Now that the Massachusetts Supreme Courthas upheld a lower court's ruling that Wells Fargo and U.S. Bancorp did not have the proper paperwork to foreclose on two homes, the question is what that means for the broader mortgage market and the future of millions of foreclosures in or about to be in process? Not only does this decision affect individual foreclosures, but it throws into question the entire mortgage securitization process.
The issue in contest over foreclosures now lies with the "note," or the IOU on the mortgage. The mortgage is the security that says the house is the collateral. Ownership of the note is critical because that note must be transferred when the mortgage is traded around. During securitization a process called "endorsements in blank" are used, so that mortgages can be transferred quickly. But you still need that note when you foreclose.
"This is really about endorsed/assigned in blank," says JT Smith of Aristar Funding. "Judges didn’t understand and transfer taxes were not paid. This is going to get very ugly. The mortgages became like bearer bonds in that whoever had possession of original wet copy was the owner, and if you didn’t have that you could not foreclose. Then if you did why didn’t you pay transfer taxes?"
"Many people might look at this and say 'I can get my house free and clear if I just contest the foreclosure and get a favorable judge that sides on my side."
It's exactly what Prof. Adam Levitin told me way back in October:
"The mortgage is still owed, but there's going to be a problem figuring out who actually holds the mortgage, and they would be the ones bringing the foreclosure. You have a trust that has been getting payments from borrowers for years that it has no right to receive. So you might see borrowers suing the trusts saying give me my money back, you're stealing my money. You're going to then have trusts that don't have any assets that have been issuing securities that say they're backed by a whole bunch of assets, and you're going to have investors suing the trustees for failing to inspect the collateral files, which the trustees say they're going to do, and you're going to have trustees suing the securitization sponsors for violating their representations and warrantees about what they were transferring."
So now what?
95 percent of troubled borrowers currently do not contest their foreclosures, Paul Miller of FBR tells me. He sees this less about the specific case as the perception of this case:
"If you see more and more of these headlines, many people might look at this and say 'I can get my house free and clear if I just contest the foreclosure and get a favorable judge that sides on my side. All of the sudden I have a free mortgage.' That’s not what’s going to happen in this case," Miller said in an interview. He believes these two homes will eventually go to foreclosure.
In fact, this Massachusetts case may not be exactly as the headlines are screaming.
The American Securitization Forum, immediately after the ruling, put out a statement saying, "The ASF is pleased the Court validated the use of the conveyance language in securitization documents as being sufficient to prove transfers of mortgages under unique aspects of Massachusetts law.
Importantly, unlike the lower court, tithe Court also said assignments of mortgage can be executed in blank, as long as a complete chain of transfers can be shown through the applicable deal documents." ASF says those documents were not introduced in the lower court and that the lower court would have ruled otherwise if they had.
"The ASF is confident securitization transfers are valid and fully enforceable," concludes the ASF's Executive Director, Tom Deutsch.
That remains to be seen, as lawsuits abound over this very issue all over the country. Clearly investors didn't like the ruling, as they sent shares of bank stocks into a despair spiral. This may be the final Massachusetts court ruling, but it will not be the final word in this chapter of the foreclosure mess.
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