When Securitization Complicates the Issue: What Are the Homeowner ‘s Defenses to Foreclosure?

http://scholarlycommons.law.wlu.edu/cgi/viewcontent.cgi?article=1300&context=crsj

Washington and Lee Journal of Civil Rights and Social Justice Volume 16 | Issue 1 Article 13 9-1-2009 When Securitization Complicates the Issue: What Are the Homeowner ‘s Defenses to Foreclosure? Victoria V. Corder Follow this and additional works at: http://scholarlycommons.law.wlu.edu/crsj Part of the Banking and Finance Commons This Note is brought to you for free and open access by the Law School Journals at Washington & Lee University School of Law Scholarly Commons. It has been accepted for inclusion in Washington and Lee Journal of Civil Rights and Social Justice by an authorized administrator of Washington & Lee University School of Law Scholarly Commons. For more information, please contact osbornecl@wlu.edu. Recommended Citation Victoria V. Corder, When Securitization Complicates the Issue: What Are the Homeowner’s Defenses to Foreclosure?, 16 Wash. & Lee J. Civ. Rts. & Soc. Just. 299 (2009). Available at: http://scholarlycommons.law.wlu.edu/crsj/vol16/iss1/13 When Securitization Complicates the Issue: What Are the Homeowner’s Defenses to Foreclosure? Victoria V. Corder* Table of Contents I. Introduction ……………………………………………………………………….. 300 II. Origins of the Mortgage Foreclosure Crisis ……………………………. 302 A . D eregulation ………………………………………………………………… 302 B. Securitization and the Rise of the Shadow Banking Sector …. 305 C . Foreclosure ………………………………………………………………….. 308 D . L egal Issues …………………………………………………………………. 310 III. Litigation Solutions …………………………………………………………….. 311 A . The Standing “Defense” ………………………………………………… 311 1. Dismissal: When There is No Documentation of Assignment of the Note and Mortgage ……………………….. 314 2. Sanctions: When the Mortgage Assignment is Misrepresented to the Court …………………………………. 317 3. Tougher Solutions: When the Plaintiff is Not the Holder in Due Course ……………………………………….. 318 a. Standing Will Incentivize Loan Renegotiation ………. 320 IV . Legislative Solutions …………………………………………………………… 321 A. Loan Servicers Can Renegotiate Loans by Contract Right …. 323 B. Who Should Facilitate Loan Renegotiation? ………….. ………… 324 1. Private Loan Modification is Idealistic ………………………. 324 2. State Laws Are Preempted ……………………………………….. 326 * J.D., Washington and Lee University School of Law, 2010; A.B., Art History, Dartmouth College, 2005. I would like to express my appreciation to Professor Denis Brion who helped tremendously with my research for this Note. 300 16 WASH. & LEE J.C.R. & SOC. JUST. 299 (2009) 3. Federal Laws Can Incentivize Servicers to M odify Loans ……………………………………………………. 327 a. A Statutory Fiduciary Duty to Bondholders ………….. 327 b. Revive the Home Owners’ Loan Corporation ……….. 327 V . C onclusion …………………………………………………………………………. 328 Fluidity of the market-X dollars Contractual arrangements between institutions and counsel-X dollars Purchasing mortgages in bulk and securitizing-X dollars Rush to file, slow to record afterjudgment-X dollars Thejurisdictional integrity of the United States District Court-Priceless. -Judge Christopher A. Boyko, United States District Court Northern District of Ohio’ I. Introduction Since the housing market peaked in 2006,2 American home values have fallen twenty percent across the country.3 As a result of declining home equity, one in ten Americans with mortgages are in financial trouble.4 Six million Americans with outstanding subprime loans 5 are at 1. In re Foreclosure Cases, No. 1:07cv2282, et al., 2007 WL 3232430, at *3 n.3 (N.D. Ohio Oct. 31, 2007) [hereinafter Boyko]. 2. FDIC: Statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation on Strengthening the Economy: Foreclosure Prevention and Neighborhood Preservation: Before the Committee on Banking, Housing and Urban Affairs; January 31, 2008 in SUBPRIME CREDIT CRISIS: EVERYTHING You NEED TO KNOW 727, 729 (Practicing Law Institute, 2008) [hereinafter Bair Testimony] (noting that the U.S. housing boom of the first half of the 2000s ended abruptly in 2006). 3. David M. Abromowitz, When in Doubt, Yell “Fannie Mae,” HUFFINGTON POST, Sept. 19, 2008, http://www.huffingtonpost.com/david-m-abromowitz/when-in-doubt-yellfannie b 127688.html (last visited October 19, 2009) (“When prices drop in a neighborhood, they don’t just fall on homes with subprime loans… [f]or the first time since the Great Depression, American home values nationally fell nearly 20% since their peak, and in some places much more.”) (on file with Washington and Lee Journal of Civil Rights and Social Justice). 4. Id. 5. A subprime loan is generally defined as a loan given to a buyer who would not otherwise qualify for a prime loan. Reform Foreclosure, Predatory Mortgage and Payday Lending in America’s Cities Before the H. Comm. on Oversight and Government, 110th WHEN SECURITIZA TION COMPLICATES THE ISSUE risk of defaulting.6 As homeowners go into default, lenders rush into court to foreclose.7 As more homes remain vacant in neighborhoods, the housing value of entire neighborhoods decreases further in a vicious cycle.8 These figures suggest that the mortgage foreclosure crisis is not a self-contained problem.9 Part I of this Note discusses the origins of the mortgage foreclosure crisis. Specifically, it tracks the path of a mortgage from securitization to foreclosure. It highlights the legal issues that arise when a trustee in possession of toxic securities backed by mortgages that are currently in default wants to instigate foreclosure proceedings. Part II addresses defaulting mortgagors’ standing defense to foreclosure proceedings instigated by trustees holding securitized mortgages. It argues that this defense is not only a technical defense, but it is also a direct way to confront the legal issue caused by the securitization of mortgages when it comes time to collect: Who has the right to foreclose? Part III examines the ways that legislation can incentivize loan servicers to renegotiate Cong. 4 (2007), (testimony of Josh Nassar, Center for Responsible Lending), available at http://oversight.house.gov/documents/200703 22175553-40982.pdf. To offset the risk, subprime loans generally carry higher interest rates than prime loans offered to creditworthy borrowers and charge additional fees. Id. All subprime loans are not predatory. Id. This Note will not distinguish between defenses available to homeowners who have defaulted on predatory loans versus those who have defaulted on non-predatory loans. 6. CENTER FOR RESPONSIBLE LENDING, ANY REAL SOLUTION MUST STOP FORECLOSURES 1 (Sept. 23, 2008), http://www.responsiblelending.org/mortgagelending/policy-legislation/congressbailout-one-pager.pdf. 7. See Boyko, No. 1:07cv2282, et al., 2007 WL 3232430, at *3 n.3 (N.D. Ohio Oct. 31, 2007) (discussing that the lenders’ decisions to file for foreclosure as fast as possible is driven by monetary concerns). 8. See CENTER FOR RESPONSIBLE LENDING, PERMITTING JUDICIAL MODIFICATION OF HOME LOANS WOULD SAVE 600,000 HOMES-PURCHASE OF SECURITIES WILL NOT SAVE ANY 1 (Sept. 19, 2008), http://www.responsiblelending.org/mortgage-lending/policylegislation/congress/crl-judicial-mod-of-home-mortgages-brf.pdf (supporting the proposition that when families cannot pay their loans, foreclosures increase, causing neighborhoods go into decline, causing more financial institutions to go under, causing even more foreclosures). 9. Although, undoubtedly, foreclosures disproportionately affect low-income and minority communities who were specifically targeted by subprime mortgage lenders. See e.g., DEBBIE GRUENSTEIN BOCIAN, KEITH S. ERNST & WEI LI, CENTER FOR RESPONSIBLE LENDING, UNFAIR LENDING: THE EFFECT OF RACE AND ETHNICITY ON THE PRICE OF SUBPRIME MORTGAGES 4-5 (May 31, 2006), http://www.responsiblelending.org/mortgagelending/research-analysis/rrO I1-UnfairLending-0506.pdf (noting that several research analyses of subprime mortgage data revealed that “African-American and Latino borrowers received a disproportionate share of higher-rate [subprime] home loans, even when controlling for factors such as borrower income and property location”). 16 WASH. & LEE J. C.R. & SOC. JUST. 299 (2009) mortgages that are at risk of default. It argues that federal legislation may offer a more permanent solution to the mortgage foreclosure crisis. This Note concludes that a case-by-case approach to the mortgage foreclosure crisis, or a solution that relies on litigating individual claims as mortgagors go into default, is admirable because it assigns the costs of securitization to one party-the trustee-and only in cases in which the trustee of the securitized mortgage has brought a foreclosure action wrongfully in violation of true sale requirements. It narrowly targets only wrongdoers by dismissing foreclosure proceedings when the trustee lacks standing. However, litigating claims individually does not provide enough incentive to trustees to settle claims before coming to court; therefore, it is not a proactive or permanent solution. By contrast, when a third party, such as a governmental entity, assumes the costs of securitization, all parties-the trustee, the loan servicer, and the mortgagor-are incentivized to renegotiate the terms of the underlying mortgage. While the loan servicer and the mortgagor can enter into loan renegotiation voluntarily, thereby dividing the costs of securitization between these two parties, in reality the trustee has no incentive to do so for fear of lawsuits by holders of securitized debt instruments. By enacting legislation that defines the liability of servicers to the holders of the securitized notes, servicers will be incentivized to renegotiate loans because there will be no hidden costs. Finally, either option is preferable to the current system where the homeowner is stuck paying for the costs of securitizing her mortgage. II. Origins of the Mortgage Foreclosure Crisis A. Deregulation The current mortgage foreclosure crisis was precipitated by the liberal policies of financial regulators and the governments who facilitated the climate of deregulation on Wall Street beginning in the 1980s.’ 10. See Robert Wade, Financial Regime Change?, 53 NLR 5, 12 (2008) (“It is no exaggeration to say that the crisis stems from the biggest regulatory failure in modem history.”). Wade uses the term “neoliberalism” to label the economic model in place from 1975 to 2008 that encouraged governments to liberalize, privatize, and deregulate as part of financial globalization. Id. at 5. But Peter Gowan notes that in addition to the neoliberalism theory espoused by Wade, there is the “accidents” theory which blames the crisis on the negligent interplay of Greenspan’s Federal Reserve, banks, regulators, and ratings agencies. Peter Gowan, Crisis in the Heartland: Consequences of the New Wall Street System, 55 NLR 5, 19-20 (2009). Gowan’s thesis, however, rejects both the neoliberal and accidents WHEN SECURITIZA TION COMPLICATES THE ISSUE Deregulation” enabled financial institutions to carry high debt-to-equity ratios, 12 create complex financial instruments, 3 and trade those instruments in opaque markets.’ 4 By the 1980s, with the aid of Washington, the financial services industry had repositioned itself atop a new global capitalist structure, and its importance in the new structure was reinforced from within it by new actors, new practices, and new dynamics created in the increasingly global world of finance. 5 Specifically, deregulation and lower interest rates encouraged the rise of the lender-trader model, speculative arbitrage, highly leveraged banks, the shadow banking sector (and with it, new types of securities), speculative trading in asset bubbles, and reliance on credit derivatives. 6 theories and argues that that the new structure of Wall Street was not haphazard at all, but was an orchestrated complex system that was preordained to fail because government no longer regulated securities that were inherently flawed. Id. at 20-21. 11. For a list of twelve deregulatory steps that led to the financial meltdown, see ROBERT WEISSMAN & JAMES DONAHUE, CONSUMER EDUCATION FOUNDATION, SOLD-OUT: How WALL STREET AND WASHINGTON BETRAYED AMERICA (Mar. 2009), http://www.wallstreetwatch.org/reports/sold out.pdf. The twelve steps Weissman lists are: (1) the repeal of Glass-Steagall, (2) off-the-books accounting for banks, (3) preventing the Commodities Future Trading Commission from regulating derivatives, (4) financial derivative deregulation under the Commodities Futures Modernization Act, (5) removal of SEC capital limits on investment banks, (6) weak capital reserve requirements for banks under Basel II, (7) failure to police predatory lending, (8) federal laws that preempted state policing of predatory lending, (9) failure to hold assignees of mortgages liable, (10) Fannie Mae and Freddie Mac’s insuring subprime mortgages, (11) bank merger mania which created a too-big-to-fail mentality, and (12) the failure of credit ratings agencies to properly inform investors about risk. Id. at 21-98. 12. See Wade, supra note 10, at 12 (“[I]t was acceptable in the eyes of the authorities for investment banks to operate with a debt to equity ratio of 30-35:1.”). In 2004, the Securities and Exchange Commission (SEC) relaxed the net-capital rule. Gowan, supra note 10, at 15. The result of this was that investment banks were allowed to decide their own leverage. Id. 13. E.g., mortgage-backed securities. See David Goldstein & Kevin G. Hall, Private Sector Loans, Not Fannie or Freddie, Triggered Crisis, MCCLATCHY WASHINGTON BUREAU (Oct. 12, 2008) http://www.mcclatchydc.com/251/story/53802.htm (last visited Oct. 19, 2009) (defining mortgage-backed securities as “mortgages that are sold to a company, usually an investment bank, which then pools and sells them into the secondary mortgage market”) (on file with Washington and Lee Journal of Civil Rights and Social Justice). 14. See Wade, supra note 10, at 12 (describing this model of banking as encouraging “high leverage, complex financial instruments and opaque markets, all of which put this crisis in a league of its own”). 15. See Gowan, supra note 10, at 6 (labeling the financial structures, actors, practices, and dynamics that came about in the wake of neoliberal policies as the “New Wall Street System”). 16. See id. at 7-8

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