What We Have Here Is A Failure To Document: NV and California Foreclosures

Now, why doesn’t the content of this paragraph cause any cries of wonder and incredulity from any part of Nevada?

When homeowners headed for foreclosure sit down with their bank to see if they can work out an agreement, state law requires the lender come equipped with documents proving who owns the home, among other things. In one-third of those mediation meetings, however, banks failed to produce the required documents, according to an analysis of the last six months of 2011.  [full story LV Sun] (emphasis added)

JPMorgan-Chase failed to provide documentation in 52% of the mediations, Bank of America failed 41%, Wells Fargo 31%, Ally/GMAC 50%, USBank 32%, Citigroup 12%.

Nevada’s story isn’t unique. However, when mediation is not a recourse, a person might expect that the actual foreclosure process would be subject to significant legal scrutiny.  Not so in San Francisco, California.  San Francisco Assessor Phil Ting conducted an audit, the results of which were released on February 15, 2011. (pdf)  Of the 382 foreclosures from 2009-2011 in the city included in the audit, 84% contained at least one “clear violation of California’s foreclosure law,” and 75% had some issue with the Deed of Trust.

The New York Times added: “The audit also raises serious questions about the accuracy of information recorded in the Mortgage Electronic Registry System, or MERS, which was set up in 1995 by Fannie Mae and Freddie Mac and major lenders. The report found that 58 percent of loans listed in the MERS database showed different owners than were reflected in other public documents like those filed with the county recorder’s office. “

The Aequitas Compliance Solutions report (pdf) states that there were “assignment issues” with 75% of the foreclosures, meaning that the assignment of a securitized mortgage was not properly recorded, filed, or executed.  In 6% of the cases there were actually two or more owners recorded for the same property.

Meanwhile back in Nevada, the foreclosure mediation program is very clear about what’s required of lenders.  The bankers are supposed to show up with the following documentation:

1. The original or a certified copy of the deed of trust, the mortgage note.
2. Each assignment of the deed of trust and each endorsement of the mortgage note.
3. Appraisal and/or Brokers Price Opinion (BPO) in accordance with NRS 645.2515 dated no more than 60 days of the notice of default.
4. Evaluative Methodology used to determine eligibility or no eligibility of the homeowner for a loan modification.
5. Confidential Proposal document to resolve the foreclosure.

The problems in both California and Nevada appear to originate when the bankers cannot present either the original or certified copy of the mortgage, or the assignments with endorsements.  Not to put too fine a point to it, but the Magic of MERS which was supposed to expedite the “filing” of mortgages/assignments such that the mortgage based securities could be cranked out and sate the investment banking communities appetite for CDOs, real and synthetic, failed to properly record, file, or execute much of anything.

And, herein is our cautionary tale.  Those who bemoan the “onerous burden of federal/state regulations” on the recording, filing, or execution of paperwork pertaining to mortgage backed securities, are deliberately ignoring sage advice from grandparents from time immemorial: “Haste Makes Waste,” and “There’s never time to do it right, but there’s always time to do it over.”

Nevada led the nation in foreclosures, and it’s all your fault

Good riddance to 2011′s housing market in Nevada.  “RealtyTrac of Irvine, Calif., which tracks foreclosures, reported Wednesday that during 2011, more than 6 percent — one in 16 — of Nevada housing units received at least one foreclosure filing. That amounted to 72,844 properties with filings last year.” [full story Las Vegas Sun ] Solutions anyone?

There’s Governor Romney’s Invisible Hand Solution: “The idea of the federal government running around and saying, `We’re going to give you some money for trading in your old car…or we’re going to keep banks from foreclosing if you can’t make your payments,” Romney said, “The right course is to let markets work.” [Boston.com]

“Let the markets work,” would be a lovely solution IF the markets were working.  What’s preventing the smooth operation of our housing markets?

(1) Toxic Assets. Surprise! Surprise! There is still a truckload of toxic assets clogging up the books of major banking and financial institutions.  As of last February U.S. banks had approximately $13.8 billion in what are politely known as “unrealized losses.”  Financial Superfund Sludge might be another way to describe it.   If it is acceptable to let homeowners “hit bottom,” then why isn’t it acceptable to make the banks “bite the bullet” and write down their losses?

“…losses are baked into banks’ book value, but don’t get counted against earnings as long as the banks believe the investments will later rebound. If those losses were assessed against earnings, it would have reduced the banks’ pretax income for the first nine months of 2010 by 21%, according to the Journal analysis.” [Wall Street Journal]

Investment in What? Are these investments in home mortgages going into default held on the banks’ books? Are these investments in derivatives based on securitized assets (in turn based on mortgages) on the banks’ books?  Are these investments in over the counter derivatives based on Heaven Only Knows What on the banks’ books?  Not only is the Great Invisible Hand not moving in this stagnant pool, it gives every appearance of trying to cover the mess up.

Not only can banks delay writing down the value of the Financial Superfund Sludge, but if they do take  action there are some accounting gimmicks that allow the bankers to prevent the write-downs from impinging on the Exalted Bottom Line.   Somewhere between “unrealized losses” and “accounting tricks” there’s a piece missing — the value of the assets.

Remember, in order for the Great Invisible Hand to function properly there must be a price (value) which can be agreed upon by the two parties in a market. Meanwhile back at the reporter’s desk at the Wall Street Journal:

“One problem centers largely on “Level 3″ securities, illiquid investments that can’t be easily valued using market prices. According to the Journal analysis, as of Sept. 30, the top 10 banks had $360.7 billion in “Level 3″ securities. That amounts to 42.6% of the banks’ shareholder equity, a pile of assets whose value is hard to verify.”

More recent figures will probably show that the weight of those Level 3 (Doesn’t that sound ever so much nicer than “Really Stinky Slimy Sludgie Stuff?”) has declined since the last calculations, but that doesn’t mean it’s gone missing.  “Value hard to verify?“  No one can verify the values because no one knows what the really stinky slimy sludgie stick’em is worth, and no one knows the worth because the only yardstick at hand is nothing more than what the bank that owns the gooey mess thinks it might be.

Someone might think to ask Governor Romney HOW a market is going to clean up the toxic assets if the situation could be stated as:  “I have a pile of paper (aka financial products) on my desk and I would like for you to buy it. I think it’s worth $13.8 billion dollars, but you think it might be worth $49.85 (the going rate for a decade’s supply of single ply industrial toilet paper). “  How do we “make a market?”

But this is all Your Fault — because your government should have known that the bankers were going to get carried away in their enthusiasm for “creative financial products,” and should have stopped them!  However, if the Mortgage Twins, the OCC, or the SEC had tried to stop them, then that would have been Onerous Government Interference in the Free Market!

(2) The problem of imMERSion.  Once upon a time the Bank of the Invisible Hand decided that Fannie and Freddie, which securitized home mortgages, weren’t moving fast enough, and those stodgy county recorders insisted on taking TIME to record property transactions — “This will never do,” cried the Bankers of the Invisible Hand, “We must move into the secondary mortgage market ourselves, and we will create MERS — an electronic mortgage recording systems — to make the process move FASTER.” So they did.

And when they did, standards for securitization declined, and so did the accuracy of the records regarding the original transactions.  In fact the Bankers of the Invisible Hand made such a dog’s breakfast of the process that a New York Appeals Court came to the following conclusion:

“This Court is mindful of the impact that this decision may have on the mortgage industry in New York, and perhaps the nation. Nonetheless, the law must not yield to expediency and the convenience of lending institutions. Proper procedures must be followed to ensure the reliability of the chain of ownership, to secure the dependable transfer of property, and to assure the enforcement of the rules that govern real property.”  [BankNY v. Silverberg]

By July 27, 2011 MERS  bowed out of the foreclosure process, and sent a message to its members: “… stating that no foreclosure proceeding may be initiated in the name of MERS and no legal proceedings in a bankruptcy may be filed in the name of MERS. ” [DS news]

Now what?  Those toxic “Level 3″ assets were often based on mortgages which were supposed to have been “electronically recorded,” except that the fancy new Super-Speedy electronic recording system didn’t work.   Not only do the banks have toxic assets on their books, which they can’t value, and don’t know if they will ever get beyond “unrealized losses” status, but now we’re having trouble figuring out what should have been a relatively simple question: Who owns what?

But this situation is all Your Fault — Because if your county recorder’s office had been up to speed with the latest and greatest in electronic real estate transfer systems, then the Bankers of the Invisible Hand would not have found it necessary to devise their own Super-Duper-Speedy MERS.  However, if you had promoted the idea of upgrading county IT systems, then that would have been “taxpayer dollars being spent on more government!” and after all, “we” want “smaller” government.

(3) Inventory and Housing Prices.  There is still slack in the housing market. “Total existing-home inventory fell again in November, by 5.8 percent to 2.58 million homes for sale. At the current sales rate, that represents a 7.0-month supply, down from a 7.7-month supply in October.” [RealEstateABC]   Good news/Bad news — yes, the inventory is down, but there are still are 2.58 million existing homes for sale.  And then there’s this pesky chart from the National Association of Realtors:

We know we’re in trouble when the little chart columns head down from the top instead of up from the bottom.  We might also read this as indicating which part of the country has the most homeowners “underwater.”   That would be “W” as in West, as in Us.

Good old fashioned common wisdom says that homeowners with 30 year fixed rate mortgages are probably not in as much trouble as those who purchased Alt-A, no-doc, subprime, or other exotic mortgages.   There’s a chart for that too:

Yes, indeed, that blue line (adjustable rate mortgage default)  shot up in 2007.  If home values held steady — or increased — then a homeowner could sell and be able to pay off a mortgage.  However, when we combine declining home values with those adjustable rate mortgages then the blue line has nowhere to go but up.

It’s never a good time to get into a protracted discussion of Loan To Value Ratios (LTVs) but it might be instructive at this point.   75 is the magic number because that’s the ratio most mortgage bankers want to see at a minimum.   The LTV equals the mortgage amount divided by the appraised value of the property.  For the truly wonkish, or totally curious, Bankrate.com has a calculator for your enjoyment.   If you need to borrow $150,000 to buy a home appraised at $180,000 then your LTV is 83 and the banker may not want your business.

This digression is appropriate because at least two things went wrong while the Bankers of the Invisible Hand were playing in the Housing Market during the Bubble.  One of the problems came in the form of inflated appraisals, when CoreLogic studied 525,000 mortgage loans in 156 pools sold by 10 investment banks from 2005 through 2007.

“By back-testing the loans using the CoreLogic model from the time the mortgage securities were originated, the analysis compared those values with the loans’ appraised values as stated in prospectuses. Then the analysts reassessed the weighted average loan-to-value ratios of the pools’ mortgages.

The model concluded that roughly one-third of the loans were for amounts that were 105 percent or more of the underlying property’s value. Roughly 5.5 percent of the loans in the pools had appraisals that were lower than they should have been.

That means inflated appraisals were involved in six times as many loans as were understated appraisals.”  [NYT]

Problem Number One with inflated appraisals was that the Bankers of the Invisible Hand palmed mortgages based on them to investors in the secondary housing market thus making the problem not only “Who Owns What? but Who Owes How Much?”  Problem Number Two with inflated appraisals is that:

“Loan originators, many paid on commission, sometimes pressure appraisers to fudge their numbers to make mortgages work, experts say. That means people who don’t have a ballpark figure in mind before they borrow — or who don’t verify numbers that sound too good to be true — could be setting themselves up for financial ruin.”  [Bankrate.com]

And, the blue line goes up.

But this situation is all Your Fault:  Because you should have known that the sales pitch for the mortgage was based on a faulty, fudged, or “bending-lending” home appraisal!  Even though the Banker of the Invisible Hand supplied the appraiser.   And, you should have known that the Bankers of the Invisible Hand were going to pool all these mortgages into asset based securities and sell them to  so-called sophisticated investors who didn’t have a clue about the underlying origination terms and values, thereby creating more Super Slimy Toxic Asset Sludge.   It’s also Your Fault because if your government had been awake while the toxic mess was being created, then the Bankers of the Invisible Hand wouldn’t have been able to manufacture these fudgy mortgages.  However, had the government agencies cracked down on questionable Invisible Hand Bank practices — that would have been onerous and burdensome regulation on the Free Market.

Governor Romney has apparently overlooked the little problems of (1) the creation and accumulation of toxic assets currently gumming up the plumbing of the financial sector, and when the Bankers of the Invisible Hand might bite the bullet and write down the costs of their enthusiasm, (2) the imMERSion issue creating questions about who exactly owns what exactly, and (3) the exacerbation of the housing bubble collapse because the machinations of the Bankers of the Invisible Hand made mince-meat of the numbers that usually underpin the housing market — like loan to value ratios — in their zeal to crank out more mortgages to satisfy their appetite for securitization.

In short, to lend credence to Governor Romney’s blesséd and blinkered vision of the Free Market Solution To Everything, one must also ignore everything the Bankers of the Invisible Hand did to create a colossal Free Market failure in the first place.

Because I Am A Capitalist

Some of the more hyperbolic conservative writers are fond of tossing about charges of “socialism” or even “communism,” when addressing the economic proposals of  progressive or liberal advocates, as if the latter were anti-capitalists.  Perhaps part of the problem can be analyzed by first making it clear that I am a Democrat BECAUSE I am a capitalist; not in spite of it.  Let’s start with a clear and commonly accepted definition:

“Capitalism:  an economic system in which investment in and ownership of the means of production, distribution, and exchange of wealth is made and maintained chiefly by private individuals or corporations, especially as contrasted to cooperatively or state-owned means of wealth.”  [Dictionary]

That’s simple enough for most people. The production, distribution, and exchange of things for money (wealth) is conducted by private individuals.  Transferring wealth is managed by creating markets, i.e. I have some books, you want to buy two of them. We “make a market” when we agree on the price, you give me the money and I give you the books.  You increase the value of your personal library by two books and I deposit the money in my bank account.   If I can supply want you demand (two books) and we can agree on the price, we’ve “made a market,” and conducted a private transaction in the classic sense of capitalism.   So, why revert to this elementary school illustration of what capitalism means?

Because there are those who have confused capitalism with unfettered individualism and unrestrained financialism, and therein lies the problem. Capitalism without some basic governance structure can quickly devolve into very “unfree” territory.  Let’s look at two simple examples:

There is no free market when I monopolize the production, distribution, or exchange of an item.  If I own the only publishing house manufacturing mathematics text books for high school students then every school, public and private, must agree, however grudgingly, to my price.  This isn’t a free market, this probably closer to highway robbery.   I am acting in my individual best interest — toward the maximizing of my profits,  but I am definitely not creating a market in the classic capitalism sense of the term.  Therefore, we allow a government to constrain tendencies toward monopolies in the interest of creating fair markets.

There is no free market when I can take someone else’s idea or product and pass it off as my own.  If we were to take the free market idea to a ludicrous extrapolation then I would be “free” to manufacture, distribute, and sell anything — whether it’s mine to sell or not.  However, the authors of the U.S. Constitution understood that this is not the way to run a fair market, so we have Article I, Section 8 allowing Congress to “Promote the Progress of Science and useful Arts, by securing for times to Authors and Inventors the exclusive Right to their respective Writings and Discoveries.”  AKA copyrights and patents.

The U.S. Constitution also discusses other elements in creating fair markets.  Congress can “regulate Commerce,” “coin money,” and “fix standards of weights and measures.”    James Madison was quite clear about what he perceived as a major flaw in the Articles of Confederation:

“The practice of many States in restricting the commercial intercourse with other States, and putting their productions and manufactures on the same footing with those of foreign nations, though not contrary to the federal articles, is certainly adverse to the spirit of the Union, and tends to beget retaliating regulations, not less expensive and vexatious in themselves than they are destructive of the general harmony. ” [LOC]

Madison’s point is fairly simple:  A totally free economic system without restraint and supervision moves very quickly from a free market to a free-for-all.

My point is essentially the same. When it’s “every man for himself” there is the least actual economic freedom.    Adam Smith, battling the conservative forces of Mercantilism, believed that enlightened self interest predicated on long term vision would be enough to curb excesses, and should that prove insufficient, a bit of government oversight would be practical. [Investopedia] Unfortunately, Smith has been pressed into service to support unrestrained, and ill advised adventures, into free-for-all economics.

What does Capitalism need in order to create a viable economy for this nation? 

If we agree with the authors of the Constitution that we’re better off when the federal government ( not each individual state) regulates interstate and foreign commerce, then our capitalist system needs some structure. If we agree with Madison that “general harmony” is a better foundation for our economy than unrestrained individualism, then our capitalist system needs regulation to encourage the creation of fair markets.

Now we come to the sticky part about ‘fair markets’ and The Invisible Hand.

There are those who argue, quite sincerely, that the consequences of economic decisions must be sought in the impersonal, invisible hand of the market.  How does this relate to the little market example about the two books?  It doesn’t.

Remember, in the example given above We Agreed On The Price.  There is nothing invisible here, and the explanation is relatively simple:

“I have often argued (and as often to no avail) that there is nothing invisible in markets – in fact it is their necessary visibility that provides the essential dynamic for their operation. Prices are very visible; they have to be because prices are what influences purchases and competitive responses. Potential buyers do not have to ‘guess’ the price. Participants, you write, “look at, and compare, relative prices” and “decide what to produce, how much to produce, what to buy and sell,how to invest their capital (if they have any)”. [ASLostLegacy]

An unfair market is one in which values cannot be computed with any reasonable expectation of accuracy.   If this sounds vaguely familiar, it should.  The inability to calculate the actual value of securitized assets on the books of several major investment houses in the U.S. during the housing bubble collapse of 2007-08 was “invisibility” at its worst, and the consequences were obvious — think Lehman Brothers, or think “Las Vegas Housing Market.”

Thus far it seems reasonable to propose that a Fair Market is not monopolized, is regulated to mitigate against fraud, theft, and abuse, and is one in which the items being exchanged have a very Visible value.

Since I believe that capitalism works best when it facilitates free and fair markets, and that free and fair markets are necessary to sustain our economy, why am I not supporting Republican candidates?  Fair question.

Here’s Willard Mitt Romney’s proposal on government regulation: “Repeal Dodd-Frank and replace with streamlined, modern regulatory framework.” And, “Amend Sarbanes-Oxley to relieve mid-size companies from onerous requirements.“

First, I have absolutely no idea what the candidate means by a “streamlined, modern regulatory framework.”  So, I’m left guessing. Does he mean allowing the bankers to regulate themselves as per the GOP version of oversight of “systemic risk?”  I think we tried this with the Gramm-Leach-Bliley Act of 1999, and the result appears to have been the demise of all the investment banks on Wall Street.  Does the former CEO of Bain Capital Management want to revert to the days of “invisible” trading in complex derivatives?  We’ve seen where that leads.

Secondly, Sarbanes-Oxley, enacted in the wake of the Enron Debacle, may not be so “onerous” as Mr. Romney suggests.  What, for example, is a mid-sized company?  If we are speaking here of “mid-sized” financial firms, do those get to make up their own rules about financial reporting?  At some point World Com, HealthSouth, and a host of other firms with dubious reputations (or down right illegal practices) were “mid sized.” Do we wait until they become behemoth blights on the economic landscape before we check up on the markets they are creating?

Perpetual candidate Newt Gingrich offers only more of the same in his description of his ideal economic structure:

Steps include: Repealing the Sarbanes-Oxley Act, which did nothing to prevent the financial crisis and is holding companies back from making new investments in the U.S; Repealing the Community Reinvestment Act, the abuse of which helped cause the financial crisis; Repealing the Dodd-Frank Law which is killing small independent banks, crippling loans to small businesses and crippling home sales; Breaking up Fannie Mae and Freddie Mac, moving their smaller successors off government guarantees and into the free market; …”

There is nothing new here.  Repeal Sarbanes-Oxley, repeal Dodd-Frank, and replace them with what?  At least candidate Romney gave me something about which to guess — there’s nothing in the Gingrich proposal except to remove all the obstacles to reverting to the Good Old Days when Enron accounting wasn’t an oxymoron, and Lehman Brothers was amassing a pile of commercial real estate paper of in-determinant worth.

Candidate Gingrich would like to disband the Mortgage Twins…and replace them with what?  A system in which there is no secondary mortgage market and banks have to hold all the home loans on their own books?  This would guarantee there would be no more housing bubbles — in no small part because there would be no more housing market.   The interesting part of the Mortgage Twin attack is Gingrich’s assumption that they were government entities, which they weren’t; and, that there was a “guarantee,” which there wasn’t — it was only implied because Fannie and Freddie were corporations, complete with CEO’s and stockholders.  Fannie and Freddie WERE playing in the free market, or rather a free-for-all-market in which they were losing market share.  Hence their miserably mishandled portfolios.

Repeal the Community Reinvestment Act? Why?  The only thing the law requires is that banks make their products available to all their depositors.  It doesn’t now, nor has it ever, required that people who don’t qualify for mortgages obtain them.  And, it certainly doesn’t require banks to create markets for Alt-A, no documentation, and other questionable mortgages.  Nothing in the CRA required banks to reduce their underwriting standards — they did that all by themselves.

There isn’t much daylight between the remaining Republican candidates, so my objections haven’t been answered.

(1) In a free and fair market, prices aren’t invisible.  They should be clear to everyone who participates.  Enron accounting IS an oxymoron (ask former employees of Arthur Anderson Inc?)  Repealing Sarbanes-Oxley, or significantly reducing the statute’s effectiveness at rendering corporate financial reports intelligible, is not the way to create free and fair markets in which buyers and sellers can agree upon valuations.

Allowing unsupervised  over-the-counter trades in credit default swaps served only to obscure the ownership and value of these financial products, and contributed nothing toward making the value of underlying assets more visible.   Repealing the Dodd-Frank Act would only allow a continuation of practices that were more conducive to obscurity than transparency and accountability.

(2) In a free and fair market, opportunities for fraud and abuse are minimized.  Let’s face it, Enron’s bookkeeping was a classic fraud.  Repealing Sarbanes-Oxley only invites more of that behavior.  Selling subprime mortgages to people who would have otherwise qualified for conforming mortgages was definitely an abuse.  Creating an electronic end run on the requirements for recording real estate transactions was an abuse.  Robo-signing real estate documentation was an abuse. Repealing the provisions of the Dodd-Frank Act only invites more such abuse.

I am left with the conclusion that all the Republican candidates are offering in support of a capitalist system is protection for the Financialists who would very much like to play in a familiar sand box, free of oversight, regulation, or any other form of restraint on the very practices which imperiled our economic system in the wake of the Enron Debacle and the Housing Bubble Meltdown.

Contrary to the image presented on the television screen, there are more markets than just the one for stocks and bonds.  We make markets for homes, for wholesale products, and for retail goods and services.  Those markets should be comfortable for participants, not predators.   Our markets should be based on the long-term vision expected by Adam Smith, not the short term quarterly earnings report view emphasized by the Financialists.

What I am looking for are candidates who want to protect our markets from predators, protect our financial system from short-termism, and protect American jobs from the not-so-tender mercies of merger and acquisition desks.   I am more interested in candidates who have not bought into the Great Supply Side Hoax, and know that a market requires not only a seller but a buyer with the earnings necessary to support our capitalist economy.

If I can’t find them in the Republican Party, then the Democrats who supported Sarbanes-Oxley and Dodd-Frank will be getting my vote.

Speed Kills: Nevada’s Mortgage Mess, MERS, and Mayhem

Nevada Attorney General Catherine Cortez Masto (D) has filed suit against Lender Processing Services Inc. and subsidiaries for “violation for tens of thousands of violations stemming from a “pattern and practice” of “falsifying, forging and/or fraudulently executing foreclosure related documents, resulting in countless foreclosures that were predicated upon deficient documentation.”  [RGJ] That is a fair summary, but actually, there’s a bit more to it, the press release from the Attorney General’s office is more specific.  Lender Processing Services: [NVAttnyGen pdf]

1) Engaged in a pattern and practice of falsifying, forging and/or fraudulently
executing foreclosure related documents, resulting in countless foreclosures
that were predicated upon deficient documentation;
2) Required employees to execute and/or notarize up to 4,000 foreclosure
related documents every day;
3) Fraudulently notarized documents without ensuring that the notary did so in the presence of the person signing the document;
4) Implemented a widespread scheme to forge signatures on key documents, to ensure that volume and speed quotas were met;
5) Concealed the scope and severity of the document execution fraud by
misrepresenting that the problems were limited to clerical errors;
6) Improperly directed and/or controlled the work of foreclosure attorneys by imposing inappropriate and arbitrary deadlines that forced attorneys to churn through foreclosures at a rate that sacrificed accuracy for speed;
7) Improperly obstructed communication between foreclosure attorneys andtheir clients; and (8) Demanded a kickback/referral fee from foreclosure firms for each case referred to the firm by LPS and allowed this fee to be misrepresented as “attorney’s fees” on invoices passed on to Nevada consumers and/or submitted to Nevada courts.

The list is more or less the definition of a “foreclosure factory.”  It’s also more or less the logical outcome of what happens when the demand for mortgages to plow into the “structured finance” maw creates a demand for close-to-the-speed-of-light documentation, and the substitution of things like MERS for good old fashioned filings with the appropriate county officials.  There should have been some stop signs along the way.

The roads through the subdivisions and financing establishments should have been posted with STOP signs for (1) Stop and think before you yield to the temptation to believe that investing in residential real estate is like investing in the stock market.  To open a margin account at your local brokerage requires a deposit which is at least $2,000 and can be higher depending on the margin agreement signed.  Your initial margin will be 50% — meaning you have to cover at least 50% of the amount you are borrowing.   The SEC goes a step further, describing the “maintenance requirement.”

“The equity in your account is the value of your securities less how much you owe to your brokerage firm. The rules require you to have at least 25 percent of the total market value of the securities in your margin account at all times. The 25 percent is called the “maintenance requirement.” In fact, many brokerage firms have higher maintenance requirements, typically between 30 to 40 percent, and sometimes higher depending on the type of stock purchased.”  [SEC](emphasis added)

Therefore, if you are investing in the stock market, and borrowing funds to purchase stocks, then the lowest percentage you’d have to cover is at least  the 25% maintenance requirement.  Now, compare that to the No-Down-Payment Adjustable Rate Mortgage business.

There isn’t an investment advising brokerage in the country who would agree to a 0% deposit, 0% reserve, no cover margin agreement with any client, so why would a “flipper,” or even someone investing in real estate as rental property, ever believe that investing in no-down payment ARMs was a sound idea?  Just as you’d have Zero in your margin account, you have Zero equity in your house.   Of course, surprise – surprise, it’s much easier to walk away from a purchase in which you have Zero invested.  (Hint: That’s why the retail broker makes you sign that margin agreement.)

The happy home flipper may have thought that residential property was an investment in which there was no deposit required to open “the account,” no “initial margin,” and nothing required but to keep up the payments until the property could be sold.   There are countless home restoration and resale specialists in this country who have voluminous experience in the resale housing market — unfortunately, the siren songs of the Get Rich Quick Bunch drowned out ages of wisdom achieved through experience — precisely like the Song Of The Electronic Documentation Siren who told financiers that there was an easier, faster, way to record property transactions rather than to deal with the stodgy clerks in the Recorder’s office.

Just because my speedometer says my vehicle can reach 180 mph, doesn’t mean I should drive at that speed.  Equally, just because mortgages and related property transactions could be electronically filed with MERS at lightning speed doesn’t mean that was the best way to properly document ownership.  There should have been a second STOP sign.

A stop sign that required mortgage handlers to (2) Stop and think that perhaps the MERS system was convenient for “structured finance,” it wasn’t the way to properly account for real estate transactions.  This should have been something to consider before the Clerk of Duval County, Florida filed suit against MERScorp, saying:

“The MERS System is not a legal system of record or a replacement for public land records. No interests are transferred on the system—they are only tracked,” Smith, Merscorp vice president of corporate communications, wrote in a response to emailed questions. “MERS does not have or maintain any document recording system, public or private, and does not do anything to compete with or supplant the public records for land located in the County records.” [NatlMortgageNews]

Third, yet another STOP sign should have popped up to advise the promoters of structured finance to (3) Stop and think about the underlying value of real estate transactions in which altogether too many buyers had too little actual ownership in the properties, which were tracked instead of recorded properly, and which because of the paucity of real ownership stakes and real documentation could easily become “toxic.”

Not to put too fine a point to it, but the short term focus of the practitioners of Financialism combined with the short term focus of those who came to believe that real estate was “just like any other investment,” was in itself a toxic brew.

Im-MERS-ion in Litigation: Why Unwinding the Mortgage Meltdown Won’t Be Simple

It’s probably a clue:  The only Republican presidential candidate who appears to favor adjusting mortgage foreclosure operations such that homeowners and mortgage holders share the “haircut,” is one of the least likely to get much support from the Nevada GOP Caucuses. [LVSun]  The lack of specifics probably illustrates the vapidity of the suggestion.  The sticking point, of course, is the Double, Triple, Quadruple, Bind in the litigation arenas.

Real Estate on Speed

One factor contributing to the Housing Bubble Casino on Wall Street was the now all too familiar securitization of mortgages into various and sundry “creative financial products” which were bought and sold amongst traders eager to make a market for mortgage based assets.  However, the huge demand for mortgages for the slicing, dicing, and tranching desires of the bankers needed more speed than could be provided by the local county Recorder’s Office.

Enter MERS, a Reston, Virginia based business created in 1995 by mortgage lending interests, was intended to speed up the process by “going paperless.”

“MERS members, mortgage industry executives, invented the so-called MERS paperless system to short cut standing mortgage lending safe guards and circumvent the legal requirements for originating mortgage loans and/or for selling and transferring these loans to subsequent holders. This would allow MERS members like Countrywide Financial, Fieldstone Mortgage, and Option One Mortgage to make loans to anyone with a heart beat and then quickly flip these questionable loans to other MERS members such a FannieMae, Freddie Mac, Bear Stearns, Merrill Lynch, Lehman Brothers to name just a few. (”Secondary Mortgage Market Players’)”  [LW.org]

The trick to finding out which companies are MERS members is that you must be a MERS member to find out the names of other members.  [MERS] Suffice it to say that if an entity sold a mortgage it was probably a member, and if it bought mortgages in the secondary mortgage market it was probably also a member because of the “need for speed.”   The faster the mortgages could be “recorded” in this “paperless” system the faster the mortgage based securities could be manufactured.

As of February 14, 2011 the rug came out from under MERScorp when it was ruled:

“MERS’s theory that it can act as a ‘common agent’ for undisclosed principals is not supported by the law,” Grossman wrote in a Feb. 10 opinion. “MERS did not have authority, as ‘nominee’ or agent, to assign the mortgage absent a showing that it was given specific written directions by its principal.” [Bloomberg]

MERS had been acting as the “common agent” for “undisclosed principals” who were foreclosing on mortgages that someone owned somewhere.

As of February 17, 2011 MERS sent a memo to its members saying it was “re-evaluating its guidelines,” and that members should not try to foreclose in its name.  [ZeroHedge]*  By July 28, 2011 the new guidelines were in place and MERS had further distanced itself from the foreclosure processes. [Housing Wire]

Someone might have wanted to recall Grandma’s Truism: Haste Makes Waste.  The fallout from this hasty computer driven electronic paperless unmarked trail of mortgage transactions has created part of the double bind — it is unclear in some cases who actually owns the mortgages, and if the ownership of the mortgages is unclear then how is it to be determined who owns the securities upon which the mortgages were based?

Let The Litigation Begin

On September 2, 2011 the FHFA filed suit against 17 banks for selling Fannie Mae and Freddie Mac nearly $200 billion in toxic assets.   The banks have predictably countered that the Mortgage Twins are the “ultimate sophisticated investors” and therefore should have been able to determine the risk involved in the transactions.  [NYT]  The filings may help publicize how the housing bubble was inflated to the detriment of the U.S. housing market, and the economy in general:

“Buried in the filings themselves, however, is a damning portrait of the excesses of the housing bubble, when borrowers were able to obtain home loans without basic proof of income or creditworthiness, and banks appeared only too happy to mine profits taking the risky loans and assembling them into securities that could be sold to investors. “  [NYT]

The claims that the banks were selling to “sophisticated investors” might pack a bit more water had not the independent Clayton analytics firm offered its warnings, and in the case of Citigroup the warnings came from within the firm itself.  Richard Bowen III, told his superiors at Citi  in June 2006 and again in 2007 that 60% of the products it had sold were “defective.”

“…mortgages were sold to Fannie Mae, Freddie Mac and other investors. Although we did not underwrite these mortgages, Citi did rep and warrant to the investors that the mortgages were underwritten to Citi credit guidelines.  In mid-2006 I discovered that over 60% of these mortgages purchased and sold were defective. Because Citi had given reps and warrants to the investors that the mortgages were not defective, the investors could force Citi to repurchase many billions of dollars of these defective assets. This situation represented a large potential risk to the shareholders of Citigroup.” [FCIC]

But, the fun is just beginning.  On September 9, 2011 a ruling declined to give investors class action status in suits involving toxic assets, leaving us with the specter of banks fighting amongst themselves over the Defective Merchandise they palmed off on one another.  Pension plans and other entities have joined the fray.  [Bloomberg]

Fun With Numbers

The situation wasn’t simplified any further when in April 2009 the SEC allowed the bankers to play with new accounting rules.  The revised rules (mark to market) are essentially:

“…giving banks greater discretion in determining what price to carry them at on their balance sheets. The new rules were sought by the American Bankers Association, and not surprisingly will allow banks to increase their reported profits and strengthen their balance sheets by allowing them to increase the reported values of their toxic assets.”  [Baseline]

Oh, good!  We may have moved from Mark to Market to Mark to Mythology?  One commenter observed: “This implies to me mark to market in this environment has begun to lose its meaning. [...] But to me this financial crisis is about this “bid-ask spread” and the unwillingness or inability by anyone to make a strong case as to where values are.” [Baseline]

Chutes and Ladders

If anyone is suggesting that there is a clear or simple way to extricate the U.S. economy from the Mortgage Meltdown, and to find justice (if not satisfaction) for homeowners, mortgage servicers, mortgage lenders, mortgage banking, federal regulators, and the general public — they have obviously NOT been paying attention.

Those who are suggesting that the Invisible Hand of the Mythical Market be allowed free rein, haven’t been watching either.  (That would be Romney?)  The Big Old Invisible Hand works quite well when all parties to a transaction know what is being bought and sold, and have agreed upon a price representing the value of the product or service being sold.   It doesn’t work so well when parties and counter-parties are dealing in “assets” based on products that were highly questionable in the first place, which may or may not be owned by someone, somewhere, and which may or may not have an agreed upon value.  And, we haven’t even broached the subject of the derivatives based on those original questionable assets + even more questionable ownership + even more questionable accounting and transactional opacity.

The point being that at some time government must determine the rules by which all the players in the real estate game are to conduct themselves.  Can they rely on “paperless” recording of real estate transactions?   Given MERS’s departure from the table this remains an open question.  How do we prevent the replication of the creation of extremely dubious loans made to evidently ineligible individuals, solely for the purpose of repackaging and selling in the secondary mortgage markets?   How much transparency is required when transactions between so-called “sophisticated investors” in the secondary market trade derivatives based on the “assets?”

When “Monoploy” meets “Chutes and Ladders” and no one has the rule book we have a perfect recipe for another im-MERS-ion.

Update:  “Speak of the Devil…”  The New York Times reported (10/27/11) that Delaware, the state in which MERScorp is incorporated had filed suit alleging “MERS engaged and continues to engage in a range of deceptive trade practices that sow confusion among consumers, investors and other stakeholders in the mortgage finance system, damage the integrity of Delaware’s land records, and lead to unlawful foreclosure practices.”   See also: “MERS subpoenaed by New York, sued by Delaware” [Reuters]  Statement from Delaware Attorney General Biden on the Delaware lawsuit, October 27, 2011 (pdf).  Panchuk,  Housing Wire, October 27, 2011 “Delaware Attorney General files lawsuit…” the Housing Wire article reports that two counties in Texas are contemplating suits because MERS failed to pay mortgage assignment recording fees.

References and Resources:  Bedard, “The 50 million mortgage meltdown,” Loan Workout.Org, June 18, 2008.  Powell & Morgenson, “MERS, it may have swallowed your loan,” New York Times, March 5, 2011.  Dennis & Cha, “In foreclosure controversy, problems run deeper than flawed paperwork,” Washington Post, October 7, 2010.    Schwartz & Roose, “Federal Regulators Sue Big Banks Over Mortgages,” New York Times, September 2, 2011.   Mauldin, “The Subprime Debacle, Part 2: New Testimony Reveals Citigroup Knew Exactly What Crap It Was Selling,” Business Insider, October 24, 2010.  Weidlich, “Banks May Fight Banks as Mortgage Investors Pursue Class Status,” Bloomberg News, September 9, 2011. Panchuk, “Romney in Las Vegas: Don’t Stop the Foreclosure Process,” Housing Wire, October 18, 2011.

*There are several accounts of this memo, the Zero Hedge post is cited because it contains a copy of the memo in question for reference.