Citigroup Call On Implications On Foreclosure Crisis: "Just The Tip Of The Iceberg"
Yesterday, Citigroup's homebuilding team hosted a call with investors in which the guest speaker was Adam Levitin, an associate professor of law at Georgetown University. Far from providing the "all green" call participants had desired, Levitin said that what we have recently seen and heard in the news is “just the tip of the iceberg” and that the foreclosure halt may well cause a "systemic problem", as was suggested on Zero Hedge when the news of the Florida's court involvement was first made public (here and here) a month ago. And since by now everyone knows what the key tension points in this potentially massive development are, we will cut straight to Levitin's somewhat unpleasant conclusions: "Our speaker predicted that more and more lenders are likely to stop their foreclosure processes in both judicial and non-judicial states. He also expects more states’ attorney generals to get involved. At the federal level, it is possible than banking regulators might step in as there is legal and reputational risk for the banks involved. Ultimately, if these issues do in fact escalate, the Administration may try to broker some sort of settlement. If such deal brokering does take place, Levitin believes that “some payment” will be exacted from the lenders and servicers. The Administration could bargain for more mortgage principal write downs." In other words, the endgame will likely end up being the extraction of material concession from the banking syndicate, in the form of systemic mortgage writedowns, with Obama's blessing, which will likely put the 25% of homeowners who are underwater on equal footing with the other 75%. It may turn out that this was the plan all along. And people naively wonder why banks have hundreds of billions in cash stashed on the sidelines...
As for Citi's official take on Fraudclosure here are the key issues:
Issues Concerning Affidavits
When the aforementioned paperwork is lost, an agent of the mortgage servicer can sign an affidavit swearing that he or she has personal knowledge that, although now lost, the trustee was once in possession of the necessary documents. The affidavit is considered to have the same weight as sworn testimony in a court of law.
Two problems have emerged with regards to affidavits. First, several news stories have reported that the people signing these affidavits had no knowledge of the matters in question despite the fact that there were legally testifying that they did. Many of these people have since been labeled “robo-signers” given the tremendous volumes of affidavits which they signed in relatively short periods of time. Second, the affidavits may be irrelevant because the issue is not that the mortgage documents were lost but they were never properly transferred at each step of the aforementioned securitization process.
Issues Concerning Tax and Trust Laws
Beyond the affidavit issues, our speaker highlighted potential problems concerning the trusts which hold the securitized mortgages. Most mortgage trusts were set up as REMICs (Real Estate Mortgage Investment Conduits) which are special purpose vehicles used to pool mortgages. Under the IRS code, REMIC confers a special tax status in which the cash flows to the trust are not taxed. Investors in the trust pay taxes. The tax exempt nature is important. If the trusts were in fact to be taxed, the taxes would distort the yields required by investors.
To qualify as a REMIC under the IRS code and enjoy the beneficial tax treatment, the trust (1) must be passive and (2) cannot acquire any new assets 90 days following the trust’s creation.
If, as described above, mortgage documents were never correctly passed through to the trust when it was established, then the trust may not actually own the underlying mortgages it purports to own. Although it is possible that this issue could be remedied by some legal maneuvering, doing so could violate the REMIC status since the trust would be acquiring assets long after the aforementioned 90 day period has expired. Such a violation in turn could trigger a sizeable tax burden for investors. Our speaker indicated that there are a handful of open questions on this front and that this is a legal gray area.
Issues Concerning Title Insurers
Levitin noted that all of the above issues may impact how title insurance companies act. If a scenario emerges in which title companies are unwilling to issue title insurance, in those scenarios lenders may cease lending.
When a home with a mortgage on it is sold, the mortgage must be released at closing by the current mortgage owner before a new mortgage with title insurance is issued. If it is not known with certainty who owns the mortgage in question, it cannot be released. If the title company is not satisfied that there is a good release on the old mortgage, it will refuse to insure the new mortgage.
None of these issues affect mortgages for newly constructed homes. Our speaker expects the mortgage market for new homes to continue to function without any material hindrances.
Issues Concerning MERS
MERS (Mortgage Electronic Registration Systems) functions as a centralized electronic registry of mortgages and tracks ownership of mortgages. MERS allows mortgage ownership to change hands efficiently and relatively quickly since it is electronic and allows all parties to forgo making a filing in local land records. Indeed, MERS was designed to function as a substitute for local land records.
Although MERS was designed to enhance efficiency in the mortgage assignment process, Levitin argued it may not conform with the law. “Slowly but surely” courts are issuing decisions which “cast validity on the MERS process.” Although ~60% of mortgages list MERS as the “nominee” which owns the mortgage, a handful of recent court cases have ruled that MERS has no standing in foreclosure actions either because (1) physical paperwork must be transferred when a mortgage is assigned by one party to another or (2) MERS has no true economic interest in the mortgage in question since it collects no payments from the borrowers.
Of course, all this is irrelevant without an appreciation of the endgame. And that may very well be what the Fed is pursuing all along - the elimination of trillions of private debt, however instead of Uncle Sam eating it all this time (via the GSEs), the banks would end up sharing some if not all of the pain. Of course, if this is indeed the case, it will be a very dangerous tight rope act, as many may just refuse to pay their mortgages outright going forward, and cause major additional pain for the TBTFs, and/or result in other traditionally unpredictable outcomes.
Full citi report, with thanks to Village Whisperer :