N.Y. judge: Mortgage securitization was not racketeering scheme

By Alison Frankel
February 11, 2014

Did you happen to see the complaint Better Markets filed yesterday in federal court in the District of Columbia, accusing the Department of Justice of obfuscating the facts behind its $13 billion settlement with JPMorgan Chase? I have some doubts about Better Markets’ standing to sue Justice but none at all about the central point of the suit: We the public are still trying to understand the magnitude of wrongdoing by financial institutions that profited from the boom in residential mortgage securitization. The oft-mangled George Santayana quote has it that “Those who cannot remember the past are condemned to repeat it.” I’m sure the same condemnation awaits those whose memories of the past are circumscribed by the efforts of excellent defense lawyers. There has been virtually no market for private residential mortgage-backed offerings since the economic crash, but as the economy recovers and banks finally resolve liability from their boom-era offerings, that will probably change – especially because of court rulings that have blessed the instruments of securitization.

Last week’s ruling by New York State Supreme Court Justice Barbara Kapnick, mostly approving Bank of America’s $8.5 billion settlement with investors in Countrywide mortgage-backed securities, is one example. Kapnick didn’t provide much analysis, but she did provide some assurances to future MBS trustees about their rights and duties. (If, on the other hand, Kapnick had agreed with some of the experts who testified for objectors to the settlement about the inevitable conflicts hobbling MBS trustees, her ruling would have been a significant obstacle to any resurrection of the market for private residential mortgage securitizations.) I’ve also told you about a series of rulings from state and federal courts that have upheld the right of the bank-originated Mortgage Electronic Registration System to aid securitization by transferring promissory notes from bank to bank. Most recently, on Monday, a federal judge in White Plains, New York, tossed a sprawling, multiplaintiff case alleging that the entire mortgage securitization industry was a giant racketeering enterprise whose victims were homeowners duped into buying property they couldn’t afford. (Hat tip: S.D.N.Y. Blog.)

U.S. District Judge Cathy Seibel, like judges in other federal trial courts, found that under the Rooker-Feldman doctrine, former owners of foreclosed properties cannot recast their challenges to state-court foreclosures judgments as federal-court claims. The onetime homeowners, represented by KamberLaw and The Law Offices of Zoe Dolan, had argued in their brief opposing dismissal that there’s an exception to the doctrine in cases in which state-court judgments were procured by fraud on the court. Seibel conceded that federal circuit courts are divided on the fraud exception, but said the 2nd Circuit has never recognized it and so she would “decline plaintiff’s invitation to create an exception.”

That finding alone would have spelled the end of the case. But Seibel went on to discredit the theory that mortgage securitization was more of a racket than a legitimate business. The plaintiffs had claimed, to quote their brief opposing dismissal, that “Defendants created a scheme to profit from originating mortgages that were designed to fail quickly, and from accelerating foreclosure proceedings after payment default,” the brief said. “To facilitate this scheme, defendants and others created the Mortgage Electronic Registration System (to enable) defendants to bypass traditional property recording requirements and cover up their activities. To further conceal their conduct, defendants implemented Financial Accounting Standards Board guidelines obtained on defendants’ behalf by the Mortgage Bankers Association. Behind these veneers of legality, defendants sought numerous foreclosures contrary to applicable state law, or they improperly accelerated foreclosures before they had the legal right to do so.”

Those few sentences are a pretty good summary of what a lot of securitization detractors think of the industry. But according to Judge Seibel, the complaint didn’t introduce any actual evidence of a RICO conspiracy. There’s no racketeering enterprise here, the judge said, just the entirely legal MERS consortium and Mortgage Bankers Association trade group. Nor is there plausible evidence that the banks, as competitors for home mortgages, “are in fact working together towards a common goal of any kind,” she wrote. Perhaps they worked together toward the common goal of facilitating securitization through MERS, but that’s not evidence of fraud or conspiracy, just parallel action by competitors. “Likewise,” she added, “a defendant’s membership in a trade association hardly renders plausible the conclusion that that entity and certain other members are functioning as an ongoing, organized, structured enterprise in conducting their business.”

The judge also agreed with defendants that there was a fundamental causation problem with the accusations of foreclosed homeowners: Homeowners lost their properties because they defaulted on their loans. “That the defendants’ misconduct may have predated the foreclosure proceedings does not change the fact that it was the judgments of foreclosure that caused the loss of the homes, and thus the injuries to plaintiffs,” Seibel wrote. “That same alleged misconduct has caused no injury to homeowners who remained current on their mortgages and were not foreclosed upon.”

So even if there was a securitization conspiracy – and, again, I emphasize that Seibel found there wasn’t, writing that, at best, the plaintiffs’ allegations were “vague, generalized, conclusory and unmoored to any concrete injury” – its ends couldn’t have been accomplished without the intervening event of loan defaults by homeowners.

To return to my original point about the potential revival of the private-label MS market, just because you haven’t done something illegal doesn’t mean you haven’t done something wrong. Here’s hoping that if and when the RMBS market comes back, loan originators and bundlers don’t engage in behavior that will give foreclosed homeowners any reason to suspect, much less allege in a suit, that they’re racketeering victims.

Jason Braiman of Goodwin Proctor, who represented Bank of America in the case and was the lead signatory on the defendants’ joint motion to dismiss, declined a request for comment. Plaintiffs lawyer Scott Kamber of KamberLaw did not return my phone call.

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