“In the West, this formal property system begins to process assets into capital by describing and organizing the most economically and socially useful aspects about assets, preserving this information in a recording system—as insertions in a written ledger or a blip on a computer disk—and then embodying it in a title. A set of detailed and precise legal rules governs this entire process. Formal property records and titles thus represent our shared concept of what is economically meaningful about any asset. They capture and organize all the relevant information required to conceptualize the potential value of an asset and so allow us to control it . . .
The reason capitalism has triumphed in the West and sputtered in the rest of the world is because most of the assets in Western nations have been integrated into one formal representational system . . . By transforming people with real property interests into accountable individuals, formal property created individuals from masses. People no longer needed to rely on neighborhood relationships or make local arrangements to protect their rights to assets. They were thus freed to explore how to generate surplus value from their own assets.”
-Hernando de Soto, The Mystery of Capital
The woes in the mortgage market are complex, deep and structural. This is more than just a few shortcuts taken by paralegals here and there — there are endemic structural problems within the US real estate and mortgage markets. (Yesterday, we touched upon the problems associated with foreclosure mills).
We are not discussing economic problems of too many homes for sale and falling prices. What is being discussed here is a full blown crisis underlying home titles, foreclosure procedures, and securitized mortgages. The rampant, epidemic and systemic abuse of legal property protections is now reaching a crisis.
Today, we will put that crisis into the greater context of the entire real estate industry, from purchases to the securitization of mortgages to default and foreclosure. What this discussion reveals are a series of short cuts, (il)legal fictions, and an utter disrespect for the mechanisms of legal property transfer that underlies our entire system of Capitalism. As Hernando de Soto discovered, the organized, reliable, functional systemic approach to property rights is the key reason why “Why Capitalism triumphs in the West and fails everywhere else.”
And we will see that at every step along the process, the reckless rush for easy profits has systemically undermined these legal property rights — how mortgages are recorded, the bungled bundling of notes to be securitized, the electronic system that fictionalized the process of assembling transfer documents, and how all the players along the way — The investment firms, banks, law firms, even court system, utterly lost sight of what they were doing.
If de Soto were to come to the United States today and review all of this, he would see a system that ignores its own laws, cheats on process, engages in wanton fraud, and is in danger of sliding not just backwards to the 18th century, but slipping towards a third world nation of dubious legal protections and the worst form of crony capitalism.
Welcome to 21st century America.
Capitalism in the West thrives because of our ability to legally transfer property, with confidence and certitude. A buyer knows they will be getting good title to what they are buying, a lender can confidently encumber a property.
Only, not so much any more.
Centuries of property law have been undercut by the entire Real Estate financing complex. From the mortgage brokers who told borrowers “just leave those lines blank, I’ll fill them in” to the banks that taught their own agents how to game their computer loan approval systems to the financial engineers assembling the mortgage sausage to the myriad law firms, process servers and courts that oversee those loans final resting place, the entire system has been corrupted as a cost-savings/profit maximizing exercise.
Here’s how to eviscerate the advantage of western law & economics in three simple steps
1) MERS: We start with the Mortgage Electronic Registration Systems. MERS is a computer registry that was “created by lenders seeking to save millions of dollars on paperwork and public recording fees every time a loan changes hands.” It holds over 60 million mortgages on American homes. Thanks to a legal fiction that pretends to follow the law — but actually does not — MERS has saved banks more than $1 billion. It has also turned what was a very successful system of tracking who owns what property and making it easy to transfer into a dysfunctional nightmare.
Gretchen Morgenson explains exactly how this worked, and then unraveled:
“For centuries, when a property changed hands, the transaction was submitted to county clerks who recorded it and filed it away. These records ensured that the history of a property’s ownership was complete and that the priority of multiple liens placed on the property — a mortgage and a home equity loan, for example — was accurate.
During the mortgage lending spree, however, home loans changed hands constantly. Those that ended up packaged inside of mortgage pools, for instance, were often involved in a dizzying series of transactions.
To avoid the costs and complexity of tracking all these exchanges, Fannie Mae, Freddie Mac and the mortgage industry set up MERS to record loan assignments electronically. This company didn’t own the mortgages it registered, but it was listed in public records either as a nominee for the actual owner of the note or as the original mortgage holder . . .
As long as real estate prices rose, this system ran smoothly. When that trajectory stopped, however, foreclosures brought against delinquent borrowers began flooding the nation’s courts. MERS filed many of them . . .
As cases filed by MERS grew, lawyers representing troubled borrowers began questioning how an electronic registry with no ownership claims had the right to evict people. April Charney, a consumer lawyer at Jacksonville Area Legal Aid in Florida, was among the first to argue that MERS, which didn’t own the note or the mortgage, could not move against a borrower.Initially, judges rejected those arguments and allowed MERS foreclosures to proceed. Recently, however, MERS has begun losing some cases, and the Kansas ruling is a pivotal loss, experts say. While the matter before the Kansas Supreme Court didn’t involve an action that MERS took against a borrower, the registry’s legal standing is still central to the ruling.”
Because of the egregious abuse of the property transfers in the legal system, MERS eventually lost its legal shield and cloak of privacy.
More significant than that, their unique combination of legal fictions and incompetence implies a huge underlying problem with many of the structured finance. This means that Residential mortgage-backed securities (RMBS) and Collateralized Debt Obligation (CDO) that relied on MERS have enormous structural problems.
2) Improper Construction of RMBS/CDOs:
Structured mortgage securities are typically constructed as Trusts. The Trust holds the mortgage notes, which allows the bundling to occur.
Under normal circumstances, the re should be some assignment of the Note by the original lender to the Trust. Frequently, this step did not occur. Nor did the requisite filing of the mortgage lien with the appropriate county clerk.
These errors plus the MERS issue led to very serious problems for much of the structured finance that was built on top of it. The creation of an RMBS or CDO needs at least two legal events to occur: One, the actual note the bank holds needs to be deposited into the Trust. Observe that it is the note holder who is entitled to receive principle and interest payments, who has a lien against the encumbered property, and has the right to foreclose and take the property in the event of a default.
The Note seems to have been somehow ignored in the structuring process. And on top of that, the proper filing of the mortgage note every time a structured product changes hand was mostly ignored. As Corrente noted:
“Because of the expense, time and paperwork it would take to record each of the assignments of the thousands of mortgages in each securitization, Wall Street firms decided to just issue blank mortgage assignments all along the channel of transfers, skipping the actual physical recording of the mortgage at the county registry of deeds.
Astonishingly, representatives for the trusts have been foreclosing on homes across the country, evicting the families, then auctioning the homes, without a proper paper trail on the mortgage assignments or proof that they had legal standing. In some cases, the courts have allowed the representatives to foreclose and evict despite their admission that the original mortgage note is lost. (This raises the question as to whether these mortgage notes are really lost or might have been fraudulently used in multiple securitizations, a concern raised by some Wall Street veterans.)
See also The American Banker.
Karl Denniger went so far as to suggest the entire MERS/structured finance industry engages in such systemic illegality as to be guilty of RICO — the Racketeering statute used to bring down drug lords and mafia kingpins. If he is right, and I suspect he is, our Banana Republic status is getting ever closer.
3) Foreclosure Fraud: This is the third and final step to the disassembling of Capitalism’s property rights. It is indirectly related to prior two steps. Mostly it reflects the same disrespect for legal process int he headlong rush for profits, legal and otherwise.
We’ve discussed this before. Rather than repeat that diatribe, let me show exactly how endemic this is, via the price list for fabricating Foreclosure documents. From naked capitalism, (4ClosureFraud Posts Lender Processing Services Mortgage Document Fabrication Price Sheet), we learn that for a price, a firm will fabricate whatever documents need for foreclosure, real or otherwise.
This makes Denniger’s RICO accusation even more poignant. Need paper work for a foreclosure, legal or otherwise? There’s an app for that.
You can view the entire Lender Processing Services price sheet here.
Welcome to the Banana Republic…
How to Get an “Iffy” loan approved at JPM Chase (March 28th, 2008 )
The Mortgage Netherworld (April 26th, 2009)
Mortgage Electronic Registration Systems Loses Legal Shield (September 23rd, 2009)
Gretchen Explains MERS For You (September 27th, 2009)
Slowing the Runaway Foreclosure Train (October 4th, 2010)
How ‘Flawed’ Was the Paperwork? (October 4th, 2010)