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Requiem for MERS (and the Banks That Created the Frankenstein Monster)

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It is now widely recognized that MERS facilitated fraud by lenders, servicers, foreclosers and securitizers. Even on the most charitable interpretation it is very difficult to believe that MERS was not fraudulent by design. So much of the story has already been told that we do not need to rehash all of it here. Let me first concisely summarize the two main problems, and then move on to the most recent developments that put the final nails in MERS's coffin. I'll conclude with my argument that there really was some "not so intelligent" design behind all of this. But it is coming back to bite the hand that feeds. The big banks will not survive the monster they created.

Whenever those who are critical of MERS and the banksters post blogs about the multiple frauds, we are attacked by commentators -- presumably industry hacks -- who try to obfuscate the issues. But recent court cases as well as testimonies before elected representatives confirm our two main claims. First, many or most foreclosures that are taking place are illegal because those doing the foreclosing do not have legal standing. And, second, the practices that created the foreclosure problems also mean that the mortgage backed securities are actually unsecured debt. That means banks must take them back, so they are toast. It all comes back to MERS's business model: it destroyed the chain of title.

Much of the rest of the fraud and scandal we are witnessing follows on from that because the banks want to foreclose the properties before the securities holders put back the fraudulent securities. The problem is that the destruction of the clear chain of title makes it impossible to foreclose, so the banks used robo-signers to forge documents in the hope they could paper over their home thefts. But homeowners, courts, legislators, securities investors, and title insurers have caught on to the scam. In addition to the forgeries, MERS and bank officials and lawyers are committing perjury in court in the hope that they can confuse the issues sufficiently that they can complete the home thefts.

However, improper foreclosures produce houses that cannot be sold legally -- so the can is just kicked down the road to the next crisis, which will reveal that those who have purchased foreclosed homes have no legal title to them. And so their debts will also be unsecured. MERS has created a disaster that will not be resolved for at least a decade, perhaps a generation. Given the scale of foreclosures (projected at 13 million by 2012), future home purchasers face a pretty good chance that if they are buying pre-owned housing, their title to the property is dubious.

Let us quickly review recent developments.

Notice of Default Robo-Signing. About half the states are "nonjudicial states" (including California, Nevada, and Arizona -- important states so far as the foreclosure crisis goes). As Kate Berry writing for the American Banker argues, the foreclosure process in these states begins with a formal "notice of default" (NOD) letter sent to the delinquent homeowner; this is followed up by a notice published in a local newspaper. The NOD is supposed to be signed by an agent of the "party of interest"--the company with legal standing to foreclosed. By signing the letter, that agent certifies that she has reviewed the relevant documents to determine, most importantly, that the homeowner had defaulted on payments and that the company for which she is acting as agent really does have standing to foreclose. But in practice, these letters are Robo-signed by people who never look at documents. They do not even seem to know for whom they are acting as agent!

For example, in the Nevada case studied by Berry, Stanley Silva (a title officer at a title firm) gave a deposition asserting that he never reviewed documents before signing NOD letters. Further, he said he was acting "on behalf of Ticor Title of Nevada, who is agent for LPS title, who is agent for National Default Servicing" who is "apparently" agent for Fidelity National, which is "apparently" a servicer for Wilshire, which acted as agent for Wells Fargo, which claimed to have standing to foreclose! Now that is a nice "daisy chain" that successfully hides the party of interest from the homeowner trying to avoid foreclosure! Lawyer Walter Hackett, who is handling a number of such cases, says "A huge percentage of notices of default and notices of trustee sales are legally questionable and probably void." Since foreclosures in these nonjudicial states do not have to go through the courts, it is probable that abuses are common -- and hard to expose because homeowners have to file a lawsuit to get to a judge. Heck, the homeowner would need a sleuth better than Sherlock Holmes to find out who holds the interest in the mortgage.

Improper foreclosures and fees imposed on active military personnel. JPMorgan-Chase was caught stealing homes from military personnel. The bank admitted 14 improper foreclosures. It is illegal to foreclose on active duty personnel--and who knows how many other cases there are that JPMorgan and the other fraudster banks have not yet acknowledged. The bank also admitted that it overcharged 4000 active duty personnel--jacking up their mortgage interest rates to 9 or 10 percent even though those serving our country are supposed to get 6% rates. The bank now says it feels their pain -- "we feel particularly badly about the mistakes we made here" said bank officials in a statement. But routine overcharges are the business model at the big banks. Then they pile on late fees when families cannot afford the overcharges -- the overcharges ensure that homeowners cannot possibly catch up (that is the purpose of the late fees -- the banks simply want to speed foreclosure). Finally, the fraudsters take the homes and throw the owners out onto the streets. When caught, the bank says it is sorry and promises it will do better in the future. Now, it is perfectly plausible that this horrendous treatment of those serving our country resulted from incompetence, not fraud. But as my colleague Bill Black says, these are banks -- they are suppposed to be able to process paperwork without error! Yet, they have officials who are signing foreclosure documents, asserting they have looked over all relevant docs. Clearly, they did not. At best they are certifiably incompetent; more likely they are certifiably criminal.

Freddie and Fannie force securities "put backs". Bank of America agreed to settle with Freddie and Fannie for $127 billion securities sold by Countrywide (taken over by BofA) that they claimed to be faulty. The problem was that the underlying mortgages did not meet the "reps and warranties" the bank had provided. BofA paid Freddie $1.28 billion and Fannie $1.52 billion -- a measly 2+% of the value of the fraudulent mortgages the bank sold. Four Democratic members of Congress rightly objected -- how could this settlement represent "the best possible recovery of funds available to taxpayers"? Obviously, it cannot. It is just more subsidizing of Wall Street using Uncle Sam's funds. Meanwhile, Freddie posted 5 straight quarters of losses, receiving $63 billion in aid from the Treasury to cover its bad deals with banks like BofA. Apparently the deal with BofA was pushed through by Treasury Secretary Geithner, who continues to protect Wall Street's "SDIs" (systemically dangerous institutions, as Bill Black puts it). But as Yogi said, it ain't over until it's over. BofA will be sued again and again over fraudulent mortgages. The problem is not just the "reps and warranties"--an even bigger problem is that the securities are not backed by mortgages.

Citi still sells trashy mortgages. A recent audit disclosed that 15% of the mortgages Citi sold to Freddie in 2010 were frauds. These are not old mortgages originated during the boom, rather these were all new originations, underwritten between February and May of 2010. The loans are rated "not acceptable quality" because they are missing documents, the properties were not properly appraised, the incomes of homebuyers did not meet requirements, and the homes did not qualify. In other words, they had the same litany of problems that all the junk mortgages had back in 2005. Citi has learned no lessons from the fiasco it helped to created. Indeed, Sanjiv Das, CEO of CitiMortgage (that originates loans for Citi) bragged that with "only" a 15% rate of fraudulent mortgages, that qualifies as "one of the most outstanding stories" of Citi's business model--a "fantastic job" he claimed. True, it is down from a 30% fraud rate in the fourth quarter of 2009. But 15%? Sold to government? What kind of confidence can that build in the minds of investors, homebuyers, regulators, or legislators? Yes, the SDIs are still dangerous and only insane public policy would keep them open to permit them to continue to perpetrate fraud. As in the BofA case, this is a "reps and warranties" problem, not directly related to MERS but it does help us to understand why the banks should be shut down along with MERS.

Ibanez decision in Massachusetts. Courts continue to chip away at the arguments made by banks and their Frankenstein creation, MERS, to justify foreclosure without proper documentation. MERS was manufactured by the industry to evade proper recording of property sales in county recorder's offices. This not only cheated the recorders out of fees and Uncle Sam out of federal taxes, but it also broke the chain of title. The fiction perpetrated by MERS is that it is simultaneously a nominee of the true owner of the mortgage debt and at the same time it is the beneficiary of the security instrument. (You cannot simultaneously be the party of interest and the nominee, of course.) It also disclaims any financial interest in the mortgage and has no claim on the mortgage payments. But it claims that it can operate as the agent of unnamed owners of the mortgage instrument, unknown owners who--since they are unknown -- have never designated MERS as agent. The Massachusetts Supreme Court ruled decisively against MERS's claims, and a growing number of other state supreme courts (Nevada, New York, Kansas, Idaho) have agreed that MERS is only a nominee or "straw man" (as Kansas put it) with no standing to foreclose.

Here's the problem. MERS was supposed to replace the old fashioned method that relied on physical docs with a newfangled electronic registry. When a homebuyer takes out a mortgage there are two essential pieces--the promissory note and the "security", "deed" or "mortgage". The first commits the homeowner to payments, the second is a lien on the property that entitles the holder to foreclose in the case of default. The note is held by the lender and the mortgage is recorded at the county recorder's office. In US law, the "mortgage follows the note"--the note holder who has the mortgage can foreclose if the payments are not made--keeping them together ensures that the one who is owed can seize the property and sell it to recover monies owed. It also protects the borrower--you cannot have multiple parties claiming an interest in the property. But MERS separated them--indeed, it argued that its electronic registry replaced the need for a note. (In Florida the notes were routinely destroyed--and this might have been a practice that was followed elsewhere, which is why there are so many "lost note affidavits".)

And as now widely recognized, when the mortgage was packaged into a security and resold multiple times, it was not properly assigned to the new owner. MERS's theory was that it would hold the mortgage until foreclosure, when either MERS or the mortgage servicer would foreclose. This is why it is so critical for MERS to claim it is an agent of every member who ever claimed ownership of the mortgage--even if they are unknown--because there was never any legal recording of the transfers, hence, no clear chain of title. The Ibanez decision ruled that without the clear chain--with every claimed owner showing exactly how it obtained the mortgage, all the way back to origination--then foreclosure cannot be completed. It is likely that many, most, or all securitized mortgages will fail to meet the Ibanez requirement. Indeed, that was fundamentally the MERS model: to reduce costs by eliminating the necessary assignments of interest at each stage, and the public recordings that make it all transparent and virtually fraud-proof.

Quiet Title actions in Utah. In Utah, judges are ruling in favor of homeowners in "quiet title actions". The owner seeks clear title to property free of lien by lenders or others. In a quiet title action, the owner takes advantage of the fact that MERS listed itself on the trust deeds as the beneficiary of the note. Utah courts have recognized that as a fraud. MERS -- with no financial interest in the mortgage -- cannot be beneficiary. It is just a data registry. It makes no loans. It does not receive mortgage payments. Hence, homeowners can go to court without any notification to MERS, serving legal papers only to the legal owners of the title to the property. This is usually some title company, that is supposed to be the trustee of the mortgage. In cases in Utah, these title companies either did not respond at all, or they simply said that they didn't "know who the beneficiary of the trust deed is" and denied any interest in the deed. The judges then hand the deeds over to the homeowners. While they can still be sued for the mortgage payments they owe, the homeowners got their homes free and clear. In other words, no one can foreclose on them. Their debts are unsecured. And note that because MERS evaded public recording, whatever is in the public records (that is -- the legal ownership) will not be consistent with MERS's illegal registry of ownership. It is probable that almost all publicly recorded owners of the mortgages believe they have transferred ownership. Quiet title actions are apparently legal in all states, designed to let homeowners discover who owns their mortgages. But since MERS has so hopelessly screwed up the records, quiet title actions might permit many or most homeowners to walk away with clear titles to their property. Meaning, the banks are screwed. Royally. By the peasants.

Title Insurers take a deep breath and refuse to take the risk. As Yves Smith reported on Sunday, AFX Title company is warning that because MERS broke the chain of title, the foreclosing banks have no legal right to the properties: "In many cases, the transfer of ownership of the mortgage loan has gone from the original lender, through several owners, and then to the foreclosing bank, none of which is recorded on the property title history." This creates a mess for subsequent purchases. Title companies are now refusing to insure the title against defects, and are forcing the banks to assume all liability. As Yves says, this is a direct result of the MERS practice of eliminating assignments of the mortgages when they were sold. Lesson? Do not buy foreclosed property.

MERS's Sloppy Practices Widely Recognized. In two excellent posts on Sunday, Yves Smith has detailed some of the latest revelations about MERS's sloppy practices and bold-faced lies about them. Particularly damning is a presentation given by Daniel Pennell, a process and systems expert, on a law proposing a ban on the use of MERS in Virginia. I will not go through the details as they are clearly presented on Naked Capitalism. We have long known that MERS did not have even a minimal system of controls in place that would be able to handle the tens of millions of mortgages. Pennell found multiple places where error (including human error) could take place, and explains how breakdown, chaos, and fraud would be the inevitable result.

Note that entries into MERS are made by members, are voluntary, and are not subject to systematic audit. Moreover, what is really shocking is that MERS disclaims any responsibility for accuracy. Yves provides the following quote from the MERS disclaimer:

"MERS makes no representations or warranties regarding the accuracy or reliability of the information provided. MERS disclaims responsibility or liability for errors, omissions, and the accuracy of any information provided. MERS does not input any of the information found on the MERS® System, but rather the MERS Members have that responsibility regarding mortgage loans in which they hold an interest.

Yet, it claims to be an agent of these members, and uses the "recording" at its registry as the basis for its claim that it can foreclose. But it has no idea whether any of the information is accurate, does not input any information, and is not responsible for errors? In other words, it neither knows nor cares whether the bank that wants to foreclose has ever owned, much less still owns, the mortgage.

Pennell goes on to conclude that if other state supreme courts follow the Massachusetts example, the "defect rate for securitized mortgages is almost 100%" because of the MERS operating model. Further, he reviews Bank of America's admission that its document error rate is above 25% (and recall from above Citi's boast that its error rate is "only" 15%). As Bill Black exclaims, these are banks! Would you accept a 25% error rate on BofA's accounting of your checking account transactions? This is not just sloppiness--no bank, not even Citi or BofA could operate with that level of incompetence. It has to be fraud. And, of course, they are only admitting to the fraud that has been uncovered. As Pennell argues, the true fraud rate is probably closer to 100%.

OK, what is this all about? How could these monstrous banks run with fraud at approximately 100%? The securitization model was flawed from the beginning. It could never have worked. It was a massive Ponzi scheme. The payment flows from borrowers could not support the huge infrastructure involved in securitization--especially securitization of less-than-prime mortgages, and especially mortgages that were never subject to good underwriting. There is no doubt that banks did not do any underwriting--much less good underwriting--that is why the mortgages were called "low doc, no doc, NINJAs and liar's loans". They replaced underwriting with credit raters, quant models, securitizations, mortgage servicers, accountants, mortgage insurers and credit default swaps, MERS, and mortgage default services. And tons of lawyer's fees.

As I have said, skyrocketing defaults and thus foreclosures were not a surprise--they were part of the business model, necessary to get the higher risk and thus higher fees earned for Wall Street. There is no way that homeowners with stagnant incomes (not to mention the job losses that would result from the forthcoming financial crisis) could ever service that superstructure. Wall Street was getting 20% of US national value added and 40% of corporate profits. It only worked so long as there was an accelerating boom in home prices that allowed over-indebted borrowers to refinance, and foreclosing banks to sell houses into a rising market.

It was doomed, of course. The Obama administration has tried to reboot it. But that will fail because it requires bail-outs and more importantly fraud on an unprecedented scale. Meanwhile, we destroy homeownership in America and set back property rights in the nation by a thousand years or more.

MERS will not survive more than a few short weeks. It has virtually no employees, no loss reserves, no capital. Its record-keeping is a joke. And it is all that is standing between the biggest banks and Armageddon -- the recognition that none of the banks has any legal claim on the property that supposedly backs the mortgage debts and thus the unbacked mortgage securities. If you ever wanted to live in interesting times, this is it.