Chicago Foreclosure Lawyer Blog

Mortgage Servicers Make More Money In Foreclosure

Tue, 17 Jan 2012 12:45:54 -0600

As I had long suspected, mortgage servicers have very strong financial incentives to push for foreclosure instead of modifying a loan. Diane E. Thompson, of counsel to the National Consumer Law Center, recently published an article in the Washington Law Review that analyzes various servicer incentives and how they prompt servicers to select loan modification or foreclosure.

In general, this decision is based on which approach will make the most money for the servicer. Although servicers will claim that an individual investor or group of investors has refused to entertain the idea of a loan modification, more often than not, investors have very little day-to-day involvement with individual loans. These investors are generally owners of mortgage-backed securities. They do not own individual loans, rather, they own an interest in receiving the proceeds from a large pool of loans.

Many investors are entities like pension funds, retirement funds, and other entities that are seeking a stable, long-term investment. In general, it is in an investor's best interest to keep the pool of loans filled with performing loans. Properties that are sold via foreclosure do not provide long-term income, and in many cases, investors see very little of the funds from the foreclosure. This is due to several factors.

First, given the fact that many properties are underwater, a foreclosure sale very rarely obtains an amount equal to the loan balance. Moreover, a foreclosure sale cuts off long-term gains from interest. A lump sum of $150,000 is worth much less than that same amount paid off over a term of 30 years at 5% interest.

Second, before investors see any return from a foreclosure sale, the servicer is paid. Servicing a loan that is in foreclosure allows servicers to obtain fees for late and missed payments, securing a property, hiring attorneys to process the foreclosure, and other costs. The longer a property spends in default and in foreclosure, the more money a servicer stands to make. Servicers make significantly less money servicing a performing loan over the long-term.

It is also worth noting that when servicers offer loan modifications, they often offer modifications that make economic sense for the servicer, not the investors. Many loan modifications provide for missed payments and the associated penalties by tacking the value onto the loan's principal balance. This means that many borrowers end up owing more after a modification than they did prior to modifying. Another popular strategy is to set aside the missed payments and fees in a separate line item. This amount can be paid down over time by making pre-payments, or it becomes a balloon amount due at the end of the modified loan's lifetime. These loans are more likely to default, sending more business back to the servicer.

Most interesting is why servicers don't generally offer principal reductions -- they are normally paid a servicing fee based on the principal balance of the loan. Reducing principal reduces that fee, which is clearly not in the servicer's interest. Servicers are also rated based upon their efficiency in resolving delinquent loans. Pushing to foreclose can help increase this rating and drive more business to the servicer.

Servicers will also keep borrowers in temporary loan modifications as long as they can. This increases the servicer's profit as it is entitled to keep the majority of its fees and penalties that relate to servicing the loan. Additionally, when a servicer denies a permanent loan modification, it can apply further fees related to the partial payments made under the trial modification. Keep in mind, trial modifications do not modify the loan, they are essentially a reduced payment period designed to test a borrower's ability to make reduced payments.

On the whole, the article is worth reading and is accessible to both academics and lay persons. Look for more updates and analysis in the future.

For those looking for a copy of the article on Westlaw or Lexis, the cite is:

Thompson, Diane E., "Foreclosing Modifications: How Servicer Incentives Discoruage Loan Modifications," 86 WashLRev 0755 (2011).

Why Foreclosure Defense Is More Than Just "Wasting Time"

Tue, 10 Jan 2012 12:22:03 -0600

As the foreclosure crisis drags on, the time it takes to complete the average foreclosure increases. This, in turn, feeds a desire to determine the cause of the slowdown. There are obvious choices such as the incredible volume of foreclosure cases and the home owners in default who have not yet been sued. Logically, if you continue to add inputs to a closed system, it will eventually become overwhelmed by those inputs and cease to function as efficiently. The fact that we have inputs that are just waiting to be added makes this correlation even more obvious.

Even if every plaintiff's firm added 10 new attorneys to their foreclosure divisions, adding more judges is not as simple.

It seems that a meme is resurfacing to explain away the logical and obvious reasons for the foreclosure slowdown. Attorneys and homeowners are to blame. Here are two examples of this trend: CNNMoney and Foreclosure.com's blog. Central to the concept is the idea that homeowners are getting a free ride while their attorneys employ "stall tactics."

According to foreclosure.com, these stall tactics include:

Challenging the bank's actions

Waiting to file paperwork right up until the deadline

Requesting the lender dig up original paperwork

Declaring bankruptcy ( in some extreme cases)

After the jump, I'll discuss just how a purposeful and strategic foreclosure defense plan protects the rights of the consumer and is more than just a waste of time.

Much Ado About Abandoned Housing

Wed, 28 Dec 2011 17:35:43 -0600

I have written a few posts about the abandoned housing ordinance that the City of Chicago enacted this year. The original version was abandoned for a version that was supposed to be a compromise with mortgage lenders and servicers. The Federal Housing Finance Agency has filed a lawsuit seeking to block enforcement of the ordinance. It claims that the City of Chicago cannot regulate a Federal regulatory body.

It would appear that Gerri Willis of Fox Business is a bit late to the party. She posted her analysis of the situation to her blog on December 27. As is to be expected, she is not a big fan of the ordinance. Once you get past the talking points and rhetorical flourishes, what remains is her proposal for fixing the abandoned property problem in Chicago: speed up foreclosures.

She claims that speeding up foreclosures would speed up the market's recovery. On one hand, it is plausible. Forcing foreclosures through the system would finally bottom out the market, leaving housing values significantly lower than they are now. Once the market bottoms out, we can finally get back to buying properties. After all, we know the prices can't go any lower, right?

Wrong. Speeding up the foreclosure process will do very little to address the two elephants in the room. First, speeding up foreclosures will increase the number of vacant properties in Chicago, not decrease them. Second, speeding up foreclosures does nothing to address the fact that almost 50% of Chicago mortgages are underwater. In order to truly end the foreclosure crisis, we need to address the need for principal reductions -- a move that FHFA has tried to block at every turn. Moreover, the derelict properties that are currently out there are falling into a further state of disrepair and continue to cause a serious risk to public health and safety.

The City's ordinance is not perfect. It does seem that the ordinance would impose duties on mortgage lenders and servicers that are normally the responsibility of the property owner. At the same time, but for an unwillingness to complete the foreclosure process, these properties would have already been repossessed by the banks, properly placing the burden of maintaining them on the banks.

I would also like to point out that Ms. Willis' assertion that Freddie and Fannie being forced to comply with the ordinance will cost taxpayers money is a bit off. Freddie and Fannie are not "federal mortgage giants," they're government sponsored enterprises that received a healthy bailout along with the major mortgage lenders and the too-big-to-fail banks.

The American taxpayer is losing money every day that properties sit derelict and abandoned. These abandoned properties are stripped clean of any valuable metals and hardware. The resale value on many of them is approaching zero. The true loss of cash here is not via the ordinance, but due to the FHFA's unwillingness to pursue a program of true principal reductions. Stabilizing housing prices can be done by allowing them to fully crash and burn or by taking a short-term loss (principal reductions) for a long-term gain (interest paid on loans that don't go into foreclosure).

The City's solution is not the most elegant, but it's the best thing that's been brought to the table so far. I'd also like to point out that the Chicago City Council and Rahm Emmanuel are relatively limited in their ability to shorten foreclosure timelines as Ms. Willis suggests. Any modifications to the Illinois Mortgage Foreclosure Law would have to be passed by the General Assembly in Springfield.

In the meantime, the urban blight in Chicago will continue to spread. Speeding up foreclosures won't stop that. It will, however, add to the number of empty properties. When you're trying to combat a disease, it's always good to add extra vectors by which it can spread. That works every time.

The Foreclosure Crisis -- A Year In Review

Tue, 27 Dec 2011 19:11:03 -0600

ProPublica has published a well-written piece that summarizes the foreclosure crisis and where it stands at the end of 2011.

It is so well done and succinct that to paraphrase it here does it no justice. You can read it here.

The Foreclosure Fraud Settlement -- End Of The Year Edition

Tue, 27 Dec 2011 18:48:40 -0600

December 25, 2011 has come and gone, and the foreclosure fraud settlement has yet to materialize. Iowa Attorney General Tom Miller had stated that he wanted it wrapped up by Christmas, but it is clear that hasn't happened.

Several states including New York and California remain out of the negotiations, which means that banks are less willing to make deals when so much liability remains off the table. The major lenders are pushing for broad waivers of liability. Time is reporting that a deal may materialize in January and has published some details.

Here's the overview: the banks will commit $25 billion to three categories. They will make $5 billion in cash payments primarily to the states. $3 billion will be earmarked for refinances. The remaining $17 billion will be used for principal writedowns for underwater homeowners.

In reality, the banks will only be committing $5 billion out-of-pocket. The writedown funds will be paid by crediting banks for every dollar of principal that they forgive.

In exchange for these concessions, the banks will be released from claims brought by the states and the federal government for servicing, foreclosure, and loan origination abuses. Individual consumers will still be able to bring lawsuits, but those lawsuits will likely be less effective than ones brought by the government. With deep pockets and an army of attorneys, it isn't hard to fight individual lawsuits -- in some cases it is merely a matter of outspending the plaintiff.

The biggest problem with this latest version of the settlement is the same as it has always been -- it does not do enough. $17 billion towards principal writedowns is a good start, but with 25% of mortgages underwater nationwide (almost 50% in the City of Chicago), it is not enough to fix every underwater loan. The $5 billion to the states will end up in the pockets of some borrowers, but likely only $1500 to $2000 per person. Those aren't small sums of money, but likely aren't large enough to truly remedy the harm of foreclosure fraud and lending abuses.

If the banks are going to obtain a broad waiver of liability, the steps they must take to obtain that remedy should be equally broad. Given that the state of Nevada is suing Bank of America/Countrywide for violating a previous settlement agreement, even an optimist has little reason to expect that the banks will comply with the settlement this time around.

Reports are that the new settlement terms will be made public in January. Until then, I'd advise against holding your breath.

Fannie and Freddie Under Scrutiny

Fri, 23 Dec 2011 16:14:21 -0600

It has not been a banner couple of weeks for Fannie Mae and Freddie Mac. The two GSEs have been under heavy fire lately, in the press and otherwise. In addition to the usual suspects trying to blame Fannie and Freddie for the subprime mortgage crisis, legitimate critics are cropping up.

The SEC has filed a lawsuit against former Fannie and Freddie executives for misrepresentations that they allegedly made while at the helm of the GSEs. The lawsuit involves disclosures made by the GSEs to the SEC. The SEC alleges that the entities grossly understated their exposure to subprime loans, making the companies seem more stable than they actually were.

In other litigation news, California Attorney General Kamala Harris has sued Freddie and Fannie in an attempt to force their compliance with 51 investigative subpoenas that call on the GSEs to identify all of the California homes on which they have foreclosed.

California also seeks information regarding the homes being used for illegal activities such as prostitution, drug dealing, and the storage of weapons and explosives. The state also wants information that demonstrates Fannie and Freddie's compliance with state and federal anti-discrimination laws.

Finally, it appears that the FBI is following in the SEC's footsteps and is investigating the allegations of fraud itself. Given that the SEC can only bring civil charges, the FBI's involvement indicates that at least one person in federal law enforcement believes that there is the potential for bringing criminal charges as well.

While this is all good news (unless you're at Fannie or Freddie), I wonder when we'll see similar things happening to the major lenders. While state action is nice, I wonder when the FBI will go sniffing around at Bank of America.

There Goes The Neighborhood

Tue, 20 Dec 2011 12:03:55 -0600

Apparently 60 Minutes has decided to roll out a series of "feel good" exposes this holiday season. Earlier this month, 60 Minutes ran two segments about whistleblowers at two major lenders whose claims have become criminal prosecutions. Delving further into the foreclosure crisis, 60 Minutes explored the effect that foreclosures have had on the neighborhoods that surround the foreclosed homes.

60 Minutes went to Cleveland, OH, where Cuyahoga County is demolishing abandoned homes in an attempt to shore up falling property values. On some blocks, there are more empty homes than homes with people. Chicago is in a similar situation, so Cuyahoga County's solution is especially topical. By turning stripped and vandalized houses into green space, the county hopes to prevent the further decline of home values and improve the value of remaining inhabited homes.

What's even more interesting about the segment is that one of the county officials interviewed just comes out and states the obvious: the only way to fix the problem is to write down the principal balance on underwater mortgages. I have stated this so many times in the past that I won't belabor the point.

Also pay attention to the homeowners who are continuing to pay on underwater mortgages. The moral obligation theory of contracts is put forth by at least one person. It breaks my heart to think that "my signature means something" could trump a bad investment/business decision. Certainly, her mortgage lender won't consider the moral hazard of her owing $100,000 on a house that is worth $50,000. Never mind that the real estate boom is what inflated home values, and that boom was driven by the same mortgage lenders foreclosing now.

As with the other 60 Minutes segments I have linked in the past, this one is worth watching.

Nevada AG Masto Files Civil Fraud Lawsuit Against Lender Processing Services

Mon, 19 Dec 2011 13:35:01 -0600

In what is shaping up to be a series of cases, Nevada Attorney General Catherine Masto has filed a civil fraud lawsuit against Lender Processing Services. LPS is one of the largest providers of software and services to mortgage servicers and their network attorneys. Given that the state recently indicted some lower-level LPS officials, this seems to be the next step in the chain. I personally won't be surprised if Nevada follows Massachusetts's lead and goes after the servicers that use LPS next.

The complaint lays out everything that industry observers and consumer rights attorneys have been saying about LPS for years. At 39 pages, it's somewhat of a lengthy read, but the first five pages neatly summarize the facts behind the state's case.

Here's some background: LPS provides document preparation services and specialized software to servicers and their attorneys. LPS was largely unknown outside the mortgage servicing industry until last year when 60 Minutes ran a piece about the robosigning that was taking place at LPS's subsidiary, DocX. At the time, LPS stated that the activity at DocX was nothing more than a clerical notarization error. LPS further stated that it had processes and internal controls in place that ensured affidavits were properly signed.

According to the complaint, LPS has:

engaged in a pattern and practice of deceptive conduct that willfully misled consumers, courts, and the public, resulting in countless foreclosures that were predicated upon false, deceptive and deficient documents that LPS prepared and/or executed and included fees that were mischaracterized and deceptively passed on to consumers.

This single paragraph captures most of the complaint. It describes LPS's attempts to cover up and recharacterize its behavior as innocent clerical errors. The complaint also discusses LPS's involvement in the foreclosure process, which has less exposure to the public. For example, LPS is more than just an administrative middle-man. According to the complaint, LPS "improperly directs and/or controls the work of foreclosure attorneys in the LPS Network."

LPS advises its attorneys how and when to proceed with various steps of the foreclosure process. It also tends to obstruct communication between the attorney and the servicer. This is a problem since the servicer is the client, not LPS. LPS also charges its network attorneys a referral fee for each case that it routes to their offices. As the AG's complaint notes, this is essentially a kickback. It also sounds like fee-splitting, which becomes a major ethical hazard. According to the complaint, these kickbacks are masked as attorney and trustee fees. Those fees are then tacked onto the judgment against the homeowner, which means that ultimately homeowners who lose their homes are paying these fees.

The complaint also does a good job of encapsulating the nature of the foreclosure crisis:

The foreclosure crisis has been fueled by two main problems: chaos and speed. LPS' business model is designed to take advantage of the former by increasing the latter. The faster LPS is able to process foreclosures -- without regard to the accuracy of the documents or the integrity of the process -- the more money LPS makes.

This paragraph sums up the foreclosure crisis for most major players, not just LPS. Servicers tend to make more money foreclosing than modifying loans -- the long-term money is something that honest investors are seeking. The majority of the wrongdoers in the foreclosure crisis make money via volume and speed. For them short-term profit is more important than long-term stability.

Also interesting is the complaint's description of LPS' business model, including the use of LPS Desktop, which is essentially foreclosure management software. Desktop is used to organize and process foreclosure cases and includes prompts and alerts for various stages of foreclosure. Most importantly, it tracks the speed with which network attorneys close out cases. As always, speed is of the utmost importance.

The complaint also explains how LPS is the exclusive contact between the foreclosure attorney and its client, the servicer. Instead of servicers directly retaining attorneys, those who use LPS are connected with attorneys within the LPS Network. Effectively, if the attorneys want business, they will play by LPS' rules and pay the referral fees. For the servicers, it may seem like a value-added service.

The rest of the complaint outlines how LPS failed to prevent robosigning and how it continued to robosign after it said it wasn't. It explains how LPS executed documents on behalf of the servicer, how it executed documents on behalf of non-existent or defunct companies, and how it misled investors about its practices.

What I find most interesting are the parts that discuss how LPS directs and controls the legal process. It would appear that this is done on a software level and a systemic level. On the software level, LPS automates a lot of the decision-making involved in the foreclosure process. Its software also creates deadlines that exceed the industry standard, forcing some firms to compromise the quality of their work to maintain the volume needed to keep LPS happy. Attorneys who consistently miss targets get downgraded and receive fewer or no referrals from LPS.

In addition to the software, systemic issues cause LPS to exert an undue influence on Network attorneys. LPS is often the contact point for the attorneys, not the servicer-client. This means that LPS often directs the conduct of attorneys. This is a huge ethical no-no for attorneys -- non-lawyers should not be directing the legal work of attorneys. Non-attorneys cannot, for instance, hold any interest in a law firm. This is why you don't see the tall-building firms issuing stocks. According to the complaint, LPS non-attorney employees not only directed the activity of attorneys, but trained them and advised them as to how to prepare various pleadings, motions, and other documents. LPS often blocks communication between the attorney and the servicer -- odds are that the answer to an attorney question comes from LPS, not the client.

What it boils down to is that LPS may be engaged in the unlicensed practice of law. Given that its software is used in about 50% of all mortgage loans, you can imagine how many counts of unlicensed practice it may be liable for.

The case is ultimately based on Nevada's unfair and deceptive trade practices act. I hope that it succeeds. Almost every state has a similar statute. Success in Nevada could mean lawsuits from other states. The latest wave of lawsuits has shed some sunlight on the underbelly of the foreclosure crisis -- now we just need more sunlight.

Federal Housing Finance Agency Sues Chicago Over Vacant Property Ordinance

Tue, 13 Dec 2011 18:12:47 -0600

The Federal Housing Finance Agency, the entity that oversees Fannie Mae and Freddie Mac, has filed a lawsuit challenging Chicago's vacant property ordinance. When I last blogged about the ordinance, it was to note that it had been amended and significantly toned down from previous versions.

Although that version had been drafted with the cooperation of several major lenders, the FHFA has stated that the $500 building registration fee is effectively a "tax" on Fannie and Freddie. Continuing violations of the ordinance can carry a fine of $1,000 per day. FHFA claims that the ordinance also represents an impermissible regulation upon Freddie and Fannie, which are currently regulated by the FHFA. The agency also maintains that the registration fee and daily fines prevent it from fulfilling its Congressional mandate, which is to preserve and conserve the assets of Fannie and Freddie.

While the FHFA may be correct that a local ordinance cannot trump its regulatory authority, I find it odd that requiring Fannie and Freddie to secure properties they intend to eventually repossess via foreclosure somehow puts the GSEs' assets at risk. Abandoned properties drive down the value of the properties that surround them. Given that Freddie and Fannie back more than 250,000 mortgages in Chicago, I would think that preserving property values would do more to preserve and conserve the GSEs' assets. Abandoned properties are frequently vandalized and gutted, leaving worthless shells in the place of once valuable housing. Again, I don't see how protecting these properties from further harm could ultimately hurt Fannie or Freddie.

This lawsuit seems a bit like a snake eating its own tail. Taxpayers effectively own Fannie and Freddie. Taxpayers in Chicago also supported the ordinance over which FHFA is suing. Given that FHFA is a taxpayer-funded entity, are taxpayers technically suing themselves to protect their own interests from their other interests? It's almost like a game of "stop hitting yourself." If we allow continued urban blight, Chicago will take that much longer to recover from the foreclosure crisis. If we hold lenders accountable for securing properties before they take legal title, we expose our investments in Freddie and Fannie to the risk of loss in the form of fees and fines.

As a spokesperson from Mayor Emanuel's office notes, this lawsuit demonstrates that the state needs to step in and take action to "hold lenders responsible for securing vacant properties."

More to come as the case develops.

Nevada Names Three Notaries In LPS Fraud Suit

Wed, 07 Dec 2011 11:48:00 -0600

I recently wrote about Nevada's lawsuit against Lender Processing Services when the first indictments were brought against two LPS officials for allegedly overseeing a scheme to file thousands of fraudulent foreclosures in Nevada.

The Nevada Attorney General's office has just announced that it has charged three notaires in the lawsuit. Each is accused of falsely attesting to legal signatures on foreclosure documents. Given that each notary is being charged with one count, my guess is that the state hopes they will become witnesses against the two LPS executives already named or that they will give up other people in the LPS corporate structure.

One other notary, who was also charged in the case, was found dead last week. While authorities are not investigating it as a homicide, some observers were a bit dubious. Nevada is an interesting state to watch given that it has been the hardest hit by the foreclosure crisis. Even though Nevada uses a non-judicial process for handling its foreclosures, it may still be a bellwether for future actions by other states. If Nevada is successful, I wouldn't be surprised to see other states bring criminal charges against corporate officials involved in foreclosure fraud.

Although Massachusetts has recently filed its landmark lawsuit against the five major lenders and MERS, it is a civil, not a criminal proceeding.

Eileen Foster on 60 Minutes

Tue, 06 Dec 2011 08:48:20 -0600

Back in September, I posted about Eileen Foster and the re-telling of her story by the Center for Public Integrity. 60 Minutes has picked up on the story. In an excellent two-part report, 60 Minutes tells the story of systemic fraud and fraud cover-ups at Countrywide. The report also features an interview with a Department of Justice attorney who attempts to explain why no criminal cases had been brought against executives from major lenders that were involved in the 2008 financial crisis.

Although the DoJ has some significant enforcement power via Sarbanes-Oxley, it maintains that Sarbanes-Oxley is just one tool in the regulatory tool kit. The representative interviewed by 60 Minutes indicates that Sarbanes-Oxley requires proving the "specific intent" to make false statements -- which is difficult to prove. While he indicates that investigations are ongoing, the question remains -- why aren't the whistleblowers featured in the 60 Minutes piece part of that investigation?

The second segment of the report addresses similar problems at CitiGroup. Both segments total about 27 minutes, but they are well worth a watch.

Here is part 1:

Here is part 2:

On the whole, these reports are even more damning than the article I blogged about in September. I'm glad to see the TV media pick this up. The more often these issues are aired to the public, the more likely it is that people will demand action.

GMAC Takes Ball, Goes Home

Mon, 05 Dec 2011 15:50:18 -0600

On Friday, GMAC Mortgage announced that it will cease purchasing third-party mortgages issued in the State of Massachusetts. The lender stated that, "[R]ecent developments have led mortgage lending in Massachusetts to no longer be viable." It seems pretty obvious that this move is related to the lawsuit filed last Thursday by Massachusetts Attorney General Martha Coakley.

The majority of GMAC's business is purchasing loans from correspondent lenders and wholesale brokers, but that doesn't mean that GMAC can't or won't directly lend money to the citizens of Massachusetts. Perhaps GMAC is hoping that other lenders will follow its lead and refuse to lend in Massachusetts as well. Here's the thing -- only five major lenders were sued by AG Coakley. There is no indication that credit unions and community/local banks are exposed to any additional risk for lending in Massachusetts.

AG Coakley's response to GMAC was, "With today's action, it appears GMAC has acknowledged it has a problem following those laws and being held accountable for doing so." I think her statement is more than apt. There is really no other way to explain the lender's sudden change in position. The implication is that if forced to follow the law, lenders cannot safely make loans. This is utterly absurd. Take, for example, credit unions and local banks, which have been safely lending for years.

The government owns 74% of GMAC. This means that we, as taxpayers, own 74% of GMAC. GMAC is fully aware of this, so it has justified its temper tantrum as fulfilling its "obligation to manage risks and deploy capital in an appropriate manner and in a way that protects the investment of the U.S. taxpayer." Hogwash. If GMAC has fixed its robosigning issues, then it has nothing to fear by continuing to do business in Massachusetts. Moreover, the issues weren't with loan origination, but with foreclosing upon mortgages.

Effectively, GMAC is indicating that if it is forced to comply with the law, it will take its ball and go home. Given the attitude of GMAC's executives, I think that may very well be the best solution for everyone involved.

Massachusetts AG Coakley Sues Five Major Lenders and MERS

Fri, 02 Dec 2011 17:09:43 -0600

Yesterday, December 1, Massachusetts Attorney General Martha Coakley filed a lawsuit against Bank of America, JPMorgan Chase, Wells Fargo, Citibank, Ally Financial and the Mortgage Electronic Registration System. A copy of the complaint is available here.

This complaint is really where the rubber meets the road. The State of Massachusetts is the first state to really lay the entire robosigning scandal out for all to see. The complaint reads like a list of "I told you so's" for any consumer defense practitioner.

AG Coakley accuses the lenders of foreclosing upon homes when they lacked the authority to do so and misrepresenting to borrowers their status as holders of the debts. She accuses them of engaging in false documentation practices to facilitate their foreclosure practices (robosigning). She also takes lenders to task for their unfair and deceptive practices in loss mitigation, including misrepresenting their desire to assist homeowners and the terms of internal and Federal loss mitigation programs. She also accuses MERS of violating the state recording statutes.

On the whole, it's a doozy of a complaint. What I like best about it are the illustrative examples of the lenders' bad acts. The examples begin on page 10 of the complaint and are worth the read. There are fourteen examples given and each is tied to a specific property and the foreclosure related to it. In no uncertain terms, the complaint lays bear the central issue in the foreclosure crisis -- in the rush to foreclose, lenders have willfully taken short cuts that include document fraud. Instead of staffing up call centers to handle the volume of borrowers seeking loan modifications and other assistance, the lenders created a Kafkaesque bureaucracy that did more to hurt homeowners than it did to help them.

This lawsuit is a major step forward. It also is an indicator that Massachusetts is not going to accept any settlement brokered by Iowa Attorney General Tom Miller. Although AG Miller's camp is apparently hopeful that AG Coakley will sign back onto their negotiations, this lawsuit is truly the elephant in the room.

I'm hoping that this goes to trial, or at least produces some substantive discovery. It would be nice to shed some light on the underbelly of the industry.

Are Promissory Notes Negotiable?

Thu, 01 Dec 2011 17:55:28 -0600

The title of this post may read a bit like a poorly-worded law school exam question. Generally, a good answer to this question is, "It depends." However, in the context of notes that are secured by a mortgage (every home loan in the U.S.), I think the answer hinges on the terms of the note and what has happened to the note since it was made.

This post by Adam Levitin got me thinking about this issue again. He mentions about halfway into the post that notes might not be negotiable. This isn't the first time I've encountered this argument.

Here's some brief background. In order to facilitate commerce, the majority of U.S. States have adopted various versions of the Uniform Commercial Code (UCC). The UCC's various articles apply to things like the sale of goods (Article 2), negotiable instruments (Article 3), and secured transactions (Article 9). Since every state (except Louisiana, the last I checked) follows the UCC, you can be relatively certain that the laws relating to transactions covered by the UCC will be consistent from state-to-state.

Promissory notes are generally considered to be negotiable instruments. This means that they can be transferred from person-to-person by delivery and indorsement. For example: Dave writes a check to Steve for $100. The check is payable to Steve. If Steve indorses the back of the check with his signature, the document is "indorsed in blank." This means that anyone in possession of the check can now go cash it. However, if Steve indorses the back with his signature and the statement, "Pay to the order of Mary," then only Mary can cash the check.

We call the indorsement to a particular person or entity a special indorsement, the signature only indorsement is known as a blank indorsement. Sometimes a blank indorsement reads as "Pay to the order of _________________ /s/ Signature." Foreclosing lenders frequently submit copies of notes that are indorsed in blank. In theory, a loan originator should be able to blank indorse a promissory note and then deliver it to another bank. Upon delivery of the blank indorsed note, the new bank becomes the "holder" of the note and may enforce it against the maker of the note, the borrower. Some consumer defense practitioners (I am one of them) are skeptical about these kinds of indorsements. Often, a lender will present a copy of a note that bears no indorsements. When the defense of standing is raised, an indorsed-in-blank copy magically appears.

Seems a bit fishy, right? In many cases, it may be that the note has always been indorsed in blank and the wrong copy was attached to the foreclosure complaint. On the other hand, given last year's revelations about robosigning, I would tend to doubt those indorsements.

So what about negotiability? Are these notes negotiable? It depends who you ask. Article 9 of the UCC governs secured transactions. The sale of a promissory note is one of those transactions governed by Article 9. So if a loan has been securitized, it has gone through at least two "true sales" of the note. It would sound like Article 9 would apply in that situation. Under Article 9, notes cannot be negotiated. They must be assigned for value. In that case, a non-original lender seeking to enforce a blank indorsed note cannot rely solely on the blank indorsement. Instead, that lender would need to prove that the note was assigned to it for value.

At the same time, Article 3 says that notes are negotiable via indorsement and delivery. The lender has a blank indorsed note. QED, right? Wrong.

Notes are only negotiable instruments if they contain an unconditional promise to pay a specific sum of money on or by a specific date. There are exceptions to this rule that allow for interest and mortgages, etc. However, as far as payments are concerned, adding additional requirements defeats the note's negotiability. Take a look at a standard home loan note -- the Freddie and Fannie uniform note. It contains a provision that states the borrower must notify the lender in writing that he is making a pre-payment if he is paying more than the monthly payment. This is technically an additional undertaking.

That additional undertaking would theoretically destroy the note's negotiability. Once a note is non-negotiable, no amount of indorsements in the world can revive negotiability. If these notes aren't negotiable, then lenders have a much tougher evidentiary burden to meet when proving that they have the power to enforce the note against a borrower. Instead of simply showing that they are the holder of a blank indorsed or the named payee of a special indorsed note, they must show that the note was assigned for value.

Here's the tricky part: without commemorative assignments and other dubious documents, most lenders cannot prove an assignment for value took place. Why? Because these Freddie and Fannie uniform notes are generally tied to a uniform mortgage that involves Mortgage Electronic Registration Systems, Inc. (MERS). MERS was created to take the paperwork out of assigning mortgages and notes. As such, lenders generally cannot prove a chain of title from the originating lender to the lender seeking to enforce the note against the borrower.

I will now provide a reality check: I don't know of anyone making this argument in Illinois state courts. I also don't know of anyone who has won on this argument in Illinois state courts. I am tempted to try it, but am waiting for the right case. The tough part is convincing a judge who is used to thinking in terms of negotiability that what has been commonly accepted practice is actually completely ineffective. We shall see.

If you've had success with this argument, please feel free to share it in the comments.

Federal Judge Blocks Settlement Between Citigroup And The SEC

Wed, 30 Nov 2011 18:05:35 -0600

Federal Judge Jed S. Rakoff rejected a proposed settlement between Citigroup and the Securities and Exchange Commission on November 28, 2011. Many observers are heralding this as a landmark opinion. So am I. In general, when the SEC settles a lawsuit, the settlements/consent orders involve no admission of wrongdoing on the part of the defendant. This same "no admission of wrongdoing" element has been a big sticking point in the discussions regarding the robosigning settlement with the state AGs.

In the context of this settlement, however, Judge Rakoff really hits it out of the park. When approving a settlement of this nature, the Judge has the power to determine whether the settlement is in the public interest. After all, the SEC is supposed to be protecting the public from the bad behavior of the entities and individuals that it regulates. As the Judge states in his opinion:

A court, while giving substantial deference to the views of an administrative body vested with authority over a particular area, must still exercise a modicum of independent judgment in determining whether the requested deployment of its injunctive powers will serve, or disserve, the public interest. Anything less would not only violate the constitutional doctrine of separation of powers but would undermine the independence that is the indispensable attribute of the federal judiciary.

He goes on to explain that the situation is different than one where two private parties are involved in a lawsuit. When a government agency is asking a court to assist it in enforcing the law, the importance of the public interest is made clear:

But when a public agency asks a court to become its partner in enforcement by imposing wide-ranging injunctive remedies on a defendant, enforced by the formidable judicial power of contempt, the court, and the public, need some knowledge of what the underlyin facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.

Reading between the lines a little here, I'd say that Judge Rakoff is knocking the SEC for two things: 1) generally being lax on regulation and enforcement and 2) its common practice of not demanding admissions of wrongdoing. Essentially, if the SEC is going to be bothered to enforce the law, it must be pretty darn important.

By the next paragraph, it's no longer necessary to read between the lines:

ere, the SEC's long-standing policy -- hallowed by history, but not by reason -- of allowing defendants to enter into Consent Judgments without admitting or denying the underlying allegations, deprives the Court of even the most minimal assurance that the substantial injunctive relief it is being asked to impose has any basis in fact.

Judge Rakoff also notes that allowing these kinds of settlements does not conclusively settle the allegations raised by the initial lawsuit. "As a matter of law, an allegation that is neither admitted nor denied is simply that, an allegation." In fact, case law supports the idea that once a consent judgment is entered, it cannot be used as evidence in subsequent litigation. By refusing to allow the settlement, the Judge is implicitly stating that he does not want to prevent further lawsuits against Citigroup that are based on the allegations brought in the SEC lawsuit.

The Judge also tears into the motivations of the parties in crafting such a settlement. He notes that Citigroup has violated past consent judgments, that Citigroup would escape the instant lawsuit with a fine that can be described as "the cost of doing business," and that only has minor preventative remedies that only last for three years. If ever there was a slap on the wrist, this settlement is it.

In finding that the settlement was not fair, reasonable, adequate or in the public interest, the Judge stated:

It is not reasonable, because how can it ever be reasonable to impose substantial relief on the basis of mere allegations? It is not fair, because despite Citigroup's nominal consent, the potential for abuse in imposing penalties on the basis of facts that are neither proven nor acknowledged is patent. It is not adequate, because, in the absence of any facts, the Court lacks a framework for determining adequacy. And, most obviously, the proposed Consent Judgment does not serve the public interest, because it asks the Court to employ its power and assert its authority when it does not know the facts.
An application of judicial power that does not rest on the facts is worse than mindless, it is inherently dangerous. The injunctive power of the judiciary is not a free-roving remedy to be invoked at the whim of a regulatory agency, even with the consent of the regulated. If its deployment does not rest on facts -- cold, hard, solid facts, established either by admissions or by trials -- it serves no lawful or moral purpose and is simply an engine of oppression.

That oppression, by the way, comes at the hands of some less-than-transparent financial markets and how they led to the current economy. Judge Rakoff acknowledges as much in his opinion, chiding the SEC for not fulfilling its mission to see that the truth emerges. Barring a consent judgment that admits to guilt, it appears that SEC v. Citigroup is set for trial on July 16, 2012.

I almost want to be in the gallery for this trial. I'm curious to see if Judge Rakoff is as sharp of a speaker as he is a writer.

At the end of the day, this is a massive victory for those seeking some truth about the financial meltdown, as well as those who simply want to see the rule of law enforced.