Predominant Interest Defines “True Lender”

Based on the totality of the circumstances, the Court concludes that CashCall, not Western Sky, was the true lender. CashCall, and not Western Sky, placed its money at risk. It is undisputed that CashCall deposited enough money into a reserve account to fund two days of loans, calculated on the previous month’s daily average and that Western Sky used this money to fund consumer loans. It is also undisputed CashCall purchased all of Western Sky’s loans, and in fact paid Western Sky more for each loan than the amount actually financed by Western Sky. Moreover, CashCall guaranteed Western Sky a minimum payment of $100,000 per month, as well as a $10,000 monthly administrative fee. Although CashCall waited a minimum of three days after the funding of each loan before purchasing it, it is undisputed that CashCall purchased each and every loan before any payments on the loan had been made. CashCall assumed all economic risks and benefits of the loans immediately upon assignment. CashCall bore the risk of default as well as the regulatory risk. Indeed, CashCall agreed to “fully indemnify Western Sky Financial for all costs arising or resulting from any and all civil, criminal or administrative claims or actions, including but not limited to fines, costs, assessments and/or penalties . . . [and] all reasonable attorneys fees and legal costs associated with a defense of such claim or action.”

Accordingly, the Court concludes that the entire monetary burden and risk of the loan program was placed on CashCall, such that CashCall, and not Western Sky, had the predominant economic interest in the loans and was the “true lender” and real party in interest. [E.S.]

See 8-31-2016-cfpb-v-cash-call-us-dist-ct-cal

Federal District Court Judge John Walter appears to be the first Judge in the nation to drill down into the convoluted “rent-a-bank” (his term, not mine) schemes in which the true lender was hidden from borrowers who then executed documents in favor of an entity that was not in the business of lending them money. This decision hits the bulls eye on the importance of identifying the true lender. Instead of blindly applying legal presumptions under the worst conditions of trustworthiness, this Judge looked deeply at the flawed process by which the “real lender” was operating.

A close reading of this case opens the door to virtually everything I have been writing about on this blog for 10 years. The court also rejects the claim that the documents can force the court to accept the law or venue of another jurisdiction. But the main point is that the court rejected the claim that just because the transactions were papered over doesn’t mean that the paper meant anything. Although it deals with PayDay loans the facts and law are virtually identical to the scheme of “securitization fail” (coined by Adam Levitin).

Those of you who remember my writings about the step transaction doctrine and the single transaction doctrine can now see how substance triumphs over form. And the advice from Eric Holder, former Attorney General under Obama, has come back to mind. He said go after the individuals, not just the corporations. In this case, the Court found that the CFPB case had established liability for the individuals who were calling the shots.

SUMMARY of FACTS: CashCall was renting the name of two banks in order to escape appropriate regulation. When those banks came under pressure from the FDIC, CashCall changed the plan. They incorporated Western Sky on the reservation of an an Indian nation and then claimed they were not subject to normal regulation. This was important because they were charging interest rates over 100% on PayDay loans.

That fact re-introduces the reality of most ARM, teaser and reverse amortization loans — the loans were approved with full knowledge that once the loan reset the homeowner would not be able to afford the payments. That was the plan. Hence the length of the loan term was intentionally misstated which increases the API significantly when the fees, costs and charges are amortized over 6 months rather than 30 years.

Here are some of the salient quotes from the Court:

CashCall paid Western Sky the full amount disbursed to the borrower under the loan agreement plus a premium of 5.145% (either of the principal loan amount or the amount disbursed to the borrower). CashCall guaranteed Western Sky a minimum payment of $100,000 per month, as well as a $10,000 monthly administrative fee. Western Sky agreed to sell the loans to CashCall before any payments had been made by the borrowers. Accordingly, borrowers made all of their loan payments to CashCall, and did not make a single payment to Western Sky. Once Western Sky sold a loan to CashCall, all economic risks and benefits of the transaction passed to CashCall.

CashCall agreed to reimburse Western Sky for any repair, maintenance and update costs associated with Western Sky’s server. CashCall also reimbursed Western Sky for all of its marketing expenses and bank fees, and some, but not all, of its office and personnel costs. In addition, CashCall agreed to “fully indemnify Western Sky Financial for all costs arising or resulting from any and all civil, criminal or administrative claims or actions, including but not limited to fines, costs, assessments and/or penalties . . . [and] all reasonable attorneys fees and legal costs associated with a defense of such claim or action.”

Consumers applied for Western Sky loans by telephone or online. When Western Sky commenced operations, all telephone calls from prospective borrowers were routed to CashCall agents in California.

A borrower approved for a Western Sky loan would electronically sign the loan agreement on Western Sky’s website, which was hosted by CashCall’s servers in California. The loan proceeds would be transferred from Western Sky’s account to the borrower’s account. After a minimum of three days had passed, the borrower would receive a notice that the loan had been assigned to WS Funding, and that all payments on the loan should be made to CashCall as servicer. Charged-off loans were transferred to Delbert Services for collection.

“[t]he law of the state chosen by the parties to govern their contractual rights and duties will be applied, . . ., unless either (a) the chosen state has no substantial relationship to the parties or the transaction and there is no other reasonable basis for the parties’ choice, or (b) application of the law of the chosen state would be contrary to a fundamental policy of a state which has a materially greater interest than the chosen state in the determination of the particular issue and which, under the rule of § 188, would be the state of the applicable law in the absence of an effective choice of law by the parties.”
Restatement § 187(2). The Court concludes that the CRST choice-of-law provision fails both of these tests, and that the law of the borrowers’ home states applies to the loan agreements.

after reviewing all of the relevant case law and authorities cited by the parties, the Court agrees with the CFPB and concludes that it should look to the substance, not the form, of the transaction to identify the true lender. See Ubaldi v. SLM Corp., 852 F. Supp. 2d 1190, 1196 (N.D. Cal. 2012) (after conducting an extensive review of the relevant case law, noting that, “where a plaintiff has alleged that a national bank is the lender in name only, courts have generally looked to the real nature of the loan to determine whether a non-bank entity is the de facto lender”); Eastern v. American West Financial, 381 F.3d 948, 957 (9th Cir. 2004) (applying the de facto lender doctrine under Washington state law, recognizing that “Washington courts consistently look to the substance, not the form, of an allegedly usurious action”); CashCall, Inc. v. Morrisey, 2014 WL 2404300, at *14 (W.Va. May 30, 2014) (unpublished) (looking at the substance, not form, of the transaction to determine if the loan was usurious under West Virginia law); People ex rel. Spitzer v. Cty. Bank of Rehoboth Beach, Del., 846 N.Y.S.2d 436, 439 (N.Y. App. Div. 2007) (“It strikes us that we must look to the reality of the arrangement and not the written characterization that the parties seek to give it, much like Frank Lloyd Wright’s aphorism that “form follows function.”).4 “In short, [the Court] must determine whether an animal which looks like a duck, walks like a duck, and quacks like a duck, is in fact a duck.” In re Safeguard Self-Storage Trust, 2 F.3d 967, 970 (9th Cir. 1993). [Editor Note: This is akin to my pronouncement in 2007-2009 that the mortgages and notes were invalid because they might just as well have named Donald Duck as the payee, mortgagee or beneficiary. Naming a fictional character does not make it real.]

In identifying the true or de facto lender, courts generally consider the totality of the circumstances and apply a “predominant economic interest,” which examines which party or entity has the predominant economic interest in the transaction. See CashCall, Inc. v. Morrisey, 2014 WL 2404300, at *14 (W.D. Va. May 30, 2014) (affirming the lower court’s application of the “predominant economic interest” test to determine the true lender, which examines which party has the predominant economic interest in the loans); People ex rel. Spitzer v. Cty. Bank of Rehoboth Beach, Del., 846 N.Y.S.2d 436, 439 (N.Y. App. Div. 2007) (“Thus, an examination of the totality of the circumstances surrounding this type of business association must be used to determine who is the ‘true lender,’ with the key factor being ‘who had the predominant economic interest’ in the transactions.); cf. Ga. Code Ann. § 16-17-2(b)(4) (“A purported agent shall be considered a de facto lender if the entire circumstances of the transaction show that the purported agent holds, acquires, or maintains a predominant economic interest in the revenues generated by the loan.”).

Although a borrower electronically signed the loan agreement on Western Sky’s website, that website was, in fact, hosted by CashCall’s servers in California. While Western Sky performed loan origination functions on the Reservation, the Court finds these contacts are insufficient to establish that the CRST had a substantial relationship to the parties or the transaction, especially given that CashCall funded and purchased all of the loans and was the true lender. Cf. Ubaldi v. SLM Corp., 2013 WL 4015776, at *6 (N.D. Cal. Aug. 5, 2013) (“If Plaintiffs’ de facto lender allegations are true, then Oklahoma does not have a substantial relationship to Sallie Mae or Plaintiffs or the loans.”).

The Court concludes that the CFPB has established that the Western Sky loans are void or uncollectible under the laws of most of the Subject States.7 See CFPB’s Combined Statement of Facts [Docket No. 190] (“CFPB’s CSF”) at ¶¶ 147 – 235. Indeed, CashCall has admitted that the interest rates that it charged on Western Sky loans exceeded 80%, which substantially exceeds the maximum usury limits in Arkansas, Colorado, Minnesota, New Hampshire, New York, and North Carolina. (Arkansas’s usury limit is 17%; Colorado’s usury limit is 12%; Minnesota’s usury limit is 8%; New Hampshire’s usury limit is 36%; New York’s usury limit is 16%; and North Carolina’s usury limit is 8%). A violation of these usury laws either renders the loan agreement void or relieves the borrower of the obligation to pay the usurious charges. In addition, all but one of the sixteen Subject States (Arkansas) require consumer lenders to obtain a license before making loans to consumers who reside there. Lending without a license in these states renders the loan contract void and/or relieves the borrower of the obligation to pay certain charges. CashCall admits that, with the exception of New Mexico and Colorado, it did not hold a license to make loans in the Subject States during at least some of the relevant time periods.

Based on the undisputed facts, the Court concludes that CashCall and Delbert Services engaged in a deceptive practice prohibited by the CFPA. By servicing and collecting on Western Sky loans, CashCall and Delbert Services created the “net impression” that the loans were enforceable and that borrowers were obligated to repay the loans in accordance with the terms of their loan agreements. As discussed supra, that impression was patently false — the loan agreements were void and/or the borrowers were not obligated to pay.

The Court concludes that the false impression created by CashCall’s and Delbert Services’ conduct was likely to mislead consumers acting reasonably under the circumstances

The Court concludes that Reddam is individually liable under the CFPA.

“An individual may be liable for corporate violations if (1) he participated directly in the deceptive acts or had the authority to control them and (2) he had knowledge of the misrepresentations, was recklessly indifferent to the truth or falsity of the misrepresentation, or was aware of a high probability of fraud along with an intentional avoidance of the truth.” Consumer Fin. Prot. Bureau v. Gordon, 819 F.3d 1179, 1193 (9th Cir. 2016) (quotations and citations omitted).

The Court concludes that Reddam both participated directly in and had the authority to control CashCall’s and Delbert Services’ deceptive acts. Reddam is the founder, sole owner, and president of CashCall, the president of CashCall’s wholly-owned subsidiary WS Funding, and the founder, owner, and CEO of Delbert Services. He had the complete authority to approve CashCall’s agreement with Western Sky and, in fact, approved CashCall’s purchase of the Western Sky loans. He signed both the Assignment Agreement and the Service Agreement on behalf of WS Funding and CashCall. In addition, as a key member of CashCall’s executive team, he had the authority to decide whether and when to transfer delinquent CashCall loans to Delbert Services.


So all that said, here is what I wrote to someone who was requesting my opinion: Don’t use this unless and until you (a) match up the facts and (b) confer with counsel:

Debtor initially reported that the property was secured because of (a) claims made by certain parties and (b) the lack of evidence to suggest or believe that the property was not secured. Based upon current information and a continuous flow of new information it is apparent that the originator who was named on the note and deed of trust in fact did not loan any money to petitioner. This is also true as to the party who would be advanced as the “table funded” lender. As the debtor understands the applicable law, if the originator did not actually complete the alleged loan contract by actually making a loan of money, the executed note and mortgage should never have been released, much less recorded. A note and mortgage should have been executed in favor of the “true lender” (see attached case) and NOT the originator, who merely served as a conduit or the conduit who provided the money to the closing table.

Based upon current information, debtor’s narrative of the case is as follows:

  1. an investment bank fabricated documents creating the illusion of a proprietary common law entity
  2. the investment bank used the form of a trust to fabricate the illusion of the common law entity
  3. the investment bank named itself as the party in control under the label “Master Servicer”
  4. the investment bank then created the illusion of mortgage backed securities issued by the proprietary entity named in the fabricated documents
  5. the investment bank then sold these securities under various false pretenses. Only one of those false pretenses appears relevant to the matter at hand — that the proceeds of sale of those “securities” would be used to fund the “Trust” who would then acquire existing mortgage loans. In fact, the “Trust” never became active, never had a bank account, and never had any assets, liabilities or business. The duties of the Trustee never arose because there was nothing in the Trust. Without a res, there is no trust nor any duties to enforce against or by the named “Trustee.”
  6. the investment bank then fabricated documents that appeared facially valid leading to the false conclusion that the Trust acquired loans, including the Petitioner’s loan. Without assets, this was impossible. None of the documents provided by these parties show any such purchase and sale transaction nor any circumstances in which money exchanged hands, making the Trust the owner of the loans. Hence the Trust certainly does not own the subject loan and has no right to enforce or service the loan without naming an alternative creditor who does have ownership of the debt (the note and mortgage being void for lack of completion of the loan contract) and who has entered into a servicing agreement apart from the Trust documents, which don’t apply because the Trust entity was ignored by the parties seeking now to use it.
  7. The money from investors was diverted from the Trusts who issued the “mortgage backed securities” to what is known as a “dynamic dark pool.” Such a pool is characterized by the inability to select both depositors and beneficiaries of withdrawal. It is dynamic because at all relevant times, money was being deposited and money was being withdrawn, all at the direction of the investment bank.
  8. What was originally perceived as a loan from the originator was in fact something else, although putting a label to it is difficult because of the complexity and convolutions used by the investment bank and all of its conduits and intermediaries. The dark pool was not an entity in any legals sense, although it was under the control of the investment bank.
  9. Hence the real chain of events for the money trail is that the investment bank diverted funds from its propriety trust and used part of the funds from investors to fund residential mortgage loans. The document trail is very different because the originator and the conduits behind what might be claimed a “table funded loan” were not in privity with either the investors or the investment bank. Hence it is clear that some liability arose in which the Petitioner owed somebody money at the time that the Petitioner received money or the benefits of money paid on behalf of the Petitioner. That liability might be framed in equity or at law. But in all events the mortgage or deed of trust was executed by the Petitioner by way of false representations about the identity of the lender and false representations regarding the compensation received by all parties, named or not,
  10. The current parties seek to enforce the deed of trust on the false premise that they have derived ownership of the debt, loan, note or mortgage (deed of trust). Their chain is wholly dependent upon whether the originator actually completed the loan contract by loaning the money to the Petitioner. That did not happen; thus the various illusions created by endorsements and assignments convey nothign because the note and mortgage (deed of trust) were in fact void. They were void because the debt was never owned by the originator. hence the signing of the note makes it impossible to merge the debt with the note — an essential part of making the note a legally enforceable negotiable instrument. The mortgage securing performance under the note is equally void since it secures performance of a void instrument. Hence the property is unsecured, even if there is a “John Doe” liability for unjust enrichment, if the creditor can be identified.
  11. The entire thrust of the claims of certain self-proclaimed creditors rests upon reliance on legal presumptions attached to facially valid documents. These same entities have been repeatedly sanctioned, fined and ordered to correct their foreclosure procedures which they have failed and refused to do — because the current process is designed to compound the original theft of investors’ money with the current theft of the debt itself and the subsequent theft of the house, free from claims of either the investors or the homeowner. The investment bank and the myriad of entities that are circulated as if they had powers or rights over the loan, is seeking in this case, as in all other cases in which it has been involved, to get a court judgment or any order that says they own the debt and have the right to enforce the evidence of the debt (note and mortgage).
  12. A Judgment or forced sale is the first legal document in their entire chain of fabricated documentation; but the entry of such a document in public records, creates the presumption, perhaps the conclusive presumption that all prior acts were valid. It is the first document that actually has a legal basis for being in existence. This explains the sharp decline in “workouts’ which have dominated the handling of distressed properties for centuries. Workouts don’t solve the problem for those who have been acting illegally. They must pursue a court order or judgment that appears to ratify all prior activities, legal or not.




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Many questions are piling in as lawyers start to drill down into the whole securitization scheme. The COMBO helps; yet in order to properly present the case in court you need to understand more than just your transaction. When I started the blog, and periodically thereafter, I made reference to a doctrine that was created in the context of tax litigation but which applies and has been applied in commercial situations. Sometimes you have to figure out the goal of the transaction in order to determine the parties. The doctrines that apply are the SINGLE TRANSACTION DOCTRINE and the STEP TRANSACTION DOCTRINE. The key question that is answered is what was the goal — or to put it another way, if you take out that piece, would the same transaction have otherwise still occurred in some other fashion?

Applied to debt, whether it is mortgage or otherwise, it is stated as follows: If investment bankers were not selling mortgage bonds to investors, would the loan have been otherwise been made? If the answer is no, there would have been no transaction, then the doctrines apply. If the doctrines apply, then the nature of the transaction is determined by its goal — the issuance of mortgage bonds, and all the exotic hedge and credit enhancements products that went along with it. Once that is determined, the real parties in interest emerge — the mortgage bonds were sold for the purpose of funding loans. So the loans and the bonds are the evidence of the total transaction. The borrowers and the investors are the real parties in interest. Most interpretations of RPIT come down to money — who gave it and who got it?

It might be that the more significant party in interest on the borrower side is not the homeowner at all, but rather the investment banker who created a promise to pay the investors under false pretenses. The homeowner did not know about that promise and certainly had no idea of the false pretenses. The issue is whether the mortgage, deed of trust or other security instrument is enforceable as to power of sale, foreclosure or otherwise. That can only be true if the right party has signed it and the right party enforces it. But it is also restricted to enforcement of a valid outstanding obligation, which is described in other instruments.

Usually, in a mortgage loan, the obligation is described in a note. In our current situation the obligation is described in a convoluted series of documents, some of the them fabricated, including the PSA,, prospectus etc. because the lender investor didn’t get a document from the homeowner, they received it from the investment banker. Thus the totality of the documentation with the investor and with the borrower might be used to describe the obligation — but then you have that pesky problem of Truth in Lending where all the documents must be revealed and disclosed to the borrower.

The only reasonable interpretation in securitization transactions is that the entire risk of loss would have shifted to a different party if the mortgage bonds were not being sold. This is what caused all the intermediaries to abandon normal underwriting standards. This ALL parties involved in ALL parts of the transaction are mere intermediaries or conduits and not possessed of any economic interest int he transaction, except those arising out of their role as a conduit. For example, if you write a check to Target to buy a TV, the goal was to purchase a TV. the fact that you wrote a check, that TARGET took the check to their bank, that the check was cleared through Federal Reserve or other intermediaries, and presented to your bank who sent it to their account processor which then provided the information as to whether the funds were present to cover the check, which led your bank authorizing payment is all irrelevant to the issue of the purchase of the TV. 

In our current crisis, all those intermediaries are vying for the TV when none of them has any economic interest in it. In this example, the intermediaries would have that opportunity if Target didn’t care whether or not they got back their TV or didn’t care to fight about it for whatever reason. The vacuum and opportunity for disinterested intermediaries to pretend to be interested and pretend to have rights to the TV would be almost irresistible if you had no ethics, morality or conscience. The single transaction doctrine and step transaction doctrine were created to  sort out such situations.

In the mortgage context, that is exactly what is happening. I predicted 4 years ago that litigation results would depend entirely upon whether the Banks could be successful at misdirecting the attention of the court to the parts of the transaction instead of the totality of it — the money processing through conduits and intermediaries — or if they were correctly instructed by borrowers that they now know that the real transaction was the purchase of a mortgage bond by investors and that the borrowers signature was merely incident to, and necessary for the completion of the transaction such that the investment banker would not be required to return the money to the investor.

Like Target in the example above, the investors have decided, so far, not to fight with the homeowner but rather to take their fight to the investment banker who sold them the bonds under false pretenses. But if the investors and borrowers did get together and settle the obligation in any manner or with any means, the issue of foreclosure would be over. There would be no obligation or at least there would be no default.

There are issues as to how to characterize the fraudulent foreclosures, unlawful detainer, seizure of personal property, etc. And the related question is whether those involve transfers of interests in property or if they involve instruments that are investments, securities or whatever. I have concluded as an expert that the documents of “transfer” (forgetting their foundation and authenticity for a moment) are in actuality part of a larger scheme whose end purpose was the issuance of multiple forms of securities or other instruments exempted from security regulation. Even if exempted, it doesn’t make it a real estate transaction.

It does make it a fraudulent scheme, if the the property owner was fraudulently induced into executing documents under the pretense that this was a conventional mortgage loan situation, when hidden from the property owner, it was really part of the loop of issuing “mortgage bonds” (certificated or non-certificated to investors. Since the goal was to get money from investors and then have them abandon their interests in the “mortgages” or the “property” the property aspects seem incidental to the real nature of the transaction.

In fact, when you take a step back, you will see that the borrowers were duped into becoming “issuers” of paper that they had no idea was going to be used for bonuses on Wall Street. Borrowers did not know that the amount loaned to them or for their benefit fell far short of the amount collected from investors.

Under that scenario, their was, as I have said from beginning, a single transaction. That transaction was between the investor and the property owner, which was undocumented since neither were in privity to a written instrument in which both of them appeared. Or it could be said that the note is one small part of the documentation, in which the PSA, A&A, prospectus,  bond, etc. were in TOTAL, the documentation. If those documents are, in total, the only documentation of the transaction, then the note cannot be accepted into evidence without the rest of the evidence.

And the security instrument or agreement (Deed of trust) might only mention the note. If it does that, then it has referred to a piece of paper that does not have all the terms of the transaction. Since they were intentionally hiding the existence of a the securitization chain from the borrower, it can’t be said that the omission of the other documents was accidental. Thus the security instrument would be invalid on the most fundamental grounds — it does not secure the obligation — evidence of which is contained in multiple instruments, it attempts to secure only the note, which does not contain all the evidence of the obligation and terms of repayment.

As such, if that is accepted by the Court, the security instrument would need to be reformed in order to be effective. Whether that reformation would relate back to the original recording is a question I cannot answer.  But in my opinion, no security instrument is capable of being enforced if it makes reference to a single document that is to be used as evidence of an obligation, the performance of which triggers the enforcement provisions of the security instrument — unless that single document contains all the evidence of the obligation.

Bombshell Admission of Failed Securitization Process in American Home Mortgage Servicing/LPS Lawsuit


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EDITOR’S NOTE: It is comforting to know that at least some people are paying attention. From one of the largest servicers in the country comes an admission that securitization of mortgage loans was an illusion. The facts alleged by AHMSI  in its lawsuit against LPS are true in virtually all cases in which any bank or other entity has claimed an interest in a mortgage loan.

They are actually saying two things: first, they are saying that their practice was to create the documents supporting the foreclosure by an entity that was essentially picked at random and that these documents were created only as necessary in foreclosure litigation (otherwise they just proceeded with any old documents); second, they are saying that the people who signed those documents lacked any authority or appointment to represent any real party in interest and that the signature was forged on behalf of other people who also lacked any authority or appointment to represent any real party in interest.

In the four years that I have been analyzing and writing about this mortgage crisis it has been my consistent opinion that the original mortgage transaction was a single transaction between a borrower and the lender. The single transaction doctrine or the step transaction doctrine utilized in a myriad of other cases involving both real property law and commercial transactions create simplicity out of what appears to be a complex series of transactions. I have repeatedly said in my writings and in my presentations at seminars that those who participated in the securitization scam would prevail as long as they were able to direct the attention of a judge to only one part of the transaction, to wit: the part where the borrower receives the benefit of funding a loan. The burden is on borrowers to redirect the attention of the judge to include both sides of the transaction.

The lender’s side of the transaction is as simple as the borrower’s side. The lender funded or advanced money for the purpose of funding a mortgage loan. The pretender lenders don’t want any judge looking behind the veil. But the facts are clear. The lender in the transaction was a group of investors who never received any notice of the transaction with the borrower, much less the actual note and mortgage. The investor/lender received a mortgage bond that was supposedly backed by a perfected mortgage lien on the property owned by the borrower. Instead of naming the lender as the mortgagee, nominees were inserted into the documents executed by the borrower. The failure to disclose both the identity of the lender and the terms under which the lender advanced money (contained in the prospectus and the pooling and servicing agreement) results in an imperfect lien. (The test for a perfected lien is being able to determine the identity of the party from whom you would obtain a release).

At the time of the original transaction the party designated as the “lender” was powerless to execute a satisfaction of mortgage. By definition this means that the lien was never perfected. With few exceptions all of the entities that have been involved in the initiation of foreclosure proceedings have been nothing more than middlemen pretending to represent the investor/lender when in fact their intent was to divert money, proceeds, and property from the investor/lender into their own pockets. In order to do this the pretender lenders must actually foreclose on property and conduct what purports to be a foreclosure sale and continue billing fees against the revenue stream that is due to the investor/lender. When they get to zero balance because the property value is lower than the amount due to the servicer or other middleman, the property goes to the middleman instead of the investor/lender.

This is why there can be no widespread modifications, short sales, or any mediated settlement in which the immediate result is either reinstatement of the mortgage or cash proceeds–both of which would have to be reported and paid to the investor/lenders. Nobody on Wall Street wants the investors to get anything and the borrowers are viewed with complete disdain. Who cares about them?

If the original transaction is simply viewed for what it is–a transaction between the borrower and the investor/lender the solution to the mortgage mess becomes clear. The only actual function of the intermediaries in the securitization process is to act as conduits for clearing transactions. It is obvious that they have intentionally failed to act in accordance with the requirements of the pooling and servicing agreements and the prospectus that was given to the investor/lenders. If they were playing fair they would have disclosed the identity of the actual lender and the terms of payment to the actual investor/lender. That would include payments received from the borrower as well as numerous third parties based upon factors that were not necessarily related to payments by the borrower. The transaction in which the investor/lender advanced money was based upon liability and guarantees from multiple parties.

The facts here are actually quite simple. The wrong party was designated on the note and the mortgage. Vital terms of repayment or omitted from both the note and the other disclosure documents in violation of the requirements of the federal truth in lending act. The intermediaries were only interested in the money trail and they knew they would create whatever document trail was necessary to support what they had done with the money. This is like your bank failing to post a deposit transaction or making claims on a transaction between you and a third-party in which a payment by check was involved. The bank is merely a conduit and has no rights in the principal contract between you and that third-party. This is established law. Yet in the mortgage mess the banks have succeeded in convincing judges that their mere presence as intermediaries is sufficient to establish themselves as agents for everyone. This success has not been without substantial rewards. It is the intermediaries who are taking the houses and eventually the proceeds at a cost to and detriment of the investor/lenders and the borrowers.

The borrowers have no way of knowing the actual balance due on their obligation since the intermediaries refused to provide any accounting for the receipt of any funds from any party other than the borrower. This keeps the judges attention focused on the borrower and whether the borrower made payments–instead of requiring proof that a payment was due, and if due, to whom? By requiring borrowers to deal with intermediaries instead of the principals the banks have succeeded in creating an impenetrable barrier to modification or settlement of these defective mortgage loans.

 The bottom line is that the securitization of mortgages loans never actually happened. The defects in the origination process, the absence of transfer documents and delivery in accordance with the pooling and servicing agreements are incurable. It is simply not possible to require an investor/lender to accept the transfer a loan, obligation, receivable, note or mortgage that is already in default and that had never been perfected as a lien. This leaves the record clouded with a “mortgagee” or “payee” to whom no money owed. While it is possible for the investor/lenders to assert claims and perhaps establish equitable or judgment liens, they have not shown any desire to do so. The record is devoid of any attempts in the last 10 years of any such attempt.

Thus the lien is (a) unenforceable by anyone and (b) being enforced by parties who wouldn’t have the right to try, but for the willingness of the Courts to look at only the whether the borrower made payments instead of requiring proof as to whether a payment is due, the actual balance and to whom it is owed.


Bombshell Admission of Failed Securitization Process in American Home Mortgage Servicing/LPS Lawsuit

Wow, Jones Day just created a huge mess for its client and banks generally if anyone is alert enough to act on it.

The lawsuit in question is American Home Mortgage Servicing Inc. v Lender Processing Services. It hasn’t gotten all that much attention (unless you are on the LPS deathwatch beat) because to most, it looks like yet another beauty contest between Cinderella’s two ugly sisters.

AHMSI is a servicer (the successor to Option One, and it may also still have some Ameriquest servicing). AHMSI is mad at LPS because LPS was supposed to prepare certain types of documentation AHMSI used in foreclosures. AHMSI authorized the use of certain designated staffers signing with the authority of AHSI (what we call robosinging, since the people signing these documents didn’t have personal knowledge, which is required if any of the documents were affidavits). But it did not authorize the use of surrogate signers, which were (I kid you not) people hired to forge the signatures of robosigners.

The lawsuit rather matter of factly makes a stunning admission (note that PSA here means Professional Services Agreement, and it was the contract between AHSI and LPS, click to enlarge):

Did you get it? They said that these procedures were standard between the two companies, which was to “ memorialize the transfer of ownership lender to the securitization trust” right before initiating foreclosure. If you are a regular reader of this blog, you know that is impermissibly late. The note and mortgage had to get to the trust by a clearly specified date, usually 90 days after closing. As we’ve written numerous times, in the overwhelming majority of cases, the securitization entity was a New York trust, and New York trusts are like computer code, they can only operate exactly as stipulated. The exception was trusts by Chase and WaMu, which did allow for the originator to serve as custodian for the trust.

So AHMSI has just admitted that all of its foreclosures done with LPS were completed by the wrong party. In Alabama, wrongful foreclosures are subject to statutory damages of three times the value of the house, and recent cases have awarded much higher multiples of the property’s value. This little paragraph is a litigation goldmine for the right attorneys. I hope they have fun with it.

I’ve included the entire filing.

AHMSI v LPS File-Stamped Petition

UNDISCLOSED MIDDLE: Repurchase Obligation in the Mortgage Loan Purchase Agreement


EDITOR’S NOTE: I would be better off and so would our readers if I could be as succinct in my writing as Anonymous. Somehow it always takes me longer to say what he does in a few sentences. Use HIS version instead of mine whenever possible. My version is more academic and runs the risk of putting the Judge to sleep.

  • This piece written by Anonymous underscores the BASIC point that needs to be made from the start: the TOTAL agreement between lender and borrower consists of far more than the loan closing documents.
  • The fact that the rest of the documents were withheld doesn’t mean they weren’t involved, signed, executed and delivered. It means they were not disclosed when the applicable federal and state statutes as well as common law required them to be disclosed.
  • The old school Judges and lawyers are confused ONLY because they fail to recognize this basic truth.
  • Once they accept the fact that the borrower signed a note but the lender received a bond from a party not involved in the borrower’s closing, it all falls into place.
  • There is no nexus between borrower and lender without recognizing the obvious — there were parties, documents, agreements and corresponding duties and obligations existing in the UNDISCLOSED MIDDLE.
  • The single transaction rule once applied, clears up all confusion. No money from investor – NO DEAL. No borrower to accept loan — NO DEAL. SINGLE TRANSACTION if there ever was one.
  • But perhaps the single most important point Anonymous makes is that the alleged assignment, transfer, endorsement etc of the note never took actually place which means that the title (encumbrance — mortgage or deed of trust) is and remains in the name of the originating “lender” to whom no money is owed. A classical case of an unperfected security interest.

From Anonymous: “Repurchase and stipulations is contained within the same Mortgage Loan Purchase Agreement – it is not a separate contract – it is the same document and contract under the stated Trust and SEC filings. Thus, none of the note endorsements were actually “without recourse.”

However, many of the repurchase demands were not executed because the banks often looked the other way – until they became massive – and the originators were shut down.

Most of the endorsements were in blank – only when they knew there was no longer any recourse, are the notes actually endorsed to the trustee. But, they did not know this at the time of the trust set-up.

And, the notes are executed before foreclosure – they are sold at steep discounts to the servicer and removed from the trust – at this point there is no recourse..

It is at the inception of the trust – that the notes were not actually negotiable. Thus, the trust never actually owned the notes – they did not have to – because only the receivables are passed-through.

If there was a separate contract for Repurchases – it would have had to have been filed with the SEC – along with other documents. There was no separate contract – the Repurchase agreement was part of the Mortgage Loan Purchase Agreement – they were one and the same.


In the homeowner’s war, the battlefield is taking shape, A prime area of engagement is whether the securitization process represents a series of independent transactions (lender’s position) or that all the transactions should be aggregated (BORROWER’S POSITION) and treated as a single transaction.

For reasons explained more fully below, it is our opinion that the transactions should be aggregated into a single transaction under the three tests used by the courts to determine whether a tax event should be considered to have occurred.

Given the fraudulent and deceptive practices used before and at closing, plus the TILA and other violations, the single transaction would create only one possibility for a holder in due course out of all the “holders” in the chain — the investor who actually put up the money that was used to fund the loan.

We predict that there will be instances where the investor actually did know what was going on at the loan origination and loan closing stage and participated because of the temporary boost to the manager’s performance rating in a pension fund, hedge fund or other entity. Certainly these were all, by definition, “qualified investors” who by definition are presumed to have knowledge sophistication and access to information that the borrower did not have and could not have and which the parties intentionally concealed. Thus it is possible that investors, even if they were found, might not be able to sustain their burden of showing their clean hands. If so, they might be doubly challenging for anyone to locate and tie to a particular transaction — the information for which is within the sole care, custody and control of the participants in the chain of securitization.

However, due to pre-selling and fulfilling the requirements of the tranches AFTER investment, it is entirely possible that one investor actually put up the money that was loaned and eventually given to the Seller in a specific purchase transaction or a specific borrower in a specific refi, while another investor received delivery of a certificate of asset backed securities that were unrelated to the trail of money downstream to a particular transaction.

All other parties may have been “holders” but not holders in due course under the UCC, Article 3, since the bad behavior including fraud in the inducement and fraud the execution etc. travels with the instrument unless the holder can prove they were innocent and had no knowledge. Since these parties were in many ways so interrelated, intertwined, and co-owned or operated through common service agents, it is difficult to conceive how they would meet this challenge.

Under the binding commitment test, we look at whether there was a binding commitment to enter into a later agreement. This is determined by looking at the agreements of the parties in “privity” and by the conduct of the parties and their obvious intent. Clearly the intent of the mortgage broker was to initiate the mortgage application with the intent that it would be accepted by an originating lender, knowing that the loan was either pre-sold, or would be sold on the application terms, or would be sold after the loan documents themselves.

The very existence of “selling forward” presumes securitization and the existence of one or more investors at the other end of the chain, who probably were not told that they were buying loans that did not yet exist. In fact, it appears at least in some cases, that these investors were mislead in much the same way as the borrowers were down line. Many report, and some lawsuits filed by State and County authorities assert that ABS certificates were sold under the guise of securities that were ultra-short term, could not fluctuate in value and could be liquidated at par at weekly auction. See New York State Attorney General Andrew Cuomo and related suits.

Even where the loans were completed, the description of them was at variance with reality but the intent to convey and pledge an interest in the mortgage and note is clear from the behavior of the parties.
Dropping the underwriting and appraisal standards in order to satisfy the insatiable appetite of Wall Street for paper, regardless of how worthless it was, is also a clear indication that there was a commitment intended to be fulfilled. The behavior of the “lender” in creating high risk loans and masquerading them otherwise surely indicates that the “lender” did not perceive itself at risk, thus implying a continuing transaction in the chain wherein a third party would receive the risk.

The payment of 2.5% premium over the total amount of the mortgage, instead of the usual practice of discounting loans, together with the accounting treatment where these transactions were kept “off balance sheet” is a clear indication that they were providing a service in chain that was leading upward to investment bankers and investors.

Under the end result test the case gets even easier. The investor put up the money and the borrower signed the documents. Under the investor deal, it was backed by the borrowers’ signatures and under the loan documents, it was based on money that came from the investor.

Under the interdependence test the argument is complete. There would be no reason for any of the actions of any of the parties in the chain but for the investor purchasing securities with money that would be used for the loan. Nor would there have been any loan without the money from the investor. Had the investor funds not been the source, the underwriting, appraisal and closing standards would have complied with industry regulations and expectations.


The step transaction doctrine is a rule of substance over form that treats a series of formally separate but related steps as a single transaction if the steps are in substance integrated, interdependent, and focused toward a particular result. Penrod v. Commissioner, 88 T.C. 1415, 1428 (1987). Because the Tax Court has applied the step transaction doctrine even where it did not find a sham transaction, this doctrine should be considered in addition to the economic substance argument discussed above. See Packard v. Commissioner, 85 T.C. 397 (1985).

In characterizing the appropriate tax treatment of the end result, the doctrine combines steps; however it does not create new steps, or recharacterize the actual transactions into hypothetical ones. Greene v. United States, 13 F.3d 577, 583 (2nd Cir. 1994); Esmark v. Commissioner, 90 T.C. 171, 195-200 (1988), aff’d per curiam, 886 F.2d 1318 (7th Cir. 1989).

Some lease stripping transactions may lend themselves to being collapsed. If so, the question is whether the transitory steps added anything of substance or were nothing more than intermediate devices used to enable the subsidiary corporation to acquire the lease property stripped of its future income, leaving the remaining rental expense and depreciation deductions to be used to offset other income. See Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179, 184-185 (1942).

Courts have developed three tests to determine when separate steps should be integrated. The most limited is the “binding commitment” test. If, when the first transaction was entered into, there was a binding commitment to undertake the later transaction, the transactions are aggregated. Commissioner v. Gordon, 391 U.S. 83 (1968); Penrod, 88 T.C. at 1429. If, however, there was a moment in the series of transactions during which the parties were not under a binding obligation, the steps cannot be integrated using the binding commitment test, regardless of the parties’ intent.

Under the “end result” test, if a series of formally separate steps are prearranged parts of a single transaction intended from the outset to achieve the final result, the transactions are combined. Penrod, 88 T.C. at 1429. This test relies on the parties’ intent at the time of the transactions, which can be derived from the actions surrounding the transactions. For example, a short time interval suggests the intervening transactions were transitory and tax-motivated. A short time interval, however, is not dispositive.

A third test is the “interdependence” test, which considers whether the steps are so interdependent that the legal relations created by one transaction would have been fruitless without completing the series of transactions. Greene, 13 F.3d at 584; Penrod, 88 T.C. at 1430. One way to show interdependence is to show that certain steps would not have been taken in the absence of the other steps. Steps generally have independent significance if they were undertaken for valid business reasons.

In this transaction, the nature of B and C’s involvement may support the conclusion that steps involving B and C should be eliminated from the transaction. In this event, D could be required to recognize the accelerated income arising from the purported sale of the rent stream to the bank. Therefore, through the consolidated return, E would recognize the income, and thereby match the income with the deductions.

The “step transaction doctrine,” under which “interrelated yet formally distinct steps in an integrated transaction may not be considered independently of the overall transaction,” forms a vital part of our tax law.

The scope of this extra-statutory “doctrine” in particular cases can be quite uncertain; nevertheless, the parameters of its application in some transactional forms have become well-accepted and, in those cases, some certainty has been attained by taxpayers and the Internal Revenue Service (“IRS”) regarding which individual steps of a “larger” transaction would and would not be granted independent significance for tax purposes. In Revenue Ruling 2001-46 (October 15, 2001), however, the IRS arguably changed its approach to analyzing one common form of corporate asset acquisition, described below, under the step transaction doctrine.

An acquiring corporation (“X”) wishing to effect an acquisition of the assets of a widely-held target corporation (“T”) may form a wholly owned subsidiary (“Y”). Pursuant to an overall “plan,” Y will merge into T, with the shareholders of T tendering their T stock in exchange for cash, stock, or securities of X (or some combination thereof), following which T will merge into X.

Under longstanding guidance from the IRS, the “transitory steps” of the formation of Y and its merger into T were ignored; these transactions in which X became, at least momentarily, the sole shareholder of T were treated as an acquisition of T stock by X directly from the shareholders of T. By contrast, in analyzing the consequences of that “direct acquisition” of stock, the subsequent “upstream” merger of T into X was treated as a separate transaction, rather than as part of an overall “plan.”

The effect of this analysis was to permit, in those cases in which the portion of the consideration received by the shareholders of T which did not consist of stock in X was sufficiently preponderant, treatment of the acquisition as a “qualified stock purchase” and the making by X of an election under section 338 of the Internal Revenue Code (“Code”) to “step-up” the basis of T’s assets to X’s acquisition cost.

In Rev. Rul. 2001-46, however, the IRS held that all the steps described above, including the merger of T into X, would be treated as a single transaction, which could then be treated a statutory merger of T into X, if, under the circumstances, an actual merger of T into X would have qualified as a nontaxable reorganization under Code section 368(a)(1)(A).

Foreclosure Defense: Losts/Destroyed Note is No Accident




In prior times, the possibility of a note being accidentally lost or destroyed was protected by statutes providing for proving the note and mortgage without the original. These statutes and rules of procedure are now being invoked by nominal lenders and assignees of nominal lenders to escape or navigate around a much deeper problem for them.

It is the opinion of this editor that the original notes were not accidentally destroyed or lost. There either intentionally destroyed or hidden in some trustee’s vault in an off shore structured investment vehicle. The reason is simple: the terms of the note and mortgage do not match the narrative or representations of the parties in the securitization process culminating in the sale of ABS instruments.

The nominal lender or assignee will claim that they did not lose or destroy the note and that might be true. That is why the SINGLE TRANSACTION theory must be invoked in foreclosure defense. Someone in the securitization process was responsible for the fact that between 40%-90% of the notes have vanished, whereas prior to the Mortgage Meltdown era the percentage of lost notes was less than 1/2 of one percent.

Since the promissory note is a thing of value and in fact is considered “money” in many economic models, it is a challenge to come up with reasons why anyone would “rip up a ten dollar bill.” The only reasonable answer is that if someone actually saw the $10 bill they would know it wasn’t a $100 bill, which is what they thought it was when they bought a piece of paper that referred back to the fictional “$100” bill.

The effect of this destruction and the reasons for it add considerable weight to the argument that there is no longer any enforceable mortgage, that the rescission rights of the borrower have been deflected into an abyss for lack of a real party in interest, and that the SINGLE TRANSACTION theory is the only one that accounts for everything that went bad in the Mortgage Meltdown era. In the context of multiple assignments and parsing of the notes and mortgage in the securitization, the lost or destroyed note takes on a whole new meaning.


A conduit or party acting as Mortgage Broker under false pretenses to the borrower giving the impression that it is has performed ordinary due diligence and applied ordinary underwriting standards to the approval of the loan, the appraisal, the borrower’s qualifications and ability to pay and the fees at closing.

The Nominal Lender is the party named on the mortgage as the mortgagee and named on the note secured by the mortgage as the payee. It is usually a front for some larger entity or financial institution. In virtually all cases from 2001-2008 the party so named on the closing documents was a Nominal Lender. The nominal lender abandoned virtually all underwriting standards and assessment of risk of loss or default because the nominal lender was not assuming those risks. In all cases, the nominal lender had already pre-sold the or assigned rights under the mortgage and note before execution of the underlying documents (mortgage and note) or immediately after under the expectation and agreement, tacit or written, that the nominal lender would receive a fee or profit from closing the loan and that the actual funds would come from third parties involved in the securitization process eventually culminating in the issuance of ABS instruments.

Thus the nominal lender lacks legal standing to pursue enforcement of the note or mortgage because the nominal lender has no financial interest in the note or the mortgage. It is equally true, however, that the claim under TILA, RESPA, RICO etc. might not be addressed to the correct party when the mortgage audit is completed and rendered with a proper request under RESPA for resolution.

The nominal lender lacks legal authority to settle anything since it is no longer a holder in due course of the note or mortgage. In addition, the removal of the nominal lender from the actual underwriting and funding process probably extends the time for rescission indefinitely because the real parties in interest are never disclosed to the borrower. similarly it is unlikely that the nominal lender has the authority to negotiate a settlement or even execute a satisfaction of mortgage, since it cannot return the original note (see Lost, Destroyed Note).

Early Amortization Event (EAE) — SEE LOST OR DESTROYED NOTE

A type of credit “enhancement” used in asset backed securities. One or more triggers, defined in the asset backed security’s documentation require the termination of revolving periods, controlled amortization periods and/or accumulation periods.

Once triggered, the early amortization provision requires that the monthly principal payments be distributed to investors as they are received. This “enhancement” was in actuality a massive risk factor and contributed greatly to the Mortgage Meltdown period of 2001-2008. It also may have caused certain parties to be motivated to “lose” or “destroy” the original note.

The most common trigger is a measure of how the portfolio yield net of charge-offs exceeds the base rate of servicing plus the investor coupon rate. Also called a pay-out event. Another event potentially within this category is the actual payoff of the mortgage. An analysis of the the concept of an EAE demonstrates several peculiarities and a possible explanation of the promissory note being lost or destroyed:

Given that an ABS is a derivative instrument and that traders in derivatives are comfortable with the value of these securities being “derived” by “reference” to something else, the traders are accustomed to examining not the actual “asset” or evidence of the asset (e.g. the note and mortgage) but rather a narrative describing the note and mortgage (which from 2003-2008 was, for the most part, at variance with the actual terms expressed in the note — the the existence of the original physical note put the CDO a manager at risk of discovery of having misled, lied or withheld vital information (like actual cash flow based upon negative amortization versus the stated rate on the note or the elimination of escrow for taxes and insurance which degrades the safety of the an investment based upon that mortgage and note).
Hence, the traders in derivatives relied upon summaries or narratives that were not scrutinized by any securities agencies for compliance with disclosure requirements, the most important of which were the risks of the investment in an ABS.

THEY RELIED INSTEAD ON THE RATING “AGENCIES” (ACTUALLY PRIVATE COMPANIES THAT WERE THEMSELVES UNREGULATED BUT ASSUMING THE MANTLE OF PSEUDO-GOVERNMENTAL OBJECTIVITY). And of course the rating agencies, by relying upon narratives prepared by CDO managers rather than examining the underlying documentation (the notes and mortgages) didn’t see the original note or mortgage either, much less analyze, examine or otherwise perform the due diligence that constituted the condition precedent to issuing a rating of “investment grade” on any security. This failure was prompted by monetary incentives and negotiation between the “client” (the issuer of the securities being rated and the rating company (Moody’s, Fitch etc.)
The actual projected charge-off rate was known to anyone who actually saw the loan application of the borrower, and the original note and mortgage. The narrated charge-off rate upon which the ABS derived its value was based upon the opinion of the CDO manager at the investment banking firm who had no expertise in appraising or underwriting loans. Nonetheless it is certainly an arguable position that the CDO manager knew or should have known that underwriting standards at the level of the nominal lender at closing had collapsed into a rubber stamp, since the nominal lender was in actuality playing the role of a conduit or mortgage broker.  See Nominal Lender.
The structure of the SPV (see Special Purpose Vehicle) was a more formal replay of the pattern of misrepresenting the terms, risks and attributes of the note and mortgage. “Tranches” (see TRANCHE) were created within each SPV, wherein each tranche behaved more or less as separate entities providing protection to the tranche above and moving the brunt of the risk of total loss down lower and lower to the lowest tranche which in the parlance of the finance world is called “toxic waste.” (see Toxic Waste). ABS instruments were issued not on the entire SPV “portfolio” but on selected groupings of tranches within the SPV and further complicated by the trading of credit default swaps, the cross guarantees, assurances and liability of other SPVs, other individual SPV tranches, and other third parties, insurers and assurers.
Thus the EAE represented in reality an astonishing array and number of variables that could not be quantified or analyzed by purchasers of ABS instruments except on faith and confidence of the issuers, rating agencies and other parties or by performing their own due diligence (which is now proposed under new SEC rules as of the the date of this entry, June 24, 2008).
At the root of the EAE phenomenon was the conflict between the truth of what was actually presented to the borrower at closing of the loan transaction and what was represented up-line (in the securitization process) eventually to the purchasers of the ABS instruments that provided the capital to fund the alleged “loans” which are editorialized in these pages as securities in actuality that were issued by the nominal lender under false pretenses and without compliance with banking and securities laws, rules and regulations that applied.


The lower tranche levels of an SPV (see Special Purpose Vehicle) whose main characteristic is to take whatever revenue or principal is paid on the high-risk debt obligations contained within that tranche and pay for any short-fall in higher tranches within the same SPV or through credit default swaps effecting other SPVs. It is difficult if not impossible to trace any specific mortgage or note to any specific one or more SPVs, tranches or other cross collateralization agreements and other instruments that distributed and parsed interests in individual loans in multiple parts to multiple parties and joined co-obligors at various levels before and during the securitization process (based upon the clearance procedures and record keeping of those involved in the SINGLE TRANSACTION).

Foreclosure Defense and Offense: Rating Agencies and Appraisals

Taking the entire Mortgage Meltdown process as a single transaction starting with the origination of the loan to the borrower and ending with the sale of an asset backed security to an investor, a pattern of deception and confusion emerges — providing the borrower with an arsenal of offensive and defensive strategies to avoid foreclosure, recover damages and even free their property from the mortgage altogether. In foreclosure defense and particularly offense for “lender” liability, keep in mind that there was a chain of entities who all knowingly conspired (under a cloak of what they deemed “plausible deniability”).

This chain was never disclosed to the borrower — thus the disclosure obligations set forth in TILA, state law, RICO, common law and other resources were never met and the right to rescission was blocked by lack of information, to wit: the borrower in most cases does not know who to send the rescission letter to because in all likelihood there are now multiple parties who have an interest in the security instrument, the note and the risk of loss, none of whom were disclosed to the borrower at or after closing. 

These participants are subject to liability for monetary damages and many are insured as well as having deep pockets of their own. They also de-linked several aspects of what had been a single event — the purchase of a home with a first mortgage on residential property using money in part loaned by a lender who took the risk of non-payment, followed underwriting guidelines set by the banking industry and regulators, and therefore had a direct stake in the outcome of the loan and a specific desire to avoid default on the loan. 

The de-linking of teht ransaction and overlapping with other parts of the entire single “mortgage meltdown” chain resulted in separation of the security interest from the the obligation to pay, adding obligors who had liability for payment, and adding receivers of income. Thus the classic and relatively simple foreclosure that involved non-payment by the borrower to the lender, was converted in a complex series of transactions leaving the investor who bought the asset backed security with the right to the income and some rights to the security interests, and others with the the right to the security interest but no right to payment, and still others who made payments to the investor or who were liable for non-payment to the investor who acquired the right to payment from the underlying mortgage and note from which his asset backed security derived its value.

The significance of this in foreclosure defense is that the party alleging non-payment by the borrower is NOT and CANNOT allege non-payment to the entity or person (investor) who is entitled to that payment. The usual person entering the foreclosure process is the trustee posting notice of sale or the originating lender filing foreclosure. But they do not know if the investment bank, an insurer or some other third party, including another borrower was contributing to the flow of payments that the investor received, nor do they know the allocation of those funds which the investor received.

Thus the party entitled to income from the borrower’s note may or may not have been paid by the borrower (through overcharges and other TILA violations in addition to regular monthly payments, or by third parties whose obligation derived in part from the note signed by the borrower and in part by hundreds or thousands of other notes in cross collateralization agreements or cross guarnatees, indemnifications, indentures and covneants between the lender, mortgage agregator, investment banker, seller of teh security and the investor who bought the security. 

You can therefore take the position that if the default alleged is non-payment, the entity or person making the allegation must prove the non-payment and that proving that the borrower did not make one or more payments does not prove that the party (investor) entitled to payment did not get paid in whole or in part. Thus no default has been alleged without alleging that no payment was received by the holder of the original note and mortgage and the party to whom payment was to be received as a result of the income stream from this mortgage combined with thousands of other mortgages.

Production of the original note and mortgage becomes critical and a condition precedent to any action, sale, motion for summary judgment, judgement of foreclosure, sale or rights of redemption. Equally important and perhaps more so is the production of the documents that assigned, sold or otherwise transferred the security interest, the income from the note or the risk of non-payment to one or more parties. You will find that in many cases, those are all different third parties with different interests and agendas.

Perhaps the most important, we are finding in Ohio and other states, that NOBODY can come up with documents that directly link a particular borrower with any of these third parties holding primary or secondary rights to the security instrument, the note, or the risk of loss. In those cases, we are seeing borrowers walk away with their home free and clear of any encumbrances and lawyers getting paid fat bonuses or contingency fees for eliminating the risk of foreclosure, and feeing the borrower from the entanglement in a complex transaction that was never disclosed to him/her/them.

The appraisers, who are usually insured by errors and omissions policies, state the fair market value of real property through supposedly independent analysis of comparable statistics and other factors. The standards are governed by the regulatory board in each state that licenses them, although there might still be some states who do not license appraisers. In states without licensing, they are governed by common law and other applicable law concerning deceptive business practices.

The rating agencies state the quality of a security that is used to determine the fair market value of the security. They too are supposedly using objective means, analysis and due diligence to issue their rating. In the world of the mortgage meltdown, rating agency objectivity broke down y virtue of two main factors: (a) the rating agencies were competing for customers and revenue and (b) in a related factor, the rating agency analysts were receiving gifts, pressure from clients (issuers) and pressure from management to “accommodate” the client (issuer). A Nationally Recognized Statistical Rating Organization (or “NRSRO”) is a credit rating agency which issues credit ratings that the U.S. Securities and Exchange Commission (SEC) permits other financial firms to use for certain regulatory purposes.

The nine organizations currently designated as NRSROs are:

Ratings by NRSRO are used for a variety of regulatory purposes in the United States. In addition to net capital requirements (described in more detail below), the SEC permits certain bond issuers to use a shorter prospectus form when issuing bonds if the issuer is older, has issued bonds before, and has a credit rating above a certain level. SEC regulations also require that money market funds (mutual funds that mimick the safety and liquidity of a bank savings deposit, but without FDIC insurance) comprise only securities with a very high rating from an NRSRO. Likewise, insurance regulators use credit ratings from NRSROs to ascertain the strength of the reserves held by insurance companies.

The following article described the efforts of the New York Attorney general to address the break down of objectivity caused by competition for fees.


Shifts Loom 
In Settlement

N.Y.’s Cuomo Plans 
Overhaul of How 
Firms Get Paid
June 4, 2008; Page C1

The three major bond-rating firms are set to overhaul the way they collect fees as part of a settlement with New York state’s attorney general, Andrew Cuomo, that could be announced as soon as this week, people familiar with the matter said.

If a deal is reached, it could change the $5 billion-a-year bond-rating industry as fundamentally as Mr. Cuomo’s predecessor Eliot Spitzer did six years ago with his settlement with Wall Street firms over stock-research analysts whose recommendations were compromised by investment-banking ties.

[Andrew Cuomo]

Terms of Mr. Cuomo’s settlement with Moody’s Corp.’s Moody’s Investors Service; McGraw-Hill Cos.’ Standard & Poor’s unit; and Fimalac SA’s Fitch Ratings deal with what many critics claim has been a chronic problem with bond ratings: They are paid for by the entities being rated. That financial dependence has been blamed for the industry’s failure to predict that risky subprime mortgages would crumble, resulting in losses and shaken confidence.

The accord attempts to change the incentive structure for the ratings firms. Now, while more than one ratings firm reviews most deals, not all of them always rate the deal and get paid. That gives the firms an incentive to go easy on their rating in order to win the business.

Under the Cuomo settlement, which would cover the hardest-hit portions of the mortgage market, the firms would get paid for their review, even if they didn’t end up getting hired to rate the deal. This would mean the firms would get paid even if they were tough. The plan, which requires final agreement by Mr. Cuomo’s office and the rating firms, wouldn’t dictate the exact fees rating firms could charge. But the firms would be required to charge more than a nominal fee for their preliminary work.

The bond-rating firms also have tentatively agreed to disclose on a quarterly basis the fees they are paid for nonprime-mortgage-backed securities, which include subprime mortgages and so-called Alt-A mortgages that have less documentation or don’t conform with prime-mortgage standards.

Such disclosures are seen as a potential red flag to help investors detect instances where bond issuers or their bankers may have essentially pitted different rating firms against each other in order to get a higher rating.

In an interview late last year, Brian Clarkson, then the president and chief operating officer of Moody’s Investors Service, acknowledged that “there is a lot of rating shopping that goes on…What the market doesn’t know is who’s seen” certain transactions but wasn’t hired to rate those deals. Last month, Mr. Clarkson, who once ran the Moody’s group overseeing mortgages and other structured-finance products, stepped down, effective in July.

The settlement is unlikely to satisfy critics who have urged that bond-rating firms stop being paid altogether by bond issuers or that the firms be permitted to rate any deal they choose, regardless of whether the issuer cooperates. Following the settlement, bond issuers still would get a strong say over which firms published the final rating, as well as those invited to look over a pool of loans in the first place.

For Moody’s, S&P and Fitch, the agreement largely eliminates the possibility of a nasty showdown with Mr. Cuomo, whose office has been investigating the industry for about nine months, poring through thousands of pages in documents and emails and interviewing senior executives at each of the three big rating firms, people familiar with the matter said.

Mr. Cuomo has leverage over the bond-rating industry partly because Moody’s and S&P are based in New York. The attorney general also has one of the most powerful legal tools in the nation: the 1921 Martin Act, which spells out a broad definition of securities fraud without requiring that prosecutors prove intent to defraud.

In a statement, Deven Sharma, S&P’s president, said the firm “is pleased to work with New York Attorney General Andrew M. Cuomo and other rating agencies on these important measures, which we believe will help ensure our ratings process continues to be of the highest quality.”

Rating-company shares rose after The Wall Street Journal reported news of the settlement talks Tuesday afternoon. In 4 p.m. composite trading on the New York Stock Exchange, Moody’s was at $38.45, up $1.80, or 4.9%. McGraw-Hill was up 38 cents at $41.20.

As the probe proceeded, attorneys in Mr. Cuomo’s office concluded that rating firms could be more effective if Wall Street had less control over which ones were paid, these people said. As part of the deal, the firms would cooperate with Mr. Cuomo’s continuing investigation into investment banks and other financial firms that issued mortgage-backed securities later plagued by high levels of defaults. The New York attorney general is trying to determine if banks intentionally overlooked or hid flaws in loans that were securitized and sold to investors.

The decision not to seek fines from the three major bond-rating firms partly reflects Mr. Cuomo’s firm but less-confrontational style than that of Mr. Spitzer. The 50-year-old Mr. Cuomo, elected in 2006, has promised to aggressively pursue financial wrongdoing, and the likely pact shows he believes investor confidence can be shored up without an all-out attack on the bond-rating industry.

Mr. Cuomo’s settlement will likely be structured in a way that doesn’t contradict rules being proposed by the Securities and Exchange Commission. It will take up to six months to implement and may also need to address antitrust concerns at investment banks or among smaller rating firms. “Without knowing all the details, I’m concerned it would entrench the three large rating firms,” said David Schroeder, chief operating officer of DBRS, a Toronto rating firm not included in the settlement talks.

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