Some Sand in the Gears of Securitizing

The problems with MERS began to come to light when “vice presidents” of the firm began to submit affidavits in foreclosures, saying the original note had been lost. In some cases those notes were signed by people who signed thousands of such affidavits, and have now admitted they did not actually review the files, as the affidavits said they had.

Nor were those people really employees of MERS. It turns out that MERS allows financial institutions that are its members to name anyone a vice president or assistant secretary of MERS. It seems a little unlikely that someone who had never been hired or paid by a company could be a vice president.

“Ironically, MERS Inc. — a company that pretends to own 60 percent of the nation’s residential mortgages — does not have any of its own employees but still purports to have ‘thousands’ of assistant secretaries and vice presidents,” Mr. Peterson wrote. “This corporate structure leads to inconsistent positions, conflicts of interest and confusion.”

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In a case in Arkansas, the owner of a second mortgage foreclosed on a home without notifying MERS, which was listed as owning the first mortgage. When MERS sued to overturn the foreclosure, the state supreme court ruled that MERS had no case. It had lost nothing, the court concluded, because it was not the actual beneficiary of the first mortgage.

The MERS Web site asserts that “MERS has been designed to operate within the existing legal framework of all 50 states,” adding, “Any loan registered on the MERS System is inoculated against future assignments because MERS remains the nominal mortgagee no matter how many times servicing is traded.” The company uses the slogan, “Process Loans, Not Paperwork.”

A spokeswoman for MERS, Karmela Lejarde, said Monday that Mr. Peterson was wrong about several things. “Every single court challenge to the standing of MERS in the foreclosure process has been upheld, either in the initial court proceeding or upon appeal, when proper evidence is presented before the court,” she said in an e-mail.

Asked about the Arkansas Supreme Court decision, she said “that particular case was not about foreclosures,” although it did involve an effort by MERS to overturn a foreclosure. She added that the decision was “in direct contravention to longstanding Arkansas law.”

It is possible that the courts in most if not all states will conclude that the details of how MERS functioned, even if not completely in accord with state law, should not prevent foreclosures.

But even if that happens, Mr. Levitin, the Georgetown professor, argues that there might be tax consequences that would further harm investors in mortgage securitizations. That is because the securitizations operate under a special provision of tax law that exempts them from taxation. But that status is predicated on the transfer of mortgages to the securitization when it was created. If that is not the case, that could cause a major tax problem.

In addition, Mr. Peterson argues that local governments might prevail if they sue, claiming that the basic operating structure of MERS involved the filing of false documents. In that case, they might be entitled to collect several mortgage recording fees per mortgage — money that presumably would also come out of the securitization trust.

All of these problems might have been avoided had Wall Street sought legislation in the states to assure that such issues would not be raised. It is not clear why that did not happen. Perhaps the lawyers saw no problem, or perhaps they feared that efforts to change the law would be blocked by county officials wanting to preserve a source of revenue from recording mortgage transactions. In any case, no laws were amended.

Now, Mr. Peterson wrote, the courts may be confronted with a difficult conundrum. “Had the parties to these transactions followed the simple policy of specifying in the documents who owns what, a vast amount of confusing litigation and commercial uncertainty could have been avoided. These anchorless liens now flail in the wind of our commercial tempest,” he wrote.

“Courts that come to understand this situation will be in a bitter predicament,” he wrote. A ruling against the securitizations would “throw the mortgage market into further turmoil.”

But ruling the other way, against the complaining borrowers, would have its own perils, he argued, in part because MERS has made it difficult and in some cases impossible to learn from public records just who owns a mortgage, despite a long tradition that such information must be publicly recorded.

“If the courts write opinions allowing MERS to act as a ubiquitous national proxy mortgagee, they will write into the American common law fundamental legal mischief that will plague generations to come,” he wrote.

If some courts do rule against MERS, the legal battle could be a long one. Real estate law is largely a matter of state law, leaving the 50 state supreme courts as the final arbiters.