Home Real Estate Can You Say… Oh $#!^ For REO and Foreclosures?

Can You Say… Oh $#!^ For REO and Foreclosures?

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A couple of weeks ago, I wrote that if you have a REO or short sale practice, you want to pay attention to some legal cases going on around the country:

Trouble is, MERS might lack legal standing to bring a foreclosure action. At least, that’s what the attorneys for the homeowners who are getting foreclosed are claiming.

Given that so many mortgages were packaged into securitization pools (RMBS), sliced and diced, with different investors taking a different piece of a few hundred thousand pooled mortgages… it really isn’t clear who actually owns the mortgage, and has the right to enforce its terms by foreclosure (or have its duly authorized agent/servicer do it).

I noted then that this seemingly esoteric legal issue is a thermonuclear landmine for the entire foreclosure and short sale industry, including real estate agents who represent buyers and lenders.

Well, Congress has been holding hearings on problems in the foreclosure industry. I haven’t seen too many media coverage of the hearings. This blogpost on Washington Post is one of the few I could find. I just spent valuable two hours of my life watching CSPAN video of the hearing on December 15, 2010, which is embedded above.

This topic is just too big, even for my lengthy posts. But if you have anything to do with foreclosures, REO’s, and short sales… I would suggest you spend some time looking at this issue.

MERSde!

As I said, the entire topic of foreclosures, mortgage servicing, and so on is just too big. But I think I could speak to one thing that just jumped out at me, especially in the Dec 15th hearing.

The committee spent… easily half of the hearing on MERS (Mortgage Electronic Registration System) . One defender of MERS, a Thomas Deutsch from the American Securitization Forum, testified. Arrayed against him were a law professor, Christopher Peterson from University of Utah Law School, and a number of attorneys who are involved in litigation. As it happens, Prof. Peterson wrote a law review article entitled Foreclosure, Subprime Mortgage Lending, and the Mortgage Electronic Registration System that was published in the University of Cincinnati Law Review. If you’re really bored, you might want to read that. I did. It isn’t comforting.

The thing that I couldn’t help but notice was how the members of the Committee, both liberal Democrats like John Conyers and Henry Johnson as well as conservative Republicans like Lamar Smith and Trent Franks, kept asking questions of Peterson seemingly with approval. Rep. Franks said outright that he agreed with Peterson’s views on MERS. I find it highly unlikely that Democrats will seek political points by siding with banks and institutional investors, as represented by Deutsch. (Funny thing — Conyers kept pronouncing Deutsch with a long-u sound… as in “douche”. I wonder if that was intentional or subliminal.)

At about a 1:30 mark, there’s an exchange that should send chills down your spine. Rep Bobby Scott (D – VA) straight up asks, “If a person buys a property at foreclosure, who do they buy it from?”

Peterson answers, “It’s not clear.”

Uh-oh.

I imagine legislation is coming. I have no idea what form that legislation will take. But MERS appears to be in everybody’s gun sights. And of course, that  means kaboom. As Deutsch from the ASF says, any uncertainty on MERS, on ability of investors to foreclose through MERS, would be catastrophic for the industry; the capital markets would simply freeze up, and buyers would find it even harder to actually get a mortgage.

Land of Confusion

The related issue that got some discussion is that in mortgages that are handled through MERS (some 60% of all mortgages), there are significant questions as to title. One witness, James Kowalski, who represents homeowners going through foreclosure, noted that in one of his cases, two separate investors claimed to own the same note and were foreclosing on the same house at the same time. Uh-oh.

You may not think it’s possible that some the millions of people who have bought via short sale or REO would never get a letter from some attorney representing the former homeowner who wants their house back claiming that they never surrendered title to their property… but I don’t think it’s out of the question.

The nightmare scenarios are aplenty. Presumably Congress if and when it acts has to pass some sort of legislation on foreclosures will have to do something to resolve all of the cloudy title issues arising from the combination of MERS and robo-signers. But who knows what they can do to clear title that has now been muddied up. If government action in the form of legislation results in loss of private property – which a homeowner who has lost a home and all of his equity in it would surely claim – then the Takings Clause would get involved. Congress might have the power, under the Commerce Clause, to do legislation covering foreclosures and MERS… but it might have to setup some sort of compensation to foreclosed homeowners. What might that cost? I have no idea. Uh-oh.

Predictions

Given what I’ve heard and read, here are some predictions:

  1. There will be Federal legislation on foreclosures and short sales sometime in 2011.
  2. Fannie Mae and Freddie Mac will likely be prohibited from guaranteeing or purchasing any mortgages that are connected to MERS, absent major legislation.
  3. MERS itself will likely be put right out of business, either through litigation that could go all the way to the Supreme Court, or through legislation prohibiting electronic circumvention of the state laws on recording mortgage transfers. This would likely put a major damper on securitization of mortgages… which will have other negative consequences.
  4. Loan servicers are likely going to have to deal with major increases in federal regulation, all of which is a burden. The witnesses spent quite some time talking about how loan servicers are incentivized to resist short sales so they can make more fees.
  5. There will be multiple major class-action lawsuits against banks, loan servicers, and of course, against MERS.

Not one of these things is good news for the real estate market and the industry as a whole, at least in the short-term. In the long-haul, the coming reforms may end up bringing more transparency to the market. But we’ll be living through “interesting times” for some time now.

There are so many other scary things in here (like tax exempt status for REMICs (Real Estate Mortgage Investment Conduits) going poof) that I’ll be returning to this topic periodically.

-rsh

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Rob Hahn
Managing Partner of 7DS Associates, and the grand poobah of this here blog. Once called "a revolutionary in a really nice suit", people often wonder what I do for a living because I have the temerity to not talk about my clients and my work for clients. Suffice to say that I do strategy work for some of the largest organizations and companies in real estate, as well as some of the smallest startups and agent teams, but usually only on projects that interest me with big implications for reforming this wonderful, crazy, lovable yet frustrating real estate industry of ours.

16 COMMENTS

  1. Rob, nice treatment of a very complicated topic, or set of topics I should say. While I am not anti government legislation in general (gasp) I really don’t know if our lawmakers have the clarity of thought and perserveance it would take to make much of this mess, other than a bigger mess. Hopefully, in later blog post, you can point to some free market solutions…

    • Thanks Paul. The trouble I have with this entire topic is that there is no way to separate the govt out from issues surrounding foreclosure and title. Title itself is a legal concept, after all. I don’t know that there is a free market solution.

      Furthermore, the market solution might take years and years to clear up, as well as waves of litigation.

      I really think the solution will be something like the tobacco settlement. More on that later.

  2. An interesting business that might come out of this crisis is an unwinder and buyer of securitized mortgages bringing them back to a more natural state. Once the mortgage is unsecuritized, then the foreclosure could take place. This could be very, very lucrative for someone to get involved in as the banks may have an asset that they can not foreclose upon if Congress creates legislation that is consumer focused.

      • Oh, I am sure it would not be easy, but if we see a populist uprising in Congress over the mortgage securitization issue, banks are going to have a very expensive proposition on their hands either way.

        The combination of a very nervous Washington that still does not understand the Tea Party movement but realizes they need to cater to it, and a populist uprising over foreclosures will make a very interesting scenario. The banks could be left holding the bag on this one if the legislation is just a little bit off.

  3. This is an important topic. I don’t see how this would impact short sales in which title is transferred to a new owner from the current owner just like a regular sale – the only difference being the bank agrees to remove a lien without full payment of the original debt. If so, then the question of “who owns the home” extends to any sale in which MERS was involved – not just distress. At least for past sales, wouldn’t title insurance protect the buyer? Seems like it should.

    • Bruce,

      Be sure to read your Title Insurance and Exceptions thereto VERY carefully these days. Most are putting in an exception clause to cover themselves on this issue. I had one the other day and we were able to have that clause removed prior to closing. But in most cases the clause says the Title Company “may” remove it prior to closing (or not), and do not give proof prior to closing as to whether or not they actually removed it. You have to be prepared to fight to protect your client and get all CYA clauses for the Title Company removed prior to letting it close.

    • Good point, Bruce. I suppose I felt that in a regular sale, there is no damage, no harm, so litigation is very unlikely. (Plus, the courts would throw the case out.) In a short sale, I could see some former homeowner who might plead some sort of economic harm from having to go through a short sale. Less likely than in foreclosure, but there are going to be unhappy people in a short sale situation.

  4. Many moons ago I said only Congress can deal with this. Why? The courts will take an eternity which is good for nobody. The fix will be in by this time next year.

  5. For all the confusion on this I am happy to see you post. thanks Rob, there are so many layers to this I appreciate what you were able to put into words. You predictions weigh on the side of Laws that existed prior to Mers which seemed to work fine. Now we don’t know who owns what, even on the investor side? Having followed some of the decisions that got us here I am questioning why and what was intent. Was it the search for a more streamlined system? Even if not by some plan then what was any “Smart” person thinking when we set the ground work for this mess.

  6. Rob, After our chat today I did a little more research and I still believe Congress will have no affect on this issue. The Banks are going to do what the Banks are going to do. The Realtors that these congressmen are meeting with are inept in the short sale negotiation process because they are tied to one thing…the commission. Not every short sale should go through. Whether MERS is challenged in court is to be seen. The question to ask is if someone is to be sued “Who is the damaged party?”….

    • The idea of not being able to sue if you’ve not been hurt by a given action is MERS’ whole trouble in the first place. MERS isn’t owed any money, so why should MERS get to foreclose? Yet there are all these lovely closing docs out there that say MERS is entity which is to foreclose on this note in the event of default…if enough judges decide they can’t, the debts won’t go away. It’s just that the banks won’t be able to take the houses to pay them…

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