The Fourteenth Banker Blog

September 22, 2010

Foreclosure Fraud and Why We Need New Banks

Filed under: Running Commentary — thefourteenthbanker @ 1:44 PM

By now you have all read about the mortgage foreclosure fraud going on in Florida and in other places. There is clearly a big problem and there are clearly not many constructive solutions.

This article is the best that I have seen because it explains the broader situation. From Washington Post:

Some of the nation’s largest mortgage companies used a single document processor who said he signed off on foreclosures without having read the paperwork – an admission that may open the door for homeowners across the country to challenge foreclosure proceedings.

The legal predicament compelled Ally Financial, the nation’s fourth-largest home lender, to halt evictions of homeowners in 23 states this week. Now it appears hundreds of other companies, including mortgage giants Fannie Mae and Freddie Mac, may also be affected because they use Ally to service their loans.

As head of Ally’s foreclosure document processing team, 41-year-old Jeffrey Stephan was required to review cases to make sure the proceedings were legally justified and the information was accurate. He was also required to sign the documents in the presence of a notary.

In a sworn deposition, he testified that he did neither.

The reason may be the sheer volume of the documents he had to hand-sign: 10,000 a month. Stephan had been at that job for five years.

How the nation’s foreclosure system became reliant on the tedious work of a few corporate bureaucrats is still a matter that mortgage lenders are trying to answer. While the lenders may have had legitimate cause to foreclose, the mishandling of the paperwork has given homeowners ammunition in their fight against foreclosure and has drawn the attention of state law enforcement officials.

Ally spokesman James Olecki called the problem with the documents “an important but technical defect.” He said the papers were “factually accurate” but conceded that “corrective action” may have to be taken in some cases and that others may “require court intervention.”

Olecki said the company services loans “from hundreds of different lenders,” but he declined to provide names.

Spokesmen for Fannie and Freddie confirmed Tuesday after inquiries from The Washington Post that they use Ally, formerly called GMAC, to oversee some mortgages. The companies have launched internal reviews to assess the scope of any potential issues.

Ally, Fannie and Freddie – all troubled mortgage companies that received extraordinary bailouts by the federal government during the financial crisis – declined to say how many loans might be affected.

Florida is a state with a huge foreclosure backlog and a lot of problems in the foreclosure process.  They have set up special courts to reduce the foreclosure backlog. Some of these courts are trampling on the law itself in order to clear the docket.

No one disputes that foreclosures dominate Florida’s dockets and that something needs to be done to streamline a complex and emotionally wrenching process. But lawyers representing troubled borrowers contend that many of the retired judges called in from the sidelines to oversee these matters are so focused on cutting the caseload that they are unfairly favoring financial institutions at the expense of homeowners.

Lawyers say judges are simply ignoring problematic or contradictory evidence and awarding the right to foreclose to institutions that have yet to prove they own the properties in question….

…Florida’s foreclosure mess is made murkier by what analysts and lawyers involved in the process say are questionable practices by some law firms that are representing banks. Such tactics, these people say, have drawn out the process significantly, making it extremely lucrative for the lawyers and more draining for troubled homeowners.

Doctored or dubious records presented in court as proof of a bank’s ownership have become such a problem that Bill McCollum, the Florida attorney general, announced last month that his office was investigating the state’s three largest foreclosure law firms representing lenders.

“Thousands of final judgments of foreclosure against Florida homeowners may have been the result of the allegedly improper actions of these law firms,” said Mr. McCollum in an interview. “We’ve had so many complaints that I am confident there is a great deal of fraud here.”

To be sure, adjudicating foreclosure cases is difficult, complicated by multiple transfers of mortgages and notes when a loan is sold, bewildering paperwork submitted by loan servicers and shoddy record-keeping by the many institutions that touched the mortgages during the byzantine securitization process that fueled the housing boom.

Nevertheless, Florida law requires that before a financial institution can foreclose on a borrower, it must prove to the court that it actually has the standing to do so. In other words, it has to show that it is truly the owner. And this is done by demonstrating ownership of the note underlying the mortgage.

This is where the Foreclosure Fraud comes in. Banks created this situation by developing toxic complex products and trading assets like baseball cards. To maximize value of these tradable products, they had to minimize servicing costs so the net cash flows to the investors would be maximized. So they cut corners. All information goes into electronic systems and it is those systems that buyers and sellers rely on. The documents themselves are just so much trouble. They have to be filed, shipped, imaged, tracked, stored, and so on. That costs money and is prone to human error. And, when you do this on a massive scale, there are a lot of errors. But no one really cares as long as you can foreclose anyway. Well, that monkey is no longer dancing.  Here are part of the findings of Judge Johnson of the Fourth Judicial Circuit Court in Duval County Florida:

Fraud on the Court. This is no small matter. After said finding and other similar findings, the chickens are coming home to roost.

What will solve this problem? It may be that many records will have to be sorted out, some of these swapping transactions re-documented, errors cured, new cases filed and litigated, tort cases defended, etc.

I have mixed feelings about this because slowing the clearing of the foreclosure backlog is not good for the general economy. Uncertainty will remain in the real estate markets about what the floor valuations are and buyers will not return to the markets even when they can afford to do so. But, the laws of nature cannot be reversed. Actions have consequences and those must play out.

This investment newsletter elaborates on what the consequences may be for banks. The actual dollar consequences are unknowable. But there will be consequences. The question is whether these ongoing uncertainties create what this author describes as “zombie banks” out of our largest institutions that handle something over 60% of total US bank deposits? I’m not sure we can wait to find out.

We need new banks with clean balance sheets, clear consciences, and new ways of operating.

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10 Comments »

  1. Instead of cluck clucking about Mr Stephan who had only 90 seconds to ” review” what he had never before viewed before signing the docs, just think of the political organizational aspects here.The lawyers may still challenge the chain of ownership of the loans and will now force the process to start over. The political question is the ability to impeach the judges by going after their personal peccadillo’s. But first comes organization . Activist activity against the judicial system. Zero in against the weak spots as shown many times by Saul Alinsky. Frankly, screw the banks out of as much money to buy time for your personal recovery . “You” against ” them” on a very personal basis. That said, such activity just causes furher poltical dissolution and even more weakening of commonwealth. Going further, going along with the system to aid the judges in siding with those allied to them , on the judges own economic side of the system,is to further aid weakening the existing commonwealth. That weakening though could well now be deterministic. The social system decline having wrought the determinism. Both actions weaken the present polity.
    One hell of a fix for a country to be in. The survival of the extant economic arrangement requires a restoration of debtors desire to pay and honor other aspects of their contract. The system is frankly adversarial and the tenor of the WP article must be that the adversarial proceedings be ” fair”. Fairness is biting both sides in the ass here. But it all comes down without the return of incomes to reinduce desire to pay in defaulting debtors. Catch 22 in mile high type here.

    Comment by Jerry J — September 24, 2010 @ 2:56 PM | Reply

  2. The consequences of forcing proof of ownership and chain of title of loans at issue here seems to fall solely on the financing institutuon that already had to buy back the loans. In this case WAMU, CTX and Chase are without standing to sue because they cannot prove ownership of the claim on the debtor. These entities are not the banks themselves but subsidiaries of the bank holding company. I take it , that here, the banking unit may or may not be at risk for financing the stuff back of these loans to THE MAKERS of these mortgages in foreclosure. WAMU, as an example, could go into liquidation without having an effect on the depositor institution owned by the BHC. For example, JPM owns Chase, the National Association. Chase Financial absorbed WAMU which I presume is a subsidiary of Chase Financial. What worries me is the chain reaction effect on the constituent National Association. JPM itself, the holding company, could go into liquidation excluding the NA subsidiary. Of course any such act would set off a Lehman type panic anew. So, what is really a problem here is the panic effect and not the problem of credit collections and security liquidations. The anticipatory panic kills everything first ? What do you think 14th?

    Comment by Jerry J — September 24, 2010 @ 5:13 PM | Reply

    • I think most of the title chain stuff could be remediated, though at great cost. The cost could impair the value of some securitization pools and the related derivatives. Somehow I suspect that Feds would engineer a legal bailout eventually if the situation became untenable. Some evidentiary rule. Not really my area though. Feds will not let banks sink but might let them twist in wind awhile. Perhaps some mortgage backed security holders could litigate as well. It is probably an earnings problem, not a solvency problem.

      Comment by thefourteenthbanker — September 24, 2010 @ 7:22 PM | Reply

      • Thanks. I have friends holding the bag in terms of lost value of mortgage backed securities who think litigation to override title chain problems is inevitable. I gave them my views and a couple got real upset with me. First, they bought the cash flows of mortgage secured Notes, not the Note. That seemed a revelation to them. All of these people I talked to thought they had a secured interest and were quite vocal about it. It really got hot when I outlined the chain of cash flows and the problem that only a specific amount of incoming cash flow was set aside for pooled costs to pursue foreclosures. The rest of the cash flow was their property and they had to consent to a reduction almost unanimously. To secure more funds for foreclosures, each MBS trust had to get 100 % or close to 100 % consent of the owners to reduce cash flows payable to them. It got even hotter when the realization hit that all the trustee’s of the security could do was peddle the defaulted loan for what they could get in order to comply with the contract with the owners. No different than selling defaulted credit card debt to collection agencies.

        This whole chain of agreements is still intact. In fact, the smart buyers of these MBS’s were protected by the trust also buying a mortgage protection. So, this means, barring the inability of seller of the MBS protection to pay off, the owners should get 100 % of the contracted cash flow to the point any defaulted Note is paid off by the sale of the property and the coverage of the shortfall by insurance. At this point, I asked my friends why they worried about market value if they own insurance protected Note pools. They did not understand the transaction. Every one of these people considered themselves way, way above average in financial products.

        Are the foreclosures in the WP article mostly on behalf of scavengers or attempts to get clear of forced repurchases? In 2007, for example, every major short term money market fund held huge values of these MBS secured loans to cover short term financing needs of the big processors. They did this through funding structured vehicles. My broker parked funds in his own semi-captive vehicle if the customer did not want to leave the funds at the broker. I was very, very leery by the end of 2007 and got out.

        Are what we really seeing here is scavengers trying to collect on Notes the insurers took on covering the loss? After all, the bulk of CDS protections were through the big banks and brokers who laid off the protection to the likes of AIG. Well , if AIG paid off, they own the bad paper and need collection agents to perfect the chain of title perfection. I can see where that is not possible in many cases. A scenario like my example here would introduce an awful title chain problem given the magnitude and the staffing of collection people would probably be awful bad. Just how long can people like Mr. Stephan work without going bonkers? I just dropped my notarization items on my clerk who was a notary after I signed ewverything. Did that for near a half century. But, as the lawyer for the defendant, anything I can do to damage the plaintiff people is the way to proceed. That is how the system works.

        Comment by Jerry J — September 24, 2010 @ 9:55 PM

  3. The FDIC seized and sold the assets of Washington Mutual Bank and of Washington Mutual Federal Savings Bank to JPM. Were the loans discussed here where WAMU is suing to collect assets of Chase? Or is this a suit by the rump WAMU holding company they were forced to buy back before the FDIC seizure or more importantly loans stuffed back by Chase and others against the WAMU holding company? In short, no one nows who the owner of the loan claim is? I can sure see masses of title chain problems if a given loan were sold off by WAMU the two banking units before seizure in 2008. Later , the rump corporate WAMU corporations, formerly banks, were forced to buy back the loans post 2008 with financing by the still extant WAMU Holding Company. I bet there are a dozen title chain permutations here. What is important is the effect the final legal holdings of these cases bequeath to future foreclosure actions. Chaos from a loan collection viewpoint.

    Comment by Jerry J — September 24, 2010 @ 5:40 PM | Reply

  4. mind you, not only new banks! the US is in need for a new econony, allong with a new education system, a new moral, a new way of living, a new sense of being, a new form of respect, in other words, the US needs a deep & honest soul search.

    after that the US of A will be able to reinvend herself. some evolutionary steps will not suffice, what is neede is a bold yet revolutionary jump out of her old and greedy skin.

    Comment by victor, some Dutch guy — September 25, 2010 @ 8:41 AM | Reply

  5. The AP is carrying a story today that Jerry Brown, Attorney General of California, is asking GMAC owner Ally Financial to cease foreclosures in California for a variety of reasons. One issue is that Mr. Stephan of Ally has admitted that the review process for foreclosure is a sham. Mr. Stephan being required to sign 10,000 documents a month is proof of the allegation on it’s face. This raises the most interesting question of fraud in the granting of the loans in the first place. Certainly, foreclosure attorney’s will now band together to litigate the issue of fraud. They have a perfect opening now. Is a proven sham observance of a legal requirement, fraud given that the law of notarization procedure was also admittedly a sham.

    Comment by Jerry J — September 25, 2010 @ 12:53 PM | Reply

  6. What is meant by clean assets in existing banks or new banks? We start out with huge values of dirty assets. What constitutes a dirty asset? Banks are in the business of lending long. They lend for a long term and collect the contracted stream of payments . That means to me that a clean asset is one that is performing according to contract. Consequently, these assets should be carried at cost which is unrepaid loan principle plus accrued interest. No mark to market. Any loans that are not performing to contract should be carried against a Reserve for Loan Losses as has traditionally been the practice until accounting rules got fancy with ideas like loan impairment. The Balance Sheet carrying value is the sum of all loans not written off and charged against the Reserve for Loan Losses less the balance in the Reserve for Loan Losses. The traditional way improved by better adequacy of the Reserve tests. This has nothing to do with proper amounts of bank capital. That number will be what it is . I see nothing wrong with state ownership of the bank by seizure instead of selling off the assets. Instead, the state increases the reserves from it’s own contribution with a forced match taken from lenders to the banks and non insured depositors. The existing bank is recapitalized with new owners. The state portion of capital represents the insured depositors for which the state stands surety and the rest of the capital derives from the uninsured creditors. New management would be automatic.

    Now the old bank can work out it’s problems. They have title to loans they can work out. They have title to loans written off where they can pursue collection instead of selling them to scavengers.

    If the bank then fails again… then liquidate it.

    It should be obvious… the main lesson of the financial collapse, that one cannot be both a banker and a merchant together.

    Comment by Jerry J — September 25, 2010 @ 1:58 PM | Reply

  7. I am surprised that there has been no comment on the NYT article headlined by Gretchen Morgenson about the use of retired unelected judges to reduce the foreclosure backlog. Just about every abuse possible against the debtor is covered. Florida allows pursuit of uncollected balances the debtor owes post foreclosure. Why do these people even bother to fight the foreclosure. At some strategic point why not just file bankruptcy? Sure they might technically get stuck with a Chapter 13 payout but the practicalities are a that a full Chapter 7 would result. Fill up the bankruptcy court dockets instead. An immediate bankruptcy filing movement would force the banks to become reasonable right quick and the governments along with them. From the moment of the stay, the banks owe the property taxes,insurance and maintenance on the properties. The cash flow then hits the owner of the note hard. So hard, that most must dispose of the property or literally abandon it. The property then becomes a government issue.

    The outcome of general awareness of the unacceptable risks of debt financed home ownership in states like Florida would result in a hefty plurality of potential home buyers leaving the home ownership market barring at least an enactment of a non recourse statute for purchase money mortgages. Such a result spells doom for the new home market for a very long time to come and a long term supply glut of existing houses. It also would seemingly guarantee a permanent halving of property tax revenues in Florida.

    A sustained massive increase in families living under Chapter 13 restaints would itself kill a return to economic growth any time soon. The Federal laws would be killing the Federal revenue stream too from collapsed consumerism. What people do not easily understand is that a return to consumer demand growth is marginal and we now face huge marginal downward pressures . Florida was a moronic place on the way up and is equally moronic on the way down.

    At the end of the day, after all these machinations have ended, there will be huge dispossession gains to a few while the capital supplier to the banking system , the small depositor, offloads his risk on the government. The government of capital is aiding the death of capital and itself.

    Comment by Jerry J — September 26, 2010 @ 1:32 PM | Reply

  8. […] Post, Bloomberg, Naked Capitalism, and Representative Alan Grayson’s office. A few days ago I blogged on foreclosure fraud in Florida, so I won’t run through that background again. What has newly developed in the last […]

    Pingback by Colossal Failures in Judgment « The Fourteenth Banker Blog — September 28, 2010 @ 7:45 AM | Reply


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