Delaware AG’s MERS suit should strike fear in MBS industry

By Alison Frankel
October 28, 2011

The Mortgage Electronic Registration Systems — or MERS, as it’s known — is the business everyone loves to hate. MERS was established in the 1990s to streamline the process of packaging mortgage loans into mortgage-backed securities. Its members, all players in mortgage securitization, reasoned that it would be easier to securitize mortgages if there were a centralized electronic database of the loans, rather than physical paperwork scattered at mortgage lending institutions across the country. The MERS mortgage registry was essential to the securitization boom of the 2000s. But after the housing bust, MERS has been something of a litigation piñata. Homeowners have filed a multitude of suits challenging MERS’s legal right to foreclose and its alleged robo-signing foreclosure practices. More recently, local officials have begun suing MERS for cutting them out of the mortgage registration process and supposedly cheating them out of mortgage recording fees.

Thursday’s complaint against MERS by Delaware Attorney General Joseph Biden III includes those familiar allegations, which MERS has had a pretty good (but definitely mixed) record of defending. But Biden’s complaint goes on to raise broader questions about MERS’s role in the MBS industry. According to the Delaware AG, MERS helped MBS issuers and securitization trustees peddle securities that were flawed at their core. The suit claims that MBS trusts may not actually have owned some of the mortgages bundled into the securities they sold. If those allegations prove true, this complaint could wreak havoc in the mortgage securitization industry.

It’s no secret that the New York and Delaware AGs have a lot riding on their MBS investigations. New York Attorney General Eric Schneiderman lost his spot on the committee of attorneys general negotiating a multi-state deal with five major banks because of his insistence that the settlement address failures in mortgage securitization as well as in the foreclosure and servicing process. He’s taken considerable political heat as a result, but just this week, Schneiderman told MSNBC’s Rachel Maddow that he and Biden are committed to “looking at the conduct of individual institutions and individuals to see if there were misrepresentations made, to see if there was fraud committed, to see if criminal acts were also a part of this.” He added, “We’re determined to follow it through until we get the relief the homeowners need and hold accountable the people who caused this.”

Until Thursday’s MERS suit — and a simultaneous MERS subpoena issued by Schneiderman, as my colleague Karen Freifeld first reported — the only publicly-known result of the joint Delaware-New York MBS investigation was Schneiderman’s fraud suit against Bank of New York Mellon, the Countrywide MBS trustee. By taking on MERS, the AGs are signaling an attack on the entire securitization process.

According to the complaint, “the MERS System was both unreliable and frequently inaccurate” in accounting for owners of the mortgage loans registered in its database. As a result, Delaware asserted, many loans were not properly transferred to securitization trusts — in breach of the pooling and servicing agreements that governed the trusts. The complaint claims that MERS engaged in deceptive trade practices by transferring insufficiently documented loans to MBS trusts, but it’s not much of a leap to infer potential AG cases against the trustees that were supposed to oversee MBS paperwork or, for that matter, against the issuers that assembled the mortgage portfolios underlying the securities they sold.

Lawyers for MBS investors and bond insurers have already poured untold hours into scrutinizing mortgage loan file documents for breach of contract cases against issuers. They’ve generally focused on whether the underlying mortgage pools live up to the representations and warranties MBS issuers made about things such as owner income and loan-to-value ratios. But imagine if they can argue, as the Delaware AG does in Thursday’s MERS suit, that trusts never owned the loans in MBS pools at all. We’re looking at a whole new world of put-back liability.

MERS told Reuters that there’s no merit to the Delaware AG’s claims of unfair trade practices. I left a message for MERS outside counsel Andrew Sandler of BuckleySandler, but he wasn’t available.

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