October 07, 2010

The foreclosure mess

About 15 years ago I was defending an action brought by two individuals against my client concerning ownership of a Napa Valley vineyard. It was, as such cases go, pretty interesting; for one thing, I finally understood what the phylloxera epidemic was all about, and why it had become so necessary to import ancient French root stock to California to offer resistance. Also, why roses are planted at the end of vineyard rows (they are the canaries in the coal mine - infestations tend to show up in the roses first).

Anway, while fitfully dozing through one of the tedious depositions taken in a pretentious San Francisco office, it struck me that the two individual plaintiffs were attempting to assert causes of action (claims) against my client that actually belonged to a defunct (as in bankrupt) corporation; to wit, a breach of contract claim to which that b/k corporation, and only that b/k corporation, was a party. Not these two schlemiels and their tricky lawyer - nope, the bust-o corp. Rousing myself to full consciousness, I began making notes on my yellow pad (in place of the usual Fred Flintstone sketches with which I ordinarily pass the time). Within a few weeks (a heartbeat in the litigation game), I had "severed" this issue for a separate trial - a trial on the issue of "standing" or "real party in interest," in which I challenged the right of these two yokels to pursue this claim at all. The judge liked the theory, ruled in my favor, and it was pretty much all over from there.

If this stuff sounds kind of dull, then imagine what it's like for the judges of America to sift through the "standing" and "real party in interest" implications of cases involving about $6 trillion in sour mortgage loans. Because that's what we're actually talking about here. I have not yet heard an actually cogent explanation of the crux of the problem, because this is a technical area of the law and the usual blowhards who are not legally trained nevertheless feel themselves completely competent to hold forth on this arcana. It's not that simple, no matter what Karl Denninger thinks. In essence, what is going on, in broad outline, is this: the "securitization" process (in which about 80% of all home loans were involved during the housing bubble years) was a conveyor belt, mass production phenomenon. That was supposed to be its "charm:" everybody knew that the entire housing market could not suffer a massive, coordinated, highly-correlated decline - right? Thus, safety in numbers. Individual mortgages were assembled with other individual mortages and sold into the secondary market (the shadow banking system), where they were racked and stacked into mortgage-backed securities (MBS) and then those derivatives were poured into molds called Collateralized Debt Obligations (CDO) which consisted of literally thousands of individual mortgages of all make and manner, creditworthiness, et cetera, et cetera, all tranched, sliced and diced and "rated" by the big ratings agencies like Moody's. The end purchasers of such monstrosities were pension funds, high net worth investors, hedge funds, you name it, anyone looking for that high fixed income return with virtually "zero risk," because the housing market can only go up.

It was that rosy assumption that led to the main problem we now face. You see, the hoary and ancient Law of Real Property, proud relic of Anglo-American common law, demands all kinds of formal ritual. A lot of ins and outs and what-have-yous, as Dude Lebowski said. This is because title to real property is so important to keep straight. So: deeds must be in writing. They must be signed and notarized before they can be recorded. Those who own a security interest (such as a company owning a mortgage) must also reduce their claim to writing, and must notarize the deed of trust or mortgage before recording it. And let's say that the mortgage company sells that security interest to someone else up the securitization food chain; well, then Company 1 needs to document that assignment or sale so that Company 2 acquires Company 1's interest, and the same solemn formalities need to be followed in order to "perfect" such an assignment.

Are you beginning to see the problem? Joe Sixpack, taking a break from being unemployed long enough to buy a 5-br, 4-ba charmer in North Las Vegas circa 2004, for the steal-it price of $450,000, nothin' down, ARM at 1% for the first year, infinity thereafter, signs a note, a deed of trust, receives a deed, and signs 320 other documents on the fold-out dining table in the double wide there in Bullhead City. The deal is done at the local level, but the fun is just getting started. Up the food chain the main documents go, to their eventual place of repose in Row 2,345, Column 6,784 of the indescribably complex CDO that becomes their eventual home. Lord Blackstone and the other eloquent crafters of the English common law never had this kind of thing in mind when they insisted on writings for all real estate transactions (the Statute of Frauds) and strict adherence to the concept of "chain of title" in order to prove, ahem, one's standing to enforce rights against real property, such as the right to foreclose on a mortgage one claims to own against the property as the Real Party In Interest. Specifically, how does the ultimate owner of such a mortgage prove that all the proper assignments were made as legally required all the way up the line as Joe's mortgage wound up poured, like one molecule among billions, into the Jell-O mold of the CDO?

That's what I think went on. There are other problems, such as those excuting affidavits attesting to default and the amount owed having no idea what the actual computations are on which such affidavits are based. But the huge, probably unfixable problem is that the process of moving mortgages into the secondary market became so byzantine, and performed on such a massive scale, that inevitable (and fatal) shortcuts were taken on all the intermediate paperwork necessary, legally, to establish a chain of title and assignment of mortgage rights. And the reason, really, that it got so sloppy is that no one ever thought that millions of foreclosures would ever be necessary - because the housing market only goes up.

Lawyers for homeowners are now exploiting all of these problems. Produce the "wet ink" promissory note, they say; prove that your mortgage right is in the chain of title; prove that this property did not find its way into more than one CDO (as many houses apparently did, inevitably in such an out-of-control process). One might say, well hell, the homeowners, Joe & the Little Woman, are in arrears, there ain't no question they're in foreclosure, so let's evict them, you know, on general principles. But the law doesn't work that way. Maybe they haven't made their payments, but it's still incumbent on MERS, or the Bank of America or GMAC, to prove that they (and only they) have the right to do the evicting. If they can't prove it, it's their own damn fault for participating in such madness, and it doesn't matter whether Joe "ought" to be evicted. You're not the Real Party in Interest to do it.

Fairy tales can come true, it can happen to you, as Ol' Blue Eyes used to croon.