Readers: The author has only partially sanitized the securitization process, and some of the side assumptions border on the absurd. Other than the details the author seems invested in the silly supposition that the prognosis pivots between a "u"shaped and a "v " shaped recession. You know if a medium to small bank in Kansas lost control of their compliance with contract law then the "too big to manage" banks on Wall Street have completely lost control of their due diligence. There is a piece of the title that I need to address, and that is the use of the word "debtor." The mortagagee is only a debtor by virtual of the contract agreed to with the mortgagor. Yes, it is legitimate to re-sell these mortgages as mortgages, as long as the expected due diligence is observed. When that contract is broken by either side the contract often has to be settled in a court of law. If the agent representing the nominal owners of these securities, cannot demonstrate ownership, then the process is quit. I can provide about six different ways that when a mortagae was securiztized under the current standards, ie none what so ever, ithat the mortgage as a contract was never legitimate after what ever time was required to securitize it among thousands of other mortgages. This article came out about a year ago. Since that time the practice of robo-signers and thereby the absence of due diligence, and wide spread counterfeiting of documents has been exposed. In effect I expect that most mortgages which have been securitized into tradeable securities will be fraudulent in multiple ways. Tadit Anderson

Nov 15, 2009
Would you swear your loan department knows who owns every mortgage you service? Would you swear every piece of paperwork has followed each securitized loan as it has been sold from place to place? These are questions highlighted by a recent state Supreme Court decision that leaves banks vulnerable to foreclosures where the debtor discharges the loan but keeps the house.

The case involved Landmark National Bank ($608 million) of Manhattan, Kan., and its use of the Mortgage Electronic Registration Systems (MERS), a company that registers mortgages electronically and tracks ownership of the lien, streamlining securitization. MERS, with about 3,000 bank participants, also says it acts as "nominee" for the lender in county land records and as servicer no matter how often servicing is traded.

But there is no technical or legal definition for "nominee." That's why the case raises questions about the ability of a non-lender - including bank servicers and MERS - to enforce its rights in foreclosure or bankruptcy proceedings, says bankruptcy attorney Tim Nixon, a partner at Godfrey & Kahn in Milwaukee.

"The system still requires the last lender in the chain to endorse the note over to MERS before the foreclosure can begin," explains a real estate attorney in Phoenix who wrote a guest column about the case for the Calculated Risk blog under the name "Albrt". He requested further anonymity because he was not a party in the MERS litigation. "If the lenders have been ignoring their paperwork because they think they are ‘inoculated against future assignments' [as MERS notes on its website], it is possible the lenders are worse off than they would have been without MERS."

The real culprit is securitization, which has led to multiple mortgage transfers and left "imperfect" mortgage documentation, Nixon explains. In mortgage foreclosure and bankruptcy, there must be a party that can assert rights to payment. But electronic pooling and securitization has made this harder, he says.

"I can agree with you that ... the company that made the loan is generally no longer the company that owns the loan," says R.K. Arnold, the CEO of MERS. "But the whole reason MERS was created was because the industry needed to do a better job of keeping track" of assignments. MERS has been criticized inaccurately, he says, for leading to sloppy paper mortgage filings in local real estate recordation offices. But he underscores that notes always have been freely transferable and never recorded in land records, "not even in merry old England," he adds, citing Uniform Commercial Code (UCC) article 3.

Regardless of the process, "It may not be clear who exactly currently holds the note and the mortgage," Nixon says. "What we have here is a conflict between modern technology and the law. Through technology, we've turned [mortgage lending] into a commodity business. But what made perfect sense for the financial industry doesn't comport with the law."

The problem: As a matter of law, if the note goes away, the mortgage goes away, too. "Part of the reason for the court's conclusion was that you can't separate a mortgage from the note it secures," the Phoenix attorney says.

"The mortgage doesn't stand by itself," Nixon agrees. As a result, poor documentation on a mortgage that is sold and resold could leave a lender and servicer without proof they are tied to the note, he says. If such a mortgage goes through foreclosure or bankruptcy, a court could discharge the debt and give the house to the debtor - free.

The Case that Roared: Landmark and MERS

Here are the details of the case, as outlined in the decision: Landmark held a $50,000 first mortgage, and the borrower later took out a $93,100 second mortgage with Millennia Mortgage Corporation, which filed the mortgage with MERS. Millennia later assigned the mortgage to Sovereign Bank but did not record the assignment. The borrower defaulted and Landmark foreclosed, giving notice to Millennia - but not MERS or Sovereign, which also failed to record the assignment.

The property was sold at auction, and MERS - claiming lack of notice - tried to block Landmark from collecting. This moved through the courts until MERS was denied standing by the Kansas Supreme Court, which noted that Millennia did receive notice and that MERS was "solely" the "nominee," not a lender and not a necessary party to the foreclosure.

MERS, as "nominee," is not a servicer, mortgage holder, agent or trustee of a pool, each of which has been held by courts to have legal standing, Nixon explains. He adds that, "MERS is trying to walk a fine line. They don't want liability as agent or lender. They just are a clearing house." The Phoenix attorney agrees: "Unfortunately for MERS, experienced judges are wise to this trick and will most likely continue placing reasonable limits on the ability of MERS to claim it is all things to all lenders" by using the term "nominee."

"Nobody would argue that the word ‘nominee' is foreign to the legal" community, Arnold says, adding that the terminology has been "spun" by lawyers. "It's not moon man language... I won't say that the word ‘nominee' shows up in every statute. But neither does ‘agent.'" Borrowers sign a disclosure and pay a $6.95 fee to place the loan in the MERS system, a process Arnold says turns MERS into "another form of servicer. We perform a service. It is on behalf of the lender, of course, but the borrower makes MERS the mortgagee. So why wouldn't we be able to service the loan?"

Arnold also says that regardless of the definition of ‘nominee,' MERS still has standing in Kansas to foreclose and will fight every subsequent case that challenges that right. "MERS is not going away," he vows. "There will be another Kansas case... Eventually, we will win. The law will be changed. We have 63 million loans, and that will be 100 million within a few years. We're not stopping."

Although the decision is confined to Kansas, Nixon points out that the state is "not a hotbed of liberal judicial activism," meaning decisions there are viewed as mainstream. "That's why it is a significant decision," he says. "It's not a court that makes radical, weird decisions. People will take note of that." MERS has fought off attempts in other states, including New York and Florida, to limit its ability to act as mortgagee and foreclose on behalf of members. It has been less successful elsewhere, with pending cases in Nevada and Minnesota.

Arnold agrees that MERS is involved in "a lot" of "negative litigation" because it is a party in millions of traded loans during a time of rocketing foreclosures. "That tide will turn when the economy comes back around," he says. "We're not bad guys. We're trying to help the whole industry."

The Phoenix attorney agrees with MERS that the decision is narrow, based on the fact that the mortgage document required notice to the lender, not to MERS. "The court did not say the mortgage was invalidated because MERS separated the mortgage from the note," he says. "The court said MERS did not appear to own either the mortgage or the note."

What MERS Claims & What it Really Does

But MERS does make promises on its website that have been misinterpreted: "Our mission is to register every mortgage loan in the United States on the MERS System," the Reston, Va.-based company writes. "MERS acts as nominee in the county land records for the lender and servicer. Any loan registered on the MERS System is inoculated against future assignments because MERS remains the nominal mortgagee no matter how many times servicing is traded."

"MERS can't really provide protection from all the potential errors and problems that came up when loans were being traded and securitized at warp speed all over the country," the Phoenix real estate attorney and blogger notes. "Many of the cases where MERS has gotten in trouble involved a misplaced note, but it is generally not clear that the problem was MERS' fault, and it is not all that much different from what happens when a non-MERS lender files a foreclosure suit without having the original note handy."

He says MERS probably helped many banks during the financial crisis. "What actually happens is that a MERS mortgage is recorded once, usually with MERS shown as the ‘nominee' of the lender," the blogger explains. "MERS then tracks loan assignments, including both repayment rights and servicing rights." However, the output of the tracking system is "approximately as good as the input from the lenders," he says. At times, MERS represents the mortgage holder in foreclosures if it is provided the original note endorsed in blank by the lender. "That makes MERS a 'holder' of the note, even if MERS is not actually the owner," he says.

"Most of the problems can be attributed to non-standard mortgage documents, poorly drafted foreclosure complaints, or foreclosure complaints filed prematurely without verifying the status of the mortgage and who is holding the note," the Phoenix lawyer says. These problems affect non-MERS lenders in more or less the same way they affect MERS lenders... The only broad effect of this decision is that the court refused to make a special exception for MERS mortgages. Most MERS mortgages do say that MERS should get notice. If the mortgage document says that, most courts will enforce it."

How Banks Can Protect Themselves

Several cases similar to Landmark have emerged since the financial collapse, suggesting that courts are reconsidering the traditional view that servicers and nominees may assert the rights of the mortgagee, Nixon says. Just last month, another debtor case was thrown out because the servicer could not prove who owned the mortgage.

"The cases may demonstrate a backlash against the lending industry" because of the rash of foreclosures, Nixon speculates. "The trend is getting more demanding. It's not courts randomly blowing up mortgages." Many homeowners are confused about where to send mortgage payments, especially when a servicer demands payment on behalf of a bank that bought a mortgage with missing paperwork.

"Because of the way pooling is done in such a volume fashion, the paperwork is not always done," Nixon says. "A lot of these are electronic notations. Someone punches a button somewhere, so bank X instead of bank Y owns it. Courts are concerned that someone is owed money. They say, ‘How do we know that the money is going to the right person?'"

Arnold says he is concerned about consumer group demands that MERS permit borrowers to see who owns their loan. "We are open to providing that information - not because it is legally required, but because, since we have been in this hostile environment, we have come to the conclusion that this could be good for people," he says, despite cost and privacy concerns. "If consumer groups say, ‘Would you open up the system?' we would be very open to discussions about that possibility."

Banks can find some protection on the paperwork issue by making sure they have authenticated copies of the note and mortgage and verifying recording information before filing a foreclosure, Nixon says. They also should record any assignments - such as to MERS - and grant authority or agency rights to enforce the mortgage to the current holder or trustee. Alternatively, "it might not be worth it to document this stuff en masse," he says, because the costs could be excessive.

Arnold's advice: "In foreclosure, banks need to be very careful with what lawyers they hire to do the work," he says, noting that "some are sloppier than others" by inaccurately describing MERS' role.

"On a practical level, this may be much ado about nothing," Nixon allows, because servicers and mortgagees may be able to resolve issues by completing and filing the proper assignment documents, as permitted under article 3-309 of the UCC. In addition, many debtors would not have the resources to hire a lawyer to challenge ownership of the note.

"For the moment, these are isolated cases," Nixon says. "But more and more debtors' counsels are picking up on this. There are some extreme things happening. When does a series of isolated cases become a trend? At minimum, these issues provide debtors - and perhaps commercial debtors - with additional leverage and opportunity to slow down foreclosures. Lawyers seeking to enforce mortgages in foreclosure or bankruptcy will need to do much more preparation.

"If you are in pools where you own the mortgages, or if you remain a servicer, the Landmark case matters."