DC Puts Its Bankster-Friendly Solution for Foreclosure Fraud on the Table

Looks like this will be the Administrations plan for fraudclosure  
gate.  Continue to enable the fraud,  otherwise the system will  
collapse.

regards,
-Lance

----------------------

DC Puts Its Bankster-Friendly Solution for Foreclosure Fraud on the  
Table
We’ll analyze a proposal to fix the foreclosure mess put out by a DC  
think tank known as Third Way. Normally this blog steers clear of  
delving into random policy documents. In this case, though, it is  
likely that Third Way is speaking for the administration.

Third Way is an influential think tank whose board is composed of a  
special Wall Street-type – the Rubin Democrat. These people sit at the  
nexus of politics and finance, and are conduits for big bank friendly  
information flow into the administration and Congress. The President  
of the think tank, Jonathan Cowan, was the Chief of Staff for Andrew  
Cuomo at HUD in the 1990s, and Third Way is well known in policy  
circles for delivering ‘politically safe’ and well-packaged  
conventional wisdom. Oh, and one more thing – the new White House  
Chief of Staff Bill Daley, who just left the most senior operating  
committee of JP Morgan, was on their Board of Directors.

So by looking at this proposal, we are looking at the state of play  
among high level policy makers in DC, particularly of the New Dem  
bent. This is how the administration will probably try to play  
foreclosure-gate.

Their proposal, not surprisingly, is yet another bailout.

The big difference between the original and the new, improved version  
of the bailout model is that the payouts to the banks were at least in  
part visible the first time around. This is an effort yet again to  
spare the banks any pain, not only at the cost of the rule of law but  
also of investor rights.

This proposal guts state control of their own real estate law when the  
Supreme Court has repeatedly found that “dirt law” is not a Federal  
matter. It strips homeowners of their right to their day in court to  
preserve their contractual rights, namely, that only the proven  
mortgagee, and not a gangster, or in this case, bankster, can take  
possession of their home.

This sort of protection is fundamental to the operation of capitalism,  
so it’s astonishing to see neoliberals so willing to throw it under  
the bus to preserve the balance sheets of the TBTF banks. Readers may  
recall how we came to have this sort of legal protection in the first  
place. England learned the hard way in the 17th century what happens  
with low documentation requirements: abuse of court procedures,  
perjury and corruption become the norm. Parliament enacted the 1677  
Statute of Fraudsto establish higher standards for contracts, such as  
witnessing by a third party, to stop the widespread theft of property  
that was underway.

The memo completely ignores the harm to investors from the bank  
mistakes and lacks any provisions for damage to investors to be  
remedied. Moreover, denying borrower rights removes their leverage to  
obtain deep principal mortgage modifications, which for viable  
borrowers produces lower losses than costly foreclosures and sales of  
distressed property. Thus this shredding of contractual protections in  
mortgages not only hurts borrowers but also harms investors.

So to save the banks from their own, colossal abuses of contracts that  
they devised, the Third Way document advocates Congressional  
intervention into well established, well functioning state law. This  
is a case where these matters can and should be left to the courts and  
ultimately state AGs to coordinate the template of a more broadbased  
solution.

But this proposal is this memo is a direct result of the banks losing  
in court and the fear that they will continue to lose. The  
Massachusetts Supreme Judicial Court Ibanez decision is clearly the  
trigger for the release of this plan. The SJC said its decision was  
merely articulating well established law. Consistent application of  
these principles will mean more losses for the banks. This memo is  
clearly an attempt to stop this as soon as possible. The real message  
of this document is clear: we can’t permit justice to prevail if it  
will hurt bank profits and balance sheets.

Let’s parse key sections of the document. Predictably, it chooses to  
divert attention away from the real issue, that of the greed and  
errors made by securitization industry participants, and the huge  
costs already imposed on innocent bystanders by the financial crisis.

Start with the first page:

While consumer advocates are hailing the decision as a victory for  
borrowers, homeowners are more likely to suffer the downsides—not the  
benefits—from the Massachusetts ruling. This case is certain to set  
off a massive wave of litigation by borrowers and lawyers eager to  
challenge a pending foreclosure. This in turn will create tremendous  
uncertainty in the still-wobbly housing market: Will homebuyers who  
bought a home out of foreclosure worry that their purchase will be  
invalidated? Will prospective homebuyers get too nervous to come off  
the sidelines, thereby driving up inventory and driving down home  
values? Will some homeowners be encouraged to “strategically default”  
in the hopes of winning a “free house” from technically faulty  
paperwork?

This is scare-mongering, pure and simple. It isn’t credible that a  
decision in one state with some idiosyncrasies in its real estate law  
will trigger a “massive wave of litigation”, particularly since anti- 
foreclosure lawyers often have trouble getting paid. Broke clients do  
not make for a great target market.

As to the “tremendous uncertainty” claim, where exactly has Third Way  
been? If they are only waking up now to the magnitude of the  
foreclosure mess, that alone disqualifies them from being competent to  
opine on this topic (note that this seems to reflect the advanced  
state of denial we’ve seen among securitization industry types; the  
result has been that parties further removed have been slow to wake up  
to the seriousness of this problem, despite ample evidence in local  
courts all over the US).

The homebuyer worry about foreclosure sales being invalidated argument  
is spurious; as we’ve remarked before, foreclosure sales are final. I  
can’t recall an instance of a public policy measure being implemented  
to pander to the neuroses of uninformed consumers.

Possible REO buyers sitting on the sidelines? That’s already true, and  
it’s due to doubts over validity of title thanks to MERS, not Mass.,  
as well as the concern that housing has not bottomed in many markets.  
Since Third Way appears remarkably uninformed about housing market  
conditions outside the Beltway, namely, that there’s a huge inventory  
of homes yet to be foreclosed upon, largely due to servicers keeping  
borrowers in homes. That’s partly the result of a fee-maximizing  
“sweatbox” strategy, partly to save the costs of property maintenance  
and real estate taxes since they already have more real estate than  
they can unload in many local markets, and partly due court backlogs.

Third Way manages to accomplish the neat rhetorical trick of linking  
the urban-legend of “strategic defaults” (see Mike Konczal for  
details) with the jealousy-inciting “get a free house” meme.

Let’s get this straight: not a single lawyer I’ve come across want his  
client to get a free house. They fight foreclosures to get a mod. So  
when you see banks losing these cases, it’s because everyone involved  
on the servicer side has incentives to foreclose, not to modify loans.

In addition, vIrtually no decision, including Ibanez, have been “with  
prejudice”. That means the banks can foreclose if they get their act  
in gear. But the dirty secret is that the party that probably can  
foreclose is not the securitization trust, but an entity earlier in  
the securitization chain. Having someone other than the trust  
foreclose is a disaster for the securitization industry. There is no  
way to get the sale proceeds into the trust. The end result of having  
someone other than the securitization trust foreclose is to expose, as  
Georgetown Law professor has put it, that some if not most RMBS might  
actually be “non-mortgage-backed securities.”

We’ll largely skip over a heated and heavily spun section on the paper  
trail; it of course focuses on robosigning and overlooks numerous  
other abuses such as failure to convey notes properly and all too  
common document fabrications. However, we must note it too often gets  
the background and law wrong, again raising questions of basic  
competence. For instance:

Under the UCC, physical possession of the note and the mortgage are  
not required to enforce the loan.

This is embarrassing. The UCC is not relevant to this issue. As we  
have argued, the UCC (Article 1) specifically allows parties to  
contract out of the UCC and enter into more restrictive arrangements,  
which means the terms of the pooling and servicing agreement govern.  
But the UCC has nothing to do with the legal requirements for  
foreclosure; that’s governed by state-based real estate law, not the  
UCC. And in lien theory states, it means that the party foreclosing  
can be any of 1) “holder” of the note (meaning have possession AND be  
the proper party (or an agent of the proper party), 2) produce a lost  
note affidavit, 3) be subrogated to a holder or 4) be a purchaser from  
a holder who doesn’t yet have the note. Effectively, the foreclosing  
party either has to have the note or prove that it bought it from  
someone who actually has the note. That generally means you’ve got to  
produce the note.

The next section, on remedies, again contains distortions. For instance:

….if a foreclosure proceeding is otherwise justified (i.e. the  
borrower isn’t paying the loan), documentary failures don’t nullify a  
lender’s underlying right to a remedy.

Calling these “documentary failures” greatly understates the magnitude  
of the bank recklessness. A note is a negotiable instrument, like a  
check. Losing track of notes, each worth on average hundreds of  
thousands of dollars, is so deficient that that alone ought to justify  
all the major banks being seized and put through operational audits.

And despite this level of incompetence (or malfeasance), the banks  
have not been denied the ability to foreclose. Unless banks make  
repeated misrepresentations to the judge, the cases are dismissed  
without prejudice. The plaintiffs are free to come back and try again  
once they sort matters out. But they seldom bother. And again, it’s  
often because if they do find the note, it’s likely to be outside the  
trust, which as discussed above, creates a heap of other problems.

Next, in typical think tank style, the paper summarizes goals, then  
later offers remedies organized around those points; we’ll address  
both shortly.

The first goal is “Protecting injured homeowners“.

The discussion in the summary takes the view that the only “injured”  
homeowners that get any consideration are those “genuinely damaged by  
paperwork failures”. Thus the only problems that are addressed are  
screw-ups in the mod/short sale process and wrongful foreclosures. We  
see nary a mention of origination fraud or servicing abuses and  
errors. Yet foreclosure defense attorneys have said in 50% to 70% of  
the cases they represent, the borrower got in serious arrears as a  
result of servicing errors and compounding fees; a single late or  
misapplied payment can quickly compound into a multi thousand dollar  
deficiency before the borrower even finds out something is amiss.

Now let’s turn to the summary of section 2, “Keeping the housing  
market moving“:

The Massachusetts decision shouldn’t justify the creation of a cottage  
legal
industry aimed at stalling inevitable foreclosures. Creating a limited  
safe harbor from
paperwork-related litigation for pending foreclosures on abandoned or  
severely
delinquent properties would provide more certainty to the housing  
market and help
triage potentially successful modifications from inevitable  
foreclosures. In addition, a
one-year statute of limitations on paperwork-related lawsuits would  
ensure litigation
doesn’t drag on for years.

This is a doozy. “Cottage legal industry”? This is a more  
sophisticated, drive by version of the tactic used in a widely  
deplored first page Wall Street Journalstory which demonized  
foreclosure defense lawyers for being competent at court procedure.

Is there any other instance where an entire set of parties to a broad  
class of contract have gotten a free waiver for their own enormous,  
costly, and purely elective errors? The normal arrangement is that to  
obtain a waiver or a change in contract terms that has economic value,  
consideration must be paid. Remember the JP Morgan purchase of Bear:  
the reason the price went from $2 per share to $10 was that JPM had  
made a drafting error that left it exposed to more risk than it had  
bargained for and it needed to reopen the deal.

But I see no proposal here to have borrowers receive compensation from  
servicers and trustees for having their rights compromised. Aha,  
that’s the reason for all the expatiating about the Ibanez decision  
being bad for borrowers. They should give a major concession for free  
because it’s really good for them! Stockholm syndrome in action!

If the Third Way types were truly concerned about protecting  
homeowners rather than banks, they’d at the very least give homeowners  
something in return for the rights they are being asked to sacrifice,  
such as allowing courts to write down mortgages to current market  
value in bankruptcy (a well established practice for virtually every  
other type of secured lending).

Per the Third Way logic, the new reality of contracts is not the  
libertarian model of an agreement between equals, but of raw might  
makes right. A contract is treated as an ironclad, rigid arrangement  
if you are a small guy, but compliance is optional if you are powerful  
and well connected. Rubinites clearly benefit from promoting this  
world view.

And standing is NOT a matter of “paperwork”. This is a bedrock legal  
principle. Abandon the concept of legal standing, which is what this  
document calls for, and anyone can show up in court and say he has a  
right to your house once the statute of limitations has expired. Given  
that the initial foreclosure notice often lead to payment catch-up  
plans, combined with servicer incentives to keep borrowers in a  
delinquency “sweat box”, it isn’t hard to see servicers gaming a one- 
year statute of limitations (look how good a job they did of gaming  
the far more complicated HAMP).

In the detailed remedies section later in the document, Third Way  
picks up on a Shiela Bair proposal, that of a safe harbor against  
lawsuits if the house is vacant or the servicer has offered a deep  
payment mod, at least 25%. The vacancy provision looks like a red  
herring. How many cases are there where the house has been vacated,  
yet the borrower is suing? The only one I know of is not one that does  
not hew to the proposal’s assumptions about the motives of borrowers  
who do vacate property yet sue to get it back. The borrower left  
because she had previously been wrongly evicted from a rental, and  
everything in her apartment was dumped on the curb. By the time she  
got home from work, all her possessions, including her baby’s crib,  
had been stolen or hopelessly damaged. Economically and emotionally  
she could not afford to go through that again and moved out when the  
foreclosure became final (her attorney later filed a wrongful  
foreclosure suit).

More broadly, this element of the proposal appears unnecessary, and  
may give banks too much latitude in defining what is subject to this  
safe harbor.

As for Bair’s proposal for payment mods, the problem is that research  
shows again and again that what is called for is deep principal mods.  
Why should a borrower work to keep a deeply negative equity home only  
to face a shortfall upon sale?

Note that these provisions would also presumably have the effect of  
sheltering servicers and trustees from litigation, when the trustees  
made multiple certifications that they had all the loans and  
everything was in order. Remember, if the trustees had done what they  
repeatedly said in writing, in SEC filings, that they had done, none  
of this would be an issue.

Thus the Third Way plan also destroys contractual agreements without  
approval of the parties. Investors were entitled to get collateral  
with good title and, in the absence of that, to put back defective  
collateral to the seller. This would undo such contractual provisions  
for the sole benefit of one side, those on the originating/servicing  
end of the deal.

The next section, “Preventing future failures“, is motherhood and  
apple pie. The work is fobbed off to the Consumer Financial Protection  
Bureau, which in turn has to get approval from the members of the  
Financial Stability Oversight Council. Effectively, all the document  
calls for is for the CFPB to make sure banks live up to their  
contractual commitments. What a concept!

An ironic aspect of this proposal is that it is depicted as a way to  
reduce uncertainty. In fact, any Congressional intervention into well- 
settled state based real estate law is very likely to generate  
Constitutional challenges, particularly since Federal bank regulators  
have acknowledged that state law still applies to securitization  
assets. That in turn will increase, not reduce, uncertainty, and put  
the real estate market in an greater pall than it is now.

Finally, yet more “appease the banks” is a politically fraught  
strategy. The Administration seems unable to learn the real lesson of  
the midterm elections and is redoubling its efforts to pursue a failed  
course of action. Bank-friendly Blue Dog Democrats lost, progressives  
for the most part stayed in place, and Tea Partiers became a  
Congressional force for the first time. The unifying element is that  
this was a “vote out the corporatist incumbents” move above all else.

Establishment Republicans would also be wise to give this proposal a  
wide berth. If you want to recruit for the Tea Party, you could hardly  
find a better tool that to have the Federal government interfere with  
local courts on a matter as important to most Americans as their homes.

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