Ramifications of the Foreclosure Moratorium

Within the past week, major lending institutions have suspended their foreclosure proceedings because of the possible existence of irregularities in the documents involved in the proceedings. Sounds like a bank problem, but it has dire ramifications for the economy, including:

·        The market clearing process that restores equilibrium to the housing market is suspended indefinitely;

·        The suspension of this process further delays the absorption of the large inventory of homes which, in turn, delays the recovery of the homebuilding market and the massive reemployment that would occasion;

·        Investors in the mortgage-backed securities secured by these loans are that much farther from recovery of those invested funds, which otherwise could be reinvested in other areas, thus stimulating the economy;

·        Those who purchased a home through a foreclosure sale herein the documents or proceedings were improper may not legally own the home. If they did not purchase title insurance, they may suffer financial loss.

But the news may be worse,…much worse. The purported cause for the suspension of foreclosure proceedings is irregularities in the legal processes mandated for those proceedings and in the documents themselves. First, a word about how mortgages actually work:

·        A home buyer gets a loan from a lender to assist in paying the purchase price of the home;

·        The loan is evidenced by a promissory note, or legal IOU, which is an enforceable pledge to repay the loan at the stated interest rate over the stated time period;

·        The note is secured by collateral – the house – through the recording of a mortgage that acts as a lien on the title to the house until the note is fully repaid;

·        If the home buyer/debtor doesn’t make the payment on the note, the note holder forecloses the mortgage and forces the sale of the security (the house) in order to generate the funds necessary to satisfy the debt evidenced by the note;

Here’s a snapshot of what appears to have happened:

·        Mortgages were given to individuals and entities that otherwise were not financially qualified to make the payments due on those loans. A lot of finger pointing and blame can be spread around the lending spectrum, including Congress, Fannie and Freddie, lending institution underwriting practices, appraisers, and more;

·        These mortgages, sometimes thousands at a time, were packaged into investment pools. The pools were sliced into tranches that were assigned risk factors and returns – lowest risk meant lowest rate of return and vice versa;

o   These pooled mortgages operate in what is known as a REMIC or real estate mortgage investment conduit, which must meet specific IRS requirements;

o   The mortgages in these various pools are serviced for the REMICs by MERS or mortgage electronic registration systems;

·        These securities, in the form of bonds, were purchased by investors according to their respective tradeoffs of risk tolerance versus desired rate of return;

The problem that now is emerging is that there are millions of mortgages that are in default and spread throughout the various tranches. The simple answer is to foreclose against those that are in default. Ordinarily, that would mean that the holder of the promissory note secured by the mortgage brings a foreclosure action. It’s not that simple, however.

The notes have gotten separated from the investors who bought the bonds issued by the REMICs. On September 28, 2010, a Federal judge in Oregon determined that MERS, the purported servicer of the mortgage loans, lacks the authority to transfer the notes and is merely a nominee or custodian of the notes.

This raises the critical issue of who owns the notes and has the right to enforce payment of the debts evidenced by them. Ordinarily, foreclosure actions cannot proceed until that determination has been made.

In addition, title insurance companies, which stand to lose billions if the validity and enforceability of the mortgages they’ve insured is denied, are digging their heels in where new mortgages are concerned. Lenders cannot grant mortgages unless the validity and enforceability of the mortgage lien is insured.

There is concern that those who are in default on their mortgages may be getting their house gifted to them because they don’t have to move out and don’t have to pay on the mortgage. Ultimately, that’s not how things work in America. Mortgages are governed by a body of legal principles known as Equity. Equity requires that fair outcomes be achieved. Various proceedings exist, such as interpleader, where monies can be placed into the registry of the court. In this instance, when the irregularities in the documents and or proceedings are resolved, it may be possible in some jurisdictions for foreclosures to proceed with the funds being placed into the court registry pending resolution of ownership of those funds.

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