For Respecting Contracts and Not Respecting Contracts in the Foreclosure Fraud Crisis.

David Dayen has an interview with Congressman Brad Miller, “Protecting bank solvency has been a goal of Treasury that I do not share”, that you should check out. Brad Miller is at the front of the foreclosure fraud crisis, recently signing a letter urging the newly created FSOC council of regulators to meet to investigate the servicer issues.

Here’s a fun point he brings up:

Q: Do you get the sense that Republicans are paying attention to this issue at all? What will they do with it in the majority?

Rep. Miller: Blame borrowers. Or, I’m sure they’re going to find some way to argue that it’s all government’s fault, liberals’ fault. I’m sure they’re scrambling. They probably have a full team at AEI and Cato working on that now. They’ll have some experts with a complete explanation come January.

Heh. I wonder what the conservative/libertarian line will be on the whole topic. I don’t know, but I do have some questions on conflicting thoughts I’ve seen. I’m going to use the writings of Mark A. Calabria, who runs Cato’s financial regulation studies, though I’ve seen this from many. Here’s Calabria, May of 2009, writing after cramdown (‘lien stripping’ or mortgage modification in bankruptcy) failed, With ‘Cramdown’ Rejection, Is Senate Ready to Respect Marketplace Contracts Again?:

After rejecting the proposed ‘cramdown’ changes to the bankruptcy code, the Senate may be slowly waking up to the need to respect contracts. One cannot rebuild trust and confidence in our markets, while at the same time trying to destroy the trust that underlies contractual relations. Were the cramdown legislation approved, the message to investors, or any market participants, would be that the enforceability and terms of your private agreements will be subject to the direction of the political winds.

Mike here. The most important thing here is that contractual relations are enforceable, not subject to whims or the winds of politics or power. Even though our system of property rights and secured credit are deeply embedded in our laws, if two people made a contract over a mortgage under a regime of the law to then change that law, bankruptcy or otherwise, would insult our system of marketplace contract and introduce all kinds of moral hazard into the equation. Even if it would involve fixing a disastrous collection of conflicts-of-interest and agency problems among the servicers, problems that are going straight to the bottom line of investors through junk fees and to the cohesion of neighborhoods through bad-faith modifications, contracts are contracts, and we must carry them out.

And I’m certain that this is consistent. If it turned out that banks and mortgage originators cut corners by not passing along the notes, violating Pooling and Service Agreements and trust law, they’d have to eat the losses. If it turned out they didn’t pass along the notes, and couldn’t foreclose without “actively” seeking out those notes which would violate trust law, that’s their problem. The moral hazard of changing the rules for the banks or turning a blind eye to this activity would be deafening, and Lord have mercy on anyone who would violate the sanctity of the courts by bringing in fake documents to provide standing to foreclose. Am I right or am I right?

Calabria on October 14th, 2010, White House Right to Oppose Moratorium (my bold):

Whatever mistakes might have been made by lenders do not change the basic fact: most foreclosures are happening because the borrower is not paying the mortgage…Of course, in the small number of cases where a real mistake has been made and a foreclosure is moving forward against a borrower who is current on their mortgage, the courts have the ability to stop that from proceeding. In judicial foreclosure states the easiest solution to this problem is for the judge to ask the borrower, “When was the last payment you made?” If it has been awhile, say over six months, then the foreclosure should proceed, and proceed quickly… And if we ever expect or hope to see private capital come back into the mortgage market, then government needs to stop threatening to steal away that capital once it’s invested. The current efforts by states to use technical mistakes by lenders to allow borrowers to remain in homes without paying could ultimately undermine the very concept of a mortgage: that it is a loan secured by property. Instead, we risk seeing mortgages turned into another form of unsecured lending, which would raise interest rates for everyone.

Four points:

1. There is no Foreclosure Batman. There are no vigilante foreclosures. If you tell me that you aren’t paying your mortgage, and I don’t own the mortgage and the note, I can’t kick you out of your house. That’s basic. If you aren’t the mortgagee, you don’t have a direct interest in the outcome, therefore you can’t bring a suit. This is not a technicality to be hand-waved away. We are dealing with laws surrounding secured credit and trust law, two fields where strict requirements are essential. These are the dot-the-i’s cross-the-t’s fields, fields where it has long been established that these things matter.

2. And to now hand-wave it all away would generate a massive amount of moral hazard for the banking industry, a bailout on par with TARP. Going back to 1928, New York trust law is very strict on how assets get into a trust (“Mere words never constitute a delivery”, see also Section III here). There’s a century of very strict and clear rules in how to set up a trust, and the PSA’s all these institutions signed were even clearer.

3. Calabria suggests that we toss out the process of judicial foreclosures in the states that have it, replacing it with a ‘current or no?’ style question and get foreclosures to “proceed, and proceed quickly.” Calabria doesn’t suggest how he’d compensate homeowners for this taking. Having a court vet your foreclosure is like buying an embedded option in your mortgage, and like any option you pay for it. Karen M. Pence, of the Board of Governors of the Federal Reserve System, has an excellent paper, Foreclosing on Opportunity: State Laws and Mortgage Credit, that lays out quite clearly that mortgage lenders price in the costs of judicial bankruptcy in states where it exists.

States have different markets for housing; the housing market in Ohio is not Florida is not Texas is not California. It is appropriate and wise that state governments exercise a federalism in writing foreclosures laws tailored to their local markets, and then having capital markets price that in accordingly. To just hand-wave away a legal option that consumers are paying for isn’t right, especially when there are allegations of fraud across the entire securitization industry.

(4. Also, private capital and investors hate cramdown? Someone should tell this Blackrock Vice-President, who went to the Wall Street Journal op-ed page and called for cramdown in light of all the foreclosure fraud we are seeing. Remember: cramdown protects investors and capital from the abuses of servicers and banks working as middlemen, abuses that we learn more and more about each day.)

But ultimately those who thought we need to respect contracts and the law when it came to opposing cramdown now have to consider that respecting contracts might mean trustees have no standing to foreclose. Respecting contracts when it hurts for investors and borrowers, but wanting to give leeway for contracts when it protects the largest banks and servicers. How’s that for a dilemma?

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10 Responses to For Respecting Contracts and Not Respecting Contracts in the Foreclosure Fraud Crisis.

  1. Andrew says:

    I like the idea of “Foreclosure Batman,” though I suspect many on the Right would prefer a “Foreclosure Dirty Harry”

    FDH: You come to me, snivelling “where’s the note, do I have all the paperwork, do I have standing… you and your type are scum, you’re deadbeats. I don’t need a stinkin’ note. I just need ….. this!” [Commits gratuitously violent act involving large firearm. Audience cheers]

    In a different universe, Tanta enjoyed a full recovery from cancer, and has blogged the last three years at Calculated Risk, and we all are not only better informed but have made tiny little changes that are going to fix this. Her archives are a cornucopia of nudges and warnings about what we’re seeing now:

    On the one hand, mistakes just do get made, in any business. On the other hand, the mortgage industry’s back room got incredibly sloppy during the boom. You had experienced closing and post-closing staff laid off and replaced by temps who don’t know an endorsement from a box of Wheaties, you had loans being sold by brand-new entrants into the business with no experience in these legal transactions, you had gigantic pressures to move loans through the pipeline into a security as fast as possible and paperwork be damned, you had a business too comfortable working on reps and warranties and indemnifications–on a promise to make it good if it ever blows up rather than fixing it now. You had regulators of big depositories that were sound asleep when it came to such operational “trivia.”

    And this kind of thing with Deutsche Bank and the foreclosure mess is the result. And when Wall Street analysts stand up and demand that companies beef up back rooms, pay veteran employees rather than outsourcing, and slow the hell down so that things are done right the first time, I’ll eat every promissory note I’ve ever endorsed. For every little Tanta with her hands on her hips demanding competent but expensive operations, there’s some Chainsaw Al out there “streamlining” the company.

    Sigh… as they say, read the whole thing (it’s very funny, as a lot of her writing was).

    Mike, you, dday, Adam Levitin and the rest of the #ffraud gang are doing us all a great service. Keep up the good work. I have a very bad feeling it’s all going to end in tears, as those tring to hold the busted big banks together run out of fingers to put in the dyke.

  2. Mark Calabria says:

    Mike – I’m truly touched by the attention. It is really heart warming. But you know I never “suggested” we just allow foreclosure by parties who do not actually own the mortgage. I’m all for learning and debating, but if we can stick to honest, factual debate, I think we’d all be better off. And the fact that “foreclosures” are priced into the rates is no excuse. Our tax rates are higher due to deadbeats (like our Treasury Sec) not paying their taxes, by your logic then, it is fine if someone stops paying taxes, as its already priced into the tax rates.

    And as to the Republicans having their team here at Cato, I guess that explains why we had Barney Frank over here on Friday to help us cut the defense budget. You might be a front for some political party, Cato isn’t.

  3. Mike says:


    Thanks for commenting.

    “But you know I never “suggested” we just allow foreclosure by parties who do not actually own the mortgage.”

    I didn’t say you did here. It does sound like at the time you thought the issues being found were “technical mistakes,” and I’m wondering if you still think that over the past 6 weeks of new info. And I’m interested in seeing how people on the right (and left!) change their opinions with the increasing information about fraud, cutting corners, PSA violations, etc. we’ll be finding in the next months. To me, the libertarian reaction isn’t clear here, but then again I’m not one.

    I did use the word “suggests” to say that you thought judicial foreclosure proceedings in states that allow them should be replaced with speedier ones, which I thought was a fair reading of what you wrote. I just want to bring up that we need to take into account that people pay for the option to have a full-length judicial review for foreclosures proceedings, and that if you de facto remove judicial review, which it sounds like you are at least considering, it take away from something homeowners paid for.

    I’m not sure I follow the tax rates argument. People sell put options all the time, and this is just a conceptual legal put option embedded into the laws surrounding the execution of a foreclosure. Perhaps it was mispriced, but that doesn’t seem like a reason pressure people into not exercising it if it is ‘in-the-money’ (so to speak).

  4. jpe says:

    “If it turned out that banks and mortgage originators cut corners by not passing along the notes, violating Pooling and Service Agreements and trust law, they’d have to eat the losses.”

    It really depends on whether the breach is a material breach. If it isn’t, and if the contract doesn’t call for any liquidated damages or specific remedies (and I scanned one this morning and saw neither, although I could’ve missed something), then no, they wouldn’t have to eat the losses. It would just be an immaterial breach for which there’s no remedy.

  5. Adam Levitin says:

    Here’s another following and not following contracts point: modification of interest rates, but not of principal. Both repayment of principal and payment of interest are part of the mortgage note contract. Yet somehow one (principal) is sacred, but the other (interest rates) are not. Of course this is driven by accounting–there’s no loss recognition when future interest is written down, but there is when principal is written off. Yet at the 11/16 Senate Banking Committee hearing David Lowman from Chase was mouthing this ridiculous sanctity of contracts line out of one side of his mouth while from the other he was boasting of the number of contract modifications Chase has done.

  6. Adam Levitin says:

    jpe– you’d be right if this were simply a matter of contract law. But it isn’t. Trust law doesn’t look for a material breach. It simply looks for compliance with the trust documents, and in NY if there isn’t compliance, the transfer is void, which means that there aren’t any loans in the trust–and that’s surely a material problem.

  7. jpe says:

    Are there any cites on point for that proposition? I’ve searched and can’t find anything terribly helpful. The notion that failure to deliver would void the transfer to trust altogether sounds a bit too much like magical incantantation (acknowledging that much of trust law is, to a certain extent, about magical incantation)

  8. Random Blowhard says:

    Can you run a first world economy on Banana Republic RULE OF WHIM?. My money says no. But hey look on the bright side, with a GDP per capita like MEXICO or ARGENTINA all the wars will end, your military will crumble ala Soviet Union, the bailouts will end, corporate welfare will end and your government will shrink. The civil wars, pogroms and executions will even help entertain the masses when they go to sleep under bridges at night.

  9. Pingback: Halloween Costumes, Foreclosures, Creditor’s Bargains and how the 1% View Our Laws on Debt | Rortybomb

  10. Pingback: For a few links more « Fraser Sherman's Blog

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