Wall Street Back-Office Blues: No Clerical Solution

COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary COMBO Title and Securitization Search, Report, Documents, Analysis & Commentary

EDITOR’S NOTE: In a few of my recent articles I referenced the great paperwork crisis that brought down several large brokerage firms in the late 1960’s. The article below gives more details and comparisons with the current situation. I agree with everything he is saying except that there exists a giant hole in the fact pattern underlying his assumptions and for that matter what everyone is reporting.

The giant hole is that in the 1960’s there was no question that common stock and preferred shares and other securities existed and were valid representations of ownership in the many companies that issued these securities. The problem then was truly simply a matter of matching trades in the market and determining the identity of the current owner.

The current situation is the same PLUS two fatal variables: (1) the equivalent of a “trade” does not exist because the transfer of mortgages never was executed and worse (2) the obligations, mortgages and notes can NEVER match up because the parties were different. This fatal defect in the origination of the the loans wherein the obligation was documented with essentially false paperwork is a facet that is not comparable to the 1960’s. Back then there were real shares of real companies. Now we have no shares in trusts that for the most part don’t exist based upon a loan that was advanced but never documented in favor of the lender.

Hence the conclusion that this entire affair can  be wrapped up without the megabanks crumbling is at least weakened by the reality of what they did. The 1960’s paperwork shake-down was not based upon fraud and deceit, it was the result of negligence. The current “paperwork” problems are the result of intentional acts to cover-up and withhold information that if it was disclosed would have resulted in no “trade” at all. There is no clerical solution to this mess. Regardless of how the matter is concluded (if it is ever concluded) it will be a legal solution either arbitrarily changing long-standing law that has governed commerce for centuries, or by application of the law without regard to the consequences at the megabanks (blind justice).

 

The Financial Page
Back-Office Blues
by James Surowiecki November 8, 2010

In the late nineteen-sixties, Wall Street was crippled by an unlikely nemesis: unfinished paperwork. Thanks to a booming stock market, trading volume had soared in the course of the decade; between 1960 and 1968, the number of shares traded daily quadrupled. This should have been wonderful news for brokerage houses—more trades mean more commissions—but it ended up wrecking many of them instead. Because brokerages were slow to add workers and update back-office operations, they were literally buried beneath all the new business—offices were full of stock certificates, and trade documents were stacked halfway to the ceiling. Amid the chaos, dividend checks went unsent, trades were credited to the wrong accounts, and fraud spread; hundreds of millions of dollars in securities were stolen. And since the firms often didn’t process trades quickly enough, billions of dollars’ worth of transactions a month were simply cancelled. In 1968, the stock market started closing one day a week to let firms catch up on their work, but the brokerages’ bookkeeping woes caught up to them first, and more than a hundred firms went under. It took years—and the passage of an investor-protection bill—for the crisis to abate.

You’d think the Street would have learned its lesson. Instead, it’s now threatened by an even bigger back-office crisis: Foreclosuregate. Banks, faced with a flood of delinquent mortgages resulting from the bad loans they made during the housing bubble, have done exactly what the brokerages did forty years ago: they’ve cut corners. They’ve foreclosed on homes without having the proper documentation, and relied on unqualified people to sign affidavits attesting to things they didn’t know—so-called “robosigners.” In a few cases, they seem to have actually tossed people who didn’t have mortgages out of their homes. As a result, federal regulators and attorneys general in all fifty states are now investigating. And, in the weeks since the scandal first erupted, other issues have appeared, calling into question the legitimacy of the way mortgages were packaged and sold, and raising the possibility that the banks might have to buy back piles of bad mortgages. Forecasts of “catastrophe,” “Armageddon,” and “apocalypse” have now become routine.

There’s no doubt that it’s a brutal mess. The banks have been servicing mortgages and chasing delinquents with the same carelessness and indifference to due process that they demonstrated when they underwrote and securitized the mortgages in the first place. A foreclosing bank should be able, at a minimum, to produce the original mortgage note to demonstrate that it has the right to foreclose. But many banks have been unwilling or unable to do so. The same goes for other documentation: in a study of seventeen hundred cases of foreclosure in bankruptcy, Katherine Porter, a law professor at the University of Iowa, found that necessary documents were missing in more than half of them. Servicing mortgages well means hiring and training lots of workers to help customers, modify loans, and insure that documents are in order. But that costs money, and since mortgage servicing is already a low-margin business, banks have preferred to do things on the cheap, which is an open invitation to trouble, including fraud. To those responsible, a bit of sloppy paperwork probably seemed like no big deal, but when you’re talking about taking away people’s homes paperwork and due process should matter quite a bit.

All the same, the widespread proclamations of Armageddon seem overblown. The banks’ behavior has been appalling, but the crisis probably won’t be fatal for them, however much some of them might deserve that. Criminal charges are likely, and justified. And judges are already looking more skeptically at banks’ legal claims. But we aren’t going to see a Jubilee for debtors. The actual debts are almost all real, and the records of most of them presumably exist somewhere. So some financial institution will eventually end up with the right to foreclose, even though getting there will be expensive and time-consuming. And while banks may suffer considerable losses—having to spend tens of billions of dollars to buy back mortgages that violated the warranties they made to investors—forcing them to do this will take a long time, and enable them to spread the pain out over years. Nor is the uproar going to lead millions of homeowners to stop paying their mortgages. Predictions of catastrophe are understandable—the memory of the banking crisis is fresh, and it seems like poetic justice—but we’re probably not going to see apocalypse redux.

Indeed, there’s a chance that in the long run the banks’ travails could make things better for the economy, not worse. For a start, all the sand in the gears of the foreclosure mills will make it easier for delinquent borrowers to stay in their homes—not so bad an outcome, in economic terms, as the banks would have us believe. There are eleven months of existing-home inventory for sale right now; dumping another million foreclosed homes onto the market hardly seems economically essential. More important, making foreclosures tougher to get and more expensive to process could push banks to get serious about modifying mortgages, which at this point is the best route to getting the housing market back in reasonable shape. Up to now, it’s often been easier and cheaper for banks to foreclose, and mortgage servicers commonly make more in foreclosure than in modification. But being forced to follow the law before foreclosing, and having the threat of criminal investigation over their heads, may change that calculus. (More government pressure wouldn’t hurt, either.) The back-office crisis of the nineteen-sixties compelled Wall Street to do a better job of protecting and serving investors. It’d be fitting if Foreclosuregate ended up doing the same for homeowners.

Read more http://www.newyorker.com/talk/financial/2010/11/08/101108ta_talk_surowiecki#ixzz14iT7tVRa

4 Responses

  1. Here’s a paragraph from a great article, that goes along with this story. Enjoy!

    http://www.nakedcapitalism.com/2010/11/securitization-trustees-in-the-crosshairs-in-mortgage-mess.html

    “This is the section, if Thompson Reuters has recounted it correctly, that is dishonest:

    Deutsche cautioned the major mortgage servicers that had halted foreclosures to examine their processes — including Ally Financial Inc. and JPMorgan Chase & Co. — of the need to ensure ownership of loans was properly transferred to trusts when securitizations were formed.

    Ahem! It was the TRUSTEE’S job to make sure the loans got to the trust! This wasn’t the servicer’s duty…”

  2. Right on.

  3. Ohio GMAC Foreclosure Case May Set Anti-Wall Street Precedent
    By Michael Riley – Nov 8, 2010 3:06 PM ET

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    Ohio GMAC Foreclosure Case May Set a Precedent

    The office complex of GMAC Mortgage. Photographer: Bradley C. Bower/Bloomberg

    When James Renfro had to stop making payments on his two-story fixer-upper in Parma, Ohio, a suburb of Cleveland, he triggered events that were supposed to result in the forced sale of his home.

    That Nov. 15 auction has been canceled because of defects in documents submitted by his loan servicer, Ally Financial Inc.’s GMAC Mortgage unit. Two affidavits about Renfro’s home were signed by Jeffrey Stephan, a GMAC employee who said in sworn depositions in Florida and Maine that he hadn’t read thousands of affidavits he’d signed.

    Renfro’s case has created a showdown between GMAC and Ohio’s Attorney General Richard Cordray. Cordray has asked Cuyahoga County Court of Common Pleas Judge Nancy Russo not to let GMAC simply submit new documents to cure defects without consequences. He’s taken the same stand against Wells Fargo & Co., which has said it found defects in 55,000 foreclosures.

    “This is just the first,” said Cordray, who filed an amicus, or friend-of-the-court, brief in the Renfro case. He argued that Russo should punish GMAC, the fourth-largest U.S. mortgage lender, for its conduct.

    The judge today in Cleveland set an accelerated schedule for evidence-gathering in the case, leading up to a Feb. 17 hearing on the integrity of the loan documents. Cordray’s office plans to file a motion tomorrow asking to take part in the case and participate in so-called discovery.

    Allegations of Fraud

    The precedent set by the case might hasten a settlement between home lenders and the attorneys general of the 50 U.S. states, who are investigating allegations of fraud in foreclosure filings. Those being probed include San-Francisco- based Wells Fargo, which has said it will re-file foreclosure affidavits involving statements that “did not strictly adhere to the required procedures.”

    In potentially thousands of cases across the U.S., judges have the power to impose “sanctions, penalties, fines and even default,” as the banks try to submit substitute paperwork to proceed with flawed foreclosures, Cordray said.

    “The banks want to wish this away and pretend like it doesn’t exist,” he said.

    In September, Detroit-based Ally briefly suspended foreclosures in 23 states where there is judicial review and later announced an independent survey of foreclosure proceedings that would extend nationwide. After a review, the company began reinstating proceedings in cases it said didn’t involve errors.

    ‘Facts of Default’

    “The underlying facts of default in this case are not in dispute,” Jim Olecki, a spokesman for Ally, said of the foreclosure of Renfro’s home. “We only pursued foreclosure after all other home preservation options had been exhausted.”

    Ally disputes assertions Cordray made in his amicus brief in the Renfro case.

    “To date, we have found no evidence of any inappropriate foreclosures,” Olecki said.

    Tom Goyda, a spokesman for Wells Fargo, said the lender would go ahead with plans to re-submit thousands of affidavits in cases nationwide, including Ohio. When judges seek information on documents already filed, “we will work with them to meet their concerns,” Goyda said.

    The 50-state investigation is focused on uncovering the scope of tainted foreclosures, including how many so-called robo-signers processed documents they didn’t review, Cordray said. So far, investigators have identified “double figures of robo-signers” working on behalf of lenders such as JPMorgan Chase & Co. and Bank of America Corp., he said.

    Suspended Foreclosures

    Such banks are conducting their own reviews to spot errors and determine how many cases with defects are involved. GMAC’s Stephan testified to signing as many as 10,000 documents a month. New York-based JPMorgan initially suspended foreclosures in 23 states affecting 56,000 cases to review potentially faulty documents.

    Among the least appealing scenarios for the lenders is that affected cases will have to be examined, like the Renfro case, in individual courtrooms across the country, with the possibility of thousands of judges questioning robo-signers and other loan processing officials.

    Renfro’s lawyer, Harold Williams, said he will ask to depose GMAC’s Stephan, among others. GMAC said in a filing withdrawing the sale of Renfro’s four-bedroom home from auction that “verification irregularities may have occurred.”

    Judge Russo said in an interview that until hearing the evidence, she has no way of telling whether the documents represent an error, negligence, or fraud, and that other judges will have to make the same time-consuming inquiries.

    ‘10,000 Hearings’

    “If Ohio has 10,000 of these cases, there should be 10,000 hearings,” Russo said. “I’m sympathetic to the fact that it’s onerous for the lenders, but I still have to do my job.”

    The judge said she will hear arguments related to the integrity of the documents, how GMAC identified specific cases in which documents may be flawed, and what remediation steps the loan servicer and lender are taking. If she determines the circumstances rise to the level of fraud, GMAC could be found in contempt of court, Russo said.

    “You’ll probably have different resolutions in different cases from different judges,” she said. “This is not going to be solved in a couple of months. The long-term effects are phenomenal.”

    Russo’s court on the 18th floor of Cleveland’s sprawling Justice Center has been inundated with foreclosures as the city’s declining economy was exacerbated by the subprime mortgage crisis. A projected 12,553 foreclosures will be filed in surrounding Cuyahoga County in 2010, the most of any county in Ohio.

    Renfro’s House

    One of those cases already filed involved Renfro’s house on Klusner Avenue, which he purchased in 2005 for $114,900. An affidavit in support of a summary judgment motion to authorize foreclosure was done by Stephan, who is identified as a limited signing officer for GMAC Mortgage LLC.

    Renfro had fallen five months behind in his payments by the time GMAC, the loan servicer for U.S. Bancorp, moved for foreclosure early this year, he said. An effort to reach a settlement with the lender failed because of Renfro’s high credit-card and other debt, and his $22,000-a-year salary as an auto mechanic, according to Williams, the Renfro lawyer who is with the Legal Aid Society of Cleveland.

    “Once you get so far down, it’s such a struggle to get back up,” said Renfro, 36, who lives in the house with his girlfriend, stepson and 7-year-old daughter, who is deaf.

    The nearby school is one of only two in the metro area that can provide Renfro’s daughter with a sign-language translator during the school day, he said.

    Deaf Daughter

    “It’s quiet,” said Renfro, who is following the GMAC- Cordray battle in Russo’s court. “If something finally goes my way, it will be such a relief. There’s a park at the end of the street. I wanted a safe sidewalk so she could ride her bike. Normal, typical things, I guess. I’m just trying to get back on track.”

    Judges in Russo’s jurisdiction last week drafted new guidelines for dealing with robo-signers, following similar efforts in states such as New York. Under the new rules, attorneys for lenders would have to sign an affidavit swearing that they have communicated with a representative of the party seeking foreclosure and have been informed that an official “has personally reviewed the documents and records relating to this case,” according to a draft copy.

    The policy will apply to pending cases, and an affidavit will have to be signed before a judgment is entered, said Stephen M. Bucha, the chief magistrate.

    “The hope is that will preclude any robo-signing in the future, so that we don’t see a repeat of the problem,” Bucha said.

    Future Sales

    Bucha and other Cuyahoga County judges said they fear document foreclosure defects may give former homeowners a claim on the title that will affect future sales. That scenario fuels Judge Russo’s sense of urgency to sort out problems now, she said.

    “If courts around the country do not handle this on an individual case basis and there are later problems with the title, the courts will have participated with the clouding of the title,” Russo said. “The potential for harm is so immense at so many levels.”

    The case is U.S. Bank National Association v. Renfro, 10- 716322, Ohio Court of Common Pleas for Cuyahoga County (Cleveland).

    To contact the reporter on this story: Michael Riley in Cleveland at michaelriley@bloomberg.net

    To contact the editor responsible for this story: David E. Rovella at drovella@bloomberg.net.

  4. Indeed, there is no clerical solution to the paperwork already in evidence some of these cases.

    Creation of what appears to be a ‘replacement’ for the assignments that were never done previously has only added to the mess.

    An assignment generated in 2010 to put a defaulted loan into a pool that closed in 2005? That is fraud, not a paperwork ‘fix’.

    An assignment that involves a DBA of a defunct company?

    This is like applying varnish to a patch of rotted flooring. You never know how soon someone will step on that spot.

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