The Ibanez Decision: What it means for home owners and investors
Last week the Massachusetts Supreme Court issued a decision voiding several home foreclosures by US Bancorp and Wells Fargo. The news caused the financial markets to retreat with bank stocks down hard. News reports and some analysts are predicting that the decision in U.S. Bank National Association vs. Antonio Ibanez, will mean an apocalypse for commercial banks, especially those involved in issuing residential mortgage backed securities or “RMBS.” But like most things in life, the reality is a little more subtle.
We’ve seen this movie before — in the 1930s and 40s — when disputes over foreclosures and property titles dragged on for years, even decades. I wrote about this issue previously for Reuters.com — “Everything that Americans should ask about home mortgages”). In that article, I discussed how sales of mortgage notes to investors depends upon the unsteady foundation of state law property title regimes and the partial, post-WWII fix put in place by the states.
In simple terms, in the late 1950s the states’ attorneys general for the lower 48 states subjected the mortgage note to the Uniform Commercial Code, but left the mortgage itself a purely state law document. This duality is part of the dispute now partly decided by the MA courts for foreclosures in that jurisdiction. While the founders of the U.S. provided the Commerce Clause of the Constitution to enable interstate trade in goods and services, the ownership and transfer of property remains an entirely state law matter.
Since the 1950s, however, Wall Street lawyers have taken the view that the sale of a mortgage note to another party is governed by the UCC and therefore does not require that the documentation down at the court house be up to date. Some financial counsel even went so far as to say that the mortgage document was incidental to the note and thus that the mere possession of the note was sufficient to obtain all of the rights under the mortgage as well. And in a narrow sense, under the UCC, this view is correct, as the banks argued in Ibanez.
But the MA Court decision raises some interesting questions that neither the banks, the several states, nor the Congress have addressed. First, Ibanez illustrates just how sloppy banks have become with respect to changing the lien on the property when a note is sold. In the decision, the Court shows how one mortgage was originated and then sold half a dozen times before it was eventually deposited in a trust created by Lehman Brothers. This last corporate vehicle then sold securities to investors using the mortgaged property as collateral.
The trouble is, the final “assignment” of the mortgage note to the trust was never properly completed by the seller, again relying upon the Wall Street view that the UCC protected such shoddy or non-existent legal work. The Ibanez case raises questions as to whether the investors who own the RMBS issued by the trust have any recourse to the underlying collateral, namely the house owned by Ibanez, as well as the work of lawyers and other professionals. It will come as no surprise that the trustee for the securitization trust also is a party to the Ibanez lawsuit.
It needs to be said that the transfers of a note under the UCC must comport with state law. The UCC specifically requires the note be delivered to the assignee in good order. Thus the Wall Street view of property title, where the assignment of the note is never actually completed or is merely done generically, is clearly a violation of the UCC and does not provide a legal safe harbor for defective RMBS. Indeed, the Ibanez case now drives another nail into the coffin of the private RMBS market — as if that were needed.
Second, the Ibanez decision makes clear that in Massachusetts at least, the note holder cannot commence foreclosure proceedings unless the chain of title is perfected and in good order with the state courts. The banks in the Ibanez case proceeded to foreclosure based upon the Wall Street world view that says that the UCC protects the assignment of notes in the creation of RMBS. The MA Supreme Court, however, has stated emphatically that the note holder must follow state law with respect to the transfer of property titles, including upon foreclosure.
A couple of weeks ago I helped to organize an open letter to regulators regarding the need for loan servicing standards. In order to convince a number of people to sign the letter, we included the words “consistent with state law” in the bullet point about mortgage modification. The MA Court decision illustrates that when it comes to the ownership and transfer of real property, state loan still prevails despite all of the clever subterfuges used by the banking industry to subvert our federalist system.
The Ibanez court decision only applies in MA. It does not mean that delinquent borrowers in MA or anywhere else are likely to be able to win forgiveness of their loans because the information about the lien holder of their mortgage is not up to date. But the Courts in MA have made clear that all of the documentation (and fees) must be up to date before a foreclosure proceeds. This will add expense for banks, but will really not affect the overall flow of foreclosures nationally.
Perhaps the most striking aspect of the Ibanez decision is the light it sheds on the huge liability facing large banks from the investors who purchased hundreds of billions of dollars in private label RMBS. One of the reasons that my firm remains cautious about the outlook for Bank of America, Wells Fargo and JPMorgan Chase is the huge liabilities facing these banks from investors in and insurers of private label RMBS that, in many cases, have significant defects between the note and the underlying mortgage.
In the case of MA, at least, these defects in the collateral lien on the underlying mortgage may leave investors open to large losses and expenses related to defending their rights and pursing claims on negligent financial institutions, lawyers and other professionals. As we wrote in The Institutional Risk Analyst last week when we proposed a “Brady Plan” for the mortgage sector: “This is the choice: address the problem in the mortgage sector now with restructuring and thereby jump-start the U.S. economy, or face years of additional uncertainty and losses for the banking system as we ‘extend and pretend’ under Obama and Geithner.”