It seemed like a great idea at the time. Sign folk up to mortgages, sell the mortgages to another financial player who then bundles the mortgage with thousands of others and sells various risk based slices.
It failed in three different ways – two of which we know about, but one which is just emerging.
Firstly the original mortgages were offered to people that couldn’t afford to pay them back, particularly when the so called “fixed” interest rates rose after an initial one or two year period. Much has been written about this (NINJA, Sub Prime etc)
Secondly the riskier slices of the mortgages were vastly under priced, and so the interest rate premium didn’t begin to compensate for the very real probability of a high rate of failure to service the loans.
The third one is a doozy. It turns out that because of the mortgages being sold and sliced and sold, the ownership of the original mortgage is often in doubt. It took Mamie Ruth Palmer in Atlanta, Georgia to bust this one open, in a court case that has just ended a six year saga.
Her bank tried to foreclose on her, but couldn’t prove that they actually owned the mortgage. The bank ended up in the humiliating situation of losing on pretty much all fronts:
Last month she received a settlement from the Bank of New York, the trustee for a vast pool of mortgages that included hers. Under the terms of the deal, the bank reduced Ms. Palmer’s loan balance to $59,000 from about $100,000 and has agreed to accept the proceeds of a reverse mortgage in full satisfaction of her obligation.
The settlement also eliminated about $12,000 in foreclosure fees added to her debt and called for the installation of central air-conditioning in Ms. Palmer’s home.
Roughly $10,000 in legal fees billed over five years by Ms. Palmer’s lawyer, Howard D. Rothbloom, will be covered by payments she has made toward her mortgage while she was battling foreclosure.
Fantastic. Mamie Palmer not only wasn’t humiliated, but she wins a major victory and also gets to keep her home and dignity.
…today, amid the freewheeling packaging of mortgage loans into securities that are sold off to investors, it’s much less clear who controls the note — all of which promises to cause banks enormous legal and financial headaches as foreclosures mount
The problems associated with banks that begin foreclosure proceedings when they do not have proper legal standing are now looming larger in the mortgage meltdown. Loans were heaped into trusts with little documentation of ownership or proper loan assignments — it was all about volume and the fees that came with it — and now that sloppiness is hurting both lenders and borrowers.
Not knowing whom to call is another effect of securitization. In the past, lenders knew their borrowers and vice versa; today the holder of the note securing the property is a faceless investor represented by a trustee, like the Bank of New York.
This all means that the investors that hold mortgage backed securities are less able to get their last recourse of forcing a sale of the house to get their money back. The implications are pretty severe for financiers, and pretty good for homeowners. At the very least it means that the foreclosure costs are going to be a lot higher than anyone previously thought.
Yet another middle man is the company servicing the loan; it has an obligation to the investor to extract all the money it can from the borrower. And because the foreclosure process can generate lucrative fees, servicers have an incentive to drag out the process, experts say.
This is scary – this means that there are agents that have the incentive to screw over both the home owners and the mortgage backed security owners. Not a lot of winners in this one.
Judges are beginning to catch on to all of this.
Arthur M. Schack, a justice on New York State Supreme Court in Brooklyn, is one of the judges who is putting lenders’ feet to the fire. In 14 published foreclosure decisions handed down since Jan. 1, Justice Schack has granted only one lender the right to foreclose. Of the 13 other cases, he dismissed one outright and dismissed 12 without prejudice.
So all in all this is further bad news for the housing trade, for the likes of Citigroup, Freddie and Fannie, but good news for homeowners that are over stretched. But I also have the view that this is good news as it prevents mortgage security holders foreclosing on houses too quickly, and will thus promote alternative courses of action such as renegotiated loans (e.g. for 80% of face value). Renegotiated loans are great where it gives homeowners a chance to pay back a reduced loan rather than declare bankruptcy and walk away from unsustainably high payments.