual mortgage they get paid from default fees like late charges. They get to
retain most, if not all, of these fees.

So right away they have an incentive to not find ways to negotiate to get a mortgage to a good
state. They also have a strong incentive to keep a steady stream of fees and charges going to their
books rather than to investors. So anything that puts servicers in charge of negotiating
mortgages, say the Obama’s administration’s HAMP program, is designed to fail.

Because even without bad incentives, doing good work on modification is costly, time
consuming, requires individual expertise and experience and doesn’t benefit from automation or
economies of scale. Which is to say it is the opposite structure of their normal business.

And there are additional worries. Many of the servicers work for the largest four banks – Wells
Fargo, Bank of America, Citi, and JP Morgan – and these four banks have large exposures to
junior liens. These are second or third mortgages or home equity lines of credit that would have
to be wiped out before the first mortgage can be modified. The four banks have almost half a
trillion dollars worth of these exposures and, from the stress test, are valuing them at something
like 85 cents on the dollar. Keeping a homeowner struggling to pay the second lien would be
more worthwhile to these middlemen banks than getting him or her into a solid first lien to the
benefit of the bond investor.

So keep these in mind as you read about the servicers here. There have been worries that they, as
a designed institution, were simply not qualified for this job going back a decade. They have
massive conflicts with the investors they are supposed to be working for. They profit when
homeowners collapse and lose money when they are brought up to a normal payment schedule
(made current). And if the instruments don’t have the notes necessary to bring standing to carry
out the foreclosures they have to take a massive tax hit in order to take the note into the trust.
And regulation to handle this isn’t in place.

No Regulator

Because for all the talks of regulatory burden, there is no current federal government agency that
regulates the servicers. Not the Federal Reserve. Not the Treasury. This is what happens when
the financial industry writes the deregulation. Instead you have a patchwork of state regulators
and attorney generals. Notice how President Obama has nobody to turn to and tell the press that
“So and So is on the case.” In theory the OCC regulates servicers if they are part of a bank or a
thrift. This must fall to the new regulatory counsel and the Consumer Financial Protection
Bureau to investigate, where it will properly belong.

(The Fair Debt Collections Act, which applies to debt collectors, doesn’t apply to servicers. Here
might be a fun idea for an enterprising staffer – if there is no note producible, are servicers still
legally servicers and thus exempt from the Fair Debt Collections Act? Just a thought….)

Is it any wonder that servicers are rushing these foreclosures and making a mockery of the courts
and producing systemic risk in the process? There needs to be an investigation of what is being
done and why, because this problem is not taking care of itself.

Foreclosure Fraud For Dummies, 4: How
Could This Explode into a Systemic Crisis?
Posted on October 11, 2010 by Mike

(This is a series giving a basic explanation of the current foreclosure fraud crisis: Here is Part
One, Part Two, Part Three, this is Part Four and Part Five.)

Right now the foreclosure system has shut down as a result of banks’ own voluntary actions.
There is currently a debate on whether or not the current foreclosure fraud crisis could explode
into a systemic risk problem that perils the larger financial sector and economy, and if so what
that would look like.

No matter what happens, the uncertainty about notes and what is currently going on with the
foreclosure crisis is terrible for the economy. Getting to the heart of this problem so that
negotiations can be worked out is important for getting the economy going again. There is little
reason to trust what comes out of the servicers and the banks in whatever they conclude at the
end of the month, and the market will know that. Only the government can credible clear the air
here as to what the legal situation is with the notes and the securitizations.

But I wanted to get some unlikely but dangerous scenarios on the table in which this blows up.
Bangs, not whimpers. The kind where Congress is pressured to act over a weekend. I had a
discussion with Adam Levitin about how this could explode into a systemic problem.

Title Insurance Market Breaks Down

First scenario involves title insurance. Specifically if title insurers decide to take a month off
from writing title insurance even on performing and current loans to investigate what is going on
with note transfers.

If that happened there would be no mortgage sales (except for those involving cash) in the
country. The system would simply stop. Everyone with an interest, from realtors to Wall Street
to construction to huge sections of the economy, would face a major crisis through this short-
term pinch. There would be a call for Congress to step in immediately.

You can tell that the title insurance market, which is largely concentrated and also holding very
little capital for a nationwide crisis scenario, is investigating the current problems. They are
holding off on certain types of foreclosed properties; if they decide to hold off all together you
could see a scenario where Congress is pushed to act immediately.

Lawsuits a Go-Go

The second would be a wave of lawsuits. As we discussed in Part Two, many of the servicing
agreements allowed for the trustees to force the depositors and sponsors to purchase mortgages
without notes. That would be 100 cents on the dollar for mortgages worth pennies. If the trustees
don’t take action, the investors could sue them. And the tranche warfare on this issue is intense,
as foreclosures versus a few more payments radically change the balance between junior and
senior tranche holders (See Tracy Alloway on tranche warfare here).

Here’s what this could look like. Read left side up for what the lawsuit screaming looks like and
the right side down for the response:

Much of the activity would center around the four largest participants in these areas, the Too Big
To Fail institutions of Wells Fargo, Bank of America, Citi and JP Morgan.

And many of these mortgage-backed securities are cheap. So in an interesting scenario you could
see hedge funds buying MBS for pennies just for the option to sue firms that are likely
backstopped by the government.

If title insurance froze, or if the financial markets had a panic over fears of waves of lawsuits,
there would be pressure for Congress to do something. Much of the law is New York trust law,
so it isn’t clear Congress can act. But there will be pressure.

Because if this bad-case scenario happens, which there is a small but reasonable chance it could,
progressives need to have a clear sense of what they want in exchange for negotiations when the

financial industry comes flying in over the cliff, a list of demands and questions to replace the in-
large-part steamrolling of TARP over anyone’s interests but the banks. Even if that doesn’t
happen, but the slow bleed of the current dysfunctional mortgage market continues, progressive
wonk policy initiatives that fix this crisis and get the mortgage market going again should be at
the front of the debate. We’ll cover this in Part 5.

Foreclosure Fraud For Dummies, 5: The
Necessity of Government Action and Ways
Out of The Crisis
Posted on October 12, 2010 by Mike

(This is a series giving a basic explanation of the current foreclosure fraud crisis: Here is Part
One, Part Two, Part Three, Part Four and this is Part Five.)

Here’s a guess: In one month, the large banks will conclude that there are no problems with its
foreclosure processes. The massive fraud that was committed on the courts was the result of a
few bad apples, but those are now gone and it’s back to business as normal.

At this point, either as a citizen or as a financial market participant, would there be any reason to
believe them? Is there any reason to believe that the servicer and foreclosure mill fraud is over?
 That securitizations actually have the proper legal documentation necessary? That borrowers
and lenders are actually getting a chance to come to mutually beneficials situations? Is there
any reason to believe they aren’t lying?

Because servicers aren’t currently regulated. They have a patchwork of state regulators and the
OCC may regulate their parent company if it is a bank or thrift, but there’s no current
government agent to provide any accountability here. So without action, there’s going to be no
one to confirm or deny that anything has actually changed in the housing market.

In some ways this narrative already reminds me of the BP oil spill in the gulf. The Obama
administration largely left it to BP to tell the government and the public what was wrong, hire the
contractors and then also to tell everyone what the environmental damages were. It will surprise
no one that the information BP sent out was wrong (see, for example, Kate Sheppard,“Not an
Incidental Public Relations Problem”), but for better or worse, the Obama administration is now
linked to whatever course and information BP chooses to pursue.

Why not choose a different course for this one? One that emphasizes social justice through
powerful banks having to follow the rule of law, corporate responsibility to not commit fraud,
provides a space where those who are weak and poor get a fair say instead of being bulldozed
over by the rich and strong, and actually starts to dig out of the mortgage crisis that we are in.
Check out Mike Lux’s Exploding foreclosure fraud issue: An opportunity for Democrats to turn
the tide. Not only is it relevant, but it demonstrates that there’s a good chance this is going to get

worse before it gets better. Why not get in front of it, and change course from the disastrous path
we’ve been taking?

What Just Went Wrong in the Government Response?

Because what we’ve done to this point hasn’t worked. Shahien Nasiripour and Arthur Delaney
wrote the definitive account of the failure of the HAMP program, Extend AND Pretend: The
Obama Administration’s Failed Foreclosure Program. Instead of continuing HAMP, it’s time for
a fresh response.

Pat Garofalo of the Center for American Progress has The Fix Is Over: Mortgage Foreclosure
Scandal Offers New Hope for Homeowners which has a lot on what a new foreclosure relief
program could look like:

allowing housing counselors and other public entities to approve mortgage modifications
directly, and if the borrower’s servicer doesn’t challenge the modification in 90 days, it
automatically becomes permanent. Such a step would go a long way toward streamlining the
program and getting borrowers who qualify through the maze of bureaucracy in a timely, clear
fashion without leaving them in limbo for months on end.

Mortgage mediation programs—in which a bank must meet with a borrower, in the presence of a
judge and housing counselors, before finalizing a foreclosure—should also be expanded..

Another new favorite policy option everyone should start considering: ”REMICs bestow
enormous tax breaks to investors; these breaks should be revoked for any residential home
mortgage loan holding entity that forecloses on more than a specified percentage of all of its

We have to remember what went wrong with HAMP: the servicers were in the driver’s seat. We
need a process that is involuntary, government-run and is standardizable on both the
modification and on the foreclosure end. Between this and a clearing out of the current crisis to
confirm change has actually happened we can start on a way out of this crisis.


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