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L. Randall Wray

L. Randall Wray

Posted: January 12, 2011 10:30 AM

In a ruling that could be historic, the Supreme Judicial Court of Massachusetts ruled against two fraudster banks, US Bancorp and Wells Fargo, who illegally foreclosed on homes. In short, the two banks stole homes to which they had no legal claim.

This rattled stock markets, causing the broad-based KBW Bank Index to fall by 2.2%, with Wells Fargo's stock prices falling by 3.4% as markets began to recognize that "business as usual" theft of American homes by banksters will be subject to greater scrutiny. Tellingly, the banks have been arguing that they are following industry practice. The ruling in Massachusetts (one of the most respected Supreme Courts in the US) affirms that industry practice is fraudulent. Perhaps as many as 66 million mortgages (those tainted by improper industry recording procedures) could be affected by the ruling.

As I have been arguing in a series of pieces (see here and here and here), in their haste to commit lender fraud, the banks that securitized mortgages also perpetrated tax fraud and securities fraud. The inevitable outcome of those frauds is foreclosure fraud. As Lynn Szymoniak and Ray Brown have written, 2010 became the year in which "'foreclosure fraud' emerged in case law' -- defined as 'fraud by mortgage companies, mortgage servicing companies, and banks servicing as trustees for securitized trusts." Foreclosure fraud is not a matter of some pesky little paperwork problems. It is the designated solution to paper-over the lending and securities and tax frauds that the banksters used to bubble-up and then collapse the US real estate sector. To put it simply, the Court found that the practices followed by the industry have made legal foreclosure impossible.

All of this, in turn, was happily consistent with the Bush "Ownership Society" plan to transfer all wealth to the top few tenths of one percent of the wealthiest Americans. The banksters would simultaneously burden homeowners with so much debt that they'd lose their homes, and would sell to investors fraudulent toxic waste securities while using credit default swaps to bet on failure. Bush's ownership class would end up as the creditors who got all the homes, who got all the financial wealth sucked out of pension funds and other managed funds, and with their gambling winnings from the inevitable defaults.

But in their haste to steal property, the Wall Street banksters ran up against US property law. They thought the judges would turn a blind eye to blatant theft. Unfortunately, courts across the country have awakened and are beginning to rule against them. As I have said, the banks are toast -- as anyone still holding bank stocks will discover in coming months. Losses will easily wipe out all equity at the biggest banks, several times over. Further, the vulture predators now buying up foreclosed properties will find that the titles are not clear. It will take at least a decade to sort out the mess created by Wall Street's securitization of home mortgages and to restore property rights law.

Here is the good news: Bush's Ownership Society dream has morphed into a Nightmare on Wall Street. The banks have no legal standing to foreclose. Delinquent homeowners that have been subject to foreclosure fraud can remain in their homes. While they still owe their mortgages, no one has the right to take their homes away from them. This improves their negotiating power to secure mortgage modifications -- to get payments down to something they can afford. That is good -- for the homeowners, for their neighbors, for the nation as a whole. And, ironically, even for those holding the "securitized mortgages" -- including the fraudster banks.

The current wave of foreclosures -- expected to reach 13 million by 2012 -- is not good for anyone. It is a classic example of a negative externality, where pursuit of apparent individual self-interest results in losses for everyone. Stopping foreclosures and shutting down the fraudsters will stop those losses. The only ones who will be hurt are the top management officials at the biggest banks -- who will lose their bonuses and who will be prosecuted for numerous felonies. The other 99.9% of the rest of us will experience a Pareto improvement -- as economists call it when you win and no one (but the criminal class) loses.

Let me explain. I will assume that everyone is reasonably familiar with the lending fraud, in which Wall Street rewarded mortgage brokers who induced home-buyers into NINJAs and liar's loans they could not afford -- aided and abetted by crooked real estate agents, appraisers, credit raters, and accountants. Those fraudulent loans were then packaged into fraudulent securities -- that did not meet the "reps and warranties" required by the "PSAs". (Briefly, when an investment bank pooled a bunch of mortgages to "back" a security, it guaranteed that they met minimum standards as required in the Pooling and Service Agreements. But they did not, which means the originators of the securities must take back all the bad "liar's loans".)

I will also assume that readers know that the securities, themselves, were fraudulent from inception because they did not meet those "PSAs" (the very strict requirements governing securitizations -- most important of which was the requirement that the Trustees obtain the "wet ink" notes of the homebuyers, something that apparently was never done). That, in turn, means that "mortgage backed securities" are not backed by mortgages -- they are nothing but unsecured debt and now are mostly worthless.

Finally, I will assume that readers are familiar with the tax and recording frauds perpetrated by the mortgage industry's creation of MERS (Mortgage Electronic Registry System) -- which allowed the banks to illegally evade property recording fees and allowed securities holders to evade US federal taxes. Those expose the banks to hundreds of billions of fees, back taxes, and fines.

One might have thought that all those frauds would be enough to satisfy Wall Street. But, no, the biggest fraud was yet to come -- a fraud that necessarily followed on from all the previous frauds. The structure of the whole Ownership Society juggernaut required low-cost foreclosures in order to transfer property to America's true owner class. It was a foregone -- nay, planned -- conclusion that all the NINJAs and liar's loans would go bad. There would be millions upon millions of homes that would be foreclosed.

Unfortunately, foreclosure is expensive. Over the past half millennium, Western property law evolved to make it difficult for the King or his minions to take property away from its owner. One claiming to be a creditor against land would have to present evidence, including the "wet ink" note, that one had legal standing.

Keeping track of all those notes, collecting payments, properly recording sales, processing foreclosures, and conducting sales of seized property is extremely expensive. That is why Jimmy Stewart's thrifts could not survive with mortgage defaults running higher than a couple of percent. And that was with a very cheap and efficient home finance system based on thrifts that made loans to their community while collecting the community's saving. All you needed was a good loan officer who knew his customers, a teller, and an experienced property appraiser. But the modern mortgage industry needed to support a huge infrastructure of brokers, securities originators and distributors, appraisers, credit raters, accounting firms, mortgage insurers, servicers, and -- importantly -- foreclosers. All of that is costly.

Further, the modern mortgage system was designed to generate a tsunami of defaults, orders of magnitude greater than historic proportions. Indeed, the hope was that virtually all mortgages would go bad, so that the property could be seized and transferred to our true propertied class of rightful owners -- those north of the 99th percentile -- while leaving the dispossessed homeowners in permanent debt peonage as a result of "reformed" bankruptcy law. And bankruptcy of homeowners let the banksters collect on their bets. There is no way that even the exorbitant fees and interest rates charged on hapless subprime and Alt-A borrowers could possibly cover all those costs of the "new and improved" home finance food chain.

Hence, a system of cheaper property transfers and foreclosures would be required. But the banksters were too clever by half in their hurry to create a low-cost foreclosure machine. They knew they could never afford to securitize and then foreclose on millions and millions of mortgages following well-established, legal, and expensive procedures -- with teams of paper pushers, process servers, and lawyers. So they cut corners. And it is the corner-cutting that has come back to bite them.

As I have shown, MERS was created to circumvent the expensive and time-consuming laws that required recording property sales in public offices. Only the initial sale of property would be lawfully recorded; thereafter, the dozen or more sales of a mortgage would be recorded only electronically at MERS, on the fiction that all subsequent sales were in-house transfers among deputized MERS "vice presidents" at member firms. That was recording fraud. MERS also encouraged mortgage servicers to retain the notes, in order to speed the inevitable foreclosures. But that violated Federal tax laws that required the notes to be held by the Trustees of the securitizations. Tax fraud. It also violated the PSAs that required the Trustees to certify that they had the notes. Securities fraud.

Finally, the banksters created something called the Lender Processing Services (LPS) to out-source mortgage default services in order to speed foreclosures--in other words, to circumvent lawful practice. LPS got "kickbacks" from law firms by illegal "fee-splitting", agreeing to share late fees, etc, piled on mortgages in return for sending foreclosure cases to the firms. (Thorne v. Prommis Solutions Holding Corp., Northern District of Mississippi) In addition, LPS has been found to routinely supply incorrect and doctored documents to litigants and judges in foreclosure actions. According to a ruling analyzed by Szymoniak and Brown, it is staffed primarily by paralegals (Burger King kids!), with little supervision by attorneys. Indeed, LPS was designed to minimize human involvement and judgment in the foreclosure process--to save precious time, and more precious money. Judge Sigmund Weiss concluded that LPS's "thoughtless mechanical employment of computer-driven models and communications to inexpensively traverse the path to foreclosure offends the integrity of the American bankruptcy system." But this "thoughtless" and inhuman process was required precisely to minimize the costs to the banks of foreclosing on properties. Hence, just as MERS was created to minimize costs of securitizations and multiple sales of underlying mortgages, LPS was created to minimize court costs of processing the expected foreclosures.