NY Fed takes first step to solve mortgage securitization legal issues
The Federal Reserve Bank of New York met with interested stakeholders recently to address legal questions in the framework for mortgage note transactions.
With the growth in securitization, lenders adjusted business models. Major banks were no longer originating mortgage loans to hold, rather they were writing loans to sell them. Both the note and the mortgage would be sold through the securitization process. The note, according to the N.Y. Fed, is evidence of a promise to repay, and the mortgage securing the loan was often transferred more than once.
Ultimately, the loan and the mortgage end up being owned by an entity created for the purpose of owning many loans with their mortgages, known as pooling. And that entity would then issue rights, or securities, to this pool to investors. These investors would then collect a stream of payments from this pool.
But in a paper the N.Y. Fed released this week, this process requires a method of determining the current owner of each loan and mortgage changing hands. Especially, when it comes time to foreclose on the property.
The banks thought they developed such a solution when they established Mortgage Electronic Registration Systems. The thought was MERS would allow sellers and buyers to follow interests when the loan and mortgage are transferred. Even in some cases, MERS was listed as the mortgagee or as an agent of the initial lender and all of the initial lender's subsequent buyers of the loan and mortgage, the Fed said.
"This division and fractionalization whereby there are entities that are owners of the loan and mortgage, or some part of the loan and mortgage, a servicer for the loan and mortgage, and a named mortgagee that is not necessarily the owner of the loan and mortgage has caused significant confusion," the New York Fed said in the paper.
Reams of state and federal laws that overlap and contradict one another compound the problem. There are state laws that govern the relationship between MERS and the servicer. Others govern the obligation reflected in the loan the mortgage secures. Still more establish requirements for what a mortgage can be, but there are different ones that govern the loan obligation. There are also differing federal and state laws that dictate how payment interests in the mortgage pool are sold.
Hundreds of lawsuits appeared when foreclosures began to mount, challenging the validity of MERS. The company even signed consent orders with the Office of the Comptroller of the Currency and the Federal Reserve for shortfalls investigators found in the system. MERS agreed to establish new training and oversight programs as part of the agreements.
But the New York Fed said solutions are on the way. The Uniform Law Commission and the American Law Institute, which facilitated the recent meetings, seek to clarify and update federal and state laws governing the securitization process.
They "have joined forces with various stakeholders, including the Federal Reserve Bank of New York, to deal with the legal complexity and the fact that much of the applicable law no longer adequately reflects modern financial practice and technological developments," the N.Y. Fed said.
The two organizations also drafted a report to guide judges and lawyers involved in the transactions, and, the central bank said, should make the application of present laws more transparent.
The trade groups are also meeting with their members and banks, servicers, brokers, lenders and consumers. They will discuss whether or not to revise the laws or provide regulatory guidance and clarify the documentation and procedures necessary for the process.
"The New York Fed is committed to addressing these issues and will continue to work on identifying potential changes to the legal framework which will better serve the needs of those who are subject to it," said Thomas Baxter, general counsel at the New York Fed.
Write to Jon Prior.
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