Deconstructing The Black Magic of Securitized Trusts
Wed Dec 19, 2012 by Oppenheim Law on Foreclosure Defense, Foreclosure Fraud & Foreclosure Law
Below is an abbreviated version of an article written by Roy Oppenheim and Jacquelyn Trask, which was first published this week by Thomson Reuters. The longer version of “Deconstructing The Black Magic of Securitized Trusts” was published earlier this year by the Stetson Law Review.
From 2003 to 2007, Florida saw the largest real estate boom in its history. Real estate sold at astonishing prices as people were sold a bill of goods known as the “American Dream.” But for many, that American Dream turned out to be the American Nightmare. From sub-prime mortgage lending and predatory practices by mortgage brokers, lenders and improper securitization of mortgages, this era of economic boom led to the largest crash in the history of the real estate market1, a crash from which Florida has yet to recover, and to which we have not yet seen the end. The full extent of the damage inflicted by these practices has not yet been felt, but millions of homeowners nationwide have suffered from financial crisis, foreclosure and bankruptcy. And what is worse yet is that the systemic fraud and illegal conduct of the banks has continued to pervasively infect court systems throughout the nation; further, the Florida court system has suffered from extreme abuse at the hands of the banks that have high jacked it and effectively turned it into a private collection agency for the banking industry.2
Mortgage securitization is perhaps one of the least understood areas of the real estate industry, and for good reason. With phrases such as mortgage bundling, securitized trusts, and tax-exempt structures known as Real Estate Mortgage Investment Conduits (“REMICS”), there are many terms employed to describe massive collections of bundled mortgages which were broken up and sold off in pieces. While this method of bundling mortgages was once looked at as perhaps the best thing to ever happen to the mortgage industry, allowing large scale investors such as pensions and retirement funds to own interests in mortgages in a way that was deemed “safe,”3 the securitization process has become a nightmare for the American homeowner fighting foreclosure. In fact, the securitization process has made it impossible in many, if not all cases where a mortgage is held in a securitized trust, to determine who actually owns a mortgage and note, a fact which until recently has done little to slow down the foreclosure rocket-docket.4
Perhaps the most confusing issue when dealing with securitized trusts and what those trusts mean with regard to foreclosure standing is understanding “securitization.”5 A simplified definition of securitization is that it is a “process where thousands of mortgage loans are bundled together into financial products called mortgage-backed securities.”6
In general, the securitization process and resulting trust are governed by what is known as a Pooling and Servicing Agreement (PSA), which sets forth the exact steps necessary for (i) a trust to be created, (ii) for the bundled mortgages to be transferred into the trust, (iii) for the issuance of securities by the trust to the depositor or on the open market, generally to institutional investors, and (iv) for the maintenance of the trust once created in order to maintain favorable tax status.7 In a foreclosure filed by a trustee on behalf of a securitized trust, the Pooling and Servicing Agreement is the key piece of documentation needed from the bank in order for the Judge to determine whether the trust owns the loan being foreclosed.8
Perhaps one of the most frustrating things about explaining securitization is getting people to understand that with the securitization process, the substance is the form.9 Often the general public does not understand that while it may seem trivial that person A signed the foreclosure documents and really person B should have, it is these distinctions that are crucial to proper securitization.10
During the robo-signing crisis in which the banks on Wall Street fraudulently “verified” millions of documents in order to fix their mistakes, some of the biggest names in the news media made light of the significant repercussions that such practices have for the history of the American legal and recording system.11 On October 9, 2010 the Wall Street Journal published an editorial titled “The Politics of Foreclosure.”12 The Journal’s editorial board wrote:
[t]alk about a financial scandal. A consumer borrows money to buy a house, doesn’t make the mortgage payments, and then loses the house in foreclosure—only to learn that the wrong guy at the bank signed the foreclosure paperwork. Can you imagine? The affidavit was supposed to be signed by the nameless, faceless employee in the back office who reviewed the file, not the other nameless, faceless employee who sits in the front.13
The South Florida Law Blog published a response to this outlandish opinion, pointing out the extreme disregard this Wall Street Journal’s editorial board gave to the legal requirement of standing, and the consequences that such blatant disregard for our constitutional protections could have.14
Your editorial completely disregards an important constitutional concept of legal standing. Standing is the substantive due process notion of what a party must do in order to have the legal right to bring a legal action through our judicial system. Without the protective concept of standing, anyone could sue anyone at any time, ultimately causing legal anarchy. To fabricate standing, the banks used fraudulent assignments, bad notaries, and allowed for perjured documents to be presented to judges. The banks were forced to engage in such conduct because . . . the banks broke the mortgage into different parts, splitting the Note from the Mortgage by assigning the Mortgages to a third party (MERS) and selling the Notes to another entity. The Notes were than further sold off in traunches [sic] . . . Questions will be asked for a generation how banks literally hijacked the judicial system turning it into their own collection system while dispensing with the rules of law that have protected property right owners from the day our great nation was founded.15
The same argument is then made for a trust that missed the closing deadline, but got the assignment done eventually.16 The true question becomes, “where do we draw the line?” While the lenders who improperly securitized mortgages would love for the public and judiciary to believe that it is “close enough,” the whole point is that in securitization, close-enough just doesn’t cut it.17 As Professor Adam Levitin succinctly stated in his written testimony to the House Financial Services Committee Subcommittee on Housing and Community Opportunity:
Securitization is the legal apotheosis of form over substance, and if securitization is to work it must adhere to its proper, prescribed form punctiliously. The rules of the game with securitization, as with real property law and secured credit are, and always have been, that dotting “i’s” and crossing “t’s” matter, in part to ensure the fairness of the system and avoid confusion about conflicting claims to property. Close enough doesn’t do it in securitization; if you don’t do it right, you cannot ensure that securitized assets are bankruptcy remote and thus you cannot get the ratings and opinion letters necessary for securitization to work. Thus, it is important not to dismiss securitization problems as merely “technical;” these issues are no more technicalities than the borrower’s signature on a mortgage. Cutting corners may improve securitization’s economic efficiency, but it undermines its legal viability.18
Also noteworthy is that many of the big lenders who securitized mortgages, and the high-priced law firms who represent them, have internal documents discussing and warning of the repercussions of failing to properly securitize, and the impact that creating new assignments of mortgage could have.19 In October 2010, Citi published an internal document called Foreclosures Gone Wild.20 Summarizing a conference call, Citi stated:
It appears that in many instances during the mortgage securitization process over the past few years, the paperwork was not properly transferred. If the paperwork was not transferred in the legally required manner, it raises questions . . . about the validity and tax exempt status of the trusts in which the mortgages reside.21
Further, Citi pointed out that by attempting to fix the problems created by the bad transfers, the bank may have inadvertently provided proof that this argument is valid:
Banks have attempted to remedy the aforementioned problems by having employees sign affidavits that they have personal knowledge that the trust was once in possession of the necessary documents. Two problems have emerged with regards to these 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 [sic] were legally swearing that they did. Second, the affidavits may be irrelevant because the issue is not that the documents were lost but that they were never properly transferred at each step of the aforementioned securitization process.22
To test the theory that the securitization failure was systemic, Abigail Field with Fortune Magazine did a field study on hundreds of foreclosure documents.23 This study confirmed that this is a system-wide failure.24 The article was prompted following the deposition testimony of a former Countrywide employee who testified on the record that the trustee at the time of the foreclosure, and in fact since the origination of the loan, had never had possession of the note for a particular mortgage.25
On November 16, 2010, in response to numerous articles being published regarding foreclosure defense strategies including problems with securitization of MBS, The American Securitization (“ASF”) published an article in the ASF White Paper Series titled “Transfer and Assignment of Residential Mortgage Loans in the Secondary Mortgage Market.26 In an effort to repair the damage being inflicted by foreclosure defense attorneys and securitization experts who were attacking improper securitization methods, the ASF outlined the securitization industry’s position on why perfect securitization is not necessary to enforce a note and mortgage.27 The ASF cited alternative rules such as the Uniform Commercial Code (UCC) and common contract law, under which they argued their methods were more than sufficient.28
The largest problem with these arguments is of course the PSA, which governs and supersedes both the UCC and common law.29 The traditional rule has always been that parties are free to elect the law that applies to contract, and to contract around common law principles.30 Another interesting point is that the PSA was specifically designed to govern a securitized trust because contract common law combined with trust law is virtually indestructible when it comes to the intent of the parties to the contract, which in this case intended very specific rules of transfer.31 Combined, trust law and contract law set forth extremely rigid principals for the transfer of interests, requirements that are significantly relaxed under the UCC and other types of law over which the ASF is claiming control.32
One of the first courts to recognize the failure of the banks was Judge Christopher Boyko sitting in the United States District Court Northern District of Ohio Eastern Division in the case In Re Foreclosure Cases.33 At the time of the decision in 2007, securitization and the debate that raged between experts on both sides of the fence had not even reached the public forum.34 In support of his decision, despite conficting state decisions, Judge Boyko stated:
This Court acknowledges the right of banks, holding valid mortgages, to receive timely payments. And, if they do not receive timely payments, banks have the right to properly file actions on the defaulted notes—seeking foreclosure on the property securing the notes. Yet, this Court possesses the independent obligations to preserve the judicial integrity of the federal court and to jealously guard federal jurisdiction. Neither the fluidity of the secondary mortgage market, nor monetary or economic consideration of the parties, nor the convenience of the litigants supersedes those obligations . . . [u]nlike . . . [s]tate law and procedure, as plaintiffs perceive it, the federal judicial system need not, and will not, be “forgiving in this regard.”35
