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.







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

Standing on the brink — of a fresh financial start

Nov 18, 2010 22:11 UTC

The opinions expressed are the author’s own.

For the past several years, governments around the world have been trying to avoid dealing with excessive debt, shrinking revenue and economic activity. The main approach has been for governments to lend their credit rating and cash to help banks and public sector entities paper over the problem, in the hope that a rising tide of economic activity will lift all boats.

Unfortunately, the efforts by the Federal Reserve and other monetary authorities to “reflate” asset prices and economic turnover have failed. The reason for this failure is a basic one, namely that once nations reach a certain level of indebtedness, each marginal increase in debt and/or the supply of fiat money has less and less impact. In the U.S., for example, the velocity or turnover of the money supply has fallen because the free flow of credit and related economic activity has been withdrawn.

The chief result of the temporizing approach to the crisis taken by the leaders of the G-20 nations has been to delay the day of reckoning and erode the credit standing of the member nations. First Greece, then Ireland and next likely Spain have been left insolvent due to efforts to prop up equally bankrupt commercial banks.

But now with the citizens of sovereign states from the Germany to California rejecting bailouts and cuts in government services, the day of reckoning is coming for the banks and creditors. But therein lies the path out of hopelessness and toward national renewal.

If you consider that the average price of a home in the U.S. has fallen by more than 25% from the peak levels of the housing boom, the fact of insolvency among our largest financial institutions is no big surprise. Indeed, one of the reasons why this writer has been so bearish on the situation facing the largest banks is that something like half of their assets are tied to housing — more if you include loans sold to investors.

The Fed has been attempting to reverse this large drop in asset values with a variety of expedients, but unfortunately the courts are open every day. Even as the U.S. central bank has used quantitative easing to artificially support asset prices in the securities markets at the macro level, the fact of liquidation and resolution is slowing eroding the capital of the biggest banks.

Likewise, as I wrote in an earlier piece for Reuters.com, “Bernanke conundrum is Obama’s problem,” the fact of financial insolvency makes the largest banks unwilling to refinance American homeowners, adding further deflationary pressure and thwarting Fed efforts to increase the velocity of money in the U.S. economy.

Earlier this month, Ambac Financial Group, a leading insurer of municipal bonds, was forced to file bankruptcy because claims by holders of residential mortgage backed securities (RMBS) were slowing eating away all of the company’s capital. The response by Treasury Secretary Timothy Geithner has been to try and paper over this situation and, once again, bail out the largest U.S. and European banks. The holders of RMBS with Ambac guarantees may get nothing if Secretary Geithner prevails (see “Ambac, CDS and Geithner: It’s AIG All Over Again,” The Institutional Risk Analyst, November 16, 2010).

So what is to be done? The first thing that Americans must do is to accept that the level of home prices, GDP, velocity and other indicia are not going to return to pre-crisis levels for many years to come. Once we accept this reality, then restructuring and recapitalization will become the obvious if painful choice. When I am speaking on the banking industry, I tell the audience that the task ahead is like cutting off a few fingers with a kitchen knife. The bad news is that it will hurt like hell. The good news is that the fingers, eventually, will grow back.

The Obama Administration needs to change direction and to embrace restructuring and national renewal instead of the current policy of extend and pretend. The same factors that drove Ambac into bankruptcy are working on Bank of America, Wells Fargo, JPMorganChase and will eventually force a restructuring. The sooner we start the process, the sooner the U.S. economy will recover.

Indeed, I expect that the Obama Administration will eventually, reluctantly be forced to invoke the powers under the Dodd-Frank law and restructure the top-three U.S. banks. This will be near-total losses for equity holders and haircuts for creditors, but the end result will be a solvent bank that is smaller, profitable and able to again lend.

It is important for Americans to remember that bankruptcy and liquidation are necessary steps to national renewal and economic stability. The Founders of the United States embedded bankruptcy in the U.S. Constitution for precisely this reason. The Founders knew that prolonged uncertainty and a lack of finality when it comes to insolvency was bad for society, thus they commanded Congress to create federal bankruptcy courts.

Having been through a personal restructuring a decade ago, the end result of five years of civil litigation, I do not make the recommendation of embracing restructuring lightly. But restructuring and liquidation of debt allowed me to rebuild my life. Each time that a family looses a home to foreclosure, that tragedy creates an opportunity for another family to make a fresh start. When a bank is restructured, the creditors lose money, but the bank is then able to support economic growth. And when an individual declares bankruptcy in the U.S., our Constitution provides the right for fresh start.

By speeding the process of resolving bad debts and restructuring viable companies, the U.S. courts are moving forward with the process of national renewal even though our politicians have not yet found the courage to lead the way. I suspect that this, too, is going to change and very soon. No amount of talk and obfuscation in Washington can prevent the process of liquidation underway on Main Street. Before long, the fact of renewal and restructuring at the micro level will be visible at the macro level as well, and that is good news.


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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.


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

Memo to Obama: time to break the refinance strike by the big banks

Aug 31, 2010 16:56 UTC

There are growing signs of unease bordering on desperation inside the Obama White House. Most of the O Team now understands that the real, private economy never got out of Dip Number One. The prospect of a permanent downward shift in “trend growth” to a lower track, and continued double digit unemployment, are driving a search for alternative measures that has even touched conservatives in the worlds of finance and economics.

The Obama Administration and the Fed have taken the position that the crisis affecting the U.S. economy and the financial sector is slowly ending. In fact, the largest banks remain profoundly troubled by bad assets on their books as well as claims against these same banks for assets sold to investors. By allowing banks to “muddle along” and heal these wounds using low interest rates provided by the Fed, the Obama Administration is embracing a policy of deflation that has horrible consequences for U.S. workers and households.

In a post over the weekend on ZeroHedge –  “Bernanke Fed Drives Deflation With Zero Rate Policy” — I described the negative effects of the Fed’s low interest rate policy on bank earnings, as well as consumer and corporate spending and saving. When interest rates are low, savers move their preference for liquidity to infinity, especially after the past several years of market breakdown. Retirees spend less because the interest earned on bonds and savings has plummeted.  Here’s an excerpt:

When the Fed buys securities through QE, it is removing duration from the markets, pushing down yields and volatility. For a while this boosts the net interest margin (NIM) of leveraged investors such as banks, who are able to borrow at lower rates to fund current assets. As assets re-price to the low rates maintained by the Fed, however, NIM begins to disappear. Over the medium to longer term, think of duration and NIM as being linked, so obviously a sustained period of QE is bad for NIM. This is why NIM in the U.S. banking sector is starting to fall.

Just as the earnings of leveraged investors like banks are starting to suffer due to zero rate policy, so too the spending by all manner of savers, from retirees to companies and not-for-profits to municipalities, is falling too. Fed Chairman Bernanke and the other members of the FOMC are killing the real economy to save the banks — but none of the benefit flowing to the banks is reaching U.S. households. In fact, the Obama Administration has been providing political cover for the Fed to conduct a massive, reverse Robin Hood scheme, moving trillions of dollars in resources from savers and consumers to the big banks and their share and bond holders.

The first priority is to make clear to the largest banks, especially the top four institutions — JPMorganChase (JPM), Bank of America (BAC), Wells Fargo (WFC) and Citigroup (C), that the party is over when it comes to providing credit to the real economy. Until President Obama and Fed Chairman Bernanke recognize that six institutions — FNM, FRE, BAC, C, JPM and Wells Fargo — have broken the mechanism which makes interest rate easing work, we will make little progress fixing the economy.

“In every Fed easing event during my career in finance (1986, 1992, 1998, 2002), it was the wave of refinancing of debt after the Fed eased interest rates that put permanent disposable income into the hands of households,” notes a former Fed official who worked in the banking industry for decades. “In this last easing, however, FNM, FRE and the TBTF banks have conspired to break the transmission mechanism for monetary policy and are now strangling the U.S. economy to save themselves from past errors.”

Rules changes made by FNM and FRE since the Treasury’s conservatorship began in 2008 have prevented millions of American consumers and business from refinancing their mortgage debts. The Bernanke Fed will attempt to compensate for this de facto freeze on refinancing with QE II, but this will fail.

So what should President Obama do?

First, the Obama Administration should use the power provided in the Dodd-Frank legislation to force an accelerated cleanup of bad assets and to mandate refinancing and principal reductions for performing loans with viable borrowers. If any banks resist, the Treasury should use the power under current federal law to remove recalcitrant officers and directors of these same banks.

Second, President Obama also needs to focus on the growing competitive problem in the U.S. mortgage sector. The mortgage banking industry suffered significant consolidation since 2007. In particular, the competitive, third part origination players went out of business via bankruptcy or by being taken over. The industry is now dominated by a cozy oligopoly of Too Big To Fail banks (TBTF).

The top three banks control 55% of all mortgage originations. The top 10 banks control 95%. The top five run the only surviving channels to sell loans to Fannie Mae (FNM) and Freddie Mac (FRE), and force their pricing upon the entire banking industry. Small banks give up half the economics of a typical loan to sell a loan to FNM or FRE indirectly, through WFC or JPM. Why is there no antitrust investigation of the top banks by the Department of Justice?

The Obama Administration should move to restructure FNM and FRE now, not in 2011. The Treasury should use its existing authority under the conservatorship to force FNM and FRE to make rules changes to allow for the refinancing of all existing residential mortgages, if only to reduce the current cost of the debt and increase disposable income for households.

By moving on reforming FNM and FRE, the Obama Administration can provide relief to home owners and also send a strong message to Wall Street and global investors that the practice of “too big to fail” is at an end. We should always remember that the model of the government sponsored enterprises (GSEs) goes back to fascist Italy and Germany of the 1920s. The very public demise of these GSEs is an important part of ending TBTF for the large banks — but only part of the story.

President Obama should make some political hay over the fact that loan origination margins for the top four banks have gone from ½ point to over 4 points in the last two years. This is the subsidy for Wall Street above and beyond the zero interest rate policy of the Fed. The Obama Administrations needs to require changes in the way in which FNM and FRE do business with the banking sector and with mortgage holders, and use these changes to reform the mortgage market in preparation for legislation from the Congress.

By reducing barriers to refinancing by FNM and FRE, and aggressively forcing private banks to mark mortgages to market and accept principal write-downs or short sales to clear the backlog of bad debt, the Obama Administration can restore balance to the economy and create a healthy basis for new growth.


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