Grim's Hall

Bogus Bank, Member F.D.I.C.

Did you think it was bad enough that mountains of money was loaned to homeowners who couldn't even remotely be expected to keep up their mortgage payments, on the strength of blatantly fraudulent mortgage applications? That's only half the problem. Some of the mortgages, at least, should have been worth real money, if not necessarily 100% of the face amount. But it now seems that a scary number of banks did the equivalent of throwing their mortgage assets on the campfire and dancing around the flames.

Back in the Stone Age of home finance, a buyer borrowed cash to buy a house. The cash went to the seller, who used part of it to pay off his mortgage and pocketed any excess. The buyer got title to the home: a nice, official, signed original document that was duly filed in the local county real estate records. The buyer's bank got a signed promissory note (i.e., an IOU) along with a signed deed of trust that basically said, "I, the owner of this home, agree that if I don't pay the IOU, the bank can foreclose on my home." The bank then put the original IOU and deed of trust (together, a "mortgage") in its vault and filed a formal, signed, notarized notice of the deed of trust in the same county real estate records where the title was filed. Some years later, either the process repeated itself upon sale of the home, or the owner finished paying off the IOU and obtained a signed, original "release" document from the bank, which was also filed in the county real estate records.

Way back when, it wasn't terribly common for the bank to sell its mortgage. When it did happen, the buyer traded money for the original mortgage documents and filed a notice of the transfer in the county records. A couple of decades ago, this process really got into gear as a lot of lenders started selling truckloads of their mortgages wholesale, either to Fannie and Freddie or just to corporate entities set up to sell "mortgage-back securities." Suddenly all that fusty old procedure got very inconvenient, especially since the same mortgage might be sold and resold repeatedly -- each transfer requiring a physical trip to the county office and the payment of a fee. And then someone has to take custody of the mortgages themselves and remember where they are, at least for a few weeks or months, until they're sold again.

This part of the story is commonplace. We've been hearing dark reports for years that a lot of the closings in this churning frenzy might not have been scrupulously carried out, with the result that buyers on the tail-end might not actually be able to put their hands on the purpose of the whole exercise: the original mortgages. When news began to come out in recent weeks of every single state's attorney general joining in actions to address fraud in the foreclosure process, I assumed that the main problem was that the documents were stacked at the back of some warehouse, like the Ark of the Covenant, and nobody could remember which aisle they were on. I thought that banks had been skating through foreclosures without being challenged to produce the originals, and were now looking blank as more and more homeowners and courts were forcing them to dot their i's and cross their t's.

But it's worse than that. Banks found it so inconvenient to file evidence of mortgage sales in the real estate records that many of them began to use a substitute, called the Mortgage Electronic Registration Systems (MERS), which may or may not have any legal validity in the absence of a physical transfer of the underlying documents. MERSCORP, the operator of the system, is not what you would call a solid institution. It has no employees. It licenses employees of its customers to use the title "VP of MERSCORP" in foreclosure proceedings. Customers can buy the right to use its corporate seal on foreclosure paperwork for twenty-five bucks. It's a pretty shady operation, and its computer techs are perhaps not strictly from the top drawer. Banks liked MERS so much, however, that they took to shredding the original foreclosure documents as soon as they were electronically registered in MERS.

Then came the housing crisis, with its flood of defaulted mortgages that necessitated foreclosure proceedings on an unprecedented scale. In the 23 states that require all foreclosures to proceed by lawsuit, a lender must represent formally to the court, generally under penalty of perjury, that it holds a valid mortgage, something that in most states probably requires possession of an original document. In the 27 states that allow "non-judicial foreclosure," like Texas, a bank does not file a lawsuit to initiate a foreclosure. It simply sends a series of form letters to the borrower and, if no timely cure payment is received, the home is auctioned off after a specified number of days (in Texas, 21). It's up to the borrower to contest the foreclosure with a lawsuit seeking a temporary restraining order and injunction (or bankruptcy) if he believes the bank is foreclosing in error. At some point in that lawsuit, the bank would be called upon to prove it holds a valid mortgage, perhaps by coughing up an original document. In practice, however, most borrowers lack the knowledge or the resources to file a lawsuit contesting a foreclosure, and they would be unlikely to suspect the lender's faulty title, anyway.

It's surprising, however, how seldom lenders actually do produce their original documents in court proceedings. Documents filed in court, and particularly documents produced in response to opposing counsel's discovery requests, generally are copies. Of course, it's fraud for a bank to assert that a copy is a true copy of an existing original if the original does not, in fact, exist. Up to this point, however, you can imagine that most foreclosing lenders actually believe they have the originals and are simply too rushed or disorganized to have checked in 100% of cases.

Not so for the banks who shredded their documents, or who never managed to get originals of whole batches of mortgages in sloppy closings of mortgage-backed securities transactions. These banks quickly began to realize there was a little something missing in their paper trail. No problem! An enterprising company called "DOCX" sprang onto the market. They specialized in filling gaps in the documentation, ostensibly by creating certificates to reflect the true state of the electronic mortgage title record. Only, these documents didn't look like certificates of an electronic status; they looked a lot like what purported to be original mortgages or mortgage assignments. It's just that they were made up out of whole cloth, with faked details like notarizations. What's more, sometimes the electronic record was distressingly buggy and full of holes. Increasingly, DOCX began to fix that problem by engaging in pure fiction. Nor was DOCX the only contributor to a fantasy edifice of legal documents. A rash of lawsuits is working its way through the system now alleging that banks made up foreclosure authorization documents, including notices to borrowers of a summons to court, and presented them to local law enforcement officials to induce them to evict the home's occupants -- some of whom didn't even have a mortgage and never received a summons to anything (the paper-pushers were not always scrupulous in getting the address right). The DC Caller article linked above has some examples that will curl your hair, like the widespread use of bogus social security numbers of military personnel. Between the mortgage-assignment mills and the foreclosure mills, it's unbelievable what blatant fraud low-level employees are now beginning to testify to.

Lest you think I'm enlisting your sympathy in favor of homeowners who simply want to skip their mortgage obligations, bear in mind that it's very important to ensure that a foreclosing lender is the right foreclosing lender, because otherwise there's still a lender out there that holds the true right to foreclose and that didn't collect the proceeds of the foreclosure sale. If a borrower truly has defaulted and should be foreclosed on, we want the buyer at the foreclosure sale to get good title so the home can go back into the market. But title insurance companies around the country are starting to throw up their hands and say, "If you think we're issuing a policy to insure title in these circumstances, you're dreaming." The whole process is about to grind to a halt.

The state of the law in most if not all parts of this country is that shredding an original mortgage has much the same effect as tearing up a check written on a bank account, subject to some technical exceptions and cure processes that are extremely unsuitable for high-volume portfolios. I'd like to think that some banks kept things kosher and can produce the unshredded documents that prove they own a real mortgage. Those banks can take over the business of the banks that shredded their assets and/or engaged in outright fraud. What worries me is the question of how many banks, if any, were doing it right. Bank of America recently was advised to set aside $10 to $20 billion to buy back properties sold in botched foreclosures. This could be a really big crash -- and taxpayers, via Fannie and Freddie, are on the hook for a very large piece of it.