Arnold Kling  

The Real Foreclosure Scandal

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The Washington Post is filled with the story again. Once again, they get it wrong, in my opinion.

If mortgage servicers were foreclosing on the wrong borrowers, that would be a scandal. That would be if they send the foreclosure notice to an incorrect address, or if they foreclose on a borrower who has actually made payments. Maybe there are stories like that, but I have not seen any.

Instead, we are seeing stories about improper signatures on paperwork. Glenn Reynolds, who disagrees with me on this issue, says that what the banks are doing is analogous to me stealing money out of a bank drawer and saying it's ok because I have an account there. I think it's more analogous to me signing my wife's name to a check that I deposit in our joint account.

The real scandal is that the process of recording property title is so antiquated, and there are so many interest groups that resist modernizing it. The MERS mortgage database shows what a modern system could look like. But all of the counties that charge fees for title recording, the title "insurance" companies that shake down home buyers to buy "protection" from getting sued to prove that they own their property--these interest groups want to keep the title recording system as expensive and unreliable as possible.

The real foreclosure scandal is that it is taking so long to get people who have stopped making payments out of their homes. Those costs are shifted to the rest of us. Moreover, from now on, any mortgage lender has to raise the interest rate on a mortgage loan in order to take into account the fact that the lender's losses in the event of a default are going to be much higher.

There may be individuals who are facing foreclosure for whom I would feel sorry. But, in my opinion, anyone who is fighting for delinquent borrowers as a class is doing damage to the economy and, furthermore, is on the wrong side of justice.


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COMMENTS (30 to date)
GU writes:

Agreed, especially re: the antiquated recording system. When I first learned about the way we still record titles, I almost could not believe it.

j... writes:

Banks didn't just use the wrong signature - they lied when they said that the signature was correct. Because of that, we simply do not know what is right and wrong. That is the main part of the problem: the one safeguard we have in judicial foreclosures is the integrity of the participants in the system (forced through attestation).

I'm all for updating our systems to reflect more efficient exchanges of information. And I agree that groups with self-interest block such efforts. But, the way to do that isn't by fiat. The way to do that is to work harder to update the recording systems we have in place. I find it hard to believe that the major players (i.e., the other groups with self interest) are really so disenfranchised from the process that they cannot update through legislation the recordation system.

Process matters, even if it gets us the wrong answer.

Rebecca Burlingame writes:

And in rural areas of the country where economies are not strong, titles are still routinely put together in ways that make it absolutely impossible to sell property, taking our system of (former) capital and asset mobility back to the good old days of the Soviet Union.

thrill writes:

The mortgage mess would not exist if we disallowed secured loans for primary residences. Several things would happen - people loaning money would take more care who it was loaned to. People borrowing money would need to save more before being able to get a loan. Prices of houses would market adjust to more stable values rather than speculative ones. The Fannie's would not exist. Elected officials would have less power. Unicorns would dance.

Geoffrey writes:

I am amazed that people are trying to defend the position that someone who has not paid their mortgage gets to still stay in their (former) house free just because all of the paperwork is not perfect.

Even if it is flawed, they should still leave the house that they are not paying for. Obviously for those who have been making their payments, any false foreclosure should have a speedy process to stop that. However, I haven't seen any stories of people getting kicked out of houses that they are actually paying for.

ChacoKevy writes:

"Maybe there are stories like that, but I have not seen any."

http://www.calculatedriskblog.com/2010/09/oops-no-mortgage-and-still-foreclosed.html

http://consumerist.com/2010/04/bank-of-america-forecloses-on-then-auctions-off-home-with-paid-up-mortgage.html

But even in these stories, it doesn't appear to be systemic yet, just screw ups (at this time)

dnak17 writes:

The rule of law is important in lending and banking as it is when talking about assassinating American citizens, strong-arming BP to set up recovery funds, or any number of health care related issues.

Matt writes:

Banks require title insurance, not title companies. They just sell the product banks want. It's not required between a buyer and seller.

MERS does not track the property, and whether the owner actually owns what they claim they do, or whether they sold part of the tract off, or died and had three heirs inherit it. So MERS isn't much of an example of an improvement in title tracking. It will tell you what bank claims an interest though!

The counties charge fees, true, but they also maintain records going back to the patent. And states set those fees, not the counties typically. There's no doubt the states have been raising those fees, but that's so they can increase revenue without taxes.

Despistado2 writes:


"Process matters, even if it gets us the wrong answer."

Especially if it makes us lawyers rich.

AaronT writes:

I have to agree with Arnold and several commenters here: This is not really a foreclosure scandal at all. No one is disputing that these people have defaulted and are therefore eligible for foreclosure, just that the paperwork establishing which financial institution has a claim the to the property is not complete. The fact that the former owner has no right to live there is decided and irrelevant to the issues here.

I understand a lot of the controls around foreclosure proceedings are designed to keep people off the streets, if even for a brief time. The best way to solve this while getting people out of homes they inevitably will have to leave is to offer every defaulted borrowr who agrees to accept foreclosure a free UHaul and two movers for a day completely free of charge and paid for by the government. The costs would be miniscule in comparison to arriving at a cleared housing market sooner rather than later. Until buyers believe that the supply of homes, and therefore prices, are relatively stable, this market will fail to clear and the resulting uncertainty will continue to take a heavy toll on the economy. Unfortunately, the administration and most pols seem committed to keeping people in their homes and delaying the inevitable as long as possible.

libarbarian writes:

forged documents != "improper signatures".

Nice try though.

The fact is that the banks ignored both their legal duty as well as their contractual obligation to transfer the notes when they were bundling these mortgages into RMBSs. Now that they want to foreclose and don't have the notes they need to establish standing they have resorted to forging them en masse.

Their fault. Their problem. They should be the ones to suffer for it.

bandit writes:

Thrill
-
You're certainly right that banks would be more careful - they'd be so careful you'd pretty much have to pay cash.

Oh, please! But you'll defend the predatory actions of the banks. Everyone is guilty in this mess. But if you're going to save one of the guilty parties, Wall Street, than you have a moral obligation to save the other. What's happening here is that the disgusting behavior of the banks is coming home to roost and, thank goodness, Americans and the press are starting to have some heart for Main Street. Clearly, the banks gave the moralists an opening by their shady shenanigans. It's time to level the playing field.

~ Halli Casser-Jayne
http://www.thecjpoliticalreport.com

Joe in Morgantown writes:

MERS may be a good idea.

Here is a bad set of ideas: 1) ignore existing title laws 2) set up an alternate system and 3) lie about it to the courts.

It's worth mentioning Karl Denninger's theory that the reason the packagers liked the MERS system was because it aided their fraud against the MBS investors.

Hopefully, we can discuss MERS or a MERS like system going forward. But, the clunky, old system has show itself resistant to fraud. And resistance to fraud is much more important feature than (extreme) convenience.

Mencius Moldbug writes:

I think the phrase you're looking for is Torrens title. It's basically MERS with the rule of law behind it.

In jurisdictions with Torrens title - invented over a century ago - "title insurance" is basically nonexistent or (as in Canada) costs a couple hundred bucks. I've paid something like $10K for mine, because they ding you again when you refinance. Our present chain-of-title system dates to the Norman Conquest, or something. Actually, I wouldn't be surprised if it predates the Norman Conquest. The Domesday Book would be a serious improvement. Huh?

When reading Tocqueville's actual notes from his American journey, I was surprised to note the extent to which he considered the ancient Anglo-American common law intrinsically inferior to the new Code Napoleon. This is not to be dismissed lightly, from such an Anglophile. America's legal system needs a serious top-down overhaul. Torrens title would be a no-brainer improvement.

[Comment edited for crude language.--Econlib Ed.]

ThomasL writes:

@libarbarian

Their fault. Their problem. They should be the ones to suffer for it.

The contract has two parties, you know. The lender and the borrower. The borrower is obliged to pay. The lender is obliged to receive the payment, and to follow certain delineated steps if they do not receive the payment.

Even under the most bank-skeptical view, the borrowers in question do not seem to be meeting their obligation to pay.

I see that first stage (pay/receive) as the essence of the contract, with the recourse as a secondary effect.

The banks have messed up the prosecution of their recourse, but that doesn't give everyone a pass on their requirement to pay.

I'm not saying the banks are bright or honest either one, but I am saying that regarding foreclosure they look more like knaves than villains.

In a better world they'd have all collapsed long ago.

Dan Hill writes:

In the 19th century the governor of South Australia, John Torrens, implemented a new land titling system which has come to be called the Torrens system.

The basic principle is that to be valid in law all claims to real property must be recorded on the central title register maintained by the state. A purchaser need only visit the title office and inspect the title record there to be 100% sure of the ownership and any other claims on the property (liens, easements etc). If a claim isn't recorded there as far as the courts are concerned it doesn't exist. So there is not such thing as title insurance.

The US as the colonial power in the Philippines in the early 20th century gave them the Torrens system rather than their own.

How you get from here to there is not trivial, but it is achievable. As you point out though, there are plenty of vested interests to oppose it.

ThomasL writes:

@DanHill

The only thing is we'd want 50 Torrens systems, not one.

Matt writes:

Even in countries with a Torrens system, international banks doing large commercial transactions are going to want title insurance.

Probably works well if you start out with it fresh. Be extremely difficult to do now. You'd have to federalize a significant part of state property law.

Dan Weber writes:

Okay, so if the banks paperwork isn't right, what happens? Is their no mortgage? Can Citibank go through its portfolio, find the mortgages that weren't filed properly, and cancel them?

I'm reminded of the late Tanta's screed about how little anyone in her bank cared about accurate documentation:

http://www.calculatedriskblog.com/2007/11/deutsche-bank-fc-problems-and-revenge.html

One vice president of my client who had had to drag the secretary of the board off the golf course on a sunny Saturday afternoon was good enough to tell me just exactly how unlikely I was to ever get work in this town again.

If I recall correctly the whole episode, which included flying Tanta half-way across the country on a few hours' notice to visit the vault where these original notes were kept, cost the seller about $20,000. It would have cost somebody about $20 to have had a new endorsement stamp made after the merger that included the "successor in interest" verbiage. Throughout the whole thing, Tanta kept explaining that one can spend a whole lot more than $20,000 if one of these puppies goes to foreclosure and some sharp-eyed attorney notices a bad endorsement/assignment chain.

I also found this fun article about the sorry state of finance reporting:
http://www.calculatedriskblog.com/2007/01/tanta-information-is-power-which-is.html

Learner writes:

One good effect of Obama's veto is that it keeps the Federal gov't out of State courts' business in one small way.

Something like MERS could make the market in real property much more efficient, but it absolutely must be arrived at by organic legal processes that satisfy all those traditional players in this space. Instituting it as a political favor to MBS holders just perpetuates the FNMA mistake.
Legalizing a flawed scheme that is easily corrupted pollutes the whole economic environment.

Possession is nine tenths of law. Only an agent holding clear title can demand foreclosure. Sorry if mortgage costs rise, but that's better than property rights eroding!

j... writes:

@ Dan Webber: "Okay, so if the banks paperwork isn't right, what happens? Is their no mortgage?"

The note is still there, and the obligations. Just the legal right to foreclose is, well, foreclosed. We are conflated two sets of issues in this comment thread, though. There is the problem with lying in a court affidavit (what happened to GMAC/Ally), and the inability to foreclose when you can trace recordation properly (this is basically the Massachusetts "Ibanez" problem that is up to the Mass Supreme Court [the SJC]: http://ma-appellatecourts.org/display_docket.php?dno=SJC-10694 ).

Laocoon writes:

Arnold, I'd love to hear your opinion on the perverse incentives built in to the mortgage servicing fee structure. It seems to me that getting paid a spread [percentage of the loan payments] gives the servicer every incentive to cut costs. Big guaranteed income with every payment coming in, with little to do, equals higher and higher profitability for the servicer.

During the refinancing boom, no problem, the loan got a cash payoff, again, with little work involved [unlike delinquent loans or foreclosure proceedings]. Book another loan, and so on.

So there is every incentive for the servicers to be as sloppy as possible, until/unless someone was enforcing compliance. In securitizations, that should be the trustee, but the typical trust indenture provisions are pretty weak until something goes wrong. Likewise, investors really don't play an active role in making sure they 'know where their loans are.' Securitizations were not intended to work this way, but unfortunately greed and speed gutted the social and legal contracts to make the mechanics of these deals work the way they were intended.

Hugh Watkins writes:

As the Finance Industry is just about 100% in the hands of university graduates it may be fair to observe that paperwork does not seem to have a high priority in most university courses.

Will Paperwork 101 soon be taught? Will we see learned titles such as "Paper clips vs. Stapling: a Gender Perspective"?

What does this latest mess do for signalling?

Just asking.

W. Bell writes:

"Those costs are shifted to the rest of us".

What about the costs of AIG which have been shifted to the "rest of us"? And all the other obligations which have been shifted to the "rest of us"?

The "home" is special in our society. Read the 3rd Amendment to the Bill of Rights. Think of searches and seizures regarding the home as opposed to an automobile or public place.

No other debt has "forebearance" and "rights of redemption".

Not even the mighty Wall Street banks can denigrate the protections, though they may try!!

Alan writes:

Australia has separate Torrens systems for each state and territory. Title insurance is basically unknown, because the registrar-general must compensate you (subject to limited exceptions) if you lose your land by fraud, administrative error, etc. Title fraud and error is vanishingly rare. Australian law would treat 'improper signatures' as fairly serious criminal offences.

Danny writes:

libarbarian, what "forged documents"?

James A. Donald writes:

"The real foreclosure scandal is that it is taking so long to get people who have stopped making payments out of their homes."

But the reason it is taking so long is that no one knows who owns the mortgage, what payments were owed, what the terms of the mortgage were, whether they were in fact paid, or who they should have been paid to.

We have an extremely complicated financial system that is suddenly revealed to be run by people who just are not competent or well organized.

ParatrooperJJ writes:

Actually its much more like me going to court with an affidavit saying that I think that I own my neighbor's house and since they have not been paying me I want to forclose. The affiadavits they have been filing are meant to be used if there was a fire or other calamity and the original documents had been destroyed. They were not meant to be used because that banks were too lazy to convey the morgages properly.

JohnG writes:

If the title system is antiquated, the solution is to get law makers to change the law, not to create an alternative, illegal system and then hope you can "convince" law makers to ratify it later.

Kling's analogy is also not very good. A better one is if your wife was signing a check in your name today, and then trying to pass it off as proof that you had actually signed the check 3 years ago.

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