The financial tsunami unleashed by Wall Street’s esurient alchemy of
spinning toxic home mortgages into triple-A bonds, a process known as
securitization, has set off its second round of financial tremors.
After leaving mortgage investors, bank shareholders, and pension
fiduciaries awash in losses and a large chunk of Wall Street feeding at
the public trough, the full threat of this vast securitization machine
and its unseen masters who push the levers behind a tightly drawn
curtain is playing out in courtrooms across America.
Three plain talking judges, in state courts in Massachusetts and
Kansas, and a Federal Court in Ohio, have drilled down to the “straw
man” aspect of securitization. The judges’ decisions have raised
serious questions as to the legality of hundreds of thousands of
foreclosures that have transpired as well as the legal standing of the
subsequent purchasers of those homes, who are more and more frequently
the Wall Street banks themselves.
Adding to the chaos, the Financial Accounting Standards Board (FASB)
has made rule changes that will force hundreds of billions of dollars
of these securitizations back onto the Wall Street banks balance
sheets, necessitating the need to raise capital just as the unseemly
courtroom dramas are playing out.
The problems grew out of the steps required to structure a mortgage
securitization. In order to meet the test of an arm’s length
transaction, pass muster with regulators, conform to accounting rules
and to qualify as an actual sale of the securities in order to be
removed from the bank’s balance sheet, the mortgages get transferred a
number of times before being sold to investors. Typically, the original
lender (or a sponsor who has purchased the mortgages in the secondary
market) will transfer the mortgages to a limited purpose entity called
a depositor. The depositor will then transfer the mortgages to a trust
which sells certificates to investors based on the various risk-rated
tranches of the mortgage pool. (Theoretically, the lower rated tranches
were to absorb the losses of defaults first with the top triple-A tiers
being safe. In reality, many of the triple-A tiers have received
ratings downgrades along with all the other tranches.)
Because of the expense, time and paperwork it would take to record
each of the assignments of the thousands of mortgages in each
securitization, Wall Street firms decided to just issue blank mortgage
assignments all along the channel of transfers, skipping the actual
physical recording of the mortgage at the county registry of deeds.
Astonishingly, representatives for the trusts have been foreclosing
on homes across the country, evicting the families, then auctioning the
homes, without a proper paper trail on the mortgage assignments or
proof that they had legal standing. In some cases, the courts have
allowed the representatives to foreclose and evict despite their
admission that the original mortgage note is lost. (This raises the
question as to whether these mortgage notes are really lost or might
have been fraudulently used in multiple securitizations, a concern
raised by some Wall Street veterans.)
But, at last, some astute judges have done more than take a cursory
look and render a shrug. In a decision handed down on October 14, 2009,
Judge Keith Long of the Massachusetts Land Court wrote:
“The blank mortgage assignments they possessed transferred
nothing…in Massachusetts, a mortgage is a conveyance of land. Nothing
is conveyed unless and until it is validly conveyed. The various
agreements between the securitization entities stating that each had a
right to an assignment of the mortgage are not themselves an assignment
and they are certainly not in recordable form…The issues in this case
are not merely problems with paperwork or a matter of dotting i’s and
crossing t’s. Instead, they lie at the heart of the protections given
to homeowners and borrowers by the Massachusetts legislature. To accept
the plaintiffs’ arguments is to allow them to take someone’s home
without any demonstrable right to do so, based upon the assumption that
they ultimately will be able to show that they have that right and the
further assumption that potential bidders will be undeterred by the
lack of a demonstrable legal foundation for the sale and will
nonetheless bid full value in the expectation that that foundation will
ultimately be produced, even if it takes a year or more. The law
recognizes the troubling nature of these assumptions, the harm caused
if those assumptions prove erroneous, and commands otherwise.” [Italic
emphasis in original.] (U.S. Bank National Association v. Ibanez/Wells
Fargo v. Larace)
A month and a half before, on August 28, 2009, Judge Eric S. Rosen
of the Kansas Supreme Court took an intensive look at a “straw man”
some Wall Street firms had set up to handle the dirty work of
foreclosure and serve as the “nominee” as the mortgages flipped between
the various entities. Called MERS (Mortgage Electronic Registration
Systems, Inc.) it’s a bankruptcy-remote subsidiary of MERSCORP, which
in turn is owned by units of Citigroup, JPMorgan Chase, Bank of
America, the Mortgage Bankers Association and assorted mortgage and
title companies. According to the MERSCORP web site, these
“shareholders played a critical role in the development of MERS.
Through their capital support, MERS was able to fund expenses related
to development and initial start-up.”
In recent years, MERS has become less of an electronic registration
system and more of a serial defendant in courts across the land. In a
May 2009 document titled “The Building Blocks of MERS,” the company
concedes that “Recently there has been a wave of lawsuits filed by
homeowners facing foreclosure which challenge MERS standing…” and then
proceeds over the next 30 pages to describe the lawsuits state by
state, putting a decidedly optimistic spin on the situation.
MERS doesn’t have a big roster of employees or lawyers running
around the country foreclosing and defending itself in lawsuits. It
simply deputizes employees of the banks and mortgage companies that use
it as a nominee. It calls these deputies a “certifying officer.” Here’s
how they explain this on their web site: “A certifying officer is an
officer of the Member [mortgage company or bank] who is appointed a
MERS officer by the Corporate Secretary of MERS by the issuance of a
MERS Corporate Resolution. The Resolution authorizes the certifying
officer to execute documents as a MERS officer.”
Kansas Supreme Court Judge Rosen wasn’t buying MERS’ story. In fact,
Wall Street was probably not too happy to land before Judge Rosen. In
January 2002, Judge Rosen had received the Martin Luther King “Living
the Dream” Humanitarian Award; he previously served as Associate
General Counsel for the Kansas Securities Commissioner, and as
Assistant District Attorney in Shawnee County, Kansas. Judge Rosen
wrote:
“The relationship that MERS has to Sovereign [Bank] is more akin to
that of a straw man than to a party possessing all the rights given a
buyer… What meaning is this court to attach to MERS’s designation as
nominee for Millennia [Mortgage Corp.]? The parties appear to have
defined the word in much the same way that the blind men of Indian
legend described an elephant — their description depended on which part
they were touching at any given time. Counsel for Sovereign stated to
the trial court that MERS holds the mortgage ‘in street name, if you
will, and our client the bank and other banks transfer these mortgages
and rely on MERS to provide them with notice of foreclosures and what
not.’ ” (Landmark National Bank v. Boyd A. Kesler)
Lawyers for homeowners see a darker agenda to MERS. Timothy McCandless, a California lawyer, wrote on his blog as follows:
“…all across the country, MERS now brings foreclosure proceedings in
its own name — even though it is not the financial party in interest.
This is problematic because MERS is not prepared for or equipped to
provide responses to consumers’ discovery requests with respect to
predatory lending claims and defenses. In effect, the securitization
conduit attempts to use a faceless and seemingly innocent proxy with no
knowledge of predatory origination or servicing behavior to do the
dirty work of seizing the consumer’s home. While up against the wall of
foreclosure, consumers that try to assert predatory lending defenses
are often forced to join the party — usually an investment trust — that
actually will benefit from the foreclosure. As a simple matter of
logistics this can be difficult, since the investment trust is even
more faceless and seemingly innocent than MERS itself. The investment
trust has no customer service personnel and has probably not even
retained counsel. Inquiries to the trustee — if it can be identified —
are typically referred to the servicer, who will then direct counsel
back to MERS. This pattern of non-response gives the securitization
conduit significant leverage in forcing consumers out of their homes.
The prospect of waging a protracted discovery battle with all of these
well funded parties in hopes of uncovering evidence of predatory
lending can be too daunting even for those victims who know such
evidence exists. So imposing is this opaque corporate wall, that in a
‘vast’ number of foreclosures, MERS actually succeeds in foreclosing
without producing the original note — the legal sine qua non of
foreclosure — much less documentation that could support predatory
lending defenses.”
One of the first judges to hand Wall Street a serious slap down was
Christopher A. Boyko of U.S. District Court in the Northern District of
Ohio. In an opinion dated October 31, 2007, Judge Boyko dismissed 14
foreclosures that had been brought on behalf of investors in
securitizations. Judge Boyko delivered the following harsh rebuke in a
footnote:
“Plaintiff’s ‘Judge, you just don’t understand how things work,’
argument reveals a condescending mindset and quasi-monopolistic system
where financial institutions have traditionally controlled, and still
control, the foreclosure process…There is no doubt every decision made
by a financial institution in the foreclosure is driven by money. And
the legal work which flows from winning the financial institution’s
favor is highly lucrative. There is nothing improper or wrong with
financial institutions or law firms making a profit – to the contrary,
they should be rewarded for sound business and legal practices.
However, unchallenged by underfinanced opponents, the institutions
worry less about jurisdictional requirements and more about maximizing
returns. Unlike the focus of financial institutions, the federal courts
must act as gatekeepers…” (In Re Foreclosure Cases)
While the illegal foreclosure filings, investor lawsuits over
securitization improprieties, and predatory lending challenges play out
in courts across the country, a few sentences buried deep in
Citigroup’s 10Q filing for the quarter ended June 30, 2009 signals that
we’ve seen merely a few warts on the head of the securitization monster
thus far and the massive torso remains well hidden in murky water.
Citigroup tells us that the Financial Accounting Standards Board
(FASB) has issued a new rule, SFAS No. 166, and this is going to have a
significant impact on Citigroup’s Consolidated Financial Statements “as
the Company will lose sales treatment for certain assets previously
sold to QSPEs [Qualifying Special Purpose Entities], as well as for
certain future sales, and for certain transfers of portions of assets
that do not meet the definition of participating interests. Just when
might we expect this new land mine to go off? “SFAS 166 is effective
for fiscal years that begin after November 15, 2009.” There’s more bad
news. The FASB has also issued SFAS 167 and, long story short, more of
those off balance sheet assets are going to move back onto Citi’s books.
Bottom line says Citi:
“… the cumulative effect of adopting these new accounting standards
as of January 1, 2010, based on financial information as of June 30,
2009, would result in an estimated aggregate after-tax charge to
Retained earnings of approximately $8.3 billion, reflecting the net
effect of an overall pretax charge to Retained earnings (primarily
relating to the establishment of loan loss reserves and the reversal of
residual interests held) of approximately $13.3 billion and the
recognition of related deferred tax assets amounting to approximately
$5.0 billion….” [Emphasis in original.]
I’m trying to imagine how the American taxpayer is going to be asked
to put more money into Citigroup as it continues to bleed into
infinity.
Citigroup is far from alone in financial hits that will be coming
from the Qualifying Special Purpose Entities. Regulators are receiving
letters from Citigroup and other Wall Street firms pressing hard to
rethink when this change will take effect.
Putting aside for the moment the massive predatory lending frauds
bundled into mortgage securitizations, inadequate debate has occurred
on whether securitization of home mortgages (other than those of
government sponsored enterprises) should be resuscitated or allowed to
die a welcome death. If we understand the true function of Wall Street,
to efficiently allocate capital, the answer must be a resounding no to
this racket.
Trillions of dollars of bundled home mortgage loans and derivative
side bets tied to those loans were being manufactured by Wall Street
without any one asking the basic question: why is all this capital
being invested in a dormant structure? Houses don’t think and innovate.
Houses don’t spawn new technologies, patents, new industries. Houses
don’t create the jobs of tomorrow.
Also, by acting as wholesale lenders to the unscrupulous mortgage
firms (some in house at Wall Street firms), Wall Street was not
responding to legitimate consumer demand, it was creating an artificial
demand simply to create mortgage product to feed its securitization
machine and generate big fees for itself. Now we see the aftermath of
that inefficient allocation of capital: a massive glut of condos and
homes pulling down asset prices in neighborhoods as well as in those
ill-conceived securitizations whose triple-A ratings have been
downgraded to junk.
There’s no doubt that one of the contributing factors to the
depression of the 30s and the intractable unemployment today stem from
a massive misallocation of capital to both bad ideas and fraud. Today’s
Wall Street, it turns out, is just another straw man for a rigged
wealth transfer system.
Posted By George Beckus Esq.
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