ANOTHER CHEF IN THE KITCHEN – N.Y. FED RESERVE TO WORK OUT KINK IN SECURITIZATION SYSTEM

In its desire to make corrections in the system with the hope of reinvigorating the secondary market for mortgage backed securities, it has been reported that the Federal Reserve Bank of New York is meeting with key players in the securitization market. This corresponds to the release of a paper last week authored by two members of the Federal Reserve of New York and two outside parties. The paper, titled “A Foreclosure Crisis”, simplistically highlights one of the current problems with the mortgage foreclosure process. While no specific remedies are discussed, the paper looks at the procedural requirements relating to the security interest (the mortgage) tied to the debt (the note) and the “chain of title” requirements when recording the mortgage.

The paper questions the state of the recording laws. The failure of these regulations to keep up with “modern financial practices and technological developments” is the crux of the paper. The authors also direct attention to the complexity of the securitization structures in order to meet the requirement of these more arcane regulations as well as the use of the Mortgage Electronic Registration System (MERS). As we all remember, the “MERS Issue” initially started the whole foreclosure problem, as plaintiffs’ lawyers tried that “razzle-dazzle” to confuse the judiciary as to the rights of servicers to foreclose on delinquent borrowers. The MERS issue also caught servicers not following the requirements of getting proper chain of title documents filed before instituting foreclosure actions.  

The paper heavily cites the congressional testimony of Mark Kaufman, Commissioner of the Maryland Office of Financial Regulation, before the House of Representative’s Committee on Oversight and Government Reform on March 8, 2011. In his testimony, Mr. Kaufman noted that the separation of the origination of a mortgage loan from its servicing “may have facilitated the flow of cheap capital, but [it] also fragmented roles, distorted market incentives, and severely complicated the task of modifying loans to avoid preventable foreclosures.”

Likewise, Mr. Kaufman’s testimony cited in the paper acknowledges that the economies of scale brought on by this securitization and the use of third party servicers drove the consolidation of the mortgage servicing business. This allowed the top five servicers to control almost 60% of the market today, nearly double that from 2000. Mr. Kaufman’s testimony also noted the importance of federal attention to this matter, since the largest servicers are federally supervised entities.

The paper concludes with the state of development for clarifying the current laws and current efforts to revise them. Two organizations, the Uniform Law Commission and the American Law Institute, through their joint Permanent Editorial Board of the UCC, issued a draft report explaining the application of the rules in both Articles 3 and Article 9 of the UCC to provide (i) guidance in identifying the person who is entitled to enforce the payment obligation of the maker of a mortgage note, and to whom the maker owes that obligation; and (ii) determining who owns the rights represented by the note and mortgage.

So, while the chain of title for the recording of mortgages may have gotten rusty from neglect and the individual links may have gotten bent from abuse, it appears that some people are now willing to take on the task of fixing the chain. For if this chain was to break, the 800 lb mortgage gorilla might truly get loose and cause more serious damage to the economy.

To read the paper ”A foreclosure Crisis” by Thomas Baxter, Stephanie Heller, Frederick Miller and Linda Rusch, go to http://www.newyorkfed.org/banking/consumerprotection/a_foreclosure_crisis.pdf

To read the testimony of Mark Kaufman, go to http://www.dllr.maryland.gov/finance/comm/speech-kaufman-03082011.doc.