By Christopher Moraff
Last month, in an unprecedented show of force, the attorneys general of all 50 states launched an investigation into a mortgage scandal that some commentators are warning could spark a second economic crisis if left unresolved.
The scandal — which involves thousands of fraudulent foreclosure affidavits from the nation’s leading mortgage servicers — has prompted legal advocates across the country to challenge pending foreclosures and has raised the ire of judges who are left to sift through the mess.
Here, in a nutshell, is what happened:
When a person takes out a loan on a house, two components are generated, a “mortgage” or lien, which serves as a deed or title to the property and is pledged as collateral for the loan, and a “note,” which is a negotiable instrument constituting a promise to pay a certain amount of money at a specified interest rate in an agreed upon timeframe.
Every time a home loan changes hands (and during the housing boom of the 1990s they changed hands a lot) the note needs to be formally assigned to the new owner. "Think of it as signing over a check", says Beth Goodell, an attorney for Philadelphia-based Community Legal Services; "there’s one right way to do it and lots of wrong ways."
According to Goodell, with so many mortgages being written, some lenders, for reasons that aren’t entirely clear, didn’t hold on to the original copies of their mortgage notes and transferred their loans to other lenders without proper documentation.
In many cases they relied on something called the Mortgage Electronic Registration System, or MERS, an electronic shortcut that enables properties to change hands purportedly without the necessity of recording each transfer.
Years and perhaps dozens of owners later, when it came time to foreclose on those loans, either no one had the original notes, or no one bothered to look for them. So, lenders did the next best thing, they made new ones, thousands of them.
The problem is, that looks a lot like fraud.
“That’s what we’re talking about here,” said Goodell. “It’s not a just a procedural mistake, it’s really pretty significant.”
Although the issue has only recently made headlines, housing advocates say this kind of thing has been going on since the early years of the housing crisis. As an advocate for Philadelphia homeowners facing foreclosure, Goodell says she has raised the issue of missing notes in a dozen or so cases, and has consistently survived the summary judgment phase, at least for the time being managing to keep her clients in their homes.
“For us this is just the most recent example of the mortgage companies acting with impunity,” she said. “They acted with impunity when they made these loans … they acted with impunity about how they transferred ownership, and now they are filing foreclosures based on those bad loans and the lack of appropriate paperwork and they still don’t care.”
Judges in some jurisdictions have been quietly throwing foreclosure cases out of court since at least 2007, due to lenders’ inability to produce a valid note, but it wasn’t until a few vigilant bloggers picked up on several recent courts cases that the issue hit the front pages. Testimony in the cases revealed the extent to which lenders were creating new notes, or “affidavits of standing” — notarized documents that attest to a lenders’ rightful ownership of the property to be foreclosed upon — by employing people whose sole job was to sign hundreds of these documents a day.
“Drawn from the ranks of hairstylists and assembly line workers, they were given a few days training before being put to work attesting to the contents of documents that they neither reviewed nor understood,” writes portfolio manager Richard Zahm, in the latest issue of Real Estate Law & Industry Report.
One of these so-called “robosigners,” a Montgomery County man named Jeffrey B. Stephan, testified in a deposition last June that he signed 8,000 to 12,000 documents a month as a group leader for a GMAC document execution team.
In October, as news of the robosigner scandal broadened, the Obama administration assigned an interagency group — the Financial Fraud Enforcement Task Force — and the Federal Housing Administration, to investigate. Meanwhile, the Federal Reserve launched its own inquiry.
In response, three of the nation’s top five mortgage servicers — JP Morgan Chase, Bank of America and GMAC (now Ally Bank) — declared moratoriums on pending foreclosures until they could assess the scope of the problem (the other two, Wells Fargo and Citigroup chose to continue foreclosing).
Pennsylvania banks, including Pittsburgh-based PNC, followed suit, halting foreclosures and launching internal investigations. From September to October 2010 foreclosure activity dropped 9 percent as a result.
A month has now passed, and most all of the banks have resumed foreclosures. In a Nov. 9 regulatory filing, PNC said: “Based upon our review thus far, we believe that [we have] systems designed to ensure that no foreclosure proceeds unless the loan is genuinely in default.”
That may be good enough for the banking community, but law enforcement officials say they’re just getting started. The state’s attorneys general joined forces with banking and mortgage regulators from 37 states to form a working group under the auspices of the Mortgage Foreclosure Multistate Group.
The regulators are working under the Multistate Mortgage Committee (MMC), which is chaired by Donald DeBastiani, head of the Pennsylvania Banking Department’s Bureau of Non-Depository Examinations.
DeBastiani declined to comment on the investigation, but John Prendergast, staff liaison for the MMC and its immediate past chair, says in his 24 years as a regulator he’s never seen anything like what’s going on now. But he warns against indicting the entire foreclosure system for a problem caused by unscrupulous lenders.
“You’re going to hear a lot of talk about should the foreclosure process be changed, but if you look at how this process has worked prior to the last year, it has worked very well,” said Prendergast. “What you had here was so much volume that mortgage servicers weren’t prepared. They just weren’t prepared to deal with this volume.”
William Woodward, a law professor at Temple University who serves as a pro bono lawyer and Judge Pro Tem in the Philadelphia Mortgage Foreclosure Diversion Program, says the real culprit was the exponential rise of securitized debt, a process by which thousands of mortgages are bound together into single securities.
“Before securitizations, before the 1980s, a mortgage might be transferred once or twice in 20 years, now it could be transferred 100 times in that same time span, and at every stop on that chain there are intermediaries with their hands out collecting a fee,” he said. “So there is an incentive to do quick transfers so why wouldn’t they cut corners and skip documentation unless the person on the other end of the transaction demands it, but they’re not because they are just going to pass it on to someone else.”
On top of that, fallout from the housing crisis meant mortgage servicers were dealing with more foreclosures than ever before. The total number of homes foreclosed on since the housing crisis began is approaching 10 million, and most experts expect things are going to get worse before they get better.
According to the Federal Reserve, more than 20 percent of borrowers owe more than their home is worth and an additional 33 percent have equity cushions of 10 percent or less, putting them at risk should house prices decline much further.
As of the first quarter of 2010, more than 178,000 Pennsylvania homeowners were late on their mortgage payments; and the Center for Responsible Lending forecasts that Pennsylvania will see more than 55,000 home foreclosures in 2010.
What about homeowners?
Pennsylvania is one of 23 states that require lenders to file legal proceedings in court to affect foreclosure and one of 45 that require proof of “standing” that verifies the institution actually has a right to the property. With chain of ownership a jumbled mess and courts losing patience, homeowners could come out winners.
“What all this attention is doing is it’s creating a window for homeowner advocates to figure out a way to get a better outcome for lots and lots of homeowners,” said Goodell.
How successful that will be is anybody’s guess. For one thing, while lender procedures almost certainly crossed into a legal gray area if not outright criminality, no one is arguing that the majority of foreclosures themselves weren’t legitimate.
Pendergrast thinks that at the end of the day most of the impacted mortgages will wind up being foreclosed on. “I think what you’re going to see is the overwhelming number of these are valid and will go forward,” he said.
But judges have a lot of discretion in such cases. In a Nov. 9 article, the Washington Post cited judges in New York who estimate they are dismissing 20 to 50 percent of foreclosure cases on the basis of sloppy or fraudulent paperwork filed by lenders.
Woodward says if lenders can’t produce the proper documentation and the letter of the law is followed the outcome could be very good for homeowners.
“In this country if you owe someone money they have to prove it,” he said. “Even if it’s just a matter of luck and someone took out a mortgage and stopped paying on it but the bank can’t prove it, they win. The notes are ultimately the proof that the person that brings the case is rightfully owed money, and if you can’t show that, you can’t win.”
Whatever the outcome for homeowners, the mortgage servicers at the center of the scandal can expect to be called out once the attorneys general finish their investigation.
Pendergrast says their officials have a wide variety of options available to them, ranging from fines (the number being tossed around is $25,000 per violation) or mandated loan modification to forcing lenders to set up special funds to help homeowners.