Who wants to watch 'Bank Bailout 2'?—A Commentary by Jonathan Macey ’82
Who wants to watch 'Bank Bailout 2'?
By Jonathan Macey ’82
Life has been so dull since the nation’s major banks had their last existential crisis a year or so ago. Right now, it’s like watching a beloved rerun.
We know how the story is most likely to end. The banks will lose billions. It will take a decade or so to drain the swamps — also known as the balance sheets of institutions like the Bank of America and Citigroup — of overvalued and underperforming assets. In the meantime, however, the government will probably jump in and save the banks from themselves once again.
But this time, the bailout will be more subtle because the regulators don’t have to come up with cash. They just have to persuade a few judges to bend the rules a little bit while the banks foreclose on people’s homes.
In the crisis this time, regulators have a stark choice. They must decide whether to bend — and sometimes break — a few laws so banks can cover their loan losses by foreclosing on mortgages with faulty or nonexistent documentation or to enforce centuries-old real estate laws and force banks to live by the rules.
Bankers and their lobbyists are trying to portray this mess as just another example of the out-of-control U.S. legal system, throwing bureaucratic hurdles in the path of stouthearted capitalists merely trying to protect their investments. But from another viewpoint, this foreclosure crisis is — like the crises preceding it — the result of sloppy, inattentive management, weak internal controls and more than occasional shady practices by bankers run amok.
Unfortunately, both viewpoints are accurate. The legal system is out of control. But that does not excuse the fact that the bankers’ bad practices caused this mess in the first place.
The media have not helped in sorting out villains from victims. Problems are blandly described as the cause of “improper paperwork,” “missing files” and, a bit more ominously, “robo-signers,” who spend seconds reviewing legal documents before signing. Anyone who has ever rented a car, signed the contract without reading it and lost the paperwork is guilty of these kinds of transgressions. Such vague problems might not be a valid excuse for preventing legal proceedings in the eyes of any but the most rigid formalist.
Two facts are worth considering, however. First, the documentation problems affect the rights of real people. Errors can lead to people being evicted from their homes when they aren’t behind on payments. Or foreclosure proceeds might be paid to the wrong bank — and then the bank that was actually owed the money hounds the dispossessed homeowner to pay again.
Even on the technical side, it is one thing to sign a document without thoroughly reviewing it, but it is quite another to submit false statements to persuade a court to evict an allegedly delinquent homeowner. Sure, some of the problem reflects mere failure to dot an “i” or cross a “t.” But a lot involves outright fraud. In several cases, banks tried to fix paperwork problems by producing signed affidavits — legal documents attesting to the existence of real documents proving that the banks owned the mortgages and had foreclosure rights. Many documents were simply fabricated by people who signed hundreds of such documents a day — without knowing whether the underlying note existed and, if so, where it was and who had the rights to the payments described.
As Ohio Attorney General Richard Cordray noted, the banks have created significant legal exposure for themselves “by committing fraud upon the courts.”
Meanwhile, a healthy percentage of foreclosures involve something in between, like recklessness or gross negligence. Stunningly, in many cases, the banks cannot even locate the paperwork to document outstanding loans.
Perhaps the biggest problem is in the “chain of title,” the legal term describing the sequence of documentation that establishes the property rights to a house. As every first-year law student knows, owners and lenders must be able to reconstruct the chain of title to document who is obligated to pay the mortgages on a property.
The biggest problem in this foreclosure crisis is that the chain of title has gotten confused during securitization. For roughly the past 40 years, when people took out a mortgage, the loan was securitized; pools of mortgages were bundled together and the rights to all homeowners’ payments were used to create securities that were then sold to investors. More recently, mere securitization was not enough for the financial engineers in investment banking, and loan repayments were sliced and diced so some bits of homeowners’ payments paid off some securities (or tranches of securities) and other bits went to pay off others.
As securitization grew more complicated, the documentation challenges facing bankers also got more difficult — and more important. And the bankers were clearly not up to the challenge.
Bankers would often address problems in the buildup to the subprime crisis by turning to the Mortgage Electronic Registration System, which was, according to its website, “created by the mortgage banking industry to streamline the mortgage process by using electronic commerce to eliminate paper.” Its job is to appear as the owner in the county records for the lender and servicer. It’s also supposed to track electronically all ownership rights and servicing responsibilities.
MERS has the same rights as any lender to protect a loan — including foreclosure. The idea was that MERS kept track as loans got sliced and diced, relieving lenders of the tedious obligation of recording their mortgage trading in the public records, as all ownership rights are supposed to be. This is aimed at saving lenders and consumers the transaction costs usually associated with manually recording every transaction.
But the system has itself created big problems. “There is little or no public record as to who actually owns the loan on your home,” one court observed, “or who might have the right to foreclose.”
The origins of the current foreclosure crisis can be traced to 2007, when a court ruled that Deutsche Bank National Trust Co. lacked the documentation to prove it retained the rights in certain mortgages after they were securitized. The bank was unable to produce papers that showed these loans were in default. The court also disputed whether holders of mortgage-backed securities, who were not the legal owners of the securitized property, had the right to foreclose.
As disturbing as this sloppiness and the fraud involved are, more striking is the indifference that big banks are showing toward their erstwhile clients. These folks appear to be mere statistics on balance sheets.
Not only was the documentation handled badly, but so was the entire process. Borrowers were originally encouraged and enabled to lie about their income, assets and employment. Borrowers were allowed to “estimate” their incomes and assets. Sometimes, no documentation of income, assets or employment was required. First-time homebuyers were tricked into buying overpriced houses on the basis of inflated appraisals fudged by appraisers friendly with the mortgage originators.
The good news in this story, if there is any, is that this is a sterling example of the principle that crime doesn’t pay. The banks that created this system are now suffering the consequences.
Unfortunately many innocent people are, too.
And, of course, if the banks’ problems get big enough, the government will have to come in and bail them out. Again.
Jonathan Macey is a law professor who specializes in banking and finance at Yale Law School. He is on the Hoover Institution Task Force on Property Rights.