A BNA, INC.

REAL ESTATE !
LAW & INDUSTRY REPORT

Reproduced with permission from Real Estate Law &

Industry Report, 3 REAL 732, 10/19/2010. Copyright !
2010 by The Bureau of National Affairs, Inc. (800-372-
1033) http://www.bna.com

FORECLOSURES

Attack of the Fire Ants: Homeowners Breach the Mortgage Foreclosure Wall

There’s a cry from the field. The men look up and see
a banker tearing at his leg. He’s stepped onto one of the
mounds and it’s collapsed beneath his weight. Ants are
swarming out of the ground, covering his shoes, racing
up his socks, under his trousers and onto his legs.
They’re biting into his flesh. They’re injecting venom.
Again and again and again. The man howls in pain,
tearing at his belt, pulling down his trousers, brushing
the ants from his legs. They’re now on his hands, in his
face, in his eyes. He screams louder and runs.
Another shout from the field. Another banker has
crushed a mound, sinking into a pit up to his waist. Ants
are swarming him, too. Thousands of them. They’re
stinging him as well. Red welts appear on his skin.
BY RICHARD ZAHM Worker ants, scout ants, guard ants—all enraged, all fo-

P
icture a large field filled with men in business
suits. They’re bankers and investors—a few con-
gressman stand at the edge. The bankers are
walking slowly, and as they walk, they slowly step on
small red ants, squashing them beneath their Florshe-
ims. The ants cover the field, carrying enormous loads
(they can carry five times their body weight). Small
mounds of earth mark their nests.
Richard Zahm is a direct lender and portfolio
manager based in Connecticut and Califor-
nia. He may be reached at richzahm@
gmail.com.
cused, all on attack.
More howling. More mounds are collapsing. More
men are falling. Red ants are everywhere, millions of
them bubbling out of the earth, tiny red pins of fire. The
men begin to lose their composure, crashing into one
another, pushing, shoving, looking for escape. . .
This is the picture of the mortgage market today.
The Ants.
Defaulters: Scout Ants. Earlier in 2010 a curious phe-
nomena was unfolding. People who had borrowed
money to buy a home, and who could afford to make
their monthly mortgage payments, were choosing not
to. The housing market in the United States was col-

COPYRIGHT ! 2010 BY THE BUREAU OF NATIONAL AFFAIRS, INC. ISSN 1944-9453

2
lapsing, driving the price of homes down as much as 40
percent.
Examining the amount of money they owed on their
mortgage, and comparing it against the value of their
home, they reckoned that it would be years before they
would have any equity in their homes—they owed much
more than their homes were worth.
An enormous number of people were underwater—
and their number was increasing. A portion of them
were acting. They would buy another, similar house for
a much lower price. They would rent a house for a frac-
tion of their mortgage payment. But most critically, they
would simply leave. Having analyzed their finances and
their future, they put the keys to their homes into an en-
velope and mailed them to their lender. And then they
left.
‘‘Strategic defaulters’’ were decried as deadbeats,
miscreants, people gaming the system at their neigh-
bors’ expense. But they didn’t match the description of
people who’d historically lost their homes through fore-
closure. They were educated. They had steady income,
good credit scores. They had a variety of home loans,
having signed up for the products that were sold to
them—Alt A, Option Arm, Pick-a-Pay, Prime.
Over the course of the year, as their numbers grew, it
became clear that they were not like the people who
were being evicted in the tens of thousands each month.
These were not people who should have been renters,
who had been sold subprime loans, who lost their jobs,
were foreclosed, and who packed up U-Hauls, leaving
their homes in the night.
They were young families, professionals, and the re-
tired. They weighed the impact their decision would
have on their credit scores, their savings, their life. And
they moved.
Their numbers are potentially vast.
The curious element is not how many people have
made the strategic move. It’s how few. Their decisions
came about from a combination of the capability to con-
tinue making loan payments; a belief in how quickly
their homes would regain earlier values, and the per-
centage amount their homes are underwater.
It’s debatable whether someone who purchased a
home for no money down (or, better yet, a loan for
125 percent of the purchase price) was actually
a ‘‘homeowner.’’ ‘‘Borrower’’ would be more
accurate. What’s less debatable is the savings that
result from not paying to live somewhere. Bank
of America’s loss has become The Cheesecake
Factory’s gain.
Homeowners make the decision to default primarily
based on how underwater they are. The tipping point is
around 150 percent loan to value (LTV). At this point,
35 percent of borrowers will send in the keys. At 162
percent LTV, more than half will walk away.
10-19-10 COPYRIGHT ! 2010 BY THE BUREAU OF NATIONAL AFFAIRS, INC.
Borrowers in recourse states delay their surrender
longer than those in nonrecourse states. Those with
high credit scores also delay the move. Homeowners
with FICO scores between 620-680 trigger defaults at
150 percent LTV, while those with scores above 720
hang in longer, pulling the plug at 170 percent LTV.
But the deciding point overriding all of these is differ-
ent: it’s anger. People have an innate need to believe
that they pay for something what it’s worth. Overspend-
ing is a sin, and a sale is ambrosia. For people with
mortgages much greater than their homes are worth—
and who have no equity in their homes—the natural re-
action is to seek a balance. This takes the form of a loan
modification.
The impetus for a request to a lender is usually a fi-
nancial loss—loss of a job, accompanied by an extended
term of unemployment. This isn’t unusual now: 14 mil-
lion Americans remain unemployed and at current rates
employment might not reach former levels for eight to
10 years.
Borrowers have negative experiences with the loan
servicers working for the lenders. They spend enor-
mous amounts of time on hold, their calls are not re-
turned, they receive misinformation, their files are lost,
they’re threatened. They’re scared. They’re frustrated.
Modifications that have been made have generally
been short-term catch-up plans that benefit the servicer
more than borrowers: Even Home Affordable Modifica-
tion Program (HAMP) ‘‘permanent’’ modifications are
only five-year payment reduction plans. Finding that
the modifications generate only minor reductions in
monthly payments, they turn away. (Without principal
reduction or a significant, permanent interest rate cut,
big savings are virtually impossible: do the math.)
They believe they’ve acted in good faith. And they
feel that they’ve been ignored, rebuffed, belittled, de-
layed, and lied to. And if they haven’t, they’ve heard
about the experience of others. They act. Or, increas-
ingly, they don’t.
Their credit shot (the biggest hit takes place within
the first 90 days, 130-150 points), unemployed (along
with 14 million other Americans), strung along by ser-
vicers, they take matters into their own hands.
They make their own loan modifications. They stop
sending in their payments.
Strategic defaulters were the first surge of ants.
Squatters: Worker Ants. Living on someone else’s
property, paying nothing, isn’t especially unusual. An
estimated 1 billion people do it worldwide. Enjoying
their convenience, Americans have merely taken it to
another level. Watching the experience of their neigh-
bors, who may have gone through foreclosure or who
simply moved away, they’ve streamlined the process.
They squat in their own homes.
Living mortgage free—and rent free—has become a
way of life for an enormous number of people. There
are about 7.2 million borrowers currently not paying
their mortgage. Counting the kids, this adds up to a
population of around 17 million people. That’s the
population of Washington, Oregon, Nevada, Kansas,
and Utah—Combined.
Foregoing payment frees up money to spend on other
things: visit a shopping mall in areas with high foreclo-
sure rates and look for a parking space. About $11 bil-
lion is being pumped into the economy each month,
solely from people who’ve decided to reallocate their
REAL ISSN 1944-9453

household income away from lenders. This accounts for
about 1 percent of all consumer spending in the United
States.
It’s debatable whether someone who purchased a
home for no money down (or, better yet, a loan for 125
percent of the purchase price) was actually a ‘‘home-
owner.’’ ‘‘Borrower’’ would be more accurate. What’s
less debatable is the savings that result from not paying
to live somewhere. Bank of America’s loss has become
The Cheesecake Factory’s gain.
From default to eviction, the average homeowner can
stay in his home for 420 days. This number varies by
region—Florida and New York residents reputedly are
remaining for two to three years . . . or more. Foreclo-
sure reviews and moratoria initiated by regulators in
early October could extend this backlog to as long as 10
years.
For lenders—and for the economy as a whole—
squatting may be the least-worst option. Home invento-
ries have swollen and home sales are extremely slow.
Underwater would-be sellers have little incentive to sell,
and prospective sellers haven’t found the market bot-
tom. There’s no rush to buy when better deals could be
had by waiting. Bank-owned inventories weigh heavily
on banks’ balance sheets, and foreclosures increase
losses on homes for lenders of around 20 percent to 30
percent.
Vacant houses can quickly lose value simply from
non-use, especially in hot, humid areas like Florida
where the land has its own hunger for homes. Brown
lawns and black-lagoon swimming pools are minor con-
cerns when compared to more pressing conditions, like
interior mold. Non-paying residents bring with them
some promise: They want to be in the house, they’re
likely taking care of it, and sometime in the future
there’s the possibility of receiving payment of some
type—rent, a new loan, call it what you will.
And in the meantime, there is value to the commu-
nity. Real estate taxes are being paid. Children are be-
ing educated. Groceries and gasoline are being bought.
There’s a waiting list for reservations at Applebee’s.
Watch and Guard Ants.
The Internet. The internet played the same role with
homeowners as alarm frequencies do with ants. Com-
munication between homeowners was accelerated
across the country. They learned of their experiences
with mortgage brokers, with lenders, and with their ser-
vicers. They were able to compare notes, to establish
patterns and—most importantly—to break out of the
sense of moral and financial failure and shame, isola-
tion crucial for lender control.
While newspapers were hesitant to discuss unpleas-
ant realities of life, people actually going through their
personal home nightmare were learning and gaining
strength from others. Homeowners were being crushed,
to be sure. But they were gathering knowledge.
The Bloggers. Operating outside traditional journal-
ism channels, but with enormous reader bases, blog-
gers began following the stories that weren’t seen as
relevant by popular press editors. Yves Smith (Naked
Capitalism), Ellen Brown (Web of Debt), Barry Rein-
holtz (The Big Picture) all noted procedural
peculiarities— or worse—as early as spring 2010. Their
REAL ESTATE LAW & INDUSTRY REPORT ISSN 1944-9453
3
alarms went largely unheeded until late September and
early October.
Too many incidents were breaking out for Reuters
and Bloomberg to ignore. And when the stories broke
there, government responded. House Speaker Nancy
Pelosi sounded an alarm within days; Rep. Alan Gray-
son (D-Fla.) posted an eight-minute screed on YouTube.
The Public Interest Lawyers. Finally, the unsung he-
roes might be the lawyers serving the underdogs, home-
owners unlikely to be able to pay retainer fees, let alone
their mortgage. Chipping away against the Byzantine
securitization structure itself, acting independently,
they were able to bring to light the dark, dirty secrets of
the lending world. These took the form of hapless
clerks working for law firms and servicers: Robosign-
ers.
Collapsing the Mound.
Mortgage Servicers and Robosigners. The villains—or
stooges—of Foreclosure-gate are likely to be the mort-
gage servicers. Contracted by lenders—or owned out-
right by them—they’re nominally overseen by the Fed-
eral Trade Commission, Office of the Comptroller of the
Currency, and Office of Thrift Supervision. Very few ac-
tions have ever been taken against them. There’s basi-
cally no direct government recourse against servicers
and (until now) government agencies have shown little
interest in them. The problem stems from the fact that
the regulators are overseeing the banks . . . and the
banks run the servicers.
The sole point of contact for borrowers are servicers,
who are themselves disincentivized to modify loans.
They’re required to advance principal and interest on
nonperforming loans to securitization trusts—but
they’re quickly reimbursed for foreclosure costs. Focus-
ing on foreclosures makes sense.
In mid-September ‘‘robosigners’’ were uncovered
through depositions held in a number of states. Mid- to
low-level mortgage servicer employees admitted to a
practice of rapidly signing and notarizing affidavits re-
lated to the loans being serviced. Drawn from the ranks
of hairstylists and assembly line workers, they were
given a few days training before being put to work at-
testing to the contents of documents that they neither
reviewed nor understood.
And as the robosigners were precursors of the
affidavits, affidavits (and the underlying
documents) themselves are central components to
a much bigger element: securitization itself.
They didn’t have time to. They signed as many as
10,000 affidavits a month—each—treating them like the
material they’d shoveled into chutes in previous ca-
reers. The affidavits were widespread—affidavits of in-
debtedness, lost-note affidavits, postdated mortgage as-
signments. Their purpose: cover up breaks in the chain
of title and establish legal standing to foreclose. In the
BNA 10-19-10
4
end, they created an ocean of counterfeit documents
that courts had relied on in foreclosure hearings.
In addition to forged signatures, Social Security num-
bers were swapped, documents were backdated and no-
tary stamps were apparently passed around tables like
condiments. The practices of the mortgage foreclosure
industry bear an eerie resemblance to the mortgage
origination industry, which created the situation in the
first place.
Although the robosigners caught the attention of the
media, they are only bit players. The documents them-
selves should be the focus.
Affidavits and Notes. Affidavits are effectively a
stand-in for live testimony to the court. Based on per-
sonal knowledge and belief, signed by an authorized in-
dividual, notarized, affidavits carry significant weight.
They’re not just ‘‘trivial paperwork.’’
Lost note affidavits (LNAs) have been routinely used
in the past when the actual, original, signed copy went
missing or was damaged. They’ve been described as be-
ing like automobile titles that somehow slip out of the
glove compartment and are trampled by the kids’ Uggs.
The difference here is that entire financial institu-
tions are now claiming that they are routinely losing or
damaging original promissory notes. This is what the
robosigners were attesting to: tens of thousands of lost
notes, per month.
Sidebar.
Mortgage Primer. A mortgage is made up of two com-
ponents. There is the ‘‘note,’’ which describes the
amount owed. It’s a promise to repay a debt, an IOU.
Covered by the Uniform Commercial Code (UCC), it
contains the terms of the debt obligations: how interest
is calculated, late fees, what constitutes a default. It’s a
negotiable instrument, like a check that can be signed
over to others. It requires real signatures—something
that cannot be done electronically.
Within a securitization context, the note has to be en-
dorsed over like a check, from A to B to C and finally to
the trust, all within a specified time period—usually 90
days.
The second component is the mortgage (‘‘lien’’). It’s
an ‘‘accessory’’ to the note. Covered by state real estate
law, it’s filed in county recording offices and provides a
history of land transfers. It’s also an enforcement
mechanism, giving the right to take away the collateral
(the house) if the note is not paid.
In 45 out of 50 states, if you don’t own the note, you
can’t foreclose.
More important, affidavits themselves may not prove
loan ownership regardless of how they were signed.
In Ohio, Judge Christopher Boyko reviewed claims of
big banks seeking to foreclose on home loans origi-
nated by local banks. The loans had been recorded in
public records in the name of the small banks before
they had been sold. The big banks claimed ownership
of the loans, although there was no public record of the
assignment taking place. There was also no record of
assignment of the note to a trust or successor interest.
Boyko found an inherent conflict in the filings them-
selves and denied the big banks standing. (In re Fore-
closure Cases, N.D. Ohio, 1:07-cv2282, et seq, 10/31/07)
10-19-10 COPYRIGHT ! 2010 BY THE BUREAU OF NATIONAL AFFAIRS, INC.
The situation arose from a mismatch of two different
worlds—securities and real property law. For centuries
lenders have gone to county courthouses each time a
mortgage was sold. The sale would be recorded and a
new owner would be named in the public records. In
the event of a default the identity of the loan—the party
who had the right to foreclose—was clear.
Affidavits are only the tip of the iceberg. Mortgage
pool documentation typically requires that in the event
that a small (0.01 percent) percentage of notes is a
mortgage weren’t properly transferred, then the trustee
for the bondholders can require that the investment
bank that put together the deal to repurchase the mort-
gages.
Under the circumstances being revealed, it could be
that none of the notes was properly transferred.
Similar requirements exist for the quality of mort-
gages being transferred. It’s becoming apparent that in-
dependent underwriters performing due diligence of
sample loans found as many as one-third of loans con-
tained in a pool failed to meet standards. Rather than
replace the low quality loans with higher quality ones,
investment bankers did what made sense: they merely
lowered the price.
Securitization. And as the robosigners were precur-
sors of the affidavits, affidavits (and the underlying
documents) themselves are central components to a
much bigger element: securitization itself.
Securitization complicates the paper trail for a given
mortgage by facilitating permutations in the servicing
and ownership history of the loan. A loan can undergo
several assignments on its way to the destination pool
as trustees shop for the most efficient servicer. Recon-
structing the facts behind a single loan can become a
staggering task.
Blank note assignments—standard industry
practice—dramatically increase the probability of
shoddy assignments. A note assigned ‘‘in blank name’’
becomes a bearer instrument, like a check. Bearer in-
struments require: a receipt of delivery and acceptance
from the originator to the sponsor and from the deposi-
tor to the trustee. The custodian must have all of these
documents and the original notes before a loan is con-
sidered to be owned by the trust. All of this is the re-
sponsibility of the trustee.
As more states are challenging, MERS didn’t
actually create a separate ownership interest.
Courts have held that MERS didn’t attempt to
demonstrate a tangible interest in the mortgage,
that it didn’t lend money or receive mortgage
payments, that it suffers no monetary loss, that it
has no authority to transfer promissory notes.
The rush to move large volumes of loans created fail-
ures in the ‘‘true sale’’ process. Under trust laws, notes
have to be signed over within a specified time period.
REAL ISSN 1944-9453

New York trust law—the predominant governing
law—is especially rigid in this regard. The very issue of
securitization could be called into question due to the
widespread failure of issuers and trusts to transfer
rights.
Interesting developments to watch for in the future
will be the degree of recklessness servicers and bank-
ers will have been found to have engaged in. Tales of
bank contractors breaking and entering the wrong
homes, are appearing, as are stories of multiple banks
foreclosing on the same house. Media attention is being
given to people who have had their homes foreclosed
upon . . . who have no mortgage.
As these stories collect, anger and frustration with
government and with the economy could find a strong
focus: banks.
As late as mid-September 2010 the accepted wisdom
was that the residential real estate market needed to ex-
perience a rapid clearing. Delinquent borrowers were in
the process of having their loans modified (assisted by
as many as eight separate government programs). If
they didn’t qualify for a modification, their home would
be foreclosed.
REO (bank-owned) and foreclosure sales accounted
for roughly a third of all home sales, and served to
weigh down home prices. Controlled speed was the fo-
cus. The foreclosure machine had to move forward, al-
though not at such a great rate that enormous amount
of REO properties would land on the market, further
depressing prices. Homeowners—the ants—would be
squashed, an economic necessity.
September 2010 saw a record 100,000 homes seized
after foreclosure. Foreclosure filings were up to around
350,000. One out of 371 households in the United States
received a notice of default in that month. Foreclosure
sales accounted for a third of all U.S. transactions.
Ant Swarm. By Oct. 15, the market finally began to
take notice of the foreclosure situation: Bank of
America (BofA), JP Morgan Chase, and other major
lenders each lost 5 percent of their market value—in a
single day.
MERS. In the world of mortgage backed securities—
bonds secured with hundreds or thousands of
mortgages—the annoying, antiquated recordation sys-
tem was at odds with the need to quickly transfer loan
ownership. The lending industry—led by BofA—created
MERS—the Mortgage Electronic Registration System.
MERS works like this: When a loan was originated
and sold, it was assigned a MERS number, similar to a
vehicle’s vehicle identification number. MERS then be-
came the nominal owner. Subsequent loan ownership
transfers were made within MERS—and outside the
public record.
Over 62 million residential loans in the United States
are registered in the name of MERS and recorded in
county record offices in MERS’s name. Result: the pub-
lic record system no longer contains the identity of the
holder of the note. County recording systems increas-
ingly are full of one name, without meaning: MERS.
MERS provided speed, and it cut registration fees,
claiming to have saved as much as $2.4 billion for lend-
ers (at the expense of local governments). But the re-
quirements for the conveyance of mortgages is well-
established black letter law. Failure to comply with the
requirements doesn’t create a ‘‘technical paperwork
REAL ESTATE LAW & INDUSTRY REPORT ISSN 1944-9453
5
problem.’’ It carries a catastrophic outcome: It cuts the
chain of title.
A recent California bankruptcy case (In re Walker,
Bankr. E.D. Cal., No. 10-21656-E-11, 5/20/10), following
landmark cases in a variety of jurisdictions recently
held that the electronic shortcut makes it impossible to
establish the ownership of titles—or to foreclose on
mortgaged properties.
The staggering implication is that a house in which
MERS was involved might not have a perfected security
interest as an encumbrance. Foreclosures based on
documents or presumptions based on MERS could be
void. Result: quiet title could be obtained on a home
foreclosed upon and sold years ago. Another result: 62
million homes could be foreclosure-proof.
MERS has no relationship to the note holder—it
doesn’t hold legal title as an agent for the owner of the
loan. This owner is always a trust. Or it is supposed to
be a trust.
As more states are challenging, MERS didn’t actually
create a separate ownership interest. Courts have held
that MERS didn’t attempt to demonstrate a tangible in-
terest in the mortgage, that it didn’t lend money or re-
ceive mortgage payments, that it suffers no monetary
loss, that it has no authority to transfer promissory
notes.
In addition, while MERS has been bringing foreclo-
sure proceedings in its own name, it’s not capable of
providing responses to discovery requests with respect
to predatory lending claims and defenses: It’s merely a
proxy to do the dirty work in foreclosures.
If mortgage ownership can’t be proven, the actual
loan owners foreclose because they can’t appear in
court. And if ownership can’t be proven, how can the
market value of the mortgages or the securities backed
by the bundles of mortgages be established?
Fannie Mae has taken note: Foreclosures filed after
May 1 can no longer name MERS as plaintiff on mort-
gage loans owned or securitized by the government-
sponsored enterprise (GSE).
Going forward, the focus for borrowers is to find
some paperwork error that will keep the bank
on the hook—and the borrower in the home.
Morgan Stanley estimates that as many as
9 million homes that have been or are being
foreclosed upon could challenge the validity of the
foreclosure.
REMIC. Mortgage-backed securities are pooled
through a Real Estate Investment Conduit (REMIC) that
must hold all the paperwork, demonstrating a complete
chain of title. This is Internal Revenue Service code.
Done properly, taxes are avoided.
It now appears that the original notes are still held in
loan originator warehouses . . . somewhere. Or maybe
not: enormous numbers of loan originators have disap-
BNA 10-19-10
6
peared. Because of this, the trustees do not have the
notes, either. There are no endorsements.
Why weren’t the notes conveyed to the REMICs?
First, trustees might have feared an audit by investors.
Better to ‘‘misplace’’ the notes and then later manufac-
ture new ones for foreclosure.
Another possibility is that the tracking process itself
may have prohibited the assignment of the notes to the
REMICs. Mortgages would be tranched into a variety of
securities of different quality. But an individual mort-
gage isn’t assigned to a particular tranche until it de-
faults. At default, it’s assigned to a lower tranche secu-
rity and the foreclosure process begins.
So, because a trustee had no way of knowing which
mortgage would default, there was no way to even as-
sign a note.
Trustees tried an end-run by using MERS as a con-
duit . . . but MERS didn’t have the paperwork, either.
Government Reaction. By mid-October the attorneys
general of all 50 states had joined to probe loan ser-
vicers accused of submitting false affidavits. They
stopped short of calling for a national foreclosure mora-
torium.
Their focus is on forged signatures that could have
violated laws of unfair and deceptive practices—laws
use to protect consumers from false advertising could
be applied to foreclosures. The initial call is for a
$25,000 fine per violation.
The Obama administration has been largely quiet on
the matter, perhaps by the impending mid-term elec-
tions. The GOP has been mum as well. Democrats have
called for a national foreclosure moratorium. Hearings
have been scheduled for mid-November, after the elec-
tions.
Regulators, in the meantime, have been seeking to
tamp down the furor by urging lenders to replace
‘‘flawed and fraudulent’’ court documents while con-
tinuing the foreclosure process.
They’ve also been protecting their reputation. In its
oversight of the failed IndyMac Federal Bank, the Fed-
eral Deposit Insurance Corporation was operating a
servicer that was engaged in robosigning.
Homeowners.
Show Me the Note. Homeowners and foreclosure de-
fense attorneys have been stymied by securitized loans.
MERS effectively strips away a borrower’s procedural
protections by creating barriers.
Reason: There is a lack of an identifiable and willing
counterparty. In traditional two- and three-party mort-
gage situations, borrowers had a clear idea of whom
they were borrowing from and who might foreclose
upon them. Service of process, interrogatories, and re-
quests for production of documents is relatively
straight-forward. With securitized loans, they’re faced
with a virtually impenetrable web of originating bank,
mortgage holders, mortgage servicers, mortgage-
backed securities pooling/servicing agents and inves-
tors.
And even if they can identify the parties, it can be
necessary to serve 10 or more separate businesses in or-
der to bring claims or defenses. This is made even more
daunting for a beleaguered borrower because he almost
always has no knowledge of even the name of these
10-19-10 COPYRIGHT ! 2010 BY THE BUREAU OF NATIONAL AFFAIRS, INC.
companies. Phone calls to loan servicers are routinely
ignored, or referred to clueless staff.
Going forward, the focus for borrowers is to find
some paperwork error that will keep the bank on the
hook—and the borrower in the home. Morgan Stanley
estimates that as many as 9 million homes that have
been or are being foreclosed upon could challenge the
validity of the foreclosure.
The approach would be straight-forward, and cases
could share common fact patterns. Borrowers would
not maintain to the court that they didn’t owe amounts
due, or that they should obtain title to their homes for
free. They could merely object to the foreclosing party
getting the house for free, absent proof that they’re ac-
tually the party in interest. Merely demonstrating this
simple element could prove to be a colossal task for in-
vestors.
Lessons and Possible Solutions.
s Although regulators and big banks have down-
played the situation as one requiring merely a review of
processing best practices, this is the critical determina-
tion: Is there any validity in the vast bulk of
securitization? How capable is the securitization indus-
try of disregarding its own contracts and the legal pro-
cedures designed to protect it?
s Securitization’s flaw comes not from its structure
or its theory, but from its inherent failure points: com-
plexity, human error, and greed. Regulatory oversight
is a crucial component.
s Mass production financing, the desire to do
things faster and cheaper—not correctly—doesn’t work.
MERS lost the ability to determine the lien holder of
record, and resales of mortgages within its system
broke the chain of title. Four million two hundred thou-
sand homes are now in default: MERS’s role in their
disposition is problematic.
This isn’t to say that the money borrowed is sud-
denly, magically, no longer owed, or that an equitable
lien can’t be levied on the property—in effect, a mort-
gage that could be foreclosed upon. But it’s a strictly ju-
dicial process.
The bigger implication is this: principal reductions
are inevitable. Even if a lien is perfected and enforced,
lenders can only get the amount the home is worth.
s ‘‘Putbacks’’—the requirement that loan origina-
tors repurchase entire loan portfolios from investors—
could be enormous. Early estimates for just BofA alone
for mortgages sold to Fannie, Freddie and private inves-
tors top $70 billion . . . with another $4 billion to cover
legal expenses.
s Congress somehow makes this all go away by
passing some kind of legislation fixing . . . everything.
The problem here is that in order to do this, it has to get
a waiver from the IRS related to REMIC (which it can);
suspend the UCC; all while running over state real
property law and New York trust law (which governs
most securitizations) and state tax issues. There’s little
opportunity for the federal government to create a uni-
form solution.
The Treasury Department has significant muscle. All
it has to do it threaten to enforce the IRS REMIC rules
on securitization.
s A mass federal refinancing program is enacted,
compensating for the shortcomings of the previous
eight federal loan modification programs that have
proven ineffective. States are likely to go along with
REAL ISSN 1944-9453

this, but this isn’t how the Obama administration has
operated. Mid-term elections could bring a Congress
that is significantly more anti-spending than the current
one.
s A mass principal modification program using a
bankruptcy approach used successfully by family farm-
ers in the 1980s—Chapter 12. With the Bankruptcy
Court granted cram-down authority, lenders are deeply
incentivized to write down principal to reflect current
values.
s ‘‘Foreclosure moratorium’’ is currently being
kicked around, an eerie shadow of the oil drilling mora-
torium imposed last spring in the Gulf of Mexico. In ad-
dition to penalizing lenders who were not involved in
securitization, it would grind to a halt the sale and pur-
chase of foreclosed homes, which accounts for more
than a third of the market. Another version of this
would be some type of bank holiday.
s ‘‘Owners Equivalent Rent’’: Homeowners would
make monthly payments reflecting market rent values
of their homes. The payments could be made either to
the government as some sort of receiver, or to the lend-
ers themselves. This could be combined with:
s Shared Equity Appreciation: Lenders release bor-
rowers from their mortgage using a deed-in-lieu struc-
ture. The borrowers then become tenants of the lend-
ers, paying rent at market rates. After a period of five
years, the tenants may reapply for a new loan with the
lender. The lender would take an equity interest in the
property. Alternatively, the lender could sell its interest
in the property to a third party investor.
s Accelerated stoppage, the mirror image of a
‘‘foreclosure moratorium’’: a ‘‘mortgage moratorium’’
(or ‘‘borrower holiday’’). As the New York Post asked
recently: ‘Why would anyone cut back on other things
for their family needs just to pay a loan the bank can’t
foreclose on?’’ This wouldn’t stem from government ac-
tion: ‘‘Don’t pay your mortgage, instead, go shopping!’’
Instead, it would result from government inaction,
homeowners and society collectively deciding, simply,
‘‘No.’’
REAL ESTATE LAW & INDUSTRY REPORT ISSN 1944-9453
7
s Title issues—rarely considered—could come to
the forefront. Clouds could remain on foreclosed prop-
erties for years, and title insurers could expand their re-
fusal to issue policies on foreclosed properties (or
implement tight restrictions). Homes with clean title
could carry a premium, as could new homes being de-
livered by builders. Conversely, the lead weight of bad
titles could serve to drag the market down for years.
s The winners under this scenario could be those
whose loans have been thrown into the securitization
hopper. Money that was going to the lender could be di-
verted to saving or (more likely) consumer spending.
Good times could return—at least for a while. Later on,
there will be repercussions. But how’s this any different
than when the loans were taken out in the first place?
s The biggest winners? Foreclosure defense attor-
neys and mortgage ownership auditing firms
More Ants. There are still a lot of unknowns to be
discovered—and villains identified. (Angelo Mozilo, ex-
chief executive officer of Countrywide, now owned by
BofA, settled fraud charges with the Securities and Ex-
change Commission on 10/15. BofA picked up the tab:
$65 million). The real estate market remains frag-
mented and local, despite best efforts to commoditize it.
Sadly, worst-case scenarios are difficult to dismiss.
Market confidence underpins everything and there
good news is scarce.
Second mortgages will likely make their appearance
next. Seconds are not like pesky red ants—they’re more
akin to deadly army ants, insects that can create whole-
sale animal stampedes.
Cram-downs or mass loan modifications appear to be
the most likely outcome of all of this. Lenders will pre-
fer to take a 40 percent to 50 percent loss rather than a
70 percent loss on a foreclosure. Borrowers will prefer
to stay in their homes; government just wants the prob-
lem to go away.
But this will wipe out seconds, which the four biggest
banks are carrying on their books at 80 percent to 90
percent of their face value. The amount: roughly $400
billion.
BNA 10-19-10