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Breaking: Congressional OVersight Panel Hearings

17 Nov

Yves Smith writes on the C.O.P. hearings on the mortgage crisis:

Congressional Oversight Panel Takes Tough Stand on Mortgage Documentation Problems

from naked capitalism by Yves Smith

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The spectacle of Senators in Tuesday’s banking committee hearings on the mortgage largely siding with articulate, fact-driven critics of the mortgage securitization is a sign that financial services industry misdirection and lame excuses are wearing thin. But far more devastating is the contrast between the long-promised American Securitization Forum paper on mortgage transfers, versus the Congressional Oversight Panel report on the broader issue of mortgage documentation.

A securitization lawyer called me to say he’d gotten calls from investors as soon as the ASF report was out. He said they were surprised at how weak the paper was, and complained that it did nothing to alleviate investor concerns. Georgetown law professor Adam Levitin, in the Senate Banking Committee hearings on Tuesday neatly dispatched the ASF paper. To give a rough paraphrase:

I agree with much of what is in the American Securitization Forum paper, as far as it goes, but it doesn’t go far enough. It is analyzing the wrong law. The paper discusses Article 3 of the UCC, which covers negotiable instruments, and Article 9, which covers promissory notes. But the UCC allows for parties to enter into other contractual arrangements, and the pooling and servicing agreements do that. Most securitization trusts are also governed by NY trust law, and they force additional measures for transfer.

In other words, this is pretty much the same argument that the industry has offered from the outset. There is no mention of the conflicts between the actual steps taken versus. those required by the PSA, no discussion of post closing transfers. There are some citations where courts supposedly held the PSA was a sufficient “assignment” of the mortgage loans to make up for any other transfer failings; I’ll have to read them to see how narrow they are.

It should probably not be a surprise that this report was so flimsy. The ASF had originally indicated its report would be out two dates after it promised it, which should have been the very end of October. It is noteworthy that they released it the same day as both the Congressional Oversight Panel report and the Senate Banking committee hearing. If it had been a potent document, there would be every reason to have gotten it out sooner so it could inform the hearings and the COP report. The fact that it was presented at the same time seems to be a tacit admission that it had little new to add. But having the report come out the same day as the COP paper still serves to blunt its impact. And today, Moody’s issued a report on MERS and robo signing. As a securitization expert remarked,

Great timing by Moody’s – coming out the morning of the COP report and hearings to say that they see no risk. No doubt, this was coordinated by the ASF to be timed with their white paper.

Doesn’t speak well for Moody’s having learned anything in the past three years or for their independence.

By contrast, the Congressional Oversight Panel paper is painstakingly thorough. It ties the robo signing issue into broader concerns:

While these documentation irregularities may sound minor, they have the potential to throw the foreclosure system – and possibly the mortgage loan system and housing market itself – into turmoil. At a minimum, in certain cases, signers of affidavits appear to have signed documents attesting to information that they did not verify and without a notary present. If this is the extent of the irregularities, then the issue may be limited to these signers and the foreclosure proceedings they were involved in, and in many cases, the irregularities may potentially be remedied by reviewing the documents more thoroughly and then resubmitting them. If, however, the problem is related not simply to a limited number of foreclosure documents but also to irregularities in the mortgage origination and pooling process, then the impact of the irregularities could be far broader, affecting a vast number of investors in the mortgage-backed securities (MBS) market, already completed foreclosures, and current homeowners. This latter scenario could result in extensive litigation, an extended freeze in the foreclosure market, and significant stress on bank balance sheets arising from the substantial
repurchase liability that can arise from mistakes or misrepresentations in mortgage documents.3…The severity and likelihood of these various possible consequences depend on whether the irregularities are pervasive and when in the process they occurred.

It also highlights the New York trust law issue we have discussed at length here:

New York trust law requires strict compliance with the trust documents; any transaction by the trust that is in contravention of the trust documents is void, meaning that the transfer cannot actually take place as a matter of law.40 Therefore, if the transfer for the notes and mortgages did not comply with the PSA, the transfer would be void, and the assets would not have been transferred to the trust. Moreover, in many cases the assets could not now be transferred to the trust.41 PSAs generally require that the loans transferred to the trust not be in default, which would prevent the transfer of any non-performing loans to the trust now.42 Furthermore, PSAs frequently have timeliness requirements regarding the transfer in order to ensure that the trusts qualify for favored tax treatment.43

And it draws out some implications:

Failure to follow representations and warranties found in PSAs can lead to the removal of servicers or trustees and trigger indemnification rights between the parties. Failure to record mortgages can result in the trust losing its first-lien priority on the property. Failure to transfer mortgages and notes properly to the trust can affect the holdings of the trust. If transfers were not done correctly in the first place and cannot be corrected, there is a profound implication for mortgage securitizations: it would mean that the improperly transferred loans are not trust assets and MBS are in fact not backed by some or all of the mortgages that are supposed to be backing them. This would mean that the trusts would have litigation claims against the securitization sponsors for refunds of the value given by the trusts to the sponsors (or depositors) as part of the securitization transaction.

If successful, in the most extreme scenario this would mean that MBS trusts (and thus MBS investors) could receive complete recoveries on all improperly transferred mortgages, thereby shifting the losses to the securitization sponsors.

If a significant number of loan transfers failed to comply with governing PSAs, it would mean that sizeable losses on mortgages would rest on a handful of large banks, rather than being spread among MBS investors… in many cases, any put-back liability is likely to rest on the securitization sponsors. Although these put-back rights sometimes entitle the trust only to the value of the loan less any payments already received, plus interest, the value the trust would receive is still greater than the current value of many of these loans. As a number of originators and sponsors were acquired by other major financial institutions during 2008-2009, put-back liability has become even more focused on a relatively small number of systemically important financial institutions.

There is a great deal more informative discussion in the report, and I encourage you to read it. And the discussion above no doubt explains the industry’s dilatory response to these legal concerns. The banks appear to be relying on their TBTF status to bulldoze the law. And even though they are getting pushback in the courts, the industry seems almost constitutionally unable to see that it may not be able to bully its way through the colossal mess it has created.

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