The newest fight in the mess that is now the U.S. foreclosure process is a real doozy. It's the idea that securitization trusts may not actually own their own mortgages, and therefore have no standing to foreclose.
A recent case involving Bank of America
[stock BAC][/stock] in a New Jersey bankruptcy lit the most recent fire, after reporter Kate Berry at American Banker first reported on a ruling in the case
on Nov. 22.
In the case, Kemp v. Countrywide Home Loans, Judge Judith H. Wizmur ruled that under the terms of New Jersey Uniform Commercial Code, the foreclosing party — in this case, the Bank of New York
as trustee, with Countrywide
as its servicer — must first be in physical possession of the mortgage note, which in that case it was not. During the case, BofA employee Linda DeMartini also testified that Countrywide never generally physically transferred original mortgage notes to trustees after origination, but simply held onto them as the servicer for the trust.
Various commentators immediately jumped on the ruling and DeMartini’s testimony as evidence that loans were not properly conveyed into the trusts per the terms of most pooling and servicing agreements, suggesting that securitization trusts not only have no standing to foreclose on distressed borrowers — but that the trusts themselves may never have owned the notes to begin with.
"These original notes were supposed to be transferred and delivered all the way up the line and for this witness to admit they were never transferred is pretty amazing," O. Max Gardener, a prominent consumer bankruptcy counsel, told American Banker. "I've never seen this admitted anywhere."
“If the notes and mortgages were not properly transferred to the trusts, then the mortgage-backed securities that the investors purchased were in fact nonmortgage-backed securities,” Adam Levitin, an associate professor of law at Georgetown University, testified
to the House Financial Services Committee
on Nov. 18.
Levitin also asserted that these allegedly fraudulent securitizations could bring down the biggest banks, arguing that “there is not the capital in the financial system to pay for the rescission claims; the rescission claims would be in the trillions of dollars, making the major banking institutions in the United States ... insolvent.”
Plenty of the press, including influential blogs, jumped on the news of the Kemp case. “Bank of America case hurtles toward the great MBS unwind,” screamed a recent headline
at CNBC’s NetNet blog. If sellers didn't transfer the notes, “residential mortgage backed securities are not secured by real estate,” opined
Yves Smith at Naked Capitalism, whose financial blog has been among the most vocal to assert that trusts lack standing in foreclosure actions.
The devil is in the (very) technical details
While I, too, am appalled and dismayed at the mounting evidence of sloth, greed and general incompetence at major U.S. banks within their mortgage origination and servicing processes, I have to wonder if in this particular case some commentators (including those I respect) are getting a bit too carried away with their hope that banks will eventually have to hold the bag on mortgage-backed securities — at least in terms of the argument that says a failure to physically transfer the notes represents an outright failure to convey an asset into the trust.
Smith and Levitin, among others, have been very vocal in arguing that the terms of the PSA govern the trust. In particular, most critics have been content to base their claims on the terms specified in Section 2.01 within most standard PSAs (if there is such a thing as a 'standard PSA'), terms which typically govern the conveyance of mortgage loans to the trust. Tom Adams, a New York attorney with the firm of Paykin, Krieg & Adams
, wrote a very detailed analysis
of this particular argument at the Naked Capitalism blog, for those so inclined to read it.
But it appears, at least to this nonattorney, that these commentators and others may be selectively reading only portions of the PSA contract terms.
To wit, from a 2005 Argent PSA, Section 2.03(a)
“Upon discovery or receipt of notice (including notice under Section 2.02) of any materially defective document in, or that a document is missing from, the mortgage file or of the breach by the seller of any representation, warranty or covenant under the mortgage loan purchase agreement in respect of any mortgage loan which materially adversely affects the value of such mortgage loan or the interest therein of the certificate holders, the trustee shall promptly notify the seller, the NIMS insurer and the master servicer of such defect, missing document or breach and request that the seller deliver such missing document or cure such defect or breach within 90 days from the date the seller was notified of such missing document, defect or breach, and if the seller does not deliver such missing document or cure such defect or breach in all material respects during such period, the master servicer (or, in accordance with Section 6.06(b), the trustee) shall enforce the obligations of the seller under the mortgage loan purchase agreement to repurchase such mortgage loan from REMIC I at the purchase price within 90 days after the date on which the seller was notified (subject to Section 2.03(d)) of such missing document, defect or breach, if and to the extent that the seller is obligated to do so under the mortgage loan purchase agreement.”
In case you missed it buried in the legal-speak above, let me pull out the relevant terms to make it clearer: “Upon discovery or receipt of notice … that a document is missing from the mortgage file … the trustee shall promptly notify the seller, the NIMS insurer and the master servicer of such … missing document … and request that the seller deliver such missing document … within 90 days from the date seller was notified of such missing document.”
In other words, this PSA’s terms explicitly anticipated the reality of missing documents, and also explicitly prescribed a remedy in the event missing documents were found to be a problem for the trust. A search of other available PSAs suggests that clauses such as this appear to be common in most, if not nearly all, such agreements that I could find.
So, does a missing document mean the trust doesn't own the asset? The language of this PSA and others doesn't really seem to suggest that. (I do understand the view that says a mortgage note isn't just "a" document, it's "the" document; but the PSA terms I've read clearly don't differentiate one document from another, as best I can tell.)
It's also beyond my own sense of logic as to why failing to physically transfer the notes to the trustee or its custodian, but instead keeping said notes safeguarded by an agent of the trustee — if indeed that is what occurred, as per the testimony in the Kemp case and allegations made elsewhere — represents prima facie
a wholesale failure to convey assets into a trust.
As a white paper from the American Securitization Forum
notes, and as I've been told by more than a few attorneys I've spoken with, there is a significant difference between the concepts of physical possession and so-called "constructive" or "legal" possession of a note.
While critics have assailed many aspects of the ASF paper's content — and this column isn't addressing those aspects, including matters of endorsement — at least this one point seems to make plenty of sense to me: If the collateral in question (in this case, the mortgage note) is and remains within the possession of an agent of the secured party (in this case, the servicer or master servicer), then the secured party has taken actual possession.
The attorneys weigh in
But as I said earlier, I’m no attorney. So I decided to speak to a few about the Kemp case and its implications; and to get the other side of the coin relative to the views already put forth in press accounts thus far, I spoke with attorneys in the trenches that practice in foreclosure and related work.
“The (Kemp) case is a very narrow and probably wrongly decided case,” said one attorney I spoke with on condition of anonymity, after reviewing the court docket. “Where the original note is produced and is conceded to be at all times in the possession of the attorney-in-fact for the trust, the court’s reasoning is at best questionable. In fact, it defies common sense.”
This attorney, who has practiced in this area of law for more than 25 years, went on: “The defense botched this case up beyond belief, horribly bad, and that’s probably why they got the opinion they did. I would appeal the ruling, unless the defense didn’t get the proof of assignment into evidence and didn’t make the argument.”
“The (Kemp) opinion seems to indicate that the trust owns the obligation, and even the judge seems to concede this point,” said another attorney, also under condition of anonymity. “The argument by those that say trusts do not own the notes because of failure to follow the terms of endorsement and delivery is simply not warranted here. The opinion does not address that issue in its holding, and its dicta (nonbinding discussion) is actually to the contrary.”
“The case hinges entirely on New Jersey UCC as to standing to enforce the note,” continued this attorney. “The servicer argued that the recorded assignment conveyed standing and conceded that its agent, not the trustee, had possession of the original note. The trial court rejected that argument, but there are simply no grounds here to void the security interest.”
These takes on a ruling that has sparked so much fear and uncertainty among so many at the very least should underscore a point: there are always
two sides to every story.
‘More than a few Chicken Littles’
Tom Deutsch, executive director at the ASF, took direct aim at Levitin and others' claims of trust invalidity in his own testimony to the Senate Banking Committee
last week, and said that there is no legal precedent
for such an interpretation of PSA terms.
(Showing good humor, Levitin responded on his blog
that there is no legal precedent for any interpretation of PSA terms, let alone his.)
Yves Smith at Naked Capitalism immediately derided
Deutsche’s testimony as “astonishing and wildly untruthful,” and proffered up examples of precedent: an affidavit from the aforementioned New York lawyer, Tom Adams; and a similar affidavit from Albany Law School
professor Ira Bloom, a New York trust expert.
Both affidavits were introduced in a Jefferson County, Ala., foreclosure case involving U.S. Bank
[stock USB][/stock] earlier this year, and both allege that the trust in question in the case never owned the promissory note signed by the defaulted borrower due to faulty assignments.
When I showed these same documents to well-experienced attorneys that practice in creditor’s rights, the opinions were immediate and almost guttural.
“The Tom Adams declaration is completely inadmissible, same with the Bloom declaration,” said one attorney, under condition of anonymity. “They are acting as a judge, and trying to give the judge a legal conclusion. A witness is not allowed to opine on an issue of law, only on issues of fact. These declarations are entirely an opinion of law and probably wrong at that.”
Inadmissibility, however, doesn't make them incorrect (though it might explain why opposing counsel didn't see a need to oppose them at trial). When asked to opine on the merits of the declarations as if they were admissible, this same attorney had this to say:
“The core legal issues are completely missed by these declarations. The issues are one of standing and one of N.Y. trust law. The standing issue means that the only person who can attack the issue of validity is not the person who gave the note, but the beneficiary of the trust.
“The other real issue here is one of trust law in New York. How is a property put into a trust? You will note that the declarations completely avoid any law on this issue. If the parties intended to put the asset in the trust and some defect did not result in the actual transfer, the court would typically allow for the defect to be cured and treat the asset as part of the trust.
“Look at the argument: all parties to the transaction—the trustee, the beneficiary and the party owning the secured note — all intended to transfer the asset, but perhaps may have failed to follow a procedure for note delivery. The law will always attempt to honor the intent of the parties, so long as no rights of a third party are injured. In this case, all of the parties to the transaction agree on intent, and no one is injured.
“So, who is objecting here? The person who defaulted on the secured debt. The court should deny the defaulting party standing and state that the intent of the parties controls, and allow for any repair to title that needs to be done.”
That’s not to say that attorneys in the field are outright dismissing the issues involved here as irrelevant. Far from it. There are very real and complex issues at play here, they say, especially in instances of bankruptcy; issues that they believe could take years to work out.
In the end, however, most of the industry sources I’ve spoken with doubt we’ll be talking much next year about securitization trusts becoming holders of “nonmortgage-backed securities,” as Levitin has characterized them.
“There’s simply no doctrine in law that says we throw the baby out with the bathwater,” said one of the attorneys I spoke with. “It might be good press right now, but eventually we’re going to have more than a few Chicken Littles out there.”
Long-time readers know that I was among the first to call banks to the mat for their poor business practices in servicing, long before the current batch of commentators had begun to follow this same trail. In fact, I've spent years (along with the now-deceased Tanta from Calculated Risk) effectively predicting that lax business practices would spiral ever larger and out of control; you’d have to have been reading my commentary back in 2007
, in the days of ‘produce the note’ and Judge Boyko, to remember that.
As a result, I tend to believe that my colleague Chris Whalen has it right when he says that U.S. banks face another round of crisis in the very near future. Beyond the data and ratings provided by his Institutional Risk Analytics
, which show mounting critical stress among banks, one need only consider the fact that more than $1 trillion in outstanding second liens have yet to be addressed.
That’s enough by itself to make you question the solvency of more than a few banks. Or you could consider the fact that 11 million mortgages are tied to homes that are worth far less than the par amount of the debt — and ask yourself if those mortgages should really be booked at par on a bank's balance sheet.
“There will be no recovery in the availability of credit or jobs in the U.S. economy until the Obama Administration restructures the largest banks,” Whalen wrote last week, and I believe him.
That said, I think that in some instances commentators may be pushing their anti-bank campaigns too far out of bounds; at least in terms of arguing about the physical possession and transfer of a note, it seems to me as if some critical points are being missed. While nobody should look to excuse the banks for their egregious conduct (robo-signing comes immediately to mind), my stance is and always has been that muddying the waters and confusing the issues at hand only makes it that much harder to ultimately do the right thing for aggrieved parties.
But I fear we are encouraging people who ultimately can’t save their homes to further waste limited resources and opportunities on yet another false hope. And I tend to think we’ve already given enough false hope to the American public via sham government programs like the Home Affordable Modification Program, or HAMP.
Rather than coming up with new and novel ways to prolong the misery, isn’t it time we started working on solutions to this mess instead?
Paul Jackson is the publisher of HousingWire Magazine and HousingWire.com. Follow him on Twitter: @pjackson