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The Cake is a Lie

And all the fuss about bad paperwork on mortgages is too. The real game is hidden on the dotted line.

by Jim Moriarty & Taylor Lindstrom

Back in 2008, The Economist painted a grim picture of what the Era of Foreclosure looked like as homeowners began to walk away from houses worth less than the mortgage payments they were making. For a while, it looked like homeowners were going to screw over their lenders.

Then the tables turned. Lenders started to foreclose on homeowners who didn't want to walk away. The headlines started to tell sad tales about middle-class families who had lost their jobs in the recession being turned out on the streets by super-speedy foreclosures with no room for re-negotiating mortgage payments. Most recently, we've been hearing terrifying stories about "foreclosure mills", who fudged the paperwork so that they could throw homeowners out more quickly - even if the homeowners should not have legally been foreclosed upon.

We hate to be the bearers of bad tidings, but these scenarios are hardly the worst of the foreclosure crisis. Homeowners sticking it to lenders, lenders sticking it to homeowners - it's bad, it's definitely bad.

What's worse is that both the homeowners and the lenders are getting screwed over by a third party.

And neither of them knows.

How Mortgages Work

In theory, the mortgage process is pretty simple. Jim wants to sell his house. Bob wants to buy Jim's house, but Bob doesn't have enough money, so he asks the bank for a loan. The bank agrees to buy the house for Bob and sell it to him gradually over time, so long as Bob pays the bank extra money beyond the house's value for the inconvenience of the bank taking the risk. Those payments are mortgage payments.

So far, pretty simple. Jim gets a benefit: he sells his house. Bob gets a benefit: he gets to own a house without having to put up all the money at once. The bank gets a benefit: they get to use Bob's house as an asset against which they can loan money.

And everyone is happy.

Until someone came up with the idea of securitization.

Half-Baked Mortgages 

To understand the legal problems inherent in securitization would take several years of schooling and a strong stomach, so we'll defer to a metaphor.

Imagine you are about to open a bakery whose main product will be wedding cakes. You need money for your very first commission. So you ask friends to invest in the theoretical value of your cakes over time, which they happily agree to do. They wouldn't invest in one cake, because the chance that a single cake might fail is significant. But for lots of cakes, they think it's worth the risk of investing. Even if one cake falls flat, other successful cakes will make up the difference.

So you get money for the cake, and your investors get to see your cake shop thrive and become profitable. Since they want their initial investment in the cakes to continue to grow, they leave their money happily invested in your cake shop, while cake after cake proves its value.

Unfortunately, when it comes to mortgages, the cake is a lie.

When mortgages are securitized, banks sell shares in a group of houses to which they own the mortgages. During the housing boom, mortgages were theoretically a very solid investment. It was a given that house values would always rise steadily over time, so the investment would continue to grow and grow until the investor decided to back out of the deal.

Except that housing prices started to fall, and homeowners started to run delinquent on their payments. Investors started to back out of their deals while the getting was good, and banks moved to foreclose before the houses could lose more of their value.

Which is when they made a disturbing discovery: no one owns the mortgage.

Lots of investors own a crumb, but no one owns the cake.

The Name on the Mortgage

There is always a name on the mortgage. Legally speaking, someone - or at the very least, some entity - has to be the official owner.

Unfortunately, a great many people involved in the current rush to foreclosure seem to believe that the name on the mortgage does not have to be the actual owner.

This makes sense to a certain degree. After all, the "owner" of a property might be a pool of a hundred or more investors. It would be impractical, not to say impossible, to write a mortgage stating that each of those investors was an owner of one fraction of the property. 

But perhaps someone should find a way to do so, and quickly. Because with all of the scrutiny surrounding the shoddy paperwork being filed by the foreclosure mills, a strange fact is coming to light: it seems no one has the right to foreclose. 

The owner can foreclose. But there is no owner. There's only the name on the mortgage, which, in most cases, is the decidedly inhuman-sounding MERS.


Mortgage Electronic Registration Systems, Inc. was originally created to track who officially owned a mortgage at any given time.

It is somewhat ironic that today the company's entire purpose would seem to be disguising that very ownership.

As with almost every national crisis, the problem began when people tried to cutting corners. MERS charges a small fee every time a new owner is added to a mortgage - which means a lot of fees when a mortgage is securitized to a pool of a hundred or more people. So lenders started to list MERS on their records as the official mortgagee - a title MERS justifies by claiming status as a "nominee" for the investors.

This means that the lender's name may never show up on the mortgage documents at all.

Which brings us to the current problem, the one no one is talking about: no one has the right to foreclose.

The banks could, if the banks' names were on the mortgages - but they're not.

The investors could, if the investors' names were on the mortgages - but they're not.

Foreclosures, it would seem, are rapidly becoming illegal.

The Gathering Storm

What we're seeing now in the foreclosure crisis is nothing to what's to come. Right now, lawyers are trying to figure out whether foreclosure documents have been properly filed, signed, and notarized, as well as whether foreclosure is even warranted, since there have now been multiple cases of homeowners being foreclosed upon without ever missing a mortgage payment.

But that's not the real problem.

The problem is that even when the homeowners are delinquent in their payments, even when they abandon the home because the actual value is less than the dollar amount they agreed to pay, even when the foreclosure papers are perfectly signed, filed, and notarized, there is still one problem that no one can fix:

No one owns the mortgage.

Which means no one can take it back.

When that single fact hits the general public, chaos will ensue. And we're simply not prepared for the consequences. It's time for the United States government - who happens to be our biggest investor in mortgages right now, since Wall Street dumped all those dwindling assets on them while the getting was good - to give up the idea of foreclosing and start renegotiating mortgage payments.

Being sure, this time, to put someone's name on the line that says "Mortgagee."

Someone other than MERS.

This article is the first in an ongoing series about the foreclosure crisis. For Part II, click here.

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