Sean King

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Knoxville, Tennessee, United States

Sunday, October 17, 2010

More on the Foreclosure Fiasco

This post by John Mauldin is the best explanation I've heard to date of the foreclosure fiasco, and more importantly its potential significance. Read the whole thing (I know, it's long, but do it anyway). This excerpt gives one some sense of the problem:

"So somewhere between the REMICs and MERS, the chain of title was broken.

"Now, what does 'broken chain of title' mean? Simple: when a homebuyer signs a mortgage, the key document is the note. As I said before, it's the actual IOU. In order for the mortgage note to be sold or transferred to someone else (and therefore turned into a mortgage-backed security), this document has to be physically endorsed to the next person. All of these signatures on the note are called the 'chain of title.'

"You can endorse the note as many times as you please...but you have to have a clear chain of title right on the actual note: I sold the note to Moe, who sold it to Larry, who sold it to Curly, and all our notarized signatures are actually, physically, on the note, one after the other.

"If for whatever reason any of these signatures is skipped, then the chain of title is said to be broken. Therefore, legally, the mortgage note is no longer valid. That is, the person who took out the mortgage loan to pay for the house no longer owes the loan, because he no longer knows whom to pay.

"To repeat: if the chain of title of the note is broken, then the borrower no longer owes any money on the loan.

"Read that last sentence again, please. Don't worry, I'll wait.

"You read it again? Good: Now you see the can of worms that's opening up."

To "fix" this problem, some banks engaged in fraud, forging documents in an attempt to reconstruct the chain of title after the fact so that they might foreclose on the property. Mauldin discusses all of this and gives examples.

The long and short of it is that, due to the sloppy securitization of mortgages, it's almost impossible to tell who "owns" the promissory note that your mortgage secures (Mauldin explains why). Thus, even if you've not defaulted, it's very difficult to be sure that you're paying the right party when you send in your mortgage payment each month. And, if not (granted, this is unlikely but possible), you could be forced to double pay if and when the "rightful" party finally appears! Can you imagine what will happen to banks if large numbers of homeowners suspend their monthly payment until they are able to identify with certainly who the actual holder of their promissory note may be? Due to the complexity and sloppiness of the paperwork in question, identifying the rightful payee could take weeks or even months. While this risk is mostly hypothetical at the moment, there's one that's not:

As a result of confusion over the chain of title, title companies are beginning to refuse to provide title insurance to buyers of foreclosed homes, and banks are starting to refuse to participate in short sales. Without title insurance, banks will not finance the purchase. Without financing, purchases declines and prices fall further, and this has a ripple effect throughout the economy. A decline in the number of short sales also decreases sales volume with similar potential effects.

In short, the foreclosure fiasco is bigger than advertised and is only just beginning. Ultimately, congressional action will likely be required to resolve it, but any such action will almost certainly be perceived as Congress once again showing favoritism to the very banks who created the problem to begin with. And, this perception will largely be correct.

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