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Making Sense of the Foreclosure Mess

Why are mortgage holders suspending foreclosures? And what does it mean for homeowners?

Foreclosure, photo by woodley wonderworks

The attorneys general of all 50 states and Washington, D.C. are launching a joint investigation into foreclosures. Why? Because it’s looking like mortgage holders have been asking courts to hand over people’s homes even if the mortgage holders don’t have the evidence that the law requires. Even if they don’t have the promissory note that establishes the debt, and never have had it. Even if they don’t have any firsthand knowledge that the note ever existed.

JP Morgan Chase and GMAC have suspended foreclosures on homes in 23 states (the states where a judge’s approval is required before foreclosing). Bank of America has frozen foreclosures nationwide. But, they assure us, it’s only so they can look into claims of wrongdoing.

The early coverage gives a taste of how the banks and other mortgage holders are going to tell their story to the public. They’re going with the “He hit me first” defense.

Mortgage holders are essentially saying, “We’ve never actually seen the promissory note, but this guy told us it exists and he saw it and he wants you to pay us.”

The Washington Post story on the new investigation said this: “Mortgage servicers have sought to downplay the problems as minor technicalities, contending that nearly all of the files show borrowers missed their payments and deserve to lose their homes.”

A Reuters story gives us the JP Morgan Chase point of view: “JPMorgan Chase, the second-largest U.S. bank, said on Wednesday it had identified some issues in its review of foreclosure affidavits but was "pretty comfortable" that its decisions to foreclose had been proper.

“‘We're not evicting people who deserve to stay in their house,’ Chief Executive Jamie Dimon said on a conference call.”

Which looks, at first glance, like a pretty fair statement. These are people who have quit paying their mortgages. They deserve what they get, and you can’t blame the banks for it. They hit first, and the banks are just hitting back.

There are, however, a couple of flaws with this argument.

For starters, there are laws in all 50 states that outline what a mortgage holder has to do to foreclose on a mortgage. The procedures specify what paperwork the mortgage holder has to file with the court. Because for the court to have the authority to act, it has to have evidence to act on. In a foreclosure, the paperwork is the evidence.

There’s no exception in the law for skipping steps or not filing the required proof that people don’t “deserve to stay in their houses.”

This isn’t just a matter of fudging a signature or a notarization here and there, with everything else completely on the up and up.

One of the essential parts of a foreclosure is that the foreclosing party has to prove that it has the right to be paid. The way you do that is to show the court the promissory note that the debtor signed, or truthfully say that you own it.

This isn’t a minor technicality.

For the court to have the authority to foreclose, it has to have evidence to act on. In a foreclosure, the paperwork is the evidence.

A promissory note is a negotiable instrument, just like a check. The holder of a promissory note can endorse it over to another party, just like you can a check. That’s what’s supposed to happen when a mortgage is sold, as almost all mortgages were during the recent real estate bubble.

But it appears that may not have happened during all the excitement of securitizing real estate. Which means that the note didn’t get endorsed and didn’t get passed along—and maybe nobody knows where it is any more.

The mortgage holders have been sliding past that little problem by using affidavits where they swear they used to have the note, but they’ve just misplaced it. It happens: Buildings burn down, floods destroy paperwork, dogs eat homework. It’s a rare thing, but it happens. But if, as it seems, they’re claiming it happened in thousands of cases, it starts to look a bit dubious.

So what we have is banks going to court and saying, “We used to have the promissory note, but we lost it. Please give us this house anyway.” If that were true, it might not be so bad: If you pay someone by check, and they lose the check, you still owe them the money. But if the first check turns up after you’ve paid the second time, it’s still a valid check. If the other party’s dishonest, they can take it to the bank and turn it into cash.

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But it’s even nuttier than that. Because most of the mortgage holders who are foreclosing aren’t the original lenders. They're essentially saying, “We’ve never actually seen the promissory note, but this guy told us it exists and he saw it and he wants you to pay us.”

There’s a lot of talk about irresponsible borrowers and how they’re at fault for popping the housing bubble. This developing story is a look at the other side, where people were generating mortgages and selling them off so fast they didn’t bother with petty things like proper chain of title. It was a lot easier to cut corners. And now they’re cutting corners again as they turn people out of their homes.

There’s actually a pretty good legal argument that the mortgage holders should simply lose. The law says what they have to do to foreclose. If they can’t do it, they’re not entitled to a remedy. If that seems draconian, well, it’s not the borrowers’ fault that the lenders didn’t keep their paperwork straight.

There’s actually a pretty good legal argument that the mortgage holders should simply lose. Realistically, this may provide the impetus for renegotiating mortgages to make them reflect actual market value instead of bubble value.

Realistically, this may provide the impetus for renegotiating mortgages to make them reflect actual market value instead of bubble value. If the choice is between taking that loss or taking a total loss, standard economics says you take the smaller loss. The tradeoff for the homeowner would be a chance to get clear title. Even if a foreclosure case is dismissed for failure of proof, the mortgage is going to appear in the chain of title, and the homeowner won’t be able to sell.

The banks would like us to believe they’re entitled to win, even if they can’t do it within the rules, because the people they’re foreclosing on are in the wrong. “They hit first,” in other words. What they seem to have forgotten from the kindergarten days is that the response to that is always, “That doesn’t give you the right to hit back.”


Doug PibelDoug Pibel wrote this article for YES! Magazine, a national, nonprofit media organization that fuses powerful ideas with practical actions. Doug is YES! Magazine's managing editor. He spent many years as an attorney. 

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