Last week we notedthat opponents of MERS are already gearing up to fight what they see as a government rescue of the fraud-enabling database banks used to facilitate mortgage transfers as part of the securitization process.
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Although there’s not yet any explicit campaign underway to lift the threat of catastrophic legal risk to MERS, at least some of the opposition is convinced a legislative rescue is underway.
What’s more, they are convinced that without Congressional action, MERS would not only lose its credibility—but would be snuffed out altogether by the judiciary.
Let’s start by saying that we’re not convinced that courts will destroy MERS. Even though it has suffered some legal setbacks, it has a long history of satisfying courts about its legitimacy. What’s more, courts are much more practical than they are often given credit for. It seems unlikely that they’d throw such a vast and important part of the financial system—3 out of five mortgages in the US are part of MERS—into chaos.
The legal arguments against MERS—that it undermines state property laws, cheats states of registration fees, facilitates hasty electronic transfers of mortgage property interests when traditional rules required slow and steady ‘wet paper’ assignments—have an obvious appeal to legal formalists. If you are a states rights advocate or the kind of person who thinks that all departures by the judiciary from formal legal requirements are illegitimate, you may have good grounds for believing the courts should rule in ways that undermine MERS.
But our courts are not so constrained by formalism. They balance public policy interests and something they call “equity”—which usually means a judicial view of fairness—with the “letter of the law.” The courts are wary of allowing old laws to disrupt settled practices. Importantly, many of the advocates of MERS demise seem to be opportunistic formalists—adopting a legal formalist stance only when it comes to attacking the system banks are using to foreclose on defaulting borrowers.
Even so, let’s grant for a moment the possibility of a judicially-induced apocalypse for MERS. What do the opponents of a legislative rescue for MERS really want? Do they want to see the majority of securitization deals unwound? Should the banks that underwrote securitizations be forced to buy back every single mortgage at par?
Notice that we’re talking about a zero-sum reshuffling of losses. No new wealth is being created in this process. The losses avoided by the investors in mortgage-backed securities will simply be transferred. Instead of losses on mortgage investments being visited upon the purchasers, they will be wind up with the sellers. If you despise Wall Street, perhaps this is where you want the losses to land.
But we should at least be aware that a Great Unwind of mortgage-backed securities would likely result in a bailout of the firms we bailed out in 2008. They simply do not have the capital to buy back all of those mortgages that went into the MERS system. So the opponents are not just arguing for the losses to be redistributed to Wall Street—they are effectively advocating that the losses be redistributed to the taxpayer.
To put it still differently, the Great Unwind would be a covert bailout of investors in mortgage-backed securities that will be funded by taxpayers. The investors will be rewarded for their lack of vigilance when it came to the risks in the US housing market. The market will be further infected by moral hazard, as bond investors once again find government policy immunizing them to losses. The repeated enrichment of Bond Pacificists will further damage the “Bond Vigilante” role of the credit markets in providing risk-management as an externality of their own investment interests.
What certainly won’t happen is the Great Unwind resulting in some kind of Mortgage Jubilee, with courts deciding that MERS so damaged the security interests in mortgaged homes that borrowers whose loans ended up in MERS simply cannot be foreclosed upon ever. This will not be a universal loan forgiveness program. The money was borrowed, the money is owed, the house was pledged—even if courts destroy MERS, they won’t erase these facts. Instead, they will engage in the process of figuring out to whom the money is owed once MERS-connected securitizations are unwound.
If we’re willing to enter into fantasy land for a few moments, however, it might be worth considering what would happen in the event of the Mortgage Jubilee. In the first place, nearly every mortgagee whose loan is in MERS would be highly incentivized to stop paying their mortgage. Forget about ‘strategic defaults’—it would be actually insane to keep paying your mortgage in this situation. So three out of five residential mortgages in the US would default.
This would not only throw pretty much every financial institution in the US—banks, insurance companies, broker-dealers—into insolvency. It would cause an international crisis. Foreign investors—and their governments—would look at this like a seizure of their assets. International trade would dry up, as foreigners would no longer be willing to extend credit of any kind to a nation that had just declared a national policy of loan defaults. The credit of the US government—which benefits from the fact that uniquely among all nations, it has never defaulted—would become unsustainably expensive.
As we’ve said, this is fantasy-land. The US judiciary is not about to organize the destruction of the international trade and financial system by arranging for the mass elimination of homeowner debt obligations. It is also not about the bankrupt our largest financial companies by unwinding every MERS-connected securitization. And if the judiciary did anything like this, Congress would act to stop it.
MERS opponents should at least be clear what it is that they are asking for. Rather than demanding the blanket destruction of MERS, they should be looking for a more reasonable and balanced settlement. Perhaps, as Tracy Alloway of FT Alphaville suggests, they should push the Attorneys General investigating the foreclosure fiasco to demand a Spitzer-style “global settlement” that would involve a trade-off of mortgage modifications in exchange for forgiving the flaws and frauds MERS allegedly enabled.
If the opponents go the ultra route—demanding no judicial or legislative peace accord on MERS—they are likely to come away with nothing at all. They will be brushed off as extremists, and the dealmaking will take place in smoke-free backrooms of Capitol Hill restaurants where future-lobbyists now employed by congressional banking committees negotiate with former-banking staffers turned lobbyists.
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