FYI | Feb 25 2008
By Greg Peel
Last November FNArena highlighted a particularly worrying side issue of the US housing/CDO crisis (“A Twist In The Subprime Tale”; FYI; 26/11/07). A judge in Cleveland, Ohio – one of the worst hit areas in the crisis – had halted foreclosure on several properties given the original mortgage documents could not be found. Deutsche Bank, who had assumed ownership of the mortgages after bringing distressed mortgage securities back onto its balance sheets, could not actually come up with the relevant pieces of paper, and as such could not legally foreclose and sell the houses.
Who did actually own the mortgage? Well that has proven to be one of the problems of resolving the CDO crisis. When mortgages were written by agents and then on-sold to banks to be warehoused, securitised and on-sold again, it was possible for the mortgage to effectively have change hands several times. The legalities of property ownership in the US are such that it continues to rely on a paper trail, and has not yet conceded to some computerised, paperless system. Hence each mortgage should have a “mortgage note”, and only the originals are legally binding. Copies don’t count.
The system might be a bit behind the times, but a failure to consider that piece of paper all that important has came back to haunt mortgage originators, securitisers, banks and hedge funds. How quickly was the market moving in the period 2002-06, and how lucrative it proved to be, was more important than “who’s got that piece of paper”. Many mortgage notes have simply gone missing. Others may well be piled high in depositories for such documents, but given there are several “pieces of paper” that change hands in a mortgage process the task of actually digging out the right ones amongst the millions is too monumental to contemplate, particularly if it is no longer clear who did own the mortgage before the bank took it back. And hundreds of mortgage agents have now gone out of business, and many a hedge fund has hit the wall as well. Like they really care where the paper is.
Joe Lents of Boca Raton, Florida, cares, because until someone can find the mortgage note on his $1.5 million home he’s going nowhere. Joe hasn’t made a payment since 2002, according to an article from Bloomberg reporter Bob Ivry, and supposed mortgage owner Washington Mutual has not been able to find it. So Joe has continued to live in the house free of charge. He was not a subprime borrower, it’s just that his business went bust back in 2002.
What’s frustrating for the banks is that there is no one actually denying it is they who really have the right over the house, but the Joes of the world have been able to play the system. And Joe is finding support from sympathetic judges who are using the paper trail excuse as a means of fighting for the little man. By holding up the process, judges are hoping many a loan can be resolved, and a family saved from eviction. Indeed, that’s exactly what the US government wants to see as well, as it has been leading a policy of mortgage renegotiation in order to stem the cascading foreclosure flow.
However, a bank can only renegotiate a mortgage with the party that owns it. Who might that be? Well you need to find that bit of paper.
The number of foreclosures in the state of Ohio jumped 88% last year, Cleveland reports. Fourteen of those foreclosures were dismissed last November due to lack of a mortgage note, and the state attorney general now has 40 more challengers on his books. Similar cases have now been dismissed in California, Massachusetts, Kansas and New York. An industry newsletter suggests about 19% of outstanding US mortgages have been bundled into mortgage securities such as CDOs. That represents US$2.1 trillion.
Given there is no longer any hope of saving the mortgage security industry, the next best outcome is that the housing collapse in the US can be nipped in the bud swiftly by successfully renegotiating some of the mortgages and quickly foreclosing on the others. Get the pain over and done with just like you might a bandaid, and then move on. But the problem of the mortgage paper trail is threatening to extend the life of the housing crisis as this period of paper purgatory plays out. Mortgage foreclosures as yet incomplete will continue to hang over housing prices for some time yet, prolonging the agony.
As reported in the November article, one expert believes this legal stumbling block could turn a 10% housing correction into 50% housing correction.