The Sloppy State of the Mortgage Market

photo by Badagnani

I published a short article in the California Real Property Law Reporter, Sloppy, Sloppy, Sloppy: The State of the Mortgage Market, as part of a broader discussion of Foreclosures Following Problematic Securitizations.  The other contributors were Roger Bernhardt, who organized the discussion,  as well as Dale Whitman, Steven Bender, April Charney and Joseph Forte.  My article opens,

Much of the discussion about the recent California Supreme Court case Yvanova v New Century Mortgage Corp. (2016) 62 C4th 919  has focused on the scope of the Court’s narrow holding, “a borrower who has suffered a nonjudicial foreclosure [in California] does not lack standing to sue for wrongful foreclosure based on an allegedly void assignment merely because he or she was in default on the loan and was not a party to the challenged assignment.” 62 C4th at 924. This is an important question, no doubt, but I want to spend a little time contemplating the types of sloppy behavior at issue in the case and what consequences should result from that behavior.

Sloppy Practices All Over

The lender in Yvanova was the infamous New Century Mortgage Corporation, once the second-largest subprime lender in the nation.  New Century was so infamous that it even had a cameo role in the recently released movie, The Big Short, in which its 2007 bankruptcy filing marked the turning point in the market’s understanding of the fundamentally diseased condition of the subprime market.

New Century was infamous for its “brazen” behavior.  The Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States (Jan. 2011) (Report) labeled it so because of its aggressive origination practices.  See Report at page 186. It noted that New Century “ignored early warnings that its own loan quality was deteriorating and stripped power from two risk-control departments that had noted the evidence.” Report at p 157. And it quotes a former New Century fraud specialist as saying, “[t]he definition of a good loan changed from ‘one that pays’ to ‘one that could be sold.”  Report at p 105.

This type of brazen behavior was endemic throughout the mortgage industry during the subprime boom in the early 2000s.  As Brad Borden and I have documented, Wall Street firms flagrantly disregarded the real estate mortgage investment conduit (REMIC) rules and regulations that must be complied with to receive favorable tax treatment for a mortgage-backed security, although the IRS has let them dodge this particular bullet.  Borden & Reiss, REMIC Tax Enforcement as Financial-Market Regulator, 16 U Penn J Bus L 663 (Spring 2014).

The sloppy practices were not limited to the origination of mortgages. They were prevalent in the servicing of them as well. The National Mortgage Settlement entered into in February 2012, by 49 states, the District of Columbia, and the federal government, on the one hand, and the country’s five largest mortgage servicers, on the other, provided for over $50 billion in relief for distressed borrowers and in payments to the government entities. While this settlement was a significant hit for the industry, industry sloppy practices were not ended by it. For information about the Settlement, see Joint State-Federal National Mortgage Servicing Settlements and the State of California Department of Justice, Office of the Attorney General, Mortgage Settlements: Homeowners.

As the subprime crisis devolved into the foreclosure crisis, we have seen those sloppy practices have persisted through the lifecycle of the subprime mortgage, with case after case revealing horrifically awful behavior on the part of lenders and servicers in foreclosure proceedings.  I have written about many of these Kafka-esque cases on REFinBlog.com.  One typical case describes how borrowers have “been through hell” in dealing with their mortgage servicer. U.S. Bank v Sawyer (2014) 95 A3d 608, 612 n5.  Another typical case found that a servicer committed the tort of outrage because its “conduct, if proven, is beyond the bounds of decency and utterly intolerable in our community.” Lucero v Cenlar, FSB (WD Wash 2014) 2014 WL 4925489, *7.  And Yvanova alleges more of the same.

Possession of Note Confers Standing to Foreclose

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Dale Whitman posted this discussion of Aurora Loan Services, LLC v. Taylor, 2015 WL 3616293 (N.Y. Ct. App., June 11, 2015) on the DIRT listserv:

There is nothing even slightly surprising about this decision, except that it sweeps away a lot of confused and irrelevant language found in decisions of the Appellate Division over the years. The court held simply holds (like nearly all courts that have considered the issue in recent years) that standing to foreclose a mortgage is conferred by having possession of the promissory note. Neither possession of the mortgage itself nor any assignment of the mortgage is necessary. “[T]he note was transferred to [the servicer] before the commencement of the foreclosure action — that is what matters.” And once a note is transferred, … “the mortgage passes as an incident to the note.” Here, there was a mortgage assignment, the validity of which the borrower attacked, but the attack made no difference; “The validity of the August 2009 assignment of the mortgage is irrelevant to [the servicer’s] standing.”

The opinion in Aurora makes it clear that prior Appellate Division statements are simply incorrect and confused when they suggest that standing would be conferred by an assignment of the mortgage without delivery of the note. See, e.g., GRP Loan LLC v. Taylor 95 A.D.3d at 1174, 945 N.Y.S.2d 336; Deutsche Bank Trust Co. v. Codio, 94 A.D.3d 1040, 1041, 943 N.Y.S.2d 545 [2d Dept 2012].) For an excellent analysis of why these decisions are wrong, see Bank of New York Mellon v. Deane, 970 N.Y.S.2d 427  (N.Y. Sup. Ct. 2013).

The Aurora decision implicitly rejects such cases as Erobobo, which suppose that the failure to comply with a Pooling and Servicing Agreement would somehow prevent the servicer from foreclosing. In the present case, the loan was securitized in 2006, but the note was delivered to the servicer on May 20, 2010, only four days before filing the foreclosure action. This presented no problem at all the court. If the servicer had possession at the time of the filing of the case (as it did), it had standing. (I must concede, however, that the rejection is only implicit, since the Erobobo theory was not argued in Aurora.)

If there is a weakness in the Aurora decision, it is its failure to determine whether the note was negotiable, and (assuming it was) to analyze the application UCC Article 3’s “person entitled to enforce” language. But this is not much of a criticism, since it is very likely that under New York law, the right to enforce would be transferred by delivery of the note to the servicer even if the note were nonnegotiable.

It has taken the Court of Appeals a long time to get around to cleaning up this area of the law, but its work is exactly on target.

(Non-)Enforcement of Securitized Mortgage Loans

Professors Neil Cohen and Dale Whitman, two important scholars who know their way around the UCC and mortgage law, will take on a highly contested topic in an upcoming ABA Professors’ Corner webinar: “Ownership, Transfer, and Enforcement of Securitized Mortgage Loans.” I blogged a bit about this topic a couple of days ago, in relation to Adam Levitin’s new article. There is a lot of misinformation floating around the blogosphere relating to this topic, so I encourage readers to register.

The full information on this program is as follows:

Professors’ Corner is a FREE monthly webinar, sponsored by the ABA Real Property, Trust and Estate Law Section’s Legal Education and Uniform Law Group.  On the second Wednesday of each month, a panel of law professors discusses recent cases or issues of interest to real estate practitioners and scholars.

December 2013 Professors’ Corner
“Ownership, Transfer, and Enforcement of Securitized Mortgage Loans”
Profs. Neil Cohen and Dale Whitman
Wednesday, December 11, 2013
12:30pm Eastern/11:30am Cental/9:30am Pacific
Register for this FREE program at https://ambar.org/ProfessorsCorner

Our nation’s courts have been swamped with litigation involving the foreclosure of securitized mortgage loans.  Much of this litigation involves the appropriate interaction of the Uniform Commercial Code and state foreclosure law. Because few foreclosure lawyers and judges are UCC experts, the outcomes of the reported cases have reflected a significant degree of uncertainty or confusion.

In addition, much litigation has been triggered by poor practices in the securitization of mortgage loans, such as robo-signing and the failure to transfer loans into a securitized trust within the time period required by the IRS REMIC rules.  This litigation has likewise produced conflicting case outcomes.  In particular, recent decisions have reflected some disagreement regarding whether a mortgagor — who is not a party to the Pooling and Servicing Agreement that governs the securitized trust that holds the mortgage — can successfully defend a foreclosure by challenging the validity of the assignment of the mortgage to a securitized trust.

Our speakers for the December program will bring some much-needed clarity to these issues.  Our speakers are Prof. Neil B. Cohen, the Jeffrey D. Forchelli Professor of Law at Brooklyn Law School, and Prof. Dale A. Whitman, the James E Campbell Missouri Endowed Professor Emeritus of Law at the University of Missouri School of Law.  Prof. Cohen is the Research Director of the Permanent Editorial Board for the Uniform Commercial Code, and a principal contributor to the November 2011 PEB Report, “Application of the Uniform Commercial Code to Selected Issues Relating to Mortgage Notes.” Prof. Whitman is the co-Reporter for the Restatement (Third) of Property — Mortgages, and the co-author of the pre-eminent treatise on Real Estate Finance Law.

Please join us for this program.  You may register at https://ambar.org/ProfessorsCorner.