Legal missteps by banks pursuing foreclosures sent the mortgage markets into uncertain territory this last week as details emerged about the scope of the robo-sign scandal and its potential implications. There are many unanswered questions, and few simple solutions. Are we looking at just the tip of the iceberg, with the original fraud masking deeper, structural illegalities? Can the real estate market recover from the scandal? What can be done for the hundreds of thousands of borrowers who may be in legal limbo? In order to find answers to these questions, a number of key issues must be resolved first. Once that is done, it is only then that we can start talking about solutions.
Issue One: What is the Extent of the Problem?
Just to recap what we know so far: three major banks--Ally Financial, JPMorgan Chase and Bank of America--have come forward admitting to problems with the foreclosure procedures they follow in the 23 states that require judicial intervention to foreclosure on a mortgage. These banks have halted foreclosures in these 23 states, with BofA deciding to stop all foreclosures in every state. The banks took these measures when borrower advocates exposed the fact that many of the documents filed by the banks in their foreclosure cases had serious defects, including that bank officials falsified affidavits, used electronic signatures (which is illegal), and failed to have the documents properly notarized. Admittedly, given that some major banks have been charged with fraud and discrimination in their lending practices, these allegations of procedural missteps might seem trivial. While there are real consequences resulting from these actions (see Issue Three, below), the larger question is: do the procedural irregularities hide deeper problems?
Issue Two: Does the Robo-Sign Scandal Really Mask Bigger Problems with Wide-Ranging implications?
The robo-sign scandal begs the question: were the affidavits falsified for a reason, or was it simply poor oversight of a crushing volume of cases? The affidavits contained allegations professing that bank officials reviewed bank records in preparing their foreclosure cases for the courts. These records purportedly held the facts that could establish the banks' grounds to foreclose: that is, facts proving ownership of the mortgage, that the bank had the legal right to foreclose and that the borrower was behind on his or her mortgage. As it turns out, the bank officials have now admitted that they did not review those records, despite their sworn allegations to the contrary. Now, even if this is all there is to this scandal, there are still serious consequences for filing such false affidavits (again, see Issue Three, below). At the same time, it is entirely possible, and some would say likely, that the bank officials were masking a deeper problem with these cases. Here are just two of those potential problems.
First, the banks may not, in fact, be able to prove that they have the right to sue under the mortgages. The mortgage securitization market operated at a fevered pitch in the middle years of the last decade, and each transaction in this market was not always properly documented. In many foreclosure cases, banks sometimes have a hard time proving that they are, in fact, the party with the legal interest that can pursue foreclosure on these mortgages. What the robo-signed affidavits might be masking is this fact: that banks often do not have the right to pursue mortgage foreclosures in many of these cases. Alternatively, it is possible that the banks might, themselves, have the right to bring the foreclosure actions while, at the same time, other entities also have a legal stake in the mortgages. As such, this stake makes their participation in the foreclosure cases necessary, and such cases cannot move ahead without them. Because it is often costly and complicated to bring such additional parties into a case, the robo-sign affidavits might have glossed over the existence of such parties to save the trouble of naming them and including them in the litigation.
A second problem the robo-sign scandal may mask has far deeper implications. Tax implications. Many mortgage securities are set up as what are known as REMICs (for "Real Estate Mortgage Investment Conduits"): essentially bundles of mortgages set up as trusts and managed by trustees. The bundles of mortgages generate proceeds from the borrowers' payments made under the mortgages in the trusts. These proceeds are ultimately passed on to the investors in these trusts. REMICs receive favorable tax treatment and the income coming into the REMICs from the mortgages is not taxable (though the payments made to the investors in those REMICs are). Those who create these REMICs must follow very strict rules in order to qualify for this special tax status. One of the rules requires that the mortgages in the REMIC trust must all be added to it at the time of its creation, and no additional assets may be placed in the trust after this point. If they are added, the REMIC loses its tax treatment, which has some retroactive effect. The robo-sign scandal has raised questions about whether the robo-signed affidavits covered up the fact that many of the assets of these REMICs may not have been made a part of the REMICs at the time of their creation.
Another potential technical violation at the intersection of the robo-sign scandal and REMIC tax rules involves questions regarding what entities own the mortgages in the REMICs. The REMIC rules require that the trustee of a REMIC cannot serve as the "holder" of the assets of the REMIC, as opposed to the investors in the entity. Gathering all of the investors together to bring a foreclosure action--since they are the true owners of the assets--is often unwieldy, however. Have REMIC trustees brought foreclosure cases in their own names to make foreclosure filings easier? Yet if the trustees truly own the mortgages, that would jeopardize the REMIC status. Thus, an outstanding question remains about the ownership of these REMICs: have the robo-signed affidavits been used to mask the ownership structure of the REMICs for fear that it would either jeopardize the standing of the parties bringing the foreclosures, or, in the alternative, threaten the precious tax status of the entities?
Issue Three: What Are the Penalties for these Actions?
First, the banks face the prospect of significant civil penalties in the cases in which they filed these robo-signed affidavits. Courts managing these cases can institute penalties against the banks that range from monetary sanctions to outright dismissal of the foreclosure actions. Second, bank officials face the prospect of criminal penalties for falsifying affidavits, and state attorneys general are starting to band together to conduct an investigation into these issues, which may lead to criminal prosecutions. But the potential for implications that are more far reaching is staggering.
To determine whether the robo-signed affidavits mask deeper problems--that the banks do not have the ability to bring these foreclosure actions or may have violated the tax rules in running these REMICs--we need to know more: if not "what did they know, and when did they know it," perhaps "what are they trying to hide and when were they trying to hide it." At the end of the day, it may turn out that the banks face significant hurdles to bringing foreclosures, and many of these REMICs owe billions of dollars in back taxes for their failure to follow the REMIC rules.
We need a full and frank airing of these issues in order to get a grip on them: only then can we start exploring real solutions. The residential real estate market is in crisis right now due to this scandal, mostly because of the uncertainty it has generated. The first step in resolving these uncertainties is a national foreclosure moratorium, one that will allow us to gather all of the facts. Only then we can move on to solutions.
In order to get out of the crisis, we need to know its full depth and breadth. Such an understanding will help to sort through some of the unresolved questions; it is within the answers to these questions that the true solutions lie.