Arnold Kling  

Foreclosure Paperwork

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Lifted from the comments:


If the shoe were on the other foot, if people who had obviously paid their mortgages were being thrown out of their homes because of some trivial defect in the loan documentation, would these same commenters be arguing in favor of it? I doubt it. It would be seen as Kafkaesque, and with good reason.

Exactly. Consider these situations:

1. The borrower is paying the mortgage, but the borrower did not properly sign some document at settlement.

2. The borrower is not paying the mortgage, but the lender did not properly sign some document.

Your response can be.

a) The bank has a right to foreclose and take possession in (1), and the borrower has a right to remain in his home in (2). That is nitpicky, but consistent.

b) The borrower has a right to keep his home in (1) and the bank has a right to foreclose in (2). That is what I think of as a reasonable point of view.

c) The borrower keeps his home in both cases. The bank should know better, but the borrower should be let off the hook. I think this is a popular position to take, because people love to treat banks as villains and borrowers as victims, but I think it amounts to mob rule rather than the rule of law.

Speaking of mob rule, Neil Munro writes,


Five big banks have agreed to give twenty-three Democratic attorneys general more than a billion dollars that can be distributed to housing groups and community organizers in the months prior to the 2012 election.

That is part of the "settlement" for the foreclosure paperwork foulups.

Have a nice day.


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COMMENTS (16 to date)
Bill Nichols writes:

Choice (c) is not entirely crazy. The banks are the professionals in a regulated industry and can reasonably be expected to adhere to higher standards of competence and conduct than most purchasers. But it is a matter of degree.

Resolving this by nitpicky adherence to rules and regulations *is* crazy. Common law would sort this out over time on a case by case basis, setting precedents on how the laws should be applied. Altogether, I'd rather take my chances in equity than in contract courts. Regulators on the other hand usually lack nuance. Of course the former is expensive and the latter is relatively cheap.

Warren Grimsley writes:

The Banks are villains for improper due diligence and the deadbeat mortgagees are thieves for failing to pay; ergo, the villainous banks should be put out of business and the deadbeats should be thrown out of their homes. Unfortunately, economists and politicians ache at this bad equilibrium even if it would clear two markets at once.

AngryKrugman writes:

But this assumes strict liability. One could certainly consistently hold viewpoint (c) if you believe banks more likely to knowingly falsify documentation than homeowners (who may have the "trivial" defect simply by mistake). We maintain rule of law while allowing for distinctions all the time--mens rea in criminal law, negligence vs. strict liability in torts, etc.

Tacitus writes:

Sorry to get all lawyerly about this, but it won't do to just talk about "some document at settlement" -- it makes a big difference whether we are talking about the note, the mortgage, the promise to correct, an acknowledgement of receipt of some required disclosure, or some other document. What most people looking at the foreclosure paperwork problems don't want to deal with is that U.S. mortgage lending stands at the intersection of four types of law with very different approaches to paperwork: negotiable instruments law (notes), real property law (mortgages), consumer protection law (required disclosures), and residual common law (everything else). What's nitpicky paperwork in ordinary common law terms is absolutely essential in real property law because of centuries-old adherence to the Statute of Frauds, and essential in different ways under negotiable instruments law because of the Uniform Commercial Code and its common-law predecessors.

Of course, the banks don't want to have to deal with this complexity, either -- they just want some ill-defined equitable principle to sweep away all of the formality requirements and allow business as usual to continue. But due process, it seems to me, requires that if we're going to dismantle the whole edifice of law that underpins mortgage lending, it should be done in a transparent and prospective way. All of the mortgage loans at issue right now were originated in good faith pursuant to all of the arcana that is now dismissed as nitpicking.

Matt writes:

I think reasonable people agree that the banks should be held to a higher standard than individual consumers. However that doesn't mean the banks should forfit their stakes in the houses.

However, there is a difference between not having proof you own something and creating fraudulent documents that say you own that thing. The banks are acting like outlaws, and that doesn't make them very sympathetic. If banks can't be bothered to perform reasonable due diligence on transactions that valued in the 100's of thousands of dollars they deserve to go out of business. The fact that bank of America still exists is a stain on this nation.

rpl writes:

It's worth noting that at least some mortgages (including the one on my previous home) have a clause stating that both parties agree to cooperate in correcting "clerical errors," so that would preclude option (a).

Arguing that option (c) is reasonable because banks should be held to a higher standard is counterproductive. Even the pros make mistakes, and banks are well aware of this. Therefore, if we take that position, then banks will just charge higher rates to cover the inevitable losses from munged paperwork. Thus, we all play a little more in order to fund windfalls for the lucky few who get their mortgages invalidated due to bad paperwork. My state already has a lottery, so I'd prefer not to get one bundled with my mortgage. That leaves option (b) as the only viable alternative.

The question of fraud is a red herring. People who forged documents should be prosecuted, no question about it. That, however, is completely irrelevant to the question of whether the loans should be collectible. Moreover, to the extent that there was fraud, the borrowers cannot reasonably be said to have been the victims of it, since they suffered no loss from it. Therefore, it makes no sense to compensate them (to say nothing of community organizers -- it's hard to see their becoming party to the settlement as anything but pure politics).

Jeff writes:

It's worth noting that the lender's failure to sign some document is not impairing the validity of the lien, it's that when the loans were securitized or sold, the liens weren't transferred into the new owner's or servicer's name. The fact remains, however, that a valid lien on the property exists and somebody has a right to foreclose on the property and take possession when the payments stop; it's just that, due to some sloppy record-keeping in our lovely government-engineered and steered mortgage finance system, figuring out exactly what party holds that right is not always easy.

That's the situation. The people in that other comments thread working themselves into a tizzy about widespread bank fraud and felonies and so forth do not appear to actually grasp this.

rj sigmund writes:

we're not talking paperwork foulups, we're talking fraud; here's simon johnson:

http://www.project-syndicate.org/commentary/johnson29/English

Eric Morey writes:

rpl,

"Even the pros make mistakes, and banks are well aware of this. Therefore, if we take that position, then banks will just charge higher rates to cover the inevitable losses from munged paperwork. Thus, we all play a little more in order to fund windfalls for the lucky few who get their mortgages invalidated due to bad paperwork."

Wouldn't we want the market to price this into the cost of operations of banking? Banks better at avoiding errors and not encouraging fraud and actively preventing fraud would be rewarded with higher margins or higher transaction volume and thus profits. Your mortgage linked lottery ticket is priced accordingly and you as a consumer can find additional value with research.

Bill Nichols writes:

I have some data on people making mistakes. Humans will make them with alarming consistency. Removing them is another matter, and tends to be somewhat less consistent, but experts are superior to non-experts. Any rational process and set of rules better assume there will be mistakes if humans are involved.

Foobarista writes:

This notion of "bad paperwork makes me a winner" has extremely bad incentives for corruption. How about I get a loan, bribe the loan officer to screw up on purpose, quit paying the mortgage after a few months, and get my house for free?

Bad paperwork should be fixed - and paperwork should be simple to begin with - but it should rarely result in massive and absolute victories and losses.

chris writes:

Could you repeat this in English, I don't know whose side you are on the banks or the proletariat.

ozzie 39 writes:

I have purchased several different parcels of real property, both vacant and improved from sellers who took back a purchase money mortgage as part of the price. I paid all of the payments and the mortgages were discharged. Who would now take back a purchase money mortgage after what has happened to the banks. I certainly would not! And eventually, probably sooner than we think, the banks will stop funding mortgages because: a) the government won't let them charge enough interest to cover the possibility of "loss by paper errors"; b) bank stockholders won't tolerate mortgage lending; c) depositors will withdraw funds for fear of having to cover the losses; or d) some combination of such factors. Where will we be then? How will the real property market work? Who will dare to build a house except for himself?
If you already have a house, keep it. And keep the doors locked.

John David Galt writes:

What this argument ignores is that the contract is "boilerplate" written by the bank. Isn't that supposed to mean, under existing contract law, that they're held to a higher standard than the consumer?

Lori writes:

@Arnold, Assuming it's true that robo-signing and closely related practices were a $100 billion industry then your "settlement" (in scare quotes, as you put it) is literally barely in pennies on the dollar range.

@Tacitus, agreed, but surely banks are producers as well as consumers of complexity?

@Eric-Morey, you mean the more expensive mortgage is less likely to blow up on you? Makes sense. I'm (broadly speaking) at peace with "you get what you pay for." I'm also (a bit more broadly speaking) at peace with "caveat emptor," but the combination somehow seems like a recipe for mischief. In the world as we know it, of course, the most expensive financial products are sold to the least expensive parts of the workforce, and are the most likely to blow up. This being econlog, the borrower is always to blame, but still...

[Comment edited for clarity: "@Arnold" is substituted for "@original-poster". --Econlib Ed.]

William Love writes:

@ John David Galt
There really is no such thing as "boilerplate" at least if you are a competent contract lawyer, I believe you are referring to the concept of Contra proferentem. This idea usually only applies if there is an ambiguity in the contract. I think the better idea is that if you did not sign the contract then you did not assent to the contract. After all if anyone could claim that non-signing of a document was just a clerical error then we all would would be forced to have gym memberships, no trial by jury, and always plea out when accused of a crime because it would be reasonable.

@Jeff Actually there is a very valid concern about the issue of robosigning - its the assignation of blame. Both parties, not just borrowers, can fail in the contracts pertaining to buying a property. The issue here is if the person who holds the note has failed the buyer in its contractual duties. This is an issue apart from people being foreclosed upon, although it can be used to defend against foreclosure. For instance, it is very hard to be convicted of murder even if you assault someone if that person was already truely and soundly dead. Otherwise ANYONE (such as you or I) could foreclose on people and take their houses away and the borrower would never know if their debt was extinguished (even if they had been paying their mortgage).

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