The Too Big To Fail banks have been waiting with trepidation for a ruling from the Supreme Judicial Court of the State of Massachusetts on the case titled US Bank National Association (as trustee) vs. Antonio Ibanez. They were right to be fearful. The state supreme court has ruled against the banks and upheld a lower court order that nullified foreclosures by US Bancorp and Wells Fargo, on the grounds that neither bank had the legal right under Massachusetts law to foreclose. Today’s ruling has far-reaching consequences for the banks and the housing market in general, as it throws into serious question the legal soundness of millions of mortgages in the US if, as expected, courts in other states come to similar conclusions as the Supreme Judicial Court of Massachusetts.
The Ibanez case tied together two separate but similar foreclosure actions in Massachusetts, the second case being that of Wells Fargo vs. Mark and Tammy LaRace. Both foreclosures took place on the same day, the banks having previously published their intention to foreclose in a local newspaper as required by law. The banks then purchased the properties at prices described by the court as significantly below market value. About a year after the foreclosures (in autumn of 2008) the banks then applied to the local Land Court for a ruling that in each foreclosure, the bank had full legal right to foreclose as mortgagee, that the bank title to the property was “unclouded” by any other contesting right, and that the bank therefore owned the property in what is legally known as “fee simple” status. These claims were contested by the property owners who had lost their homes in the foreclosure, and the Land Court agreed with the homeowners that the foreclosures had been invalid. Critical to the decision of the Land Court was the fact that both banks admitted that they did not receive assignment of the mortgage to the property until after the foreclosure.
The State Supreme Judicial Court Upholds the Ruling of the Lower Court
The Supreme Judicial Court found that the Land Court made no errors in its judgment for the defendants. Citing the Ibanez case as an example, the justices noted that Antonio Ibanez executed a mortgage in 2005 with Rose Mortgage Inc., which allegedly assigned this mortgage (which gives the proper holder the legal right to foreclose) to Option One Mortgage Co. They in turn assigned it to Lehman Bros. Lehman Bros. supposedly assigned the mortgage to Lehman Bros. Holdings Inc., which packaged it with about 1,000 other mortgages to be sold as a security. These mortgages were supposed to be placed with Structured Asset Securities Corp, set up explicitly for the purpose of protecting the bondholders who bought the securities. This company was supposed to assign the mortgages to US Bancorp N.A., as trustee. In the event there was need to foreclose on any of the properties, it was the job of US Bancorp to do so, on behalf of the trust and the interest of the bondholders. This is why US Bancorp entered into a foreclosure action against Antonio Ibanez, who clearly had defaulted on his mortgage, and it is why US Bancorp became a plaintiff in front of the Land Court and the Supreme Judicial Court of Massachusetts.
This chain of assignments is important to the case, because all it took for the banks to win was to show up in court with the proper legal documents evidencing the mortgage assignment. They didn’t even have to show up with the original mortgage or the note from the borrower – they just had to have documentation for each link in the chain of assignments. Not only did they not have this, the best they could show was an assignment after the date of the foreclosure, meaning the banks never had assigned the mortgage properly in the first place. This was the basis under which the Land Court ruled against the banks, and which was convincing proof for the state supreme court justices that the foreclosures were never legal.
Carelessness Is a Polite Term for Criminal Recklessness by the Banks
One of the justices who concurred in this decision, Justice Cordry, wrote:
[W]hat is surprising about these cases is … the utter carelessness with which the plaintiff banks documented the titles to their assets.
Carelessness is a polite word. The banks have acted with criminal recklessness. In these and similar cases that have cropped up around the country, it is becoming obvious that the big banks involved in securitizing mortgages during the past 15 years purposefully evaded local legal requirements for registering mortgages and accompanying borrower notes with a county recorder of deeds. The banks sold mortgages to other banks without bothering to transfer to the buyer a proper document of assignment evidencing the sale. Mortgages were bundled up into trusts for the purpose of securitizing them to investors, but the trusts were also never given proper legal evidence of the assignment of the mortgages. Then, when the housing market blew up and banks were forced into pursuing millions of foreclosures, they created the assignments after the fact, used “robo-signers” to submit legal documents to the courts (in one such case the signer had been dead for over five years), falsified notarizations, and in other similar ways perpetrated fraud upon the courts. This is on top of the thousands of documented cases where foreclosures were conducted even though the borrower was not notified in advance, or the borrower was specifically told by the bank to withhold payments in order to qualify for a mortgage modification but then declared in default by the bank, or the bank added thousands of dollars of “late fees” to the borrower’s account, forcing them into default.
Today’s ruling by the Massachusetts supreme court is just one more step in this long judicial argument over foreclosures, but it is consistent with a string of similar rulings from common law courts and bankruptcy judges against the banks. It remains to be seen whether today’s ruling will be appealed by the banks to the US Supreme Court, but this may be highly risky. Real estate law is almost always viewed by the federal courts as the province of state legislatures and courts, so it is hard to overturn a state supreme court on such a matter. Moreover, the banks’ case is exceptionally weak. Banks have been unable in courts anywhere in the US to show up with basic documentation, including a stream of assignments properly executed, that shows they are the holder of the mortgage with a right to foreclosure.
The right of the banks to foreclose on residential property is now being contested in every state. People who have lost their homes in foreclosure are now suing for compensation for their loss, on the grounds the foreclosure was fraudulent. Even more serious than this, investors who bought “mortgage backed securities” are beginning to file claims of fraud against the banks, arguing that these securities were never properly collateralized in the first place. These investors want 100% of their money back, which would lead to claims of trillions of dollars against the big banks.
There are therefore two areas of jeopardy for the big banks. First, investors who bought securities that were supposedly collateralized by mortgages can claim they were victims of fraud, and demand their money back. This means that the big banks will become direct mortgagee not only for the properties in their portfolio now, but for millions more that they must buy back. This could constitute much more than half of all homes/mortgages in the US, of which over 3% are now already in default.
The second problem is that the mortgages in many of these cases may now be deemed legally invalid. This doesn’t mean the homeowner can live for free forever in their home if they default; it just means that the banks have to pursue the defaulting homeowner as it would someone who defaults on an unsecured credit card loan. Credit card defaults are usually absorbed 100% by the banks since there is no collateral to posses and sell. Credit cards therefore carry interest rates as high as 30% p.a., compared to mortgage rates of around 5%, even though the term of a mortgage is much longer. If mortgages were unsecured, they would be priced much closer to 30% p.a. to ensure that the banks made enough money on their mortgage portfolios after taking 100% of the loss on defaults. This would make homeownership virtually unaffordable for any American.
Are You Incredulous Yet?
What is beginning to unfold before our eyes is a situation which can only be comprehended with jaw-dropping incredulity. For at least ten years the large US banks have been selling a product – the residential home mortgage – with a fatal legal flaw that renders it uncollateralized. The product should have been priced like any other unsecured consumer loan – at rates at least triple the actual mortgage rate in the US. There are something like $6 trillion of mortgages extant in the US, among over 55 million borrowers. Most of these mortgages have been grossly underpriced, and at existing default rates, there is simply not enough equity capital in the banking system – and not enough profit being generated by mortgage portfolios - to absorb current losses. Even if you assume the banks don’t have to take a full 100% loss on a home default, and that some portion of the home sale after bankruptcy will eventually trickle down to the bank as a general creditor, the Too Big To Fail banks are doomed to insolvency.
Dragged into this situation automatically is the federal government. The US Treasury owns Fannie Mae and Freddie Mac, which are already insolvent and must turn to the government for capital infusions every quarter just to cover the losses on their existing home mortgage portfolios. These institutions are now facing much higher loss rates on their own portfolios of trillions of dollars of home mortgages. You may throw into this picture also the Federal Reserve System, which chose to buy over one trillion dollars of mortgage backed securities from the banks in 2008 and 2009, and which is itself technically insolvent if this portfolio turns out to be uncollateralized, as is becoming increasingly likely.
With increasing desperation, banks along with their enablers in Washington are going to try to jerry-rig a way out of this problem. Unfortunately for the banks, ex post facto laws are strictly forbidden by the Constitution, which is now being treated with new-found reverence by the Congress. It may be impossible to construct a law that solves problems like this that already exist. Perhaps the banks will get lucky, and some courts will begin to find in their favor, though that is certainly not the trend at the moment. Maybe the US Supreme Court will accept the banks’ argument that the securitization process in itself established a valid foreclosure claim even though mortgages were not properly assigned as required by state laws. This, however, would require the Supreme Court to make up a legal doctrine out of the blue (as the banks have done), thereby overturning all state laws and court rulings going back well over 100 years. Only a Supreme Court bought and paid for by bank lobbyists, and willing to prostitute itself publicly to its paymasters, would issue such a ruling.
This means that the likely progression of events – the path we are now on - will lead to a near complete collapse of the housing market, because the big banks and the two government enterprises responsible for supporting the housing market will be fatally crippled wards of the state. The US government itself, including the Federal Reserve, will be equally crippled. Try as you might, you will find no words in the Bible – no phrases applicable to The Flood or to the destruction of whole cities at the hands of a vengeful God – that appropriately capture the financial gravity of this situation. But if we are forced to come up with some metaphor, Financial Armageddon will have to do.
First published in The Agonist