Foreclosure Fraud For Dummies, 2: What is a Note, and Why is it So Important?

(This is a series giving a basic explanation of the current foreclosure fraud crisis: Here is Part One. This is Part Two, Part ThreePart Fourand Part Five.)

The SEIU has a campaign: Where’s the Note? Demand to see your mortgage note. It’s worth checking out. But first, what is this note? And why would its existence be important to struggling homeowners, homeowners in foreclosure, and investors in mortgage backed securities?

There’s going to be a campaign to convince you that having the note correctly filed and produced isn’t that important (see, to start, this WSJ editorial from the weekend). This is like some sort of useless cover sheet for a TPS form that someone forgot to fill out. That is profoundly incorrect.

Independent of the fraud that was committed on our courts, the current crisis is important because the note is a crucial document for every party to a mortgage. But first, let’s define what a mortgage is. A mortgage consists of two documents, a note and a lien:

The note is the IOU, it’s the borrower’s promise to pay. The mortgage, or the lien, is just the enforcement right to take the property if the note goes unpaid. The note is crucial.

Why does this matter? Three reasons, reasons that even the Wall Street Journal op-ed page needs to take into account. The first is that the note is the evidence of the debt. If it isn’t properly in the trust then there isn’t clear evidence of the debt existing.

And it can’t be a matter of “let’s go find it now!” REMIC law, which governs the securitization, is really specific here.  The securitization can’t get new assets after 90 days without a tax penalty, and it can’t get defaulted assets at all without a major tax penalty. Most of these notes are way past 90 days and will be in a defaulted state.

This is because these parts of the mortgage-backed security were supposed to be passive entities. They are supposed to take in money through mortgage payments on one end and pay it out to bondholders on the other end, hence their exemption from lots of taxes; the tradeoff is that they can’t be de facto managers of assets, and that’s what going to find the notes would require.

For Distressed Homeowners

The second is that it also matters a great deal for homeowners who are distressed. The note lays out the terms of late fees and other penalties. As we will discuss in the next section about mortgage servicers, the process of trying to get people behind on their payments current instead of driving them into bankruptcy has broken down. But for now it’s clear that mortgage servicers don’t have great incentives to get distressed homeowner’s records correct.

There’s well-documented evidence that extra fees are tacked on to mortgages that have fallen behind, fees that aren’t following the terms of the note. This is usually only found out in bankruptcy where there is a lawyer (and multiple parties), not in foreclosure cases. But if homeowners wants to challenge whether what the servicers claim is the correct final due amount, the terms of the note are necessary for the court.

This will matter a great deal for many homeowners. Small, marginal differences in the total owed could allow for a short sale. It could determine if the homeowner has any equity in their home. And this can only be determined by producing the note.

For Investors, Who Took This Seriously at the Beginning

Last reason: you can tell it’s important because all the smartest finance guys in the room thought it was important. Let’s look at a Pooling and Service Agreement form from 2006 between “GS MORTGAGE SECURITIES CORP., Depositor, and DEUTSCHE BANK NATIONAL TRUST COMPANY, Trustee.” (h/t Adam Levitin for this example.) Let’s reproduce the chart from part 1 to see the chain between depositors and trustees who oversee the trust:

So what agreement did they come to when it comes to the proper handling of notes in securitization? Did they think this was no big deal, or that it is something serious? From the PSA (my bold):

(b) In connection with the transfer and assignment of each Mortgage Loan, the Depositor has delivered or caused to be delivered to the Trustee for the benefit of the Certificateholders the following documents or instruments with respect to each Mortgage Loan so assigned:

(i) the original Mortgage Note (except for up to 0.01% of the Mortgage Notes for which there is a lost note affidavit and the copy of the Mortgage Note) bearing all intervening endorsements showing a complete chain of endorsement from the originator to the last endorsee, endorsed “Pay to the order of _____________, without recourse” and signed in the name of the last endorsee…

The Depositor shall use reasonable efforts to cause the Sponsor and the Responsible Party to deliver to the Trustee the applicable recorded document promptly upon receipt from the respective recording office but in no event later than 180 days from the Closing Date….

In the event, with respect to any Mortgage Loan, that such original or copy of any document submitted for recordation to the appropriate public recording office is not so delivered to the Trustee within 180 days of the applicable Original Purchase Date as specified in the Purchase Agreement, the Trustee shall notify the Depositor and the Depositor shall take or cause to be taken such remedial actions under the Purchase Agreement as may be permitted to be taken thereunder, including without limitation, if applicable, the repurchase by the Responsible Party of such Mortgage Loan.

Read that again through to the end and use the chart to follow the chain. If more than 0.01% (!) of mortgage notes weren’t properly transferred, the trust can force the sponsor (in this case, Goldman Sachs) to repurchase the bad mortgages.   And this is just one contract for one part of the ~$2.6 trillion dollar mortgage backed securities market.  How’s that for systemic risk?  Especially if this is found to be widespread….

Looking at the documents you see that the smart guys who created these mortgage-backed securities put large poison pills into them to try and prevent the kind of note fraud we are currently experiencing as a country.  They took the policing and legal recourse (and legal ability to cover their ass) very seriously on this issue. So seriously they can force repurchases of this bad debt.

So don’t believe the hype of anyone who says these are just technicalities; the people who wrote the contract didn’t believe they were.

(Special thanks to Katie Porter and Adam Levitin, who you can read at credit slips, as well as Tom Adams and Yves Smith, who you can read at naked capitalism, for in-depth discussions on this material.)

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32 Responses to Foreclosure Fraud For Dummies, 2: What is a Note, and Why is it So Important?

  1. Pingback: Foreclosure Fraud For Dummies, 1: The Chains and the Stakes « Rortybomb

  2. Jack Straw says:

    “Last reason: you can tell it’s important because all the smartest finance guys in the room thought it was important. ”

    I would non-concur here. The note is important not because the SGITR think its important, but because it’s fundamental to proving debt. There’s an old saying: “‘A’ students become professors, ‘B’ students go to Wall Street, ‘C’ students become the judges.” While this isn’t strictly true in my experience (except for the professors), it is true that judges think the note is important, and I listen to them over the SGITRs, generally.

    While it is important, there is another problem – the negotiability of those notes is not always obvious, and it is frequently the case that they are not negotiable instruments, and thus not under the UCC. As Prof. Dale Whitman (Nelson & Whitman, Real Estate Transfer, Finance & Development) writes in a recent law review article (“How Negotiability Has Fouled Up the Secondary Mortgage Market, and What to Do
    About It”):

    “There is simply no way to resolve this question [of negotiability] conclusively. Yet, it seems bizarre that the negotiability of the most widely used mortgage note form in the nation (Fannie Mae’s), employed in many millions of transactions, is uncertain and that no one has bothered to do anything to clarify it.”

    It will be up to the courts, and as Whitman’s article makes clear, this is an issue that has not been extensively addressed. He argues that the securitizers simply didn’t care whether the note was negotiable.

    In addition, I would amend this statement “If it isn’t properly in the trust then there isn’t clear evidence of the debt existing.” There is plenty of evidence of the existence of the debt (that is, there is a whole loan package including copies of the note), but what is not clear is who is the lawful obligee/payee after transfer[s]. The reason why the negotiability/non-negotiability question is so important is that the have different rules for transfer, possession and claiming ownership. The assumption that the UCC rules control is not necessarily right. If the note isn’t negotiable, common law mostly controls.

    The forced repurchase option will only be effective for solvent originators, so long as they are solvent, which won’t be very long, particularly as FHA is probably going to be first in line – before private labels (for sure).

  3. Pingback: What is a note? - Massive Mortgage Mess

  4. lagarita says:

    Here’s a question that’s been bothering me for a while:

    I’ve been poking around county recorder websites for while. At least in my state, a real estate transaction typically involves recording a deed transferring the property and a deed of trust that gives the lender a lien on the property. I remember reading someone (maybe Tanta at CalculatedRisk) saying that you could require that the note also be recorded. So the question is: if notes were recorded would that solve the problem with not being able to locate them? Would a copy of a recorded note be an adequate substitute for the original? Or would the note have to be re-recorded every time it changed hands? Which would be why we have MERS, right?

  5. Jack Straw says:

    Terminology is frequently misused. Although “mortgage note” is not incorrect, it is confusing, and it generally just means “note.” There is a mortgage, meant to be recorded, which generally has to be recorded to be a perfected lien. Since “mortgage” is often used interchangably with the broader terms “home loan” or “real estate loan,” I actually prefer the term “security instrument’ for precision. And there is the “note.”

    Notes are unrecordable. Statements about how notes are unrecorded is a major peeve of mine. They are not meant to be recorded. They do not conform to recordation standards.

    Suggestions to the effect that they should be recorded are a good tipoff to take whatever else a poster says with a grain of salt. Regrettably, this suggestion is frequently part of too many posts.

    Notes are unrecordable. In addition, the original can be like cash and meant to be kept secure. Sending it to a county for recording would be gross negligence by whomever did it.

    Did I say notes are unrecordable and they’re not meant to be recorded?

  6. Jack Straw says:

    Deed of Trust = security instrument. Another reason I prefer that term.

    • Micheas says:

      A deed of trust is not at all like a mortgage from a legal point of view.

      Most non-judicial foreclosure states use a deed of trust, which is where the homeowner gives the deed (the house) to the lender with the promise that the lender will return the deed/house when the loan is paid off. The lender has the house, so there is no statute of limitations.

      A mortgage is a lean against the property, and in california at least, is void 40 years after the last payment has been made, or when the loan is paid off.

      States that have mostly mortgages and not very many deeds of trust can probably clean up the title messes just by shortening the statute of limitations for the debt from the last payment. Deeds of trust do not have such an elegant solution to clear up the titles, that I am aware of.

  7. lagarita says:

    Thanks for the replies Jack.

    At my local county recorder, there are examples of recorded notes. They all seem to be the result of ‘owner carry’ sales.

    Are you saying that the language of a note does not meet legal standards so that recording it has no value? Or that only the original paper document is valid so that recording it is meaningless – if you can’t produce the original signed note, any recorded copy doesn’t help you?

    Finally, does that mean that MERS really has 2 functions – the electronic registration part and warehousing of the actual physical notes?

    It seems odd to me to be so dependent on a physical document – if the warehouse burns, then you can’t foreclose?

  8. Dylar says:

    Pretty sure that the quoted language allowing for repurchase is only if a copy of the recorded instrument, i.e. the mortgage lien, (not the note, which is not recorded,) isn’t produced within 180 days. Hard to tell from the quote, really.

  9. Pingback: Moral Hazard and the Foreclosure Crisis « Synthetic Assets

  10. Pingback: The foreclosure scandal « Jim’s Blog

  11. Pingback: FT Alphaville » The MBS mess from the beginning – the deal docs

  12. Pingback: The Media Consortium » Weekly Audit: Will Obama Save Homeowners From Wall Street’s Latest Fraud Scheme?

  13. Pingback: The Media Consortium: Weekly Audit: Will Obama Save Homeowners From Wall Street’s Latest Fraud Scheme? |

  14. “Produce the note” started back in january-february of 2009. Funnily enough, the AP article discussing it is ‘no longer available’. I’m not a suspicious man, but…

    • Micheas says:

      One issue causing confusion is that the note does not need to be produced for a non-judicial foreclosure(CA and NV), but it does for a judicial foreclosure, while in a judicial foreclosure (NY and FL) it does need to be produced.

      However, if the borrower in a non-judicial foreclosure state declares bankruptcy the debtor can demand that the creditor provide proof that they are the party that the debt is owed, before the debt can be released from bankruptcy court.

  15. Jack Straw says:

    Seller carry-backs are frequently forms off the internet, or old stationary store forms. You do raise a good example where the note is part of the security instrument. That would be recorded, but despite it being a note, and because it is a security instrument. The ordinary forms used by commercial lenders (Fannie/Freddie forms) would not combine these documents.

    So, I do stand a little corrected. But still, as general rule, a stand-alone note should never be recorded, and generally would be unrecordable. For example, it contains no property legal description, is not acknowedged in front of a notary, and basically, would have no effect anyway, because it is not a security instrument.

    Interestingly, however, if a stand-alone note was recorded, official certified copies of it (by the county recorder or registrar) might be admissible as evidence in some states. You definitely have a conflict of rules between statutes authorizing admissibility of official certified copies as originals on the one hand, and rules about original notes being required. I suspect this conflict would be resolved by referring to the more specific rules about notes, and then allowing for “lost note” exceptions. Just a stab.

  16. Pingback: Midday open thread - Online Political Blog

  17. Obtaining a note:Do u have to get leagal obtain a note and if not how do u go about doing so,just ask the lender? Joe Belyeu Jr.

  18. Pingback: Foreclosure Fraud: what is really happening? - Also sprach Analyst

  19. zach says:

    How does this differ between title theory and lien theory states?

  20. Gene Perez says:

    its hard to believe that this mess is still going around these banks pretty much caused this mess most of the homes in my area are either foreclosure or short sales and I cannot believe this mess is still going on.

    Santa Maria Homes For Sale

  21. leslie says:


    In May 2005 we deposited and invested $200,000 in Real Property, where we recently found out that $118,800 was embezzled out of our property from Mortgage Lenders and Trust Brokerage Companies, namely Goldman Sachs through an escrow Transaction. The $118,800 in funds was paid to these embezzlers from the Investors unbeknownst that the securitization happened by encumbering our property and making up a fraudulent fake Promissory Note and Deed of Trust.

    See the link for further information:

  22. Pingback: The Morality of Requesting a Note « Rortybomb

  23. Pingback: The Alchemy of Securitization |

  24. Frederick Turner says:

    They need to put these people in Jail.. The Bankers thats the only way we can stop this Greed

  25. Pingback: Mortgage-gate begins! | Don't Panic!

  26. Pingback: Moral Hazard and the Foreclosure Crisis — Clearing and Settlement

  27. Misty Stidham says:

    Plz feel free to notify me via email

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