If a bank modifies a loan, the modification may result in injury to certain classes of investors. Such financially injured investors may then sue the banks for improper administration of the investment resulting in billions of dollars of liability. Foreclosure, the measure generally accepted and prescribed in the investment documents to cure default of securitized loans, averts risk and liability for lenders.
The securitized mortgages are subject to rules created in the investment documents and rules issued by the Internal Revenue Service to secure favorable tax treatment for securitized loans. These rules constrain the ability of the banks to modify mortgages. Such rules may include the following:
(a) Imposing the restrictions on mortgage modification required to be made to qualify for pass through tax treatment under IRS regulations.
(b) Imposing restrictions upon the number of mortgages in the pool which may be modified.
(c) Providing a procedure and fees to be paid for foreclosure but no procedure to modifying the loan as an alternate dispute resolution.
(d) Creating securities with classes of ownership (“tranches”) with adverse and opposing financial interests resulting in so called “tranche warfare” so that a modification which favors one tranche may work a detriment upon another.
(e) Restricting the ability to lower interest payments on the note.
(f) Restricting the ability to increase the number of payments to be made.
(g) Restricting the ability to defer payments.
(h) Restricting the ability to extend the term of the mortgage.
(i) Restricting the ability to impose a temporary moratorium on payments.
(j) Restricting the ability to accept “short sales”.
(k) Creating potential liability to a specific class of certificate holders by entering into a modification agreement required for an alternate dispute resolution.
(l) Requiring the servicing agent to purchase any loan which has been modified.
These restrictions work a modification of the Transaction without the consent of the borrower. This constitutes either a breach of contract or a tortious interference with a contract, or both. Failure to have obtained the consent of the borrower to a securitization of the mortgage is a legally fatal flaw.
Following the rules imposed on securitized mortgages constrains and restricts the ability of banks to modify loans. Even where the loan is modified only by extending the term of the loan so that the original principal and interest rate are unchanged, the cash flow generated may not be sufficient to permit modification of the loan if the investors hold fixed rate bonds. In short, banks make fees when they foreclose; banks incur actual and potential liability when banks modify mortgages.
The Administration and the banks have shown nothing more than a willingness to pay lip service to the achieving loan modifications instead of foreclosure. Documents issued by federal financial agencies and Congressional Committees show that the government is fully aware of the institutionalized constraints but loath to discuss such constraints with members of the public. There has been no serious effort by our government to address and overcome the institutionalized constraints to loan modification. Until there is a serious countervailing force to compel lenders to modify mortgages which overrides the institutionalized constraints, the sorry rate of foreclosures will continue unabated. Unless such a countervailing force emerges from the private sector or from a need to respond to massive political pressure, very little is likely to change.
The discussion above has shown that the note holder disappears in securitization and the securitization works an illegal modification of the Transaction without the consent of the debtor. As organized, securitizations have a third major difficulty. Typically a third party to the Transaction is required to make any monthly payment to the certificate holders which is in default. In other words, if a specific mortgagor fails to make the January payment, a third party will make the payment for the mortgagor. Accordingly, the allegation in a foreclosure proceeding that the January payment was not made and is in default is false. The January payment was paid to the investors. How many times must the investors be paid the January payment? Once is enough. Is there any requirement in the Transaction or anywhere else that only the named mortgagor can make the required January payment to the servicing agent? Absolutely not.
It may well be that such a third party who has made payments in default is entitled to a legal recovery against the debtor. However, that party is not a party to the mortgage or a successor in interest to the mortgagee and therefore has no right whatsoever to foreclose to effect repayment. To use the mechanism of foreclosure to recover the third party debt perpetrates a fraud and misuse of the foreclosure proceedings. The mortgage is not intended to secure repayment of anyone. It is intended only to secure repayment of the mortgagee and the mortgagee’s successors in interest. In the case of securitization, the third parties making payments in default are indisputably not the successors in interest of the original mortgagee.
It is but a question of time until Congress and the courts are compelled to recognize that securitization, as practiced and without any public regulation, has resulted in “Morgicide”, the illegal and intentional destruction of mortgages by Wall Street. The upshot of this Morgicide will be the realization that the nation’s largest banks and financial institutions have caused millions of illegal foreclosures. Think of it this way. Your neighbor purchased a new car with an installment credit loan. Your neighbor has failed to make monthly installment payments. The dealer has the right to repossess. Instead, I come along and take the car. The police arrest me and charge me with Grand Theft Auto. At trial, I defend myself by arguing that since my neighbor was in default, I had the right to repossess the car. Sorry, this will not work, and I am going to jail.
The judge will rule only the dealer, not me, has the right to repossess. I acted as a mere thief in the night. Similarly the financial institutions acting as plaintiffs in the foreclosure of securitized mortgages are acting like the thief in the night. They are taking the house on behalf of the secured creditor without being the secured creditor.
So far, just as in the Sherlock Holmes mystery known as “Silver Blaze” where the dog did not bark in the night, our judges have been suspiciously silent. This will change as more and more lawyers become familiar with securitization. Look to see multibillion dollar class actions suits for wrongful foreclosure as part of the shameful legal legacy of unregulated securitization. As long as lawyers chase ambulances and sue for malpractice, Morgicide will not go unpunished.