by Christopher Peterson
On monday the American Banker ran a well written story by Jeff Horwitz on the document problems slowing down foreclosures. It focuses on whether document custodians actually have the possession of key documents, including especially promissory notes. The article (subscription requried; 2010 WLNR 21191843) quotes document custodians insisting that they have all the documents they need, but it also includes some scepticism from Diane Thompson, April Charney, and Max Gardner. It is good to see financial journalists paying more carefull attention to consumer rights advocates.
This being said, I think the story is still missing some important points. Because I have a million other things to do today, I’ll limit myself to three thoughts that jump to mind. First, one reason some originators may have been lax in sending proper documentation on to the depositor (and in turn the document custodian or trustee) is a false belief that designating MERS as the mortgagee or deed of trust beneficiary would facilitate quick foreclosures without all the proper documentation. MERS is an important partial driver of the affidavit problems. Some financial institutions convinced themselves that MERS would be a cradle-to-grave proxy eliminating the need for them to keep the collateral jackets with blue ink documents that old-fashion lenders once maintained. Why keep track of paperwork if MERS is just going to do your foreclosures for you? This is an easy thing to believe when (1) they really wanted to believe it and (2) the motto of company is “process loans, not paperwork.” Should we be surprised that the paper might not have actually changed hands?
Second, the representations the document custodians are making in Mr. Horowitz’s article are inconsistent with what some mortgage bankers themselves have admitted. A brief the Florida Bankers Association submitted to the Florida Supreme Court takes the totally opposite view on whether the promissory notes are lost. It states, “The reason ‘many firms file lost note counts as a standard alternative pleading in the complaint’ is because the physical document was deliberately eliminated to avoid confusion immediately upon its conversion to an electronic file.” Yikes! Memo to all bankers: destroying promissory notes is a bad idea. But don’t trust me. Instead very carefully read this next sentence recently written by two Judges on the American Bankruptcy Institute’s Uniform Commercial Code Committee: “for the note to be enforced, the person who asserts the status of the holder must be in possession of the instrument.”
But wait, there’s more…
Third, the lost note problem is not the financial institutions’ only legal problem. The security agreements used in MERS registered loans state: “MERS is the mortgagee.” Three state supreme courts have now held that MERS is not a mortgagee. The ultimate outcome of this basic legal discrepancy is not yet known and has the potential to be different in various states. Just focusing on one potential implication from this very basic discrepancy, it is legally unclear that recording a mortgage with MERS listed as a mortgagee is sufficient to create a perfected security interest. A basic objective in recording mortgages is to establish priority vis-à-vis other lenders, lienors, and buyers. With the exception of Minnesota, every state land title act—the statutes that set out the rules granting priority through recording—was written before MERS came into being. The legislatures that drafted these statutes did not contemplate the possibility that every lender in the country would record their loans in the name of one shell company owned by banks. Any state supreme court (except for Minnesota) is currently free to decide that recording in the name of this proxy-mortgagee-shell-company does not perfect the mortgage. Will any state supreme court have the guts to insist on transparent real-party-in-interest recording? Unfortunately, there is no crystal ball on my desk. Before the financial crisis and all of the documentation problems I probably would have guessed that the industry would get away with this power grab that privatizes the record keeping system. But now….? I’m not so sure.
The MERS folks and their lawyers will continue to point to the occasional case from our history where one court or another has allowed some form of recording where there was some unusual agency relationship involved. They will say that these occasional cases prove their concept is “legal.” But just step back and think about it for a minute. Is there really a case that proves that their concept is legal? No. Obviously there is not because their concept was totally new in the history of the country. So many people I talk to seem to think that hidden in the bowels of our country’s case law there is some nexus of complicated cases that must—surely must—make this quirky idea perfectly OK. However, every case the MERS folks cite to will have the potential to be distinguished by a state Supreme court that believes its legislature did not authorize this type of change to the system. And those courts will be on solid ground because—let’s be honest—state legislatures simply did not willfully grant permission for this radical change in recording. The land title statutes contemplate recording by many different actual mortgagee’s and deed of trust beneficiaries, not by one single a shell company that stands in the place of the entire industry. They will not find a case that binds a state supreme court to hold otherwise.
This is, of course, not to say that the MERS folks cannot win on this question. Many judges will be willing to look at the occasional case MERS’ lawyers drag up and hold that: “yes, behold, the land title laws DO allow one shell company to be the national mortgage proxy.” My own impulse is that a judge that takes this route is either clueless or a wee-bit intellectually dishonest. But maybe that’s too harsh. I suppose I could understand a judge saying to herself, “Well, … I’m going to let them interpret the statute this way because I don’t want to cause a crisis—and let the legislature’s original meaning of the land title act be damned.” I suppose there is something of a cynical virtue in this position. The thing I don’t like about that is that Supreme Courts ought not to get in too far into the business of macro economics. Their job is to enforce transparent rule of law. We are counting on them to do that. Plus, they are lousy economists. The truly conservative position on these cases will be to insist that radical changes to the legislatures’ land title acts be made by legislatures, not by bank sponsored financial snake oil salesmen. I actually think that the greatest exposure of the industry on this question could be in republican, civic virtue oriented courts that are not particularly impressed by Fannie Mae or Goldman Sachs bling-bling. There are smart judges in Wyoming, in Kansas, in Oregon, in Ohio, in Florida that will resent turning over the county recorders democratically maintained recording system enshrined in law by the democratically elected legislature to this bank owned short cut made for the convenience of the Wall Street investment banks out of control GSEs that trashed our economy.
Ultimately, these problems, and the present uncertainty they are creating, will not be resolved quickly.
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