Housing, debt ceilings & zombie banks

Aug 17, 2011 15:08 UTC

In a Washington Post report this week, the Obama Administration was said to have decided to adopt a proposal to continue a major government presence in financing mortgages.  The Treasury subsequently denied this report in a statement posted by Deputy Secretary Neal S. Wolin:

“The Obama Administration believes that the private sector – subject to strong oversight and consumer protection – should be the dominant provider of mortgage credit.  That’s why, in each of the three options we outlined in our report to Congress, the government’s footprint in the housing finance market will shrink substantially.  That’s why, in each of the options, any government support for housing finance will be targeted and limited. This will help ensure that taxpayers are protected and the private sector bears the burden for losses.”

Would that any of this were really true.  Let’s go through this statement and pick out some of the more notable canards and omissions of fact.  First and foremost is the idea that the private sector is willing to take a leading role in housing finance in the U.S.

Since the 1930s, the U.S. has used a full-faith-and-credit guarantee for housing finance to turn disparate home mortgage notes into commodities attractive to investors.  The private mortgage market prior to the Great Depression and the New Deal is not comparable to the government-sponsored market for agency securities today, investment paper that is a close surrogate for Treasury debt itself.

The largest portion of the market for residential mortgage backed securities or RMBS has been government sponsored for 80 years.  By extending guarantees to private mortgage paper, banks were able to package the notes from each home mortgage and sell securities to investors backed by these notes.  This virtuous cycle provided liquidity for the banks, which recovered their principal and then were able to make additional home loans.  That cycle is now broken.

The role of the private sector in the RMBS market has been limited at best with private investors buying significant quantities of non-guaranteed paper only during times of market exuberance in the past decade.  Today banks are avoiding “first loss” risk on U.S. real estate and instead write almost all of their loan production to be guaranteed by one of the three housing agencies — the FHA, Fannie Mae or Freddie Mac.  Almost all of this flow of “new” loan business is refinancing for better borrowers.

This brings us to the second fallacy in the debate over the future of the government role in housing, namely that the current policy is meant to protect the taxpayer and the public generally.  You may have noticed that the Obama Administration has started to talk about creating opportunities to turn foreclosed properties into rental housing, a common-sense initiative that is born of necessity.  Hold that thought.

Empty homes represent tens of billions in future losses to the Treasury.  When the house is sold, the government takes the loss.  Thus the last thing either the Treasury or the White House wants to see is any effort to move the restructuring of the housing sector or the largest banks before the 2012 election.  Delay means higher cost to the taxpayer.

We talked about the need to restructure Bank of America as a precursor to clearing the U.S. housing market in an earlier post on Reuters.com, “Uncertainty and indecision threaten Bank America and global markets.” But given the recent debate over the debt ceiling, President Obama does not want to tell Congress that he needs at least a $1 trillion in borrowing authority to fix the GSEs and the largest banks.  Politics is the chief obstacle to fixing the housing mess.

Attorney Fred Feldkamp reminds us that “we knew virtually all the Texas S&Ls and banks were broke by 1984, but we could not get Congress to permit enough coverage in the federal debt limits and restructuring costs to close the vast bulk of them until FIRREA was passed in August of 1989,” he recalls.  “Even then, Congress tried to renege on the 1988 deals that kept the S&L problem from becoming twice as large.  It wasn’t until 1996-2004 that the people who were promised the 1988 deals received what they bargained for.”

One of the reasons that I have pushed for an FDIC resolution of some of the huge housing exposures facing the largest banks is that the cost can be kept off the federal budget.  FDIC is an industry funded mutual insurance scheme with powerful receivership and debt issuing authority, especially with the Dodd-Frank legislation.  The U.S. banking industry, not the taxpayer, has always paid to clean up the mess in previous crises via the FDIC.  The present housing crisis demands a similar response.

If the banking industry were to use the FDIC to restructure BAC and other large lenders, then immediately spin the smaller, better capitalized banks back into private hands, this would not only help Washington to focus scarce public resources on the losses inside the major housing agencies but would also greatly rehabilitate the industry’s public image.

Americans need to see some good examples of civic action, instances of private people and companies moving with purpose to solve our national problems.  A private sector approach to the housing problem, using the industry funded vehicle at the FDIC to restructure some of the largest banks and breath life into moribund housing assets, could be a powerful tool to that end.  But do we have the courage and the vision to make it happen?

COMMENT

For the record, I’m with Lambertstrether, too. I’ve been advocating widespread RICO prosecutions since 2008, but that is a side issue.

Regarding Chris Whalen’s article, I would like to see some data regarding his assertion that almost all of the “new” real estate loan business is refinancing for better borrowers. I suspect that his claim is true, but are we talking about a 75/25 split or a 95/5 split?

I also agree that the FDIC should now be used to clean up this banking mess. In 2008, the magnitude of the problems would have overwhelmed the FDIC, but there should be no more harm done to taxpayers at this point.

The banking industry needs to quickly expand the size of the FDIC and be start restructuring. BAC has a huge exposure to the tottering Eurozone.

Posted by breezinthru | Report as abusive

Putting “trust” back in American housing finance

May 17, 2011 17:12 UTC

News reports suggest that New York prosecutors are preparing fraud charges against a number of large investment banks for defrauding insurance companies with respect to mortgage loans. These allegations and many civil claims with precisely similar predicates illustrate one of the most important aspects of the subprime financial crisis, namely the construction and collapse of the non-bank financial sector.

Thousands of trusts based on a variety of different assets were created to sell bonds to investors, and some of these trusts carried private mortgage insurance. Most of the trusts used to fuel the subprime debt debacle were filled with residential mortgage loans, but other types of loans and commercial paper also were used as collateral. Roughly a third of the US financial markets were financed by the non-bank sector, which has largely disappeared. Thus deflation abounds.

The subprime investment vehicles of 2007 were almost precise copies of the trusts employed in the years leading up to the Great Crash of 1929. The investment trusts of the early 1900s were often fraudulent vehicles used by Wall Street to enrich the sponsors and stiff investors — like many private deals done during the past decade. Railroad trusts and other seemingly reputable issuers of debentures were highly unpredictable and the assets underlying a trust were always opaque. There was no SEC and no public disclosure standards to provide even minimal information to investors about the assets inside a trust. And the Robber Barons owned the courts, too.

In 1925, during the laissez faire presidency of Calvin Coolidge, the progressive Chief Justice of the Supreme Court, Louis Brandeis, laid down the law on the assignment of all collateral, from commercial receivables to mortgage notes. We wrote about this important Supreme Court decision in a previous piece on Reuters.com. The key paragraph in the Brandeis decision in Benedict v. Ratner follows:

But it is [268 U.S. 353, 363] not true that the rule stated above and invoked by the receiver is either based upon or delimited by the doctrine of ostensible ownership. It rests not upon seeming ownership because of possession retained, but upon a lack of ownership because of dominion reserved. It does not raise a presumption of fraud. It imputes fraud conclusively because of the reservation of dominion inconsistent with the effective disposition of title and creation of a lien.

The Brandeis decision struck down the practice of making a simple, often verbal common law pledge of receivables. The claims supposedly held by Ratner, the creditor of a defunct company over which Benedict was the receiver, was eventually rejected by Brandeis in a decision that shook the ground of American finance and began a seven-decade long debate over the proper construction of secured financial transactions in the US. It led to the adoption of Article 9 of the Uniform Commercial Code, which even today governs the methods used to create most commercial security interests in collateral.

In plain terms, the above paragraph means that an assignment of collateral is deficient without “the effective disposition of title and creation of a lien.” A financial transaction involving security that lacks these features “imputes fraud conclusively,” wrote Brandeis. Indeed, by that measure, many mortgage backed securities (MBS) created over the past few decades are fraudulent as a matter of law.

While the Benedict decision was good for investors, it also arguably encouraged the 1929 crash. The strict requirements set by Brandeis for delivering collateral to the trustee effectively brought the Wall Street sausage factory to a halt for more than a decade — a situation not unlike what we see today in the evaporation of private mortgage finance since Lehman Brothers failed. This same systemic breakdown in the non-bank, non-GSE finance sector since 2007 is why housing prices remain weak now four years since the subprime crisis started. As I told Tom Keene on Bloomberg Television, there will be no economic recovery until we fix the non-bank financial sector.

The Trust Indenture Act of 1939 began the rebuilding process for secured transactions in the private sector. It required an independent trustee to act on behalf of bondholders. The Act also mandated that bond indentures conform to certain standards set forth by the SEC and the Act itself, and that issuers must report financial information periodically. It was not until the 1970s, though, that Wall Street lawyers were able to convince regulators that pledges of mortgage notes to a trust as collateral could be accomplished consistent with Benedict v. Ratner.

In those days, the way to make private MBS compliant with the law was to physically deliver each properly-endorsed mortgage note to the trustee. That is how documents for MBS deals done under the laws of the State of New York read even today. But do investment bankers and other professionals always do what the documents say and Benedict requires? Of course not.

Unfortunately, members of the bar in the US began to attack Benedict and to go so far as to suggest that common law pledges of collateral were OK. Some even said that Benedict need not be interpreted strictly. In “Rethinking Benedict v. Ratner” Edward Janger wrote:

To the extent that commercial law professors mention Brandeis’s role in the case, it is to point out with a certain self-aggrandizing satisfaction that the great Brandeis even got the law wrong.

Such new thinking was common in the 1990s and allowed the private mortgage finance industry to compete with government sponsored entities like Fannie Mae and Freddie Mac — for a while, anyway. From the start, Wall Street firms cut corners on documenting the transfer of title from the seller of the mortgages to the trust, relying on the revisionist view of the Benedict decision and other new era concepts like federal common law. This is one of the key complaints of mortgage insurers against the banks that created trusts and securities based upon false descriptions of the security.

But now we know that this was all nonsense. The creation of the ersatz housing title registry, Mortgage Electronic Registration Systems (MERS), by the banking and mortgage servicing industry was effectively an end-run around the clear legal standard set by Brandeis. In litigation and foreclosures, these make-believe standards for securitizing home loans are turning into dust in the hands of the banks and investors. Lenders who relied upon MERS to document their secured interest in a mortgage are increasingly at risk when the title is contested.

Benedict v. Ratner is still the leading case on the question of when there is an invalid lien,” veteran securities attorney Fred Feldkamp said. “This is confirmed by the manner in which the requirements Brandeis stated in Benedict were incorporated when Frank Kennedy wrote the Bankruptcy Code (and the 1983 Uniform Fraudulent Transfer Act). Kennedy was ‘bowing’ to the genius of the Brandeis opinion, NOT denying it.”

In more and more cases where the supposedly secured party cannot produce a properly endorsed mortgage note, the courts are ruling in favor of the debtor. Experts in the fields of the law and forensic accounting tell me that missing or nonexistent mortgages leave investors effectively unsecured — and leave debtor homeowners unsure about the identity of the true note holder.

Anyone familiar with the carnage today in the mortgage servicing world understands that Benedict v. Ratner is again the operative standard for secured transactions in the state and federal courts. In particular, the ancient concept that “the collateral follows the note” affirmed and codified by Benedict is very much operative in the world of home foreclosures. As one attorney told me: “If you don’t have the note today, you don’t have no game.”

A very troubling issue raised by the last comment is related to the issue of missing documents, namely the growing number of foreclosure cases where a mortgage was pledged multiple times. One of the dirty little secrets about MERS and the use of electronic registry systems generally is that they enable fraud. A bank or non-bank seller can pledge the same loan as collateral multiple times if there is no hard requirement to deliver the physical note as per Benedict, which is an open invitation to fraud.

There are a number of proposals in Congress at present for fixing the private mortgage finance sector, but virtually none address the issue of what constitutes a good sale or pledge of a mortgage note in the US. It is interesting to note that a recent paper by the Federal Reserve Bank of New York on housing finance does not even mention the issue of collateral or Benedict v. Ratner.

Sad to say, neither federal regulators nor the large banks have any interest in talking about the issue of good sale and/or delivery of collateral to a trust because of the massive amounts of litigation presently underway. The question of documentation related to loan sales is at the forefront of some of these disputes. Investors want to know how these disputes will be resolved and, more so, what the rules are for loan sales going forward.

One thing you can depend upon is that there will be no fixing of what is wrong with the US real estate sector until Congress addresses once and for all the issue of delivery of a note as collateral for a mortgage backed security. Unless, and until, we fix the private mortgage securitization market, the housing sector will not stabilize and the chance of further deflation will remain a threat to economic recovery.

 

 

 

 

 

COMMENT

Prosecuting Wall Street investment banks and their “geniuses” is not only a matter of democracy, but more importantly, it is about survival of America that we all love…and the only path for our kids’ future.
How did we become just one big hypnotized mass, even after the truth has been revealed? We’re walking around as if we’re mesmerized, not standing up, not demanding justice, still paying our mortgages to lenders who don’t even legally own them…
However, there are few people like NY Attorney General and we should all stand up with them.
Please read my blog post about MA Register of Deeds, a real people’s hero: http://tinyurl.com/3qsu87x

Posted by Senka | Report as abusive

More debt and inflation will not create economic prosperity

May 5, 2011 19:31 UTC

“[F]or many philosophers, conflict is inevitable in politics because a government should seek both to make its people equal in wealth and opportunity and also to safeguard their liberty, but it cannot do both because people can be made equal only through serious constraints on their freedom. This is not simply a statement of the obvious fact that different people and different communities hold different values. The argument claims that even a single sensitive person cannot express, either in how he lives or how he votes, all the ideals he knows he should recognize.”

Justice for Hedgehogs
Ronald Dworkin

In an article in the April 28, 2011, New York Review of Books, “For a National Investment Bank”, Robert Skidelsky and Felix Martin argue that the Obama Administration ought to create yet another state sponsored financial institution in the US to explicitly stimulate the economy by issuing debt. This is a truly bad idea whose time has come and gone.

The authors rightly describe the lack of aggregate demand in the US, something we have also discussed at some length in this space. “Few dispute that the US is not enjoying a normal recovery by recent standards,” they write. So true. But their suggestion of creating a new government sponsored enterprise (GSE) to address slack growth and employment lacks imagination and practicality. Skidelsky and Martin specifically want to use the NIB to finance public infrastructure projects, but without the new debt required showing up on the federal budget. How clever.

Nowhere do Skidelsky and Martin, nor most neo-Keynesian economists, admit that much of the nominal economic growth of the past several decades in the US was increasingly supported by debt and inflation. The national investment bank they propose would take its place alongside dozens of existing New Deal and Great Society agencies such as Fannie Mae and the Federal Housing Administration, as well as the Bretton Woods GSEs including the IMF and World Bank. Martin, an economist at Thames River Capital LLP, worked at the World Bank for two stretches between 1998 and 2008 and must be familiar with this history. The NIB is more of the same stuff in policy terms.

The NIB proposal shows just how bankrupt the American political discourse has become when it comes to economics, but especially on the left.  It also reveals the indifference of liberal economists to the political consequences of economic policy choices. This is not to suggest that Republicans are exactly fonts of economic innovation at present. Most Republicans are indistinguishable from big government Democrats in terms of their willingness to prune back the corporate state. Fiscal conservatives have been fighting this battle for decades now.

The first observation about the NIB proposal is that we are talking, once again, about using debt to create the illusion of economic prosperity. Skidelsky, Emeritus Professor of Political Economy at the University of Warwick and the author of Keynes: The Return of the Master (2009), is an unabashed advocate of the aggressive state in action. Yet what he and Martin propose promises few benefits in economic terms. Indeed, you cannot make an argument for more GSEs on utilitarian grounds.

The most offensive thing about the NIB proposal is that it pretends to rely upon Keynes. Skidelsky and Martin say that they intend some sort of pump-priming, jump starting catalyst for private sector growth. Keynes was no apologist for using debt to simulate real economic growth but he also believed in individual economic liberty, which he greatly benefited from. Living through the privation in the UK during and after WWII, Keynes understood the desperate situation facing Britain. Modern economists spend too little time considering politics when assessing the motivations of the day.

My friend Sol Sanders and William Alpert talked about Keynes in The Institutional Analyst last month (Keynes, Keynesianism — and Keynesianitis): “‘The day is not far off’, he wrote, ‘when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems/the problems of life and of human relations, of creation and behavior and religion.’  In 2010 we are still waiting.”

The same lack of demand and unemployment that faced Keynes and the leaders of the Western economies after WWI and WWII, and to which Skidelsky and Martin rightly raise in alarm, has driven liberals today to embrace ever more inflation and debt. An aggressive combination of reflation by the Fed and restructuring of the housing and banking sectors is the way to restore US economic growth, but you won’t hear about restructuring large banks from adherents of the neo-Keynsian faith.

Skidelsky and Martin assess the political situation facing the Obama administration, saying “that it has become politically impossible to increase the deficit.” Quite right. But the solution offered by these two honorable gentlemen is to create yet another GSE to issue more debt off the books? Such expedients are entirely transparent to the marketplace, but Skidelsky and Martin do not seem to appreciate that more incremental debt buys less and less bang for the buck in terms of nominal economic growth.

Skidelsky and Martin, and their American contemporaries led by the likes of Paul Krugman, call for “fiscal stimulus,” but what they are really arguing for is permanent inflation. The Fed has been pursuing the reflation path via quantitative easing, but with less than astounding results, owing to the lack of benefit for US households.

The only way to fix the twin problems of deflation and unemployment is to keep money easy and restructure the insolvent parts of the banking system and economy. In both the US and EU, the policy has been implemented but the lack of financial restructuring of the insolvent banks of the US and EU is the chief obstacle to economic renewal. To restructure and renew is the alternative to the proposal from Skidelsky and Martin.

Instead, Skidelsky and Martin want to layer more state-guaranteed debt on top of an already wobbly foundation. This is not only bad economic policy, but it has truly hideous political implications. John Stuart Mill acknowledged that utilitarianism had to admit the moral superiority of classical liberalism and that, to save it, certain preferences (those the classical liberals generally would favor) simply had to be acknowledged as preferable.

Why is it that so few economists ever assess the social and political implications of their policies? Skidelsky and Martin are following the road to hell trodden by Franklin Roosevelt in the 1930s. Not only do we have the New Deal zombies like Fannie Mae and the Federal Housing Administration as examples of failure, but dozens of parastatal banks and development entities in the EU that are effectively insolvent today. The embrace of the fascist economic model proposed by Skidelsky and Martin has not saved the EU from economic malaise.

As Ronald Dworkin notes in his new book, Justice for Hedgehogs, the differences between different ethical and political systems do matter very much. Keynes believed in using temporary government action to help restore private economic activity, but I doubt he would have supported the type of debt accumulation much less the creation of permanent GSEs that Skidelsky and Martin propose.

Instead of embracing a permanent state of inflation, as has been the case in the US since the 1970s, we need to deflate the bubble and start again. It is not too late for President Obama and Congress to restructure the US financial system, fix the housing market and create the conditions for true economic growth. All we need to succeed is leadership and the knowledge that the bastard children of Lord Keynes cannot help us in the difficult task ahead.

COMMENT

So far, the restructuring of insolvent financial entities has been done on the backs of taxpayers.

What exactly do you mean by “restructure”? Are you referring to restructuring in the “Greek” sense?

Posted by breezinthru | Report as abusive

As Obama and Congress fiddle, America liquidates housing sector

Mar 29, 2011 13:28 UTC

Republicans in the House of Representatives are busily assembling several legislative proposals to reform the housing sector and reduce government support for the secondary market in home loans used by banks to manage their liquidity.

According to Joe Engelhart at CapitalAlpha Partners: “House Republicans are considering an ambitious series of standalone legislative initiatives to reduce the role of Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac) over the next five years.”

Meanwhile, President Barack Obama has started another war in the Middle East with his political soul mates in the EU.  The President has also embarked upon an ambitious schedule of foreign tourism and domestic campaign stops, but nothing of substance.

Obama is compared by some to Louis XIV XVI (and Mrs. Obama to Marie-Antoinette)  in terms of his detachment from the nation’s priorities, particularly the ongoing meltdown in the housing sector.

“Pres. Barak Hussein Obama has given new meaning to that epithet “imperial presidency,” my friend Sol Sanders opines.  “It was slung at Pres. Richard Nixon not only for his extravagant “palace guard” — some in kitschy uniforms — but his more serious unconstitutional overreach.  But if imperial in his style, Mr. Obama reigns; he does not rule.”

In many ways, the current national policy mix of more regulation, decreased government subsidies and, to add further urgency, a shrinking banking system, is the perfect storm for the housing, which is now down six months in a row.  Despite my long-held desire to see market-based reform in the US housing sector, I think all parties need to be aware of the precarious situation facing the American economy and banks as home prices collapse for lack of credit.

The slide in home prices and receding bank lending footprint is one of the reasons why at my firm we have begun to talk about putting aside structural reform of the housing sector this year and instead increasing the size of the loans guaranteed by the government, even while raising the cost of such “g fees” as they are called by housing market mavens.  Without credit, the real estate sector is left with a cash market liquidation with grave implications for financial intermediaries and investors.

We wrote this week in The Institutional Risk Analyst, “Wanted: Private Investors Seeking First Loss Exposure on RMBS, March 28, 2011,” about some of the details of the secondary mortgage market.  In simple terms, there is about $11 trillion in financing behind the real estate sector: $4.4 trillion in the portfolios of banks, $5.5 trillion in agency securitizations guaranteed by Uncle Sam, and $2 trillion or so in private label securities.

In order to believe the claims of my conservative friends about “reform” of government agencies like Fannie Mae and Freddie Mac you must believe that some of the $5.5 trillion in no-risk agency securities is going to be willing to migrate into the bucket of private label securities, where investors take actual credit risk.  It is unlikely that we are going to see any significant increase in the private market home loans unless interest rates rise significantly.

The net, net here is that the available pool of credit available for the housing sector is shrinking and thus prices must also decline to adjust for that supply of credit.  This fact of continued decline in home prices is going to have a chilling effect.

As we wrote in The IRA this week: “It is no accident that states such as Illinois, Nevada, Missouri, and Maryland are all considering legislation to ban appraisers from using involuntary foreclosure sales in home valuations. In a rational world where programs such as HAMP were really effective to restructure underwater loans and, of necessity, say 50% of all HELOCs were written down to zero, both the Too Big To Fail banks and the private mortgage insurers would be insolvent. ”

This week regulators are starting to work on the risk-retention rules of the Dodd-Frank legislation, yet another point of friction that is making it more difficult for Americans to obtain housing credit.  The political fight over what constitutes a “qualified residential mortgage,” which does not require banks to keep 5% of the risk, will only marginally effect the deflationary forces now working on the housing sector.

While the media will be fascinated by all of this insider play over the “QRM”, the real story is out in the housing market, where more than half of all home sales this year will be involuntary foreclosure liquidations.  The slow erosion of home prices is likewise eating away at the willingness of lenders to take risk in real estate, thus the 4% decline in loan balances YOY according to the FDIC.

I estimate that Fannie and Freddie alone are hiding $200 billion worth of bad loans on their books simply because there is no market for these foreclosed homes.  Ditto for the largest servicer banks such as Wells Fargo, Bank of America, JPMorgan Chase and Citigroup.  To clean up this mess with finality is going to cost $1 trillion or so in round numbers.  But nobody in Washington wants to go there.

The Obama Administration and the Congress need to put aside their respective fantasy world views and focus on the horrible economic reality ongoing in the housing and banking sectors.  It may be that the degree of self-delusion in Washington has reached the point that only another financial catastrophe can wake us from out collective distraction.  But if President Obama really believes he can win reelection with housing prices falling from now till November 2012, then perhaps those who liken him to Louis XIV XVI are right.

Editor’s Note: The piece has been updated with the correct regnal number for Louis.

COMMENT

The reason the housing bubble inflated is because there was a disconnect between borrowers and lenders. The disconnect was facilitated by Nationally Recognized Statistical Organizations (Fitch, Moody’s, S&P) and government guarantees and by government loan guarantees.

Twenty percent down and requiring originators to keep a large proportion of the loans they fund on their balance sheet would fix the problem. In fact it would have prevented the problem from occurring in the fist place.

Central planners always have such complicated solutions.

Posted by DiegoForever | Report as abusive

Everything that Americans should ask about home mortgages

Oct 20, 2010 15:42 UTC

Americans are discovering the concept of foreclosure and the loss of a home in a very real and disturbing way.  Despite the rhetoric from Washington and sensationalist media, the process of resolving defaulted mortgages is moving ahead, one reason why the U.S. will not be Japan.  But we have all forgotten the experiences of the 1930s when it comes to home foreclosure.

We seem to be moving from voluntary foreclosure moratoria put in place by banks for public relations purposes in 2010 to unilateral state law foreclosure moratoria like those put in place during the 1930s in 2011.  States such as Michigan are considering “new” laws to limit foreclosures by creditors.  But all Americans are also experiencing a journey back to the 1930s, a journey of remembering and one that is teaching this writer something new each day.

In the 1930s, a total of 28 states enacted foreclosure moratoria and a 1934 Supreme Court decision upheld such laws provided that a state of emergency existed.  Many of these state law moratoria remain on the books today and were last invoked during the 1980s.  The Iowa laws provided for suspension of foreclosures in the event of natural disasters such as drought, Neil Harl reported in his book, “The Farm Crisis of the 1980s,” or by order of the governor of the state.  These state moratoria drove the banking industry to look at changes in how home sales are financed and particularly the rights of investors.

Another Supreme Court decision that predated the Great Depression already had set in motion a series of changes in commercial practice in the U.S. regarding mortgages.  In Benedict v. Ratner, 268 U.S. 353 (1925), Justice Louis Brandeis simply and accurately said that ambivalent mixtures of possession and control of collateral for debt are “conclusively fraudulent,” veteran mortgage securities attorney Fred Feldkamp recalls. This decision and the resulting body of precedents would eventually lead to agreement on new disclosure procedures that would exempt validly secured loans under Article 9 of the Uniform Commercial Code, including possessory pledges of mortgage notes.

“To survive the Brandeis logic, one must assiduously follow the UCC and avoid all the pitfalls of the Uniform Fraudulent Transfer Act,” Feldkamp said in an email last week. “Otherwise the state mortgage recording laws and Benedict v. Ratner could turn an investment record error into a fraud and may require them to rescind the investment –either under securities laws or common law fraud.”  Then a young attorney, Feldkamp worked on an early legal opinion for one of the mortgage insurers in the 1970s that helped define the first loan servicer agreements and pave the way for the securitization boom.

What does the Benedict v. Ratner decision by the Supreme Court and the related agreement by the states in the 1950s mean to today’s families fighting foreclosure and communities striving to clear the real estate markets?   First and foremost, the key thing to understand is that the fundamental principles on which securitization was built are (1) sound financial assets namely homes and (2) ALWAYS remember — the collateral follows the debt –and ownership of the debt is most clearly represented by possession of a note.

The basis of the original “true sale” opinion for mortgages was that respected counsel in 48 states all agreed (and opined to attorneys such as Feldkamp and to the credit rating agencies) that if there is a dispute between a bona fide holder of a mortgage note and a different assignee of record of the mortgage, the note holder always wins.  The fact of the mortgage note coming under the UCC means that while the record at the courthouse regarding the assignee of record on the mortgage may be a complete mess, this is not necessarily evidence of fraud nor does it void the obligation of the borrower to repay.

Thus when that young activist lawyer is telling you and yours to fight a foreclosure — this even though you have not paid the mortgage in more than six months — it is time to start looking for a new place to live.   The fact is that despite all of the bad press, MERS (done correctly) eventually wins in most foreclosure hearings that are contested.  This is not reason for joy in terms of the human suffering involved in the loss of a home.  But the sad fact is that the family that is not paying the mortgage probably is unable to pay property taxes either.

Ultimately it is important for Americans to learn how mortgages are priced and sold, both to borrowers and investors alike.  There are big legal problems now being exposed in this multi-trillion dollar industry, a financial sector which is essential to the economic well-being of the U.S.  For example, what happens to the investor in a mortgage backed security if the underwriter fails to deliver the mortgage note to the trustee?   This is just one issue that will be litigated by the banks, investors and housing agencies in Washington for years to come.

But the most important thing for all consumers to understand is that when a mortgage is in default, the fact that the title records at the court house are in disarray does not void the mortgage note nor does it change the fact that the loan is bad.  Foreclosure is a tragedy for one family, but an opportunity for another and the means by which communities and financial institutions defend their tax base and financial health.  This process of liquidation and sale is why the U.S. will recover from the housing mess.

The bad guys in the housing bust are not the banks who must foreclose on homes, but the politicians in both political parties who used reckless housing policies to further their personal interests. This is a bipartisan national scandal.  Barney Frank, Chris Dodd, Phil Graham, Alan Greenspan and their contemporaries are the authors of our collective misery, not the local banker who must clean up the mess created by government intervention in the housing market.

COMMENT

A beautifully written and throughly misleading piece.
One has to wonder what his “Risk Analysis” stand was, back when all of the freshwater economists were poo-pooing the obvious fraud that the industry was so eagerly engaged in.

Despite false claims that “nobody-could-see-this-coming” many did.

At this point, there are all types of flavors of “how do we corrupt established rules” to prevent the widespread fraud from taking down the insolvent banking sector.

Most sickening is the excuses about “saving”; real estate, the economy, homeowners…etc. What Christopher and his lobbying ilk are trying to “save” is the corrupt insolvent institutions that played fast and loose with the law to make a bonus buck.

We don’t need to codify fraud, we need punishment to encourage honest players.

Christopher, the truth is that “The bad guys…” are, in fact, the banksters. No amount of shuffle and jive are ever going to convince the American people otherwise.

Posted by MediocreFred | Report as abusive
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