Ever since the Dodd-Frank Wall Street Reform Act passed last year, there has been a running debate about the Resolution Authority in the bill. Would it actually prevent another taxpayer bailout of a bank or banks to avoid a financial meltdown? I believe there is a real possibility that the present mortgage mess could trigger such a test.
The Congressional Oversight Panel of the TARP, which I chaired until it ceased operations earlier this year, held a number of hearings and issued numerous reports on problems within the federal government's Home Affordable Modification Program. I came to suspect that the entire system in place to bundle and sell mortgages through securitization might be fatally flawed.
When you bought a new home before the 1960s, you negotiated with a lender for a mortgage that was then filed at the county property office. In most places, by law, any time ownership of that mortgage changed hands, the change had to be filed at the county property office.
Beginning in the 60s but becoming the norm in the 90s, banks developed a system that combined many individual mortgages into a security that was then sold to investors. This securitization led to a dramatic increase in the rate at which ownership of mortgages changed hands.
In order to avoid having to record repeated changes in ownership of millions of mortgages at thousands of county property offices, major banks devised a workaround: the Mortgage Electronic Registration System. MERS, which was incorporated in Delaware in 1995, was supposed to fix the problems inherent in the securitization process.
It didn't. In April of this year, most of the large housing lenders, including Bank of America, Wells Fargo and Citibank, settled a complaint brought by the Federal Reserve, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision related to a range of shoddy practices in the mortgage market. The lenders committed to pay to correct major problems with their foreclosure procedures. The settlement revealed many problems, including banks' practice of filing foreclosure affidavits in court in which their employees claimed they had personal knowledge of facts that they did not know to be true.
Since then other problems have surfaced. A number of courts around the country have questioned whether MERS has the legal right to transfer mortgages. It seems that every day more information comes to light demonstrating that the management failures identified in the April settlement were widespread. It now looks like MERS and the system set up to legalize securitization was jerrybuilt at best. Mortgages and other documents have been lost or destroyed or, in some cases, were never legally signed in the first place. Files have disappeared. Evidence of falsified statements is pervasive.
Sheila Bair, until recently head of the Federal Deposit Insurance Corporation, said in testimony before congress last December said that "while the legal challenges under the representations and warranties trust requirements remain in their early stages, they could, if successful, result in the 'putback' of large volumes of defaulted mortgages from securitization trusts to the originating institutions."
Those court rulings are no longer in their "early stages," and the ultimate cost to the banks could be staggering. The major banks are now in settlement negotiations with the 50 states' attorneys general. Numbers in the billions are being discussed. However, Attorneys General Eric Schneiderman of New York and Beau Biden of Delaware, recently joined by Martha Coakley of Massachusetts, have said that any settlement must allow their investigations to continue so that all evidence of wrongdoing comes to light. This week AG Schneiderman moved to stop a settlement between Bank of New York Mellon and Bank of America, accusing Bank of New York Mellon of fraud in its role as trustee overseeing mortgage investment pools for investors.
If all these investigations disclose that the whole mortgage system is as rife with mistakes, abuses, and fraudulent activity as many observers now suspect, hundreds of billions may be at stake. This could put several banks in a very precarious situation and severely test the Resolution Authority of Dodd-Frank. Could the financial system survive the failure of one or more megabanks or would the government once again have to use taxpayer finds to bail them out?
When I was in the Senate, Ohio Senator Sherrod Brown and I fought to include in Dodd-Frank an amendment that would have placed capital requirements and liability limitations on the megabanks. That amendment, which failed to pass, would have ensured that no U.S. financial institution was too big to fail.
It is time for all the regulators to commit to increasing capital requirements on the megabanks, and reducing their size. A good first step would be to unwind the mergers made by the megabanks during the financial crisis.
Hopefully, the mortgage mess will not cause a test of Too Big To Fail, but after all that Americans have endured these past three years they deserve a lot more than hope from their government.