Mortgage mess leaves much to be sorted out

The Congressional Oversight Panel of the TARP, which I chaired until it ceased operations earlier this year, held a number of hearings and issued numerous reports on problems within the federal government’s Home Affordable Modification Program.

I came to suspect that the entire system in place to bundle and sell mortgages through “securitized” mortgages might be fatally flawed.

When you bought a new home before the 1960s, you negotiated with a lender for a mortgage that was then filed at the county property office. In most places, by law, any time ownership of that mortgage changed, the change had to be filed at the county property office.

Beginning in the ’60s, banks developed a system called securitization that combined many individual mortgages into a security that was then sold to investors. That led to a dramatic increase in the rate at which ownership of mortgages changed hands. In order to avoid having to record repeated changes in ownership of millions of mortgages at thousands of county property offices, major banks devised a workaround: the Mortgage Electronic Registration System. MERS, which was incorporated in Delaware in 1995, was supposed to fix the problems underlying the mortgage market.

It didn’t. In April of this year, most of the large housing lenders, including Bank of America, Wells Fargo and Citibank, settled a complaint brought by the Federal Reserve, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision related to a range of shoddy practices in the mortgage market. The lenders committed to pay to correct major problems with their foreclosure procedures. The settlement revealed many problems, including banks’ practice of filing foreclosure affidavits with unverified information.

Since then, other problems have surfaced. A number of courts around the country have questioned whether MERS has the legal right to transfer mortgages. It seems that every day more information comes to light demonstrating that the management failures identified in the April settlement were widespread. It now looks like MERS and the system set up to legalize securitization was jerry-built at best. Mortgages and other documents have been lost or destroyed or, in some cases, were never legally signed in the first place. Files have disappeared. Evidence of falsified statements is pervasive.

Sheila Bair, until recently head of the Federal Deposit Insurance Corporation, said in testimony before Congress last December that “while the legal challenges under the representations and warranties trust requirements remain in their early stages, they could, if successful, result in the ‘put-back’ of large volumes of defaulted mortgages from securitization trusts to the originating institutions.”

Those court rulings are no longer in their “early stages,” and the ultimate cost to the banks could be staggering. The major banks are now in settlement negotiations with the 50 states’ attorneys general. Numbers in the billions are being discussed. However, Attorneys General Eric Schneiderman of New York, Beau Biden of Delaware, and Martha Coakley of Massachusetts want to make sure that any settlement allows their investigations to continue so that all evidence of wrongdoing comes to light. If those investigations disclose that the whole mortgage system is as bad as recently indicated, hundreds of billions may be at stake.

When I was in the Senate, I fought along with Ohio Sen. Sherrod Brown to include in the Dodd-Frank Wall Street Reform Act an amendment that would have slimmed down the megabanks to assure that no U.S. financial institution was too big to fail. Our amendment failed. These recent mortgage-related developments have made that amendment, or something like it, even more important if we are to avoid another financial crisis.

Three things must change. First, federal regulators must put in place real size limits and slim down the too-big-to-fail banks to assure that no taxpayer money is to bail out any bank. Second, the new Financial Stability Oversight Council, established in the Wall Street Reform Act, must thoroughly scrutinize the risks to our financial system posed by MERS and other non-bank players in our financial system. Finally, the attorneys general must assure that no settlement precludes further investigations to determine fault and damages for victims.

Originally published 31 Jul 2011 on