An Extremely Long Metaphor to Explain Mortgage Chaos

Happy New Year, America...

Have multiple relatives en route to my home this morning, but wanted to post a few thoughts on an interesting story that came out this week before I disappear into a weekend of overeating and meaningless NFL games.

The piece, which came out Thursday, is the Washington Post's feature on MERS, the electronic mortgage registration company that is at the center of the foreclosure/mortgage bubble mess. MERS is the brainchild of the mortgage-lending industry and is essentially an effort at systematically evading taxes (more on that in a moment) and hiding information from homeowners in ways that enabled the Countrywides of the world to defraud investors and avoid legal consequences for same.

The idea behind MERS was to wipe away centuries of legal tradition that mandated the physical transfer of loan notes and ownership information. Whereas lenders once were required to physically register with county clerk offices every time a mortgage loan was extended or re-sold, MERS provided an "electronic registry" of mortgage notes where all such transfers were recorded in the wiry brain of a giant computer instead of on paper.

Instead of the individual banks or lenders registering with the counties each time a loan was sold or re-sold, MERS would handle the initial registration and then become the "nominal" note-holder. Then, each time the note was passed on, MERS would record the transaction in its computer -- but no matter who the actual owner of the note was, MERS would remain the legally registered assignee of the note.

Imagine, say, a family of twelve, two elderly parents in Iowa and ten adult children scattered in different states all over the country. Mom and Dad on the farm own one Ford F-150 that they owe $300 a month on. Every month, the truck gets passed to a different family member, who in turn becomes responsible for the monthly payment. But no matter who has the car and whose turn it is to come up with the $300, the truck stays in Dad's name and the money, in the end, comes to Ford Finance via Dad's checking account.

Looking at this as an individual and unique case, you wouldn't think there was much that was inherently wrong with this setup. Obviously the family arrangement violates the spirit of many laws and procedures -- vehicle registration (from month to month, the true owner of the car is hidden from the state), credit application (Pops technically committed credit fraud if he got the car loan in his own name knowing the children would actually be paying), and taxes/fees (the state misses out on its registration fees every month, when the car is informally "sold" from child to child without the nominal paperwork fees being paid to the DMV of the state in question). But again, looking at this as an individual case, not many people would say any of these "violations" were major moral transgressions, if they were really moral transgressions at all. After all, this is family!

But once you take this setup and institutionalize it, and employ it everywhere on a vast scale, it becomes seriously problematic. This is particularly true if, say, Pop begins allowing his kids to "rent" the car out to non-family members, so long as they kick a small fee upstairs. Say it's March and Pop gives the truck to son Jimmy in Toledo; in April Jimmy gives the truck to his buddy Rick in Akron, charging the $300 payment plus a $20 convenience fee. May: Jimmy gives the car to his girlfriend Trudy in Phoenix, telling her to wire $300 plus another $20 back to Pops in Iowa; she in turn lends the car to her occasional lesbian love interest Madison, who begins renting the car on a day-to-day basis in Tuba City as part of her family's Painted Desert Resort and Tourism business, etc. etc. And she's now kicking the fees back to Iowa.

Within a year Pop is buying fifty vehicles an hour and shuttling cars to new customers all over the country, collecting millions in fees every day; he becomes a billion-dollar corporate fixture, hiring the entire local Elks club to come with him to work as support staff.

So now, to take this already absurdly overwrought metaphor one final painful step further, there is a string of grisly homicides being committed on highways across America. Witnesses spot that original F-150 truck and the license plates at each of the murder scenes, but when cops come looking for the truck owner, they find old Pop in a wheelchair in Iowa, alibied on the night of every crime by forty-five fellow members of the Dubuque Elks. They drag Pop into the station to question him, but he won't give up which of his boys did the crimes -- hell, he doesn't know, anyway.  

This, roughly, is what MERS is. The functional effect of MERS is to create an obfuscatory wall between the homeowner and the actual owner of his mortgage loan. The problem with MERS is a paradox at the heart of the "ownership" question. On the one hand, MERS is the legal assignee of a lot of these mortgage notes. On the other hand, it's not the "real" owner of the notes, in any way that could ever help you, or the state, or the investors in mortgage-backed securities. From the Post piece:

Some state courts agree. The Missouri court of appeals said in June 2009 that MERS lacked the authority to assign a mortgage from one service company to another. Because the transfer by MERS "had no force," the court ruled, the owner of the loan "lacks a legally cognizable interest" and could not pursue the delinquent borrower.

The Kansas Supreme Court ruled in August 2009 that MERS did not have any interest in the underlying property of a bankrupt borrower whose home was auctioned - even though MERS was listed as the mortgagee. Moreover, the court said that the MERS transfer of the mortgage was invalid because the owner, Sovereign, had never recorded its interest in Ford County, Kan.

In short, the mortgage industry considers MERS owner enough to foreclose on you, but not owner enough to be sued, or reasoned with, or even to provide basic customer service. As noted in the above passage, the courts are beginning to disagree with the industry's position here, but it's a long process. In short this was the perfect ownership structure for a subprime industry geared toward massive fraud and predatory lending, in which mountains of dicey loans were issued factory-style and quickly sold off so that the original lenders could not be on the hook when they blew up.

It's not a surprise that MERS was at least in part dreamed up by Angelo Mozilo of Countrywide. Again, from the Post piece:

The savings and loan crisis had just passed and the mortgage business was picking up again. At the time, an unconventional entrepreneur named Angelo Mozilo was on the MBA board. Eventually Mozilo would pay a $67.5 million to settle Securities and Exchange Commission allegations of fraud and insider trading. But back then Mozilo was one of the industry's most admired executives, known for his inventiveness and technology investments at his firm Countrywide Financial, which in 1992 catapulted to first place among the nation's mortgage originators.

Mozilo began brainstorming with a young MBA technology expert, Brian Hershkowitz, about ways to computerize and centralize the way the industry did business to take it to a new level.

"Angelo Mozilo loved to think about that," Hershkowitz recalled. He was "the inspiration" for what would eventually become MERS.

Another detail here: for those of you wondering why so many localities are broke, here's one small factor in the revenue drain. Counties typically charge a small fee for mortgage registration, roughly $30. But with MERS, just like with Pop and his pickup truck, you don't need to pay the fee every time there's an ownership transfer. Multiply that by 67 million mortgages and you're talking about billions in lost fees for local governments (some estimates place the total at about $200 billion).

Outrageously, MERS actually marketed itself to its customers as a way to save money by avoiding the payment of legally-mandated registration fees. Check out this MERS brochure from 2007. It brags on the face page about its fee-avoiding qualities ("MINIMIZE RISK. SAVE MONEY. REDUCE PAPERWORK") and inside the brochure, in addition to boasting about helping clients "Foreclose More Quickly," it talks about how clients save money because MERS "eliminates the need to record assignments in the name of the Trustee." 

All of this adds up to a system that enabled the mortgage industry to avoid keeping any kind of proper paperwork on its frantic, coke-fueled selling and re-selling of mortgage-backed securities during the bubble, and to help the both the Countrywide-style subprime merchants and the big banks like Goldman and Chase pull off the mass sales of crappy loans as AAA-rated securities.

Anyway, the Post has some amazing factoids in it. I took particular note of this passage:

But critics say promises of transparency and of ironing out wrinkles in record-keeping haven't panned out. [MERS], which tracks more than 60 percent of the country's residential mortgages but whose parent company employs just 45 people in a Reston office building, is on the firing line now.

Emphasis mine there. Forty-five people, tracking 67 million mortgages. Does anyone wonder why the system is in chaos?

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