Until recently borrowers have been at a disadvantage when in court for a foreclosure. It’s usually a cut and dried process. A debt is secured by a house. Payments aren’t made, so the bank gets to take back the home. This month a ruling in federal bankruptcy court shook the mortgage world. In the Southern District of New York, Judge Robert D. Drain eliminated a $461,263 mortgage debt owed to PHH Mortgage, because it hadn’t proved its claim to actually own the property. The state was wiped clean and the homeowners now get to stay in the home mortgage free.
At the heart of the ruling is that PHH Mortgage hadn’t proved itself to be the real party in interest, the holder of the mortgage. The reason for this ostensible quirk in mortgage law is the relatively recent process of mortgage securitization. Historically, mortgage notes were owned by local banks or savings and loans. Remember George Baily’s business in the Frank Capra film “It’s a Wonderful Life.” In the last few years, lenders have converted their mortgages to collateralized mortgage obligations, CMO. Each individual mortgage would get sliced into shares, or tranches. For example, a $500,000 mortgage at 7% would get divided into 500 bonds of 1000 dollars each yielding 6.5%, amortized over the life of the home loan. The remaining .5% would go to the servicer, like PHH Mortgage to handle billing and accounting. The bonds from many different sources were bundled, then issued by as securities by Wall Street stalwarts like Lehman Brothers, Bear Sterns and Merril Lynch. Given how steadily property values were increasing until the crash, rating agencies considered these investments safe. Money poured in, creating increased demand for more mortgage back securities, generated by more mortgages, fueling the housing bubble. With dozens of investors reaping the interest from an individual mortgage, who actually has title to the property in the event of a foreclosure?
The case tried before Judge Drain was handled by David B. Shaev a Manhattan attorney who in the course of filing a Chapter 13 bankruptcy to protect a client from foreclosure, simply wanted a loan modification. When PHH continued to delay approval of payment reduction, Mr. Shaev asked for proof of PHH’s right to press its claim. At that point, PHH revealed that it was the servicer of the loan, but that US Bank owned the note. However, US Bank had not been involved in the foreclosure proceeding.
Typically any transfer of ownership to real property has to be registered with the states, although in many jurisdictions, lenders and servicers have been relying on Mortgage Electronic Registration Systems, Inc., MERS a private corporation. In the New York case, MERS recorded the transfer of the mortgage to US Bank after the bankruptcy had been filed.
Judge Drain’s ruling.shocked Mr. Shaev “We are in uncharted territory,” the attorney said. “Right now I am in bankruptcy court with a house that has no discernible debt on it, yet I have a client with a signed mortgage. We cannot in theory just go out and sell this house because the title company won’t give a clear title on it.”
Other jurisdictions are taking up this question of who actually has the status to file a foreclosure claim in a world of mortgage securitization:
- A Providence attorney, Geoge Babcock is challenging the validity MERS recorded mortgage ownership transfers for of 100 of his foreclosure clients. Mr. Babcock lost a key decision on August 25th but he’s appealing it to the Rhode Island Supreme Court.
- In Kansas, August 28th the Supreme Court ruled that MERS registration alone is not enough to protect the rights of a lender.
- In Massachusetts, Judge Joel B Rosenthal ruled against Ameriquest when in a bankruptcy case it claimed to be the holder of a note and mortgage. When this position was contested by the debtor, Ameriquest revealed that it was merely the loan servicer and not the lender. Judge Rosethal concluded that Ameriquest had misrepresented its position in court and sanctioned the servicer $250,000.
It remains to be seen whether the issue of cloudy mortgage ownership emerges as a viable foreclosure defense in more than a single case.However, if you are a distressed borrower, you can take heart from the fact that at least in one case where all hope seemed lost, the homeowners got to keep their beloved home, mortgage free.
