"Mortgages Lost in the Cloud
The foreclosure documentation mess isn't just a clerical problem.
It erodes certainty about property rights—the key to capitalism
…Americans took their title-recording system for granted, abused it during the housing boom, and let it deteriorate. "Somehow in the last 10 or 15 years, everything that was good record-keeping isn't telling the truth anymore," says ..Hernando de Soto, a Peruvian economist…"My feeling is this: Your recession is going to last. And it's going to last, and it's going to last, because essentially the trust has broken down."
De Soto …has correctly identified why the foreclosure mess is not a simple clerical problem. It's part of a broader breakdown in the financial world—the one that nearly caused a depression in 2008 when banks and other financial players couldn't tell whose balance sheets were stuffed with toxic subprime mortgage debt and whose weren't. Unable to trust one another, the big institutions pulled back from every asset except Treasury debt.
…That crisis is past, but its causes aren't. …Lenders can't say for sure who holds a mortgage—which means that sales can't go through. Buyers won't put down good money for a property if they aren't sure they'll get clear title to it, nor will lenders extend loans. Buyers of hundreds of billions of dollars' worth of mortgage-backed securities may have grounds to sue.
…Titles and mortgages on real property are officially recorded in county clerks' offices, a slow-moving, old-fashioned, deliberate world of ink, paper, and filing cabinets. The process has been perfected over a millennium, going back to the Domesday Book, the survey of English property completed in 1086 for William the Conqueror. This paper-based system, though admirably accurate and permanent, wasn't equipped for the era of rapid-fire refinancing and securitization. When over 8 million new and used homes are sold per year, as at the height of the boom, and most loans are packaged into securities, you need a lot of clerks.
The mortgage industry responded to the scale and speed of the modern housing market by creating an electronic overlay called Mortgage Electronic Registration Systems (MERS) in 1997. MERS, however, lacks the thoroughness and—more important—the legal standing of the old system. Some judges have rejected foreclosures based on MERS when the party claiming to hold the mortgage couldn't produce the note to prove to the court's satisfaction that it was in fact the creditor. The courts want to see paper.
…The private sector couldn't afford to wait for government to catch up. Hence the MERS database, a unit of MERSCorp in Reston, Va., which was founded by Fannie Mae (FNM), Freddie Mac (FRE), and the mortgage industry. The concept was to avoid the cost and delay of recording the passing of loans from one party to another by naming Mortgage Electronic Registration Systems as the mortgagee for the lifetime of the loan, regardless of how many times it changed hands and to whom.
Some judges accepted MERS' right to foreclose on a delinquent homeowner. Others didn't. Instead of untangling the confusion early on, MERS forged ahead. It's now the mortgagee for more than 60 percent of new mortgage loans.
A promissory note—i.e., a paper I.O.U.—is the only legal proof of creditorship that courts ordinarily accept. Incredibly, though, the Florida Bankers Assn. told the state Supreme Court that when its members converted to electronic records, "the physical document was deliberately eliminated to avoid confusion." Further angering judges, MERS deputized bank executives to handle foreclosures, making it unclear who the people appearing in court really worked for. In Brooklyn, state Supreme Court Justice Arthur Schack in 2009 rejected a foreclosure in which a Bank of New York executive identified herself as a MERS vice-president. He called her "a milliner's delight, by virtue of the number of hats she wears." Ally Financial said in September that it found a "technical" deficiency at its GMAC Mortgage unit that let employees sign foreclosure documents without a notary present or with information they didn't know was true.
If the transition from paper to terabytes were unprecedented, it would be easier to give lenders a pass. But the banks behaved more straightforwardly in 2003 when they sought permission to digitize paper checks—a similar legal leap, since electronic copies had long been considered unacceptable in court. The banks lobbied Congress, which in 2003 passed the Check Clearing for the 21st Century Act. Now your monthly bank statement contains images of your checks instead of the paper, saving time and money. Because the reform was done with the blessing of Congress, there have been few problems.
…The problem is that the data in the MERS system isn't verifiable or legally binding. That recalls de Soto's insight into what made the U.S. work so well in the first place. "What characterized the rise of capitalism was that you actually created facts—statements that can be tested for truth. Now you've got plenty of information, but you don't have facts that can be tested for truth. Can you have a prosperous market economy without knowledge of who owns what and how they're related?"…
Peter Coy with John Gittelsohn
Business Week
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