Fixing Massachusetts Foreclosures Won't Be So Easy

Last week, the top court in Massachusetts handed down a ruling chastising banks for their "carelessness" during the securitization of Massachusetts mortgages. That carelessness has clouded the title of thousands of already-foreclosed properties and creates major problems for future foreclosures.

Not surprisingly, the interests on the banks' side have put out messages trying to minimize the significance of the decision, messages that Adam Levitin, associate professor of law at Georgetown University, dismantles in the blog Credit Slips. More recently, the law firm K&L Gates, a major, sophisticated firm that did securitization deals, sent out a reassuring newsletter that clients should look at skeptically.

K&L's basic pro-bank spin is this:

  • Completed Massachusetts foreclosures aren't a big problem because they're not "automatically" invalidated.

  • A complete set of securitization documents successfully transfers mortgages, and perhaps blank assignments can just be filled in, so there's no fundamental problem foreclosing in the future.

Those claims are misleading and wrong.

The "In Blank" Problem Isn't Easy to Fix

In order to foreclose, the bank has to show it owns the mortgage or is acting for the entity that does. For securitized mortgages, that entity is supposed to be a trust.

The trust holds the mortgages and sells securities to investors, including pension funds. In exchange for the purchase price, the trust promises to pay the investors the mortgage payments it collects. (Note, if the trust didn't get the mortgage in the initial securitization, then it's not clear the trust can get the mortgage now under trust law or the securitization contracts themselves, as the blog Naked Capitalism has reported.)

The trusts in the Massachusetts case (Ibanez) didn't get the two mortgages at issue when they were securitized -- or any other Massachusetts mortgages, most likely. The way the banks tried to give the mortgages to the trusts was illegal under longstanding Massachusetts law.

In Massachusetts, a mortgage owner has to name the person he's selling the mortgage to; assignments "in blank" -- without naming the buyer -- don't cut it. But as the K&L newsletter acknowledges, "assignments in blank" were used in the "typical mortgage loan securitization process."

Are Any Massachusetts Mortgages Successfully Securitized?

Although K&L trumpets the court's statement that a complete set of securitization contracts could transfer the mortgages to the trust, the court's statement should give little comfort for two reasons. First, if the"typical" assignment in blank occurred before the securitization process as it did in the case, the trust didn't get the mortgages. Second, even if a deal was unusual and involved assignments in blank only during securitization, the contracts work only if the bank can produce all the papers.

In the Massachusetts case, neither US Bank (USB) or Wells Fargo (WFC) could, despite being given a special opportunity to do so. How likely is it that the banks will be able to produce the complete papers In future cases?

So many, conceivably all, of the Massachusetts mortgages that were ostensibly securitized weren't transferred into their trusts -- and now their trusts can't foreclose.

So how can the trust get the mortgages, and thus the right to foreclose on the loans? That is, assuming trust law and the securitization contracts let the trusts get the mortgages now? The traditional way would be to bring the company that executed the assignments in blank to court. Unfortunately not all of those companies still exist -- and in any case, that process would add time and cost to the already lengthy foreclosure process.

Can't Fill In the Blanks

Theoretically, an easier way would be to have the owner that signed the blank documents just give the mortgages to the trust.But problems abound there, too. As a CNBC analyst detailed,the lack of a relationship between the trust and that owner leaves no free or easy path to an assignment. And when that owner has gone out of business, that route is a dead end.

K&L's newsletter suggests a way forward for the banks that appears to be akin to theft: "It remains to be seen whether, pursuant to its express power of attorney [from the trust], a servicer can fill in the name of a trustee on an assignment of mortgage in blank."

That's right: K&L is suggesting that maybe their clients can just fill in the blanks, and make the problem go away. The idea, on its face, appears fraudulent.

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To understand why, consider the facts of the Ibanez mortgage. Antonio Ibanez borrowed money from Rose Mortgage Inc. Rose sold the mortgage to Option One. Option One signed a blank assignment, essentially selling the mortgage to whomever was holding onto that piece of paper. US Bank presented the blank assignment, claiming Option One sold the mortgage to Lehman Brothers Bank, which sold it to Lehman Brothers Holding, which sold it to a "special-purpose vehicle," which sold them to the trust, with US Bank acting as the trustee.

The Massachusetts high court said no, that's not what happened. Since assignments in blank are illegal in Massachusetts, Option One failed to transfer the mortgage into the securitization chain. Option One still owns the Ibanez mortgage.

So when K&L suggests that perhaps a servicer can just put the trust's name on the blank assignment, in the Ibanez case it means maybe the trust can give itself Option One's property. How can that be legal?

The reason Massachusetts says Option One owns the mortgage -- the reason why the state cares whether the assignment's blank is filled in or not -- is it's the only way to be sure who actually owns a Massachusetts home. Title to real estate in Massachusetts stays with the mortgage owner until the mortgage is paid off; the homebuyer just has use of the property. So somebody, not a blank line, has to be the identified as owner of the mortgage. It's kind of like rent-to-own, but with much lower interest.

Perhaps the fill-in-the-blank idea seemed sound because it is essentially what happens on a regular basis through the magic of MERS -- Mortgage Electronic Registration Systems, the tracking database firm named on some 60% of mortgages today.

Just Like MERS?

Mortgages enter the MERS database with the firm acting as the nominee for one entity, for example, "MERS as nominee for Option One." When mortgages leave the database, an employee at the company that's going to be assigned the mortgage fills in an assignment from MERS, say, "Assignment from MERS as nominee Option One to Wells Fargo" signed by John Kennerty, officer of MERS (and employee of Wells Fargo.)

That is, in the context of MERS, the banks wanting to foreclose on a mortgage already have the habit of assigning the mortgages to themselves.

Many Massachusetts mortgages are in the MERS system. Therefore, assuming trust law allows it, the banks can try the MERS magic to solve the assignment problem. They can claim MERS lets them fill in the blank. Unfortunately for the banks, the MERS assigning practices are sometimes rejected by courts, and the overall legality of MERS is uncertain.

So, it looks like trusts wanting to foreclose on securitized Massachusetts mortgages will have to gamble on MERS or jump through one more hoop -- a court proceeding -- in order to start foreclosing. Of course, if trust law and/or the securitization contracts forbid the trust from getting the mortgages now, all bets are off. What will the companies in Option One's position in Ibanez do with all the mortgages they suddenly realize they own? What if the company doesn't exist anymore?

In any case, it's easy to see why it would be convenient if servicers could just fill in the blanks. So pay attention, Massachusetts foreclosure defense attorneys: Is the blank filled in? If so, who filled it in and when?

Why Completed Massachusetts Foreclosures Are a Big Problem

One problem in the Massachusetts cases is that the foreclosing banks were assigned the mortgages after the foreclosure was completed. An assignment can't happen after the foreclosure starts, much less after it's been completed, the court explained, unless the assignment is essentially a redo of an existing assignment. Then the late assignment would just "confirm" the original.

Since the "typical" securitization involved assignments in blank, I'll bet very few of the trusts that foreclosed in Massachusetts had the mortgages when they foreclosed. If the banks had been aware of the issue and were dealing with it, it's hard to understand why they would have told the Massachusetts high court that assignments in blank were legit.

That would mean any assignment to a securitization trust that happened after the foreclosure started -- apparently "typical practice" in Massachusetts, as it is elsewhere in the country -- wasn't "confirming" an existing assignment, despite K&L's claim to the contrary in its newsletter:

[I]n the context of securitization, such confirmatory assignments will serve to validly confirm the language of assignment contained in the underlying securitization agreements and can thus properly confirm the earlier assignment of mortgage which itself bestowed the authority to foreclose.

Unless the original assignments weren't in blank, the late assignments aren't "confirming" anything. They're the first time the trust is being given the mortgages.

K&L gets one thing right: A foreclosed homeowner probably has to go to court to show that the foreclosure was invalid. That's because just showing the assignment to the trust occurred after the foreclosure started -- an easily determined fact in the land records -- isn't enough. The homeowner has to find out if that late assignment to the trust was the first one or a "confirmatory" one. That is, did any assignment in blank break the chain or not?

Since such assignments were typical, then most if not all of the foreclosed homeowners should be able to invalidate their foreclosures. Precisely what that means for the foreclosed homeowner, the foreclosing trust, the servicer and the purchaser of a foreclosed Massachusetts home isn't clear. At a minimum, the new owner doesn't have good title because the bank that sold it didn't have it to give.

Problems Elsewhere?

K&L also points out that the case hinged on Massachusetts law, which is true -- and the firm tries to reassure people that, for that reason alone, its consequences are limited. Well, maybe. Maybe the securitzers ignored only Massachusetts law.

Speaking of which, how did that happen? The Massachusetts high court emphasized that the illegality of assignments in blank was basic real estate law. How on earth did the big firms advising on securitization deals -- and it's many sophisticated firms, not just K&L -- not realize the "typical" deal violated Massachusetts law?

Boston alone is chock-a-block with big corporate law firm headquarters and branches. Surely, they had partners who knew better. Since the banks' lawyers blew it in Massachusetts, can we really take their word that they didn't blow it any place else? I wouldn't.

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