Well, what initially looked to be a technical road bump in the foreclosure process is now certainly blossoming into something with a more material impact on the housing market.
Initially, this situation had the appearance of a sloppy record-keeping scandal, one that was important to resolve but that involved supporting documents that could ultimately be located and where correct procedures could be put into place.
On the other hand, there are hints now of a mortgage system that has been put into place in service of mortgage securitization objectives that may have become detached somewhat from the underlying governmental recording procedures for titles and mortgages.
The latter situation involves a Reston, VA based company named Mortgage Electronic Registration System (MERS), which launched a mortgage tracking system in 1997. The system was designed to simplify the registration and transfer of mortgage ownership. From their Web site:
MERS acts as nominee in the county land records for the lender and servicer. 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. MERS as original mortgagee (mum) is approved by Fannie Mae, Freddie Mac, Ginnie Mae, FHA and VA, California and Utah Housing Finance Agencies, as well as all of the major Wall Street rating agencies.
OK. For those fortunate individuals not initiated into the intricacies of deeds and mortgage notes, this statement might need further elaboration. Let’s use an analogy. Let’s say that you, me, and a bunch of our friends all sell mortgages to people who want to buy homes. But, once we’ve sold a mortgage to an individual, we periodically re-sell it to each other. That is, I take the note that I’m holding on a house located at 123 Main Street (that obligates the homeowner to pay me a certain principal plus interest) and I sell it to you. Now the homeowner living at 123 Main Street pays their monthly mortgage payment to you and not me (and I’ve gotten a lump sum payment from you in return).
In the old days, this exchange would involve me walking down to the county courthouse and filling out some paperwork transferring the mortgage on 123 Main Street over to you. Not fun, but not the end of the world either. Enter mortgage-backed securities. Now, it’s not just a few of us friends holding onto mortgages. We create a bunch of companies that buy certain mortgages and then essentially sell shares in this new company to investors, each of whom now owns a small piece of all the mortgages owned by the new company (i.e., mortgage-backed securities). In this new world, we’re transferring mortgages on homes all the time. I’m not just having to go down to my local courthouse and assign the mortgage to another of my mortgage-holding friends. I’m having to go to the more than 3,000 courthouses around the country and assign the rights to a multitude of different parties. I’m on the road all the time just doing paperwork or I’m having to pay somebody in all the counties to do it for me. This whole recording process has become more than a minor nuisance. It’s now a major cost of business for me and it seriously affects the speed at which I can buy and sell mortgages.
So, you and I come up with an idea. We get our friend Sally to agree to be listed as the mortgagee on all these mortgage notes instead of you or me. Sally is someone we both trust and agrees to serve as an honest broker for recording agreements between you, me and all of our other, mortgage-holding friends. So, for example, when I sell the homeowners of 123 Main Street a mortgage, we file a mortgage note that lists the homeowners as the borrower and Sally as the mortgagee (instead of me although I’m still listed as the lender, a distinction that will become important later). Sally then starts a spreadsheet where she lists me as the actual lender of 123 Main Street. When I go to sell this mortgage to you, I don’t need to go down to the courthouse and transfer the mortgage to you. We simply call up Sally and tell her to update her spreadsheet with the information that you are now the lender for the mortgage on 123 Main Street and not me (I also send a letter to the homeowners telling them to send their monthly payment to you now and not to me). This innovation makes the current lender of any mortgage quickly knowable by anyone and allows for the rapid transfer of mortgage rights. Think of it as a clever work-around to the Federal system put into place by our Founders (i.e., local, state and national governments, each of which controls different governmental functions) which can make nationalized businesses that deal with local-level processes cumbersome.
The current imbroglio that seems to have developed arises when the homeowners of 123 Main Street stop making payments to you (assuming I’ve sold the mortgage to you), thus necessitating you to foreclose on them. When this occurs, you tell Sally to head over to the county in which 123 Main Street is located and file a foreclosure notice (since Sally is the registered mortgagee for the property). Generally, this proceeds along the lines of any foreclosure: the house is foreclosed and you attempt to recoup some of your money by selling the house subsequently. Sally is really just acting as an agent on your behalf in this process.
In some cases, however, the local courts will take a dim view of the record-keeping system that you, Sally and I have set up. They will assert that, according to their records, Sally is the mortgagee but I’m still the lender of record. They’ll go on to say that since Sally is not the lender and they have no record that you are, in fact, the lender either (remember, my sale of the mortgage to you was just recorded in Sally’s spreadsheet, not with the county itself), neither Sally nor you can foreclose on the property. Only I can, but I’ve long since forgotten about this mortgage because I sold it to you (but only told Sally about the sale, not the county). This leads Sally to whip out her spreadsheet in open court and start explaining the system that we’ve set up. This, in turn, can leave the judge feeling a bit like a New York state judge who, when confronted with exactly this scenario in his courtroom this past May, observed that the mortgage and servicer companies seemed to be “operating in a parallel mortgage universe.” He actually called it the Twilight Zone. His opinion is a good read.
Just to make sure we’re all on the same page in this analogy, you and I are mortgage-holding companies like Bank of America, HSBC, and others. Sally is the Mortgage Electronic Registration System, a company jointly owned by all the big financial firms which has as its members any financial firm that lends money for mortgages and wants to easily exchange them to other firms. Sally’s spreadsheet in the analogy is actually the MERS database which is online for anybody to look at. Any mortgage for which MERS is acting as the mortgagee will list a MIN number (see example below). Anybody can type this MIN number into the MERS website and find out the name of the servicer and the actual lender for the mortgage (note, sometimes the lender info is not shown and you must contact the servicer first). Try it yourself: Search for MERS on your county recorder website, type any MIN number that you happen to find into the MERS system and see what you get.
So, where does all this leave us?
- The securitization of mortgages in this country has been a powerful innovation which has created enormous benefits to homeowners. Mortgage-backed securities provide vastly more money for the mortgage markets than would be available in the prior system where lenders held onto each mortgage that they originated. Ok, let’s be honest, it probably benefitted too many consumers during the bubble, lots of whom got mortgages because the money was there courtesy of securitization while the people approving the mortgages weren’t aware enough of the potential risks. By reaching deeper into the pool of potential homeowners to sell new mortgages, the risks were two-fold. First, they were lending to people with more credit risk (so, in bad times, default rates would be higher). Second, the expansion of homeownership helped fuel unsustainable price appreciation which, when markets began to correct, made real estate a depreciating asset. This depreciating asset roiled both the newer, less credit-worthy borrowers but also lots of the more credit-worthy people who now found themselves in negative equity precisely at a time when lots of them started to lose their jobs in the recession.
- I’m not a real estate lawyer so I won’t comment on the legality of the MERS system, but it does seem a logical response to the tangible problem of complying with long-standing county recordationprocesses while still enabling a modern mortgage market. It’s been in place since 1997, has registered more than 64 million mortgages, and, notwithstanding the occasional legal challenge that I describe above, it seems pretty well established in most jurisdictions.
- If the entire MERS approach were deemed illegal tomorrow, the only thing that would change is the speed with which these foreclosures would occur. Back to our analogy, if a court deemed that neither Sally nor you could foreclose on the homeowners of 123 Main Street, they could ask me to come down to the courthouse and do the foreclosure myself. Or, more likely, I would make an official assignment of the mortgage to you, and then you now have the legal standing to proceed with the foreclosure. The house would still be foreclosed upon, a fact that was precipitated by the homeowner’s non-payment, not by anything about the record-keeping system itself. A reversion to the old county process would just make things go more slowly.
- At the risk of understatement, slowing down the foreclosure process just for the sake of slowing it down is really not helpful at this point in the housing correction. In fact, it’s really quite bad for the market as it will delay the natural process of supply and demand reaching equilibrium because buyers will stay away from a market that they view as still heading down. And we’ll have less of a real sense of total supply because a lot of it will be tied up in homes that are in foreclosure limbo. We absolutely need to make sure that the foreclosure process is proceeding in a legal and transparent manner but, once that is satisfied, it’s not going to help real estate markets to delay foreclosure actions that are ultimately going to happen anyway at some point in time.
- With the various states serving as laboratories for different foreclosure processes, we have the opportunity to see the differing results produced by these processes. I believe that a key reason for why markets in some non-judicial states like California seem to be recovering faster than markets in judicial foreclosure states like Florida is because foreclosures are clearing through the market faster in the non-judicial foreclosure states. Since I risked understatement in my previous bullet point, let me be clear here: calls for a moratorium on foreclosures – while politically attractive for elected officials and their regulators – are misguided and would do significant damage to the nascent stabilisation in home values.
- Those of us who’d like to find a way to help stem the foreclosure crisis should focus on some of the concrete proposals to help homeowners like tweaking the FHA streamline refinance guidelines or more ambitious proposals like that of Hubbard and Mayer. I don’t always agree with every proposal but it’s ideas like these that explicitly target the foreclosure problem that merit our consideration, not putting our hope in gumming up the gears of government and commerce (again, unless we come to the conclusion that these gears are not legally constituted).
- My hunch is that the MERS approach will stand up to scrutiny and that this current situation will end up being more of a sloppy record-keeping scandal that should and will be cleaned up. This will result in a slowdown of foreclosures over the next 30 to 90 days. If the MERS approach doesn’t survive, I’d be gravely concerned for the near-term stabilisation of the housing market and for the long-term viability of mortgage securitization.