This Could Destroy Mortgage Securitization as We Know It

I guess that I am over a week late to this game, but there has been a very significant case in Kansas that could completely reshape the fact of mortgage securitization.

Basically, the Kansas Supreme Court has ruled that the Mortgage Electronic Registration System (MERS), which is basically an electronic yellow pages for securitized mortgages, has no standing in foreclosure cases.

Considering that MERS records about ½ of the mortgages in the US, this is a very big deal.

While the precedent only applies to Kansas, it's a state court after all, it is likely that their decision might influence other courts in other state:

The development of “electronic” mortgages managed by MERS went hand in hand with the “securitization” of mortgage loans – chopping them into pieces and selling them off to investors. In the heyday of mortgage securitizations, before investors got wise to their risks, lenders would slice up loans, bundle them into “financial products” called “collateralized debt obligations” (CDOs), ostensibly insure them against default by wrapping them in derivatives called “credit default swaps,” and sell them to pension funds, municipal funds, foreign investment funds, and so forth. There were many secured parties, and the pieces kept changing hands; but MERS supposedly kept track of all these changes electronically. MERS would register and record mortgage loans in its name, and it would bring foreclosure actions in its name. MERS not only facilitated the rapid turnover of mortgages and mortgage-backed securities, but it has served as a sort of “corporate shield” that protects investors from claims by borrowers concerning predatory lending practices.

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The real parties in interest concealed behind MERS have been made so faceless, however, that there is now no party with standing to foreclose. The Kansas Supreme Court stated that MERS’ relationship “is more akin to that of a straw man than to a party possessing all the rights given a buyer.”

What this means is that the original lender, who sold the loan and transferred the title, has no standing, and that MERS has no standing, since they are not the title holder, and that the owner cannot actually be determined, since it has been abstracted into a sort miasma of Mortgage backed securities.

So in many cases, no one has standing to foreclose on the house, at least not in Kansas. (insert Toto joke here).

Matt Tiabbi, in his always amusing style describes this as, "Waking up to discover the mortgage market was a giant criminal enterprise."

Barry Ritholtz notes another feature of MERS, that, "MERS also acts as a shield, making it all but impossible for many borrowers to deal directly with whoever happens to be holding their mortgage at the moment, which is why, to a large degree that I think it exists, so that you can f%$# over the homeowner, and they have no one to sue, so this is not a bug, it's a feature, only, with the prices of homes falling, it's become a bug.

While MERS does technically save some transaction costs by ignoring about 500 years of property laws by not requiring the physical transfer of a title, the real advantage here is that it means that the investors have become completely insulated from, and completely passive to, the realities of the underlying mortgage.

As Karl Denninger summarizes it rather pithily:

They [MERS] may as well have said "we have decided that we can abrogate state law with impunity." Oh wait - they did, didn't they?

Sorry folks, life doesn't work that way.

If state law requires an unbroken chain of recorded assignments in order to document ownership of a mortgage and thus standing to foreclose, MERS cannot override this state law by fiat.

Can this be fixed on a case by case basis? Absolutely.

If you were someone who recorded and researched titles to property, given enough time and effort, could track down the paperwork (which is all electronic and does not exist), and then get the original paperwork, or a certified copy (like they do with so-called "original" birth certificates), and then get each and every person to whom the title was assigned over the life of the loan, you should be able to do it, except, or course, this information is not there is a coherent way, because it was considered to be inconvenient to keep.

But remember, this is what you would need to do each and every time that someone defaulted on a mortgage.

You are probably looking at something in the low 5 figure dollar range, and probably something in excess of 90 days, just to find out who has standing, which makes the foreclosure even more ruinously expensive.