What, Exactly, is the Problem With Foreclosures?

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Since he has frequently made the point in the comments section that non-lawyers are egregiously misunderstanding the issues at stake, I have asked Rob Lyman to explain what he means.  Rob used to have his own blog, once upon a time, and as you can see, the world lost a great blogger when he gave it up.


So, thanks to the generous invitation of our gracious hostess, herewith my discussion of why the mortgage mess has nothing to do with "archaic land records systems." There are doubtless more legal errors that merit discussion, but I'm going to stick with what I know best. Several things should be said 1) this is not legal advice. It's general information. Consult a lawyer, and pay him well. 2) The law varies considerably from state to state, so some of what I say may be downright wrong in your state; I'm speaking in broad generalities here. 3) I'm not actually a land lawyer. I'm a patent lawyer. It happens that patents have a title system which closely resembles the land title system, and yes, I've written a mortgage intended to cover a patent. But I may make mistakes that a real estate lawyer wouldn't make. Feel free to correct me.
I'm going to start with a summary of the purposes and effects of the recording system used by most counties in the US. Then I'll pause briefly to discuss the rules surrounding transfers of the documents in issue. After that, it should be clear what the problems the banks are currently experiencing are, and what they should have done to avoid them.

So. Land records. It is obvious that it is possible to have possession and apparent ownership of land without actually owning it, or having the right to sell it. You can't just walk up to the guy living in the house and buy it from him and expect that to go well. Renters obviously can't sell the house, and there are many sorts of "estates" in land which permit possession without the power of sale. The way one transfers (or proves) ownership is by deed: here is a document showing that the previous owner transferred it to me, and showing what sort of transfer it was.

But of course the question arises: how did the previous owner get the right to do that? Who sold it to him? This gives rise to the concept of a "chain of title," stretching back to time immemorial, which at common law was 1189. So now suppose your seller shows you a nice chain of title going back to the coronation of Richard I, and you buy the house. The next day, some other dude shows up and says HE bought the house from the same owner, too. Or worse, somebody shows up with a chain of title dating back to the coronation of Richard II, claming to have bought the place from an entirely different "previous owner." Which one of you gets it?

At common law, first in time was first in right; whoever had gotten their deed from the previous owner won, and the other guy had no recourse but to sue that the seller for fraud. Or maybe sue the guy who has been dead for a few hundred years for fraud. This system was obviously not fully satisfactory. The solution is to permit buyers to record their deeds in searchable books at the county courthouse, so that you can see if anyone else has bought the place before you.

Additionally, the recording laws operate to cut off the interests of people who fail to record their deeds. This means that if buyer A fails to record his deed, and buyer B comes along later and, after a diligent search of the land records, buys the house from the sneaky seller, buyer B can deprive buyer A of the property by recording. There are different types of recording statutes which operate in slightly different ways, but the basic rule is this: you don't have to record, but if you don't, you risk somebody coming along later, "buying" the place from the same guy who sold it to you, and then kicking you out successfully. On the other hand, if you record promptly, you can be protected from somebody who bought before you, but failed to record, as well as anyone who buys after you.

Lenders who get mortgages from buyers can (and should!) also record their mortgages, and for the exact same reasons: they don't want their interest in the property (the right to take it over if they aren't paid) to be cut off by a subsequent buyer. Mortgages will have a priority based on the order of their recording: first recorded will generally be the first paid. So recording the mortgage is a pretty good idea.

Note something here however: recording is generally not mandatory, nor does it affect the validity of a deed or mortgage. It is perfectly possible to, say, bring a trespassing action against someone even if you have no recorded deed, as long as you can produce the actual deed to show the court you are in fact entitled to bring it. Similarly, to foreclose, no recordation is necessary. The county records affect ONLY the rights of prior and subsequent buyers/mortgagees. So the fact that mortgage securitizers didn't record these transfers does not in any way affect the validity of the transfers. They weren't required to record them.

One other thing to note is that county recording offices usually record only documents affecting title to land (although they do vary in both their rules and the rigor with which they are enforced). That means that transferring the note (the evidence of the debt) wouldn't even be recordable in many places; only the mortgage (which is a security interest in real property) would even be accepted by the clerks.
So what happened?

Well, there's a right way and wrong way to transfer the rights to both a stream of payments (the note) and to foreclose (the mortgage or deed of trust). I have been saying that the former calls for "wet ink" on the face of the document, which nk101 pointed out isn't quite right. Wet ink is required to make someone a "holder" of the note, but not to grant the right to enforce it, for which being a mere "assignee" will suffice. So I got that wrong (or exaggerated a bit). But what is clear is that to transfer ownership of either a note or a mortgage, you must do it in writing. A handshake or a call to your broker isn't good enough, even if it's a really really earnest handshake. This doesn't necessarily have to be a literal piece of paper, although I confess I have a personal preference for that sort of thing. You could do it with some kind of electronic document and digital signature, if you like. But either way, the transfer must be evidenced by some kind of document, which you will then have to produce for the court to prove you have the rights you say you have.
Also, of course, somebody is going to have to produce proper evidence of the original note and mortgage; a scan or photocopy should suffice, presuming your bank hasn't managed to get a reputation for forgery, in which case the judge may start wanting to see wet ink on that, too.

It appears that the formality of a writing was neglected in many MERS-related cases. So while the bankers all agree amongst themselves (thanks to MERS), that Servicing Company A has the right to receive payments and sue for foreclosure, SCA is unable to produce documentary evidence sufficient to support that claim in court.

However, SCA was never required to record the transfer of the mortgage, and had the transfer been properly accomplished, the failure to record would have had no effect on their right to foreclose. SCA is in some sense taking a risk that whoever sold them the mortgage might sell it to someone else, too, but since bankers have deep pockets, they don't generally go in for that kind of easily proven fraud. Plus, since all the bankers are using MERS, an erroneous extra transaction would probably be denied by the MERS system (I don't really know how MERS works, but I presume this is why it was created: to give banks some of the confidence that recording laws give them).

The problem here is improper assignments of mortgages (and notes), not failure to do something which was, after all, never legally required. In some sense, a policy of recording transfers would have prevented the problem, because if you're going to go record something, you need to actually have that something in hand, and thus you wouldn't neglect to create that something. However, failure to record is not an attempt to "circumvent the law," and having a highly sophisticated recording apparatus wouldn't have prevented idiots from failing to effect transfers in writing.



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Megan McArdle is a columnist at Bloomberg View and a former senior editor at The Atlantic. Her new book is The Up Side of Down.

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