More Thoughts On The MBS / Foreclosure Mess

After some more thought on the Tickers I’ve written of late related to the MBS mess (including here, here, here and more), I’ve got a few thoughts on how to resolve all of this.

Let’s not forget that The Housing Mess and fraudulently-issued loans were why I started writing The Ticker more than three years ago.  Indeed, it was the recognition of that scam back in the first quarter of 2007 that induced me to start chronicling this crap – not as a means to make money, but as a way to, hopefully, enlighten the people as to how they got robbed – and why it really wasn’t any different than how they got robbed in the 1990s.

Indeed, here’s the index page for April of 2007 – have a read of the first handful of Tickers, all of which date from April 1st (and yes, they really were from April 1st!)

So let’s look at the basics of Contract Law and see if we can find a way out of the box, because I think we can.  It may require some courage, but it’s not impossible.

Contract Law is in the general sense very simple.  You have offer, acceptance, and an act in furtherance of performance.  That is, someone must offer something, the other party must accept, and then one of the parties has to do something toward what you just agreed to.  That’s the basics.

But along the way lawmakers realized that there were some problems with this.  Chief among them is the fact that you and I could agree verbally to something that might take five years to complete.  Humans have notoriously bad memories, especially when it’s in their best interest to “forget” little things, so one of the “additions” that got tacked on is a thing called The Statute of Frauds.

That Statute doesn’t say “this is fraudulent”, as the name implies.  Rather, it says that in order for certain contracts to be valid, they have to be reduced to writing and bear an actual signature.

What are those contracts?

In most States they are any agreement that:

  • Contemplates performance over a period of more than one year. That is, if you wish to have a contract to clean your pool for six months, you can do that verbally.  But if it’s for more than one year it has to be in writing, or it’s unenforceable.
  • Deals with the sale or a security interest on real estate.  That is, you can’t have a binding agreement to sell your house verbally.  It has to be reduced to writing (a cocktail napkin counts though!) and carry signatures of both parties.

There are a few other sorts of contracts that fall under this Statute and it varies a bit from State to State, since this is a State Law thing.  But for the most part you can expect that if you want to do something related to real estate (or the security interest associated with real estate) or contract to do a thing over more than a year’s time, it has to be reduced to writing and carry an original wet signature or it’s not enforceable.

So we have a way out of the box here.

See, the typical way these transactions worked was something like this:

  • Joe “buys” a house.  He executes a deed which is recorded and names him as the owner.  He also executes a mortgage, which gives a security interest in the deed to the bank that funds the loan.  The seller conveys the title (with a written document) and there’s a discharge of any other security interest that may exist (also with a written document bearing a signature.)  So far, so good.  (Incidentally, I’m aware that this is state-specific…. and is very different in some states, especially non-judicial foreclosure states!)

  • Joe goes home.  But the bank bundles up and “sells” that paper to a MBS trust in a securitization.  Is there a paper agreement bearing an actual signature for each of these loans? Or did this all go into “MERS” and then was “traded and tracked” electronically?  Note that there is no “or substitute as someone wants” in the law in virtually all states.

  • Now it gets even murkier.  Some of these notes were endorsed “in blank”.  That’s not allowed in some states either – they do not allow trusts to hold bearer paper of any sort.  On a Federal level doing so effectively creates a bearer bond, which runs afoul of TEFRA, a 1980s-era law signed by Ronald Reagan to discourage drug dealer use of these things as a way around the lack of “large” currency denominations.  Bearer Bonds were not made explicitly illegal, but TEFRA requires that on creation of any bearer instrument 1% of the face value of the instrument for each year of duration is due to the IRS as a tax!   Needless to say that hasn’t been happening….

If there’s a defect – especially a problem under The Statute of Frauds – these problems cannot be fixed.

The aggrieved party (that’s the MBS holder who got rooked into buying paper that was allegedly “Prime” when it really wasn’t) should have every legal right to void the agreement.

Well, what happens if he does?

No, the homeowner doesn’t (necessarily) get a free house.

But he does have a deed with a security interest.  The bank that originally funded the loan however, was paid in full.  They cannot enforce a security interest they no longer have.

Or do they have it?

Well, they sure do if the MBS holder sticks it back on them and demands the full face value of the paper!  And it would appear that they have every right to do so, as a contract that does not comply with the legal requirements to be a contract is no contract at all!

That is, unwind the transactions from the first defect forward.  This will typically force the paper back onto the bank’s balance sheets, and they will have to pay face value to the MBS trust, which (once that has happened) has nothing left and thus dissolves, having returned the funds to the buyers (since the instrument they bought no longer exists and never did as a matter of contract, they’re entitled to have their money refunded for that which never legally happened.)

The banks now have the loans and the right to foreclose, but they also have all the losses that come with it.  That is, the hot potato that they tried to drop (and in many cases DID drop) on various institutional and other buyers lands right back in their lap.

If this kills them, so be it.

I’m well-aware that this suggestion will raise howls of protest.

It is also the only just way to deal with it.

Put back the paper that violates The Statute of Frauds, and at the same time put back paper where there was a material false statement made with regards to reps and warranties.

I’m willing to bet that’s most of the non-agency mortgages and perhaps a good percentage of the agency ones as well.

Let the losses fall on those who made the loans, knowingly selling paper into trusts without compliance with the reps and warranties, or, in some cases, who effected a contractual sale without meeting the requirements of a contract in the first place.

If state law requires an unbroken chain of assignments we still have one at that point.  The homeowner doesn’t wind up with a “free house”, but the bank that originally funded the loan (whether directly or via a warehouse line they were providing the money for) gets stuck with whatever loss might accrue as a consequence of the foreclosure, instead of trying to foist it off on the taxpayer.

And that, my friends, is exactly as it should be!

Source: The Market Ticker