About the Author
Patrick Pulatie is the CEO of LFI Analytics. He can be reached at 925-522-0371, or 925-238-1221 for further information. www.LFI-Analytics.com, email@example.com.
The Securitization of Loans
Loan Securitization is one of the key elements in mortgage lending today. The securitization of mortgage loans provides much needed capital for the mortgage lending function, and allows the populace an availability of funds for home purchases.
Prior to the Housing Crisis, loan securitization provided 80% of all funds for mortgage lending. Today, that number has increased to 95%, almost all of which has been through the GSE’s, VA and FHA.
Securitization of mortgage loans began in 1970 with the selling of loans by Ginnie Mae (GNMA) as Pass-Through Securities to the secondary market. The loans had been funded by the FHA or VA. Shortly thereafter, Fannie Mae, established as a Government Sponsored Entity (GSE) in 1968, began to sell loans to the secondary market as well. Freddie Mac soon followed in this process. The benefit of selling loans was to move the loans off their balance sheets, and with it, corresponding interest rate risks. The first of many financial innovations had begun.
In 1983, Fannie Mae engaged in a new innovative product designed for mortgage loan investors. Fannie Mae created the first Collateralized Mortgage Obligations (CMO). A more complicated product, the CMO would take the cash flows into the Mortgage Trusts and redirect them to “securities” with different payment features. The purpose was to mitigate prepayment risk of the obligations, which was the largest factor that prevented expansion of demand for Pass-Through products.
The CMO innovations were unique when instituted. To address potential legal issues related to the innovations, Congress created the Real Estate Mortgage Investment Conduit (REMIC) program. Along with favorable tax law changes, the REMIC allowed for the new CMO’s to be problem free. Today, Fannie and Freddie are the largest issuers of such products.
B of A and Salomon Brothers began securitization efforts in 1977, and continued throughout the 1980’s, building upon the success of Fannie and Freddie. Lewis Ranieri, who is considered the “father” of securitization, led these efforts which were the fore-runners of the modern MBS products prevalent during the Housing Boom.
Hard money lenders were also doing private securitization type issuances in the 1980’s. The loans were to investors/REMIC’s. The actions, though small even by the standards of the time, were quite successful. But there were events coming to the lending industry that would change the industry forever.
In 1990, Long Beach Savings introduced the first major “privately securitized” offering for $70 million, executed through Greenwich Capital. It was extremely successful and other lenders took immediate interest in the business model. The principals in the Long Beach Savings securitization effort would eventually leave to create the Sub Prime market, beginning with the formation of Ameriquest Mortgage in Irvine CA. From this point on, securitization began to take on a life of its own.
Benefits of Securitization
Securitization efforts offered many benefits to the lending industry. Chief among the benefits was that securitization brought large sums of money from the secondary market and Wall Street for the purposes of lending. No longer would lending be constrained by the availability of money from banks.
Securitization also lowered the cost of borrowing for homeowners. The availability of money resulted in much lower interest rates, as evidenced by the decreases in mortgage interest rates from the 1980’s through 2007.
Securitization also spread money for lending purposes throughout the U.S. Geographically and economically constrained areas had the benefit of receiving money for lending from across the U.S. This also contributed to lessening of default risk for the pools of loans to be securitized.
Investors benefited from securitization of loans. Investors now had available a new array of financial products to meet their various risk requirements and needed Returns on Investments.
Lenders benefited significantly from securitization. They were no longer constrained on lending by the amount of deposits that they had on hand. Lenders could originate loans, earn fees on the loans, and then sell the loans to MBS pools. With the money received from the sale of the loans, they could lend to other borrowers, keeping the lending cycle going, and creating a strong economic environment. (The excesses that led to the housing crisis, now well-known, are not discussed in this paper.)
Private Securitization and the Problem of Note Transfers
Private Securitization offered a set of problems for loan transfers that needed to be addressed and overcome. (Other issues were present, but those issues are not relevant for this paper.) When a loan was securitized, a complicated Chain of Note transfers had to occur so as to ensure that the transactions were bankruptcy remote, REMIC acceptable and met securities law and IRS regulations. The transfers posed logistical and financial issues. To illustrate the Chain of Note and Assignment transfer problems, the following would be a sample transaction with all recordings present:
- ABC Mortgage originates the loan with itself as beneficiary. ABC decides to sell the loan to its Warehouse Lender, Countrywide. To sell the loan, they must prepare and notarize an Assignment of Beneficiary to Countrywide.
- Countrywide purchases the loan. They must then record the Assignment of Beneficiary in the relevant county. If electronic recording was not available, then Countrywide would need to cut a check to the County Recorder, and then arrange delivery of the documents to the Recorder with check, wait for the Recorder to record the Assignment, and then return the Assignment to CW. This could take weeks to accomplish.
- CW decides that they are going to securitize the loan. They select ALT as the entity who will be the Sponsor for the securitization effort. CW must then execute an Assignment of Beneficiary to ALT.
- Sponsor ALT purchases the loan, and then must record the new Assignment. Once again, the check must be prepared, sent to the Recorder, and then returned, another costly and time extensive experience.
- ALT sells the loan to the Depositor, MLT. They prepare the Assignment to MLT, who must then again go through the procedure of getting the loan recorded.
- MLT, as the Depositor, is the entity that will “deposit” the loan to the Trust. To deposit the loan to the Trust, MLT must again prepare another Assignment, but this time, they must also ensure that the loan is assigned to the Trust, executing and recording the assignment, since the Trust is simply an entity with no employees.
With this process, there would have been four assignments of the Deed to accompany the four transfers of the Note. The cost of this process, man hours, preparation and notarization of the Assignment, delivery of the documents to the Recorder, filing fees, and the time and expense of waiting for the return of the documents becomes excessive and cumbersome.
When a trust is formed, there are two critical time dates that are of great importance, the Cut-off Date and the Closing Date. The Cut-off Date is the date that loans which are to go into the trust must be identified. The Closing Date is the date that all loans must be assigned to the trust. The intervening time period is usually no more than thirty days.
There can be from hundreds to over 8000 loans in any trust, spread out over hundreds of counties. With the amount of work, money and time required to “correctly” assign just one loan to a trust, it becomes readily apparent that it would be next to impossible to meet the demands of assigning all the loans to the trust within the one month time frame from Cut-off to Closing.
Assignments in Blank and Securitization
An additional problem with securitization of loans was that it was often the case that a loan might be originally scheduled to go into one trust, but then be replaced by another loan either prior to the trust closing date, or even after the closing date. Such actions would require that assignments again be executed for the new entities.
To simply the assignment problem, lenders developed a new practice for transferring loans. The lenders would execute assignments in blank and then transfer the loans using the blank assignments. Only if needed, and this was spelled out in the Pooling and Servicing Agreement, would an assignment be filled in with the name of the beneficiary, and then recorded, usually in response to a foreclosure action.
With assignments in blank being issued for each loan, tracking of loans from party to party would become impossible without an entity whose primary purpose was to keep track of the loans.
In 1993, Fannie Mae, Freddie Mac, Mortgage Bankers Association, Bank of America and numerous other lenders “commissioned” a study to evaluate the lending industry, the occurring innovations in financial instruments, the legal needs of those instruments, and how the innovations could be effectively incorporated into existing law.
Among many different subjects that the Commission looked at, were the variations in recording laws between the different states. Each state had different recording statutes, and an effort to standardize the recording laws across the country was deemed to be not a feasible alternative.
Recording delays and errors in Assignments were also considered. The more documents needing recorded, the greater the likelihood of delays, or errors.
Most important, the problems associated with transfers of a loan through securitization channels were addressed, and alternative methods of compliance with the REMIC provisions considered.
After consideration of all options, the decision was made to create the Mortgage Electronic Registration Systems, also known as MERS.
How MERS Operates
MERS is an on-line computer software program that serves as a tracking system for mortgage loans, and the entities involved in the mortgage transaction. MERS keeps tracks of the ownership of the Deeds and Notes, the entities that each Note and Deed passes through, and the servicers associated with the Note and Deed. (Not every loan is registered with MERS. It is believed that 60% of all loans are registered through MERS.)
MERS was developed with the problem of missing or incorrect assignments in mind, as well as the problems inherent in securitization of mortgage loans. It was designed to eliminate the need for “follow-up” assignments of mortgages and deeds upon transfer or sale of a loan to another entity.
When a loan is ready for funding and the loan documents are drawn, the loan will be “registered” with MERS. A MERS Identification Number (MIN) will be assigned to the loan and pertinent data entered into the MERS database. When the loan is recorded, all data is then updated to reflect that the loan was actually funded and recorded.
For recording purposes, MERS is named on the Deed as “Nominee for the Beneficiary”. This allows MERS to act in an agency relationship for the true Beneficiary and Note Holder. MERS remains in this capacity until the loan is paid off, or until a foreclosure is eminent, when the loan will be assigned to the true beneficiary, before the foreclosure is completed.
Throughout the history of the loan, as changes occur in loan ownership or servicers, the current servicer of record will update the MERS database. No Assignments will be recorded in public records to reflect the changes since MERS is acting as an agent for the Beneficiary.
At this time, MERS has only about 65 employees. When Assignments of Beneficiary, Substitutions of Trustee or other documents need to be executed by MERS, there are obviously not enough MERS employees to handle the execution of the documents. MERS has established a unique manner for solving this problem.
When a lender, servicer, or other entity signs up with MERS, the entity is directed to name people in the organization to become “MERS Certifying Officers”. The named persons will become “Vice Presidents” or “Assistant Secretaries” of MERS by corporate resolution. They are not employees of MERS, nor are they paid by MERS.
As a “Certifying Officer”, the person is given the ability to sign MERS documents, through the “agency relationship” created by the corporate resolution. When such documents are needed, the servicer or lender will create the document, have it signed by the Certifying Officer, and then recorded.
Through the usage of MERS, untold billions of dollars in costs of servicing loans have been saved. As a direct result of MERS, the private securitization of mortgage loans was enabled to allow for money to flow from Wall Street to the housing sector without the problems associated with assignments of all loans to each entity in the Chain of Transfers.
But, has MERS been problem free?
Up until 2007, the MERS process was rarely challenged. If the MERS process was challenged, it was solely because a homeowner was in foreclosure, and an enterprising attorney thought he might have an argument for unlawful foreclosure to allege. There were no other known actions whereby MERS would be challenged, except in response to foreclosure actions.
With the start of the Housing Crisis in 2007, a “cottage industry” of foreclosure websites opened on the Internet. The websites, run by both attorneys and non-attorneys, advocated using the MERS issues as a homeowner defense against foreclosure. Allegations against MERS have consisted of all types of imaginable and unimaginable claims, trying to find defects and deficiencies in the MERS process, so as to delay or prevent foreclosure of homes in default.
Arguments against the MERS process generally consist of several different allegations. They are:
- MERS cannot lawfully foreclose on a property because MERS has no “beneficial interest” in the Note.
- When MERS is the Beneficiary, and the Note is held by another entity, then the Note and Deed are permanently separated and there is no ability to foreclose.
- MERS “Certifying Officers” are not able to lawfully sign the Assignments or Substitutions for various reasons, some legitimate and others not legitimate. The advocates lump all such arguments together under the category of “Robo-Signing”.
- MERS cannot be a lawful agent or “nominee” for the beneficiary.
- A Nominee on a Deed of Trust or Mortgage has no powers to foreclose or to execute assignments and substitutions.
- An assignment that is not recorded at the time of transfer, but is recorded at a later date, is backdating of the assignment.
- MERS cannot be used in Securitized Trusts in place of mortgage assignments.
The arguments can be reduced to a “central theme” that needs to be resolved:
Is MERS able to act as an Agent for the “Beneficiary” on a Deed of Trust? If so, what are the duties and responsibilities allocated to MERS? Do the duties and responsibilities include the ability to execute assignments of the Deed, or to foreclose on delinquent loans? Does the presence of MERS on a Deed of Trust negate a need for follow up assignments of the Deed when the Note is transferred to another entity?
MERS and Homeowner Litigation
The question of MERS is currently under assault in court rooms across the nation. The actions are being taken in both State and Federal Courts. These cases seek to clarify the status of MERS, but the cases are fraught with difficulties.
Each state has different laws and statutes regarding agency, assignments, and foreclosure processes. The laws and statutes are not consistent across state lines, and what is unlawful in one state is found to be lawful in a neighboring state. The result of the differing statutes and laws is evident in the rulings about MERS across the country
California law regarding MERS has been largely settled. Appellate Courts have recently ruled in Gomes v Countrywide and Cavallo v Countrywide that operations of MERS is lawful, MERS is an agent, and that MERS duties include the ability to make assignments and to foreclose. Gomes was appealed to higher courts, and both the CA and US Supreme Courts declined to hear the appeal. The 9th Circuit Court of Appeals in the Cervantes decision further reinforced the legitimacy of MERS.
Courts in Oregon and Michigan have ruled against the ability of MERS to foreclose on a home under state statutes, but otherwise appear to support the MERS operation. A U.S. Federal Court in Georgia has recently ruled that MERS can conduct assignments.
Some courts in New York attack MERS operations without reservation, but other New York judges allow for MERS. Florida Appellate Courts are taking a harsher view of MERS, at least regarding foreclosure.
Bankruptcy courts are just as confused. In California, some BK courts are looking at legal standing issues and siding with homeowners. Yet, other CA BK Courts ignore the issues. Meanwhile, BK Courts in other states will come down on the side of MERS, or for the Homeowners. Identical cases in the same courthouse will find often find opposing rulings. The same problems can be found in court rulings in all fifty states.
At this time, the Courts are of no assistance in resolving the question of MERS.
Office of the Comptroller of the Currency, MERS & Homeowner Litigation
The Office of the Comptroller of the Currency (OCC) has now weighed in on the MERS issue. On April 13, 2011, the OCC issued a Consent Decree to MERS. The Consent Decree poses questions that will need to be considered by all in future litigation involving MERS.
When the OCC issued the Consent Decree, they did so with the argument that MERS was acting as an agent for lenders. As an agent for lenders, MERS would then be covered under various federal legislations like the National Banking Act, the Alternative Mortgage Transaction Parity Act, Home Owners Loan Act and other regulatory acts. This reasoning gave the OCC the right to issue the Decree and address deficiencies that the OCC perceived in the operations of MERS, using various legislation as the.
The OCC is a department within the Department of the Treasury. If the OCC can regulate the policies and the operations of MERS, then this may very well lead to arguments on behalf of MERS related to “Federal Preemption”. If such arguments are found to be legitimate, then this would end much of the controversy over MERS.
The OCC also addressed the issue of MERS Certifying Officers. The OCC recognized that the Certifying Officers were legitimate, as long as certain processes and regulatory functions were carried out. This would also appear to put the issue of Certifying Officers to rest.
The only option that an enterprising attorney might have in rebutting the arguments is that the Decree states that operations must follow all state laws. Of course, this could then set up the battle over “Federal Preemption”.
In light of the recent Consent Decree being issued to MERS, it would appear that MERS could lay claim to even greater legitimacy through the recognition of the OCC and the Treasury oversight.
MERS & State Litigation
Many states and counties in different states are now engaging in legal action against MERS. The lawsuits are primarily aimed at recovering “assignment fees” not paid to the counties. The claim is that the failure of MERS to record follow up assignments when loans were transferred violated recording laws and denied the counties money. The lawsuits are aimed at collecting the fees.
Potentially, these lawsuits are the most damaging of all lawsuits. If the lawsuits are won by the states, then homeowners might have a much stronger case for challenging foreclosures, based upon the “missing” assignments. Furthermore, loss of the lawsuits will “financially harm” MERS, and maybe result in MERS closing down.
“Unintended Consequences” of MERS Loss – The Neutron Bomb
Little consideration has been paid to the “unintended consequences” of MERS losing state lawsuits. There is much more at risk than the billions of dollars that the states and counties are suing for in damages. Losses could affect both the real estate and financial industries across the country.
The lawsuits are like Neutron Bombs that are armed and ready to detonate. When a Neutron Bomb explodes, the structures remain standing, but the high radiation levels destroy all life in the vicinity. In this situation, homes would be standing, but ownership would be “destroyed”.
Possible consequences include:
- The Deeds of Trusts and the Mortgages used to “secure” the loan may be void. The result would be that homes legitimately in foreclosure could not be foreclosed upon, except through the Note Holder taking judicial action against the homeowner, and getting a court’s permission to foreclose.
- The Note and the Deed might be found to be permanently separated, which would again require litigation to foreclose.
- Home sales where MERS has ever been on title would be “conflicted”, not allowing for a proper Chain of Title. Title Insurance might not be available for purchases. Home purchases would be dramatically curtailed.
- Homes that had been purchased years before with MERS having been on the title may be conflicted. Former homeowners could claim to still own the home, even though they had been paid for the home.
- If MERS cannot be used in place of assignments to Trusts, does this mean that the Trusts are “empty”? Who owns the loans? Is the Trust lawful under REMIC statutes?
These are only a few of the questions that could be raised by the States winning their lawsuits. But with just these problems alone, the real estate industry as we know it would be destroyed.
Can MERS be re-habilitated or is it fatally damaged?
Assuming that the courts do not rule against MERS with the end result being the destruction of MERS, can MERS be re-habilitated, or is MERS fatally damaged regardless?
At this time, it is impossible to determine the final outcome for MERS. There are far too many interdependent factors present that will play a role in the final outcome for MERS.
The insertion of the Media into the situation will play a huge role in the survivability of MERS. To date, the subject of MERS has been difficult for media to make sense in reporting, outside of the “Robo-Signing” sensation. The legal issues make simplified sound bites impossible to achieve, even if the reporters understand the issues. Additionally, only a small section of the public is even aware of the controversy, which makes the subject even harder to communicate. Once the media does begin to understand how to communicate the subject, then the likelihood of MERS survival will certainly decrease.
Politics will play a key role also. Delaware Attorney General Biden, in what is certainly a political move, has initiated perhaps the most damaging lawsuit to date against MERS. It is true that other Attorneys General have also filed lawsuits, but the allegations were not as “severe” as the Delaware case.
It is possible to foresee that at some point in time, a higher level “intervention” will be needed to solve the MERS issue. It is simply not practical, nor is it realistic to allow different courts in different states to have completely different outcomes with MERS. To say that MERS is lawful in one state, but not in another, and then to have all foreclosures or titles ruled void in the “non-MERS” state would be devastating for the state and country as a whole. At some point in time, there will be a need for the legislative branch of the Federal Government to step in and end the confusion. Otherwise, the entire real estate system and industry in the U.S. could fail.
Is There a Need for a MERS-like Entity?
Is there a need for an entity like MERS to assist in resolving the problems inherent in lending today? Deficiencies in the current recording process, whether through the recording offices, or through the problems of lenders and servicers, and the needs of securitization, certainly indicate the need. What form that this entity would take will generate its own controversy.
Note: From this point on, references to a “MERS-like entity” will take the name of “RegCo”. This is done to distinguish what may be needed from MERS as it now stands.
Continue on to Part III, in which a way forward is discussed for the entire national recording and securitization complex.