Bloomberg reports that the worst financial peril may come from state attorneys general:
JPMorgan Chase & Co., Bank of America Corp. and Ally Financial Inc., defending allegations of fraudulent home foreclosures from customers and Congress, may face the most financial peril from investigations by state attorneys general.
Authorities in at least seven states are probing whether lenders used false documents and signatures to justify hundreds of thousands of foreclosures, and the number of these inquiries will grow, according to state officials and legal experts.
And from the Wall Street Journal:
For mortgage investors, the recent suspension of foreclosures could potentially cause further losses in the already-battered $2.8 trillion market for residential mortgage-backed securities.
In the past two weeks, three major loan-servicing companies put thousands of foreclosure sales and evictions on hold in the 23 U.S. states where foreclosures are handled by the courts. On Tuesday, House Speaker Nancy Pelosi called for a federal investigation into the issue.
“We urge you and your respective agencies to investigate possible violations of law or regulations by financial institutions in their handling of delinquent mortgages, mortgage modifications, and foreclosures,” Ms. Pelosi and 30 other California House Democrats said in a letter sent to Federal Reserve Chairman Ben Bernanke, Attorney General Eric Holder and John Walsh, the acting comptroller general of the Treasury.
The stoppage is but the latest frustration for bond investors, who have wrestled for more than three years with a market in disarray.
I think Bloomberg assesses the most immediate danger to the real estate mortgage financing industry correctly: It will come from the parochialism of state attorneys general and judges in those states where non-judicial foreclosures are not allowed.
This is not surprising. In many respects, the danger strikes at the heart of a condition precedent to the country having had a national real estate market in the first place. The properties securing the repayment of these funds are subject to state and local laws and regulations. It is often said that all politics is local. So, too, is real estate. But in the years before the boom, the funding of real estate mortgages and the rights and obligations attendant therewith, became standardized, i.e., non-local. Mortgages had to “conform” to Fannie Mae and Freddie Mac guidelines before money would be provided. A 3/2 dump in Rochester might be less expensive than a 3/2 dump in San Francisco, but the mortgages securing the money used to buy them had essentially the same obligations, the mortgage in each state being tailored to account for each state’s laws such that a “conforming” mortgage had effectively the same basket of rights and responsibilities everywhere.
Conforming mortgages are what made the securitization industry possible. If mortgages from all the fifty states were effectively the same, then they could be packaged together to form Collateral Debt Obligations and/or Residential Mortgage Backed Securities, that could then be sold to investors the world over. This securitization ability, that really got cooking in the nineties, is what made the real estate mania probable, after the Fed provided a spark of ultra-cheap money after the dot-com implosion and 9/11. Securitization made residential real estate equity nearly as liquid as cash, and liquidity always carries a premium.
The market for residential real estate funding is now national, even international, in scope. Fannie Mae and Freddie Mac, government-sponsored entities until the bust, provided funds for about half of the nation’s real estate mortgages during the boom. Now they are simply government agencies, but provide virtually all of the money for residential real estate mortgages. A goodly portion of the money they provide to the market comes from international investors. In many respects, the GSE’s (we’ll continue to call them that) fund our huge trade deficits by laundering foreign currency surpluses accumulated by our trading partners.
Now it has come to light that some loan servicers (a loan servicer is an entity that collects the payments and deals with the borrower–it may or may not be the actual owner of the note and the mortgage it is servicing) may have cut corners during the course of foreclosing on defaulted loans, particularly in states where court supervision of a foreclosure is required. This is unfortunate for a number of reasons, all of which detrimentally impact the liquidity that securitization on a national scale had previously provided. First, it gives an impetus to each such state so affected to drastically slow the crunch of foreclosures in order to ensure all the paperwork is in perfect order, satisfying the populist impulse of the state’s politicians, particularly those in the attorney general’s office, to lash out at these evil out-of-state bankers. Second, if improperly filed affidavits, e.g., are allowed to call into question the validity of the underlying note and mortgage, a great deal of time will be spent searching for improperly filed affidavits, while the whole idea of a conforming mortgage slinks to oblivion. Third, the malfeasance of the loan servicers threatens to subsume the entire mortgage industry into a tit for tat struggle among its competing interests, state vs. fed, borrower vs. lender, etc., for which the whole market will suffer.
The end result of a populist struggle championed by state politicians against national players in the residential mortgage funding market will be severely impaired residential real estate markets in those places that pursue such a strategy. There might arise something of a dual market, one comprised of those states that allow non-judicial foreclosures, where the court doesn’t have direct supervision over the process of a foreclosure, and those that require judicial foreclosures. Which market would likely see the biggest decline in real estate values going forward? Presumably, the market comprised of states that do not allow non-judicial foreclosures.
But, this gathering cloud on the real estate mortgage market might just carry some drought-ending rain. If the actions of the loan servicers washes real estate prices to a defensible low such that sustainable, non-government-induced growth can then ensue, the storm will have been well worth enduring.
I missed it initially, but the New York Times is also weighing in on this story, but not without getting its facts wrong:
As banks’ foreclosure practices have come under the microscope, problems with notarizations on mortgage assignments have emerged. These documents transfer the ownership of the underlying note from one institution to another and are required for foreclosures to proceed.
First, mortgage assignments do not transfer the ownership of the underlying note from one institution to another. They transfer the rights contained in the mortgage. The mortgage has to have an underlying note, else it is a nullity, but notes are transferred, like a check, by endorsements. Only the mortgage is transferred by, a typically notarized, assignment.
Second, there is no requirement that mortgage assignments be executed and recorded for a foreclosure to proceed, unless the foreclosing mortgagee is different than the mortgagee named in the mortgage (except successors in interest, like Wells Fargo for Wachovia) or in its last assignment. If the mortgagee is a nominee, such as Mers, it shouldn’t matter who owns the note and to whom the mortgage is assigned, so long as the foreclosure is conducted by Mers.
This whole brouhaha is a bit disingenuous. The Times story (read on my nytimes.com/TRtoday reader) relates that the Texas attorney general has issued a letter to thirty (out of state, of course) lenders, demanding they cease immediately their foreclosure operations. He claims they need to check to see if they are doing them properly. Huh? Texas needs to just go ahead and secede if they want to pursue these kinds of shenanigans. The Texas AG is playing the populist defender of people’s homes, but is doing worse than anything the mortgage companies might be, issuing a blanket condemnation of their practices with no evidence to support his claim.
These attorneys general may get what they want, and foment a populist revolution. If they do, the homeowners in their respective states will regret it.