Time to Audit the Real Estate Mortgage Investment Conduit Trusts
As I have written, when we peel back the layers of the real estate “onion” what we find is layer after layer of fraud. From the mortgage brokers to the appraisers and lenders, from the securitizers to the ratings agencies and accountants, from the trustees to the servicers, and from MERS (Mortgage Electronic Registry System) through to the foreclosures, what we find is a massive criminal conspiracy—probably the worst in human history. I realize that is a harsh claim but I cannot find any other words that fit.
In the old days, we used to hang horse thieves. The justification was that a man’s horse was necessary to his way of life, and in some cases, to his very survival. There can be little doubt that a home is equally important to maintenance of a middle class living standard today for most Americans. There is almost no calamity worse than loss of one’s home. It is the main asset that most Americans hold—essential to the educational success of one’s children, and to a comfortable retirement of our citizens. Americans typically borrow against their home equity to put their kids through college, to ease the financial distress caused by unexpected health care expenses, and to finance other large expenditures. The accumulated equity in the home is the only significant source of wealth for the vast majority of Americans. The home is necessary to one’s continuing connection to the neighborhood, school district, and network of friends. Theft of one’s house today is certainly equivalent to theft of a horse 150 years ago.
And, yet, we are not hanging the thieves who are stealing millions of homes from Americans. The thievery today is orders of magnitude greater than the horse thievery of the distant past. Today’s foreclosure thieves have stolen more property of citizens than all previous thieves combined since the founding of our nation. The only thing that could trump it would be the theft of property and livelihood from our native Americans. To be sure, we have evolved as a nation, and I would not advocate hanging those responsible. But without question they ought to be incarcerated in prison, with long terms and with confiscatory monetary penalties—perhaps 10 years for anyone who helps to improperly foreclose on a homeowner’s property, and $10 million for each case of fraudulent foreclosure. That would provide the proper incentive as well as the proper monetary reward that will be required to get good lawyers to take cases of homeowners who are being illegally thrown out of their homes every minute of every day.
The real estate finance sector is trying to pin the blame on some sloppy paperwork and overburdened workers. They promise to put things right, hiring more workers to work diligently to dot those eyes and cross those tees. In reality it was all fraud, intentional and massive. Home theft was the business model. That is what the Bush administration meant when it pushed the “ownership society”—a society in which the top tenth of one percent would own everything.
First, they changed bankruptcy laws so that a first mortgage on one’s principal residence is the only debt a judge cannot reduce. This was to ensure that when the wave of foreclosures began, those who lost their homes to the true ownership class would still have to pay off the mortgage. Next, they created “affordability” products—such as the neutron bomb hybrid adjustable rate mortgages hawked by Chairman Greenspan–that were designed to blow up the borrowers while leaving the real estate intact. Then they created derivatives—the so-called mortgage backed securities–sold to investors. Toxic waste derivatives were then re-packaged into even more trashy collateralized debt obligations that were sold to bank customers, with banks buying credit default swap “insurance” to place bets against their own customers.
The banks then farmed out mortgage servicing to their own subsidiaries, “misplacing” payments that ought to have gone to the securities holders. This was in order to claim borrowers were delinquent so that the servicers could squeeze late fees and default fees and extra interest out of them. Investors in the securities would be last in line, with the servicers maximizing their own incomes and protecting the interests of their mother banks (which often had second liens on the properties in the form of home equity loans). This is why the servicers make it so difficult to modify the loans—which is in the interests of the borrowers and the investors, but against the interest of the banks with second liens. And they created MERS to operate as a foreclosure steam roller, which outsourced the foreclosures back to the servicers with deputized “vice presidents” pretending to be officers of MERS in order to scam the courts.
We now know that the “mortgage backed” securities were not backed by mortgages. In reality they are unsecured debt. The “pooling and servicing agreements” (PSAs) that govern securitization require that the mortgage documents (including the wet ink notes as well as a clean chain of title) are transferred in a timely manner to the trustees. This was rarely and perhaps never done, because it was counter to the recommendation made by MERS (Mortgage Electronic Registry System). Instead, notes were either destroyed or held by the servicers to speed the foreclosures that were always envisioned as the end result of the mortgage origination process. Not only does this practice render the securities fraudulent but it also violates the federal tax laws that govern the REMICs—meaning back taxes are due.
But worse than all that, by breaking the chain of title and by destruction of documents, MERS and the servicers have jeopardized the entire system of property rights. Most, perhaps all, foreclosures have been fraudulent, which means that resales of the homes are also frauds. It goes without saying that the original mortgages were frauds from the very beginning—to complete the transformation to the ownership society it was necessary to ensure that by construction, default was inevitable. Either the homeowner would be unable to pay, or the servicer would “lose” the payments. By obscuring the chain of title, it would be impossible for the debtors or the courts to sort things out. Separating home owners from their property was necessary to ensure that we can create Bush’s ownership society. It is the modern form of the feudal foreclosures and seizures of peasant lands that concentrated ownership in the hands of agricultural capitalists—creating the first ownership society.
The scale of the problem is huge. Some estimate that as many as $6.4 trillion worth of home mortgages (33 million of them) are frauds, with destroyed or doctored documents. Probably all of the $1.4 trillion worth of private label residential mortgage “backed” securities violate the PSAs—so are actually unsecured debt. Three state supreme courts have already ruled that MERS cannot be the owner of mortgages, hence, has no standing in foreclosures. MERS contaminated 65 million mortgages—decoupling the mortgages from the notes and destroying the chain of title. A consortium of investors (including PIMCO, Black Rock, and Fannie and Freddie) that owns $600 billion of the private label securities are suing the banks to take them back. One investor action alone against Bank of America concerns $47 billion in fraudulent mortgages—enough to put a serious dent in its purported net worth of $230 billion (which is probably a vast overstatement resulting from cooking the books). A suit in California seeks $60-$120 billion in lost recording fees alone. All 50 states are investigating the servicers for fraud. The top five servicers (Bank of America, Wells Fargo, JPMorgan Chase, Citigroup, GMAC-Ally) have 60% of the business and include the top four banks that account for 40% of the banking business.
It is time to push the reset button. All foreclosures should be stopped immediately. The REMIC trustees should be audited to see if they have properly followed the requirements of the PSAs and laws applying to REMICs. If they do not have the notes, the securities should be put back to the banks. If the banks cannot absorb the losses, they must be closed and resolved. The FDIC in turn will end up with the mortgage backed securities and underlying mortgages. Working with Freddie and Fannie, all of these should be modified, into new fixed rate mortgages—with a “clawback” to reset principle to current market value of the homes, and with new notes. Investors are going to take losses so there will be fall-out that government will have to address. There will be hundreds of billions of dollars of losses. Congress must find a way to mitigate effects on the economy as well as on investors in MBSs and other assets related to real estate. This is a big problem, but it is not insurmountable.
Every top management official of all the biggest dozen banks, plus everyone at MERS, all officers of every servicer, rater, appraiser, accounting firm, and mortgage broker ought to be investigated for fraud. In the aftermath of the thrift crisis, 1852 bank insiders were prosecuted and 1072 were jailed. So far in this much bigger crisis there have been only 50 criminal probes and 80 civil lawsuits authorized by FDIC. It is time to get serious about the home thieves.
L. Randall Wray is a Professor of Economics, University of Missouri—Kansas City. A student of Hyman Minsky, his research focuses on monetary and fiscal policy as well as unemployment and job creation. He writes a weekly column for Benzinga every Thursday.
He also blogs at New Economic Perspectives, and is a BrainTruster at New Deal 2.0. He is a senior scholar at the Levy Economics Institute, and has been a visiting professor at the University of Rome (La Sapienza), UNAM (Mexico City), University of Paris (South), and the University of Bologna (Italy).