Should we return to paper-based mortgages?

We like to live in a world where everyone gets the same deal. If you can buy a washing machine at Sears for $500 then I don't want to pay more. And if it happens that the speed limit is 45, it should be 45 for both you and me.

While a general notion of equality permeates our society, it doesn’t permeate everywhere. When it comes to foreclosures, the rules and standards for borrowers and lenders are very different. When borrowers have something to lose it takes certificates, declarations, insurance, documents, oaths, and notaries to avoid foreclosure — but when lenders want to take a home then too often proof is just a technicality, something which need not trouble the legal system.

Until now.

Take Our Word For It

“It used to be that foreclosures were a fairly simple process,” says James J. Saccacio, chief executive officer at, the leading online marketplace for foreclosure listings and data. “When a mortgage was first created the borrower signed a note acknowledging that a debt was owed and outlining the repayment terms. If the loan was not repaid, the note was evidence that the debt existed and that the terms of the agreement had been violated. No less important, state rules typically required the lender to have the note in hand before a foreclosure could begin.”

The good old days of financial clarity are now largely gone, rather than a lender, a note and a borrower we now have a new system which works like this:

First, the borrower gets a loan from a lender, only now the “lender” is often a mortgage broker who has no cash.

Second, the lender sells the loan to an “issuer” on Wall Street such as a bank or brokerage. The issuer bundles thousands of loans together. The combined loans are then used to create a mortgage-backed security (MBS). Pieces of the mortgage-backed security with differing levels of risk are sold to investors. The investors are paid interest from the mortgages and the principal as loans are repaid.

Third, the borrower makes payments to a “servicer” who has been hired by a mortgage “trustee.” Who is the trustee? Essentially, the trustee represents the investors who own the mortgage.

So what happens if a mortgage must be foreclosed? The servicer or the trustee take the borrower to court, if a hearing before a judge is even required.

No Record

If you go through the current process of buying and selling mortgages you will notice there’s a quirk in the system. The loan was first recorded in local property records as a debt owed to the original lender. All the later packaging, securitizing, selling and re-selling has not been recorded in local records. Instead electronic chits are being bought and sold. There’s a digital record, an electronic accounting of who owes what to whom. In the eyes of a growing number of judges, however, only the original lender who has the note can foreclose — but that’s not possible because the original lender no longer owns the mortgage and the location of the note is unclear.

So how has ownership of the loan been transferred? Typically the transfer is done through the Mortgage Electronic Registration Systems (MERS). “MERS,” says the company, “was created by the mortgage banking industry to streamline the mortgage process by using electronic commerce to eliminate paper.”

In other words, with MERS it’s claimed that there’s a right to foreclose even if a mortgage note with the current owner’s name is not locally filed — or filed at all.

The company explains that MERS acts as nominee in the county land records for the lender and servicer. Any loan registered on the MERS System is inoculated against future assignments because MERS remains the nominal mortgagee no matter how many times servicing is traded. MERS as original mortgagee (MOM) is approved by Fannie Mae, Freddie Mac, Ginnie Mae, FHA and VA, California and Utah Housing Finance Agencies, as well as all of the major Wall Street rating agencies.”

Follow The Money

Much of the reason for electronic records was to enable the development of mortgage-backed securities and avoid the bother and costs of local recordation offices every time loan ownership changed hands. This electronic system is not yet in shambles, but if a number of judges and attorneys have their way the moment of reckoning is not far off.

One of the interesting aspects of the MERS system is that it allows lenders to transfer loan ownership without the bother of filing new paperwork with local recordation offices.

“Lenders save at least $25 for every new loan they register on the MERS System,” said Carson Mullen, executive vice president of the MERS customer division, in 2007. “Since the beginning, MERS has saved the mortgage industry over $1 billion in unnecessary costs.”

But if you’re a local government you now have one less stream of income. Some of that $1 billion might be yours. No less important, a number of courts are not accepting the contention that loan ownership can be transferred electronically without re-recording the note.

No Note, No Foreclosure

There are now a small but growing number of cases where lender assertions of loan ownership have not been accepted by individual courts. These cases are important because they give foreclosure defense attorneys ammunition to stop foreclosures.

In 2007, Federal Judge Christopher Boyko ruled that 14 foreclosures could not proceed in Ohio because the lender shown on public records was not the lender who had brought the foreclosures to court. To Boyko, it was the ownership record shown in local offices that counted, not electronic assignments.

In August, the Kansas Supreme Court ruled in a foreclosure case that “MERS did not demonstrate, in fact, did not attempt to demonstrate, that it possessed any tangible interest in the mortgage beyond a nominal designation as the mortgagor. It lent no money and received no payments from the borrower. It suffered no direct, ascertainable monetary loss as a consequence of the litigation. Having suffered no injury, it does not qualify for protection under the Due Process Clause of either the United States or the Kansas Constitutions.”

In June, the Missouri Court of Appeals determined that a foreclosure could not go forward because “there is no evidence in the record or the pleadings that MERS held the promissory note or that BNC (the lender) gave MERS the authority to transfer the promissory note. MERS could not transfer the promissory note; therefore the language in the assignment of the deed of trust purporting to transfer the promissory note is ineffective.” (Parenthesis mine).

In An effort to re-write federal law would meet stiff opposition from many states, states who want pieces of that billion dollars. The whole question would become a well publicized political matter. No doubt the headlines would read “Banks Want New Rights To Foreclosure,” a headline that would discomfort politicians and enrage voters.Whatever the decisions above, it’s important to say that most foreclosures with MERS assignments float right through the judicial system. Whether that will be the case in the future is less certain than even a year ago.

The Coming Mess

Let us imagine for a moment that the MERS system is over-turned in a series of court rulings. Then what?

If it’s not possible to foreclose through MERS, and if most loans are now part of the MERS system, then how can borrowers be compelled to make their monthly payments? What’s the quick alternative to MERS that will protect the interests of investors?

This is important because if investor interests cannot be protected then why would any insurance company, pension or rich individual buy mortgages? If local lenders can't sell mortgages then why would they make new ones? Without fresh financing home sales would essentially stop, home values would plummet without buyers and every property owner would be impacted even if their home was paid in full.

One option would be to change federal law to plainly authorize the MERS system. However, the standing of lenders and investors in Washington is just about zero. As Rep. Barney Frank (D-MA), chairman of the House Financial Services Committee, told the Washington Post, “the larger financial institutions have the opposite of political clout today. They’re radioactive.”

An effort to re-write federal law would meet stiff opposition from many states, states who want pieces of that billion dollars. The whole question would become a well publicized political matter. No doubt the headlines would read “Banks Want New Rights To Foreclosure,” a headline that would discomfort politicians and enrage voters.

But the reality is that we need a reliable property records system so that investor interests are protected and to assure that no home is ever taken unfairly. Something will have to be done if MERS is repeatedly and successfully challenged. Toward this end, it many be necessary to create a nationwide foreclosure moratorium, call in the accountants to audit every mortgage-backed security, physically locate every mortgage note, and update every local property record. This could only be done at enormous cost and over a period of a few years, something not likely to be favored by banks, brokerages, trustees or mortgage brokers — but a joy to the nation’s property recordation offices as well as CPAs, accountants and bookkeepers everywhere.

Peter G. Miller is syndicated in more than 100 newspapers and operates the consumer real estate site, .