«DECONSTRUCTING THE BLACK MAGIC OF SECURITIZED TRUSTS: HOW THE MORTGAGE-BACKED SECURITIZATION PROCESS IS HURTING THE BANKING INDUSTRY’S ABILITY TO ...»
56. Federal Reserve Bank of New York Staff Reports, Understanding the Securitization of Subprime Mortgage Credit, March 2008. Of course, the credit-rating agencies had their own vested interest in giving securities an inflated credit rating, considering that they were paid by large lenders to rate these securities. Roger Lowenstein, Triple-A Failure, NEW YORK TIMES, April 27, 2008. Simply put, if they did not give high enough ratings to sell the securities, they would not be hired to rate more. Id. Eventually, the credit rating agencies became so large that no one questioned the ratings they were giving to less than ideal mortgagebacked securities, which were still receiving credit ratings of Triple-A, the same rating given to the U.S. Treasury bond. Id. In 1996 Thomas Friedman, a New York Times columnist, stated, “[t]here are two superpowers in the world today in my opinion. There’s the United States and there’s Moody’s Bond Rating Service. The United States can destroy you by dropping bombs, and Moody’s can destroy you by downgrading your bonds. And believe me, it’s not clear sometimes who’s more powerful.” Id.
57. BITNER, supra note 10, at 108–10 (2008); Lowenstein, Triple-A Failure, supra note 56.
58. BITNER, supra note 10, at 108–10 (2008).
2011] THE SECURITIZATION CRISIS 11 [t]hink of it this way: Imagine taking 10 different vegetables and pureeing them in a food processor until you have something close to soup. Ask someone to identify the ingredients but don’t let him taste it – make him rely strictly on his sense of sight. Your concoction is sure to make him wonder what’s inside.63 As noted in the New York Times article Triple-A Failure published back in 2008 when the ratings began dropping drastically on mortgage-backed securities following the beginning of the real estate implosion:
[o]bscure and dry-seeming as it was, this business offered a certain magic. The magic consisted of turning risky mortgages into investments that would be suitable for investors who would know nothing about the underlying loans. To get why this is impressive, you have to think about all that determines whether a mortgage is safe. Who owns the property? What is his or her income? Bundle hundreds of mortgages into a single security and the questions multiply; no investor could begin to answer them. But suppose the security had a rating. If it were rated triple-A by a firm like Moody’s, then the investor could forget about the underlying mortgages. He wouldn’t need to know what properties were in the pool, only that the pool was triple-A – it was just as safe, in theory, as other triple-A securities.64 When mortgages held in securitized trusts began defaulting at alarming rates, the rating agencies began performing mass downgrades on their ratings, adding fuel to the belief held by many experts that they had been artificially inflated from the beginning.65 While the rating agencies are certainly to blame, government regulation by the SEC was also lacking, making it easier for rating agencies to rely on bad or incomplete information to inflate ratings.66 Of course, long after the damage was done the SEC began investigating whether the ratings agencies were guilty of fraud by failing to meet their due diligence requirements, which would have allowed them to adequately rate the mortgage-backed securities.67 All in all it just goes to show that numerous institutions on Wall Street and the United States government
64. Lowenstein, Triple-A Failure, supra note 56.
65. Roy D. Oppenheim, Meet the Wall Street Enablers: Credit Rating Companies, South Florida Law Blog, June 21, 2011, http://southfloridalawblog.com/2011/06/21/meet-the-wallstreet-enablers-credit-rating-companies/ (last visited Sept. 30, 2011).
through its various agencies all contributed to this mass crisis, a crisis for which the American public is paying the price.68
THE SHELL GAME: THE POOLING AND SERVICING AGREEMENT ANDWHAT
THE BIG BANKS DON’T WANT THE JUDICIAL SYSTEM TO KNOWIn general, the securitization process and resulting trust are governed by what is known as a Pooling and Servicing Agreement (“PSA”) which sets forth the exact steps necessary for a trust to be created, for the bundled mortgages to be transferred into the trust, for the issuance of securities by the trust to the depositor or on the open market, generally to institutional investors, and for the maintenance of the trust once created in order to maintain favorable tax status.69 In a foreclosure filed by a trustee on behalf of a securitized trust, the Pooling and Servicing Agreement is the key piece of documentation needed from the bank in order for the Judge to determine whether the trust owns the loan being foreclosed.70 In general, the Pooling and Servicing Agreement is a public record and can be found through the SEC website as an Exhibit to SEC filings made by each individual trust. However, the true essential component of the PSA is not a public record, but rather a document attached to the PSA known as the Master Loan Schedule. While the PSA is essential because it sets forth the rules for each bundle of mortgage loans, and defending a foreclosure based on bad securitization entails demonstrating to the court that the sponsor, depositor, trustee or servicer has violated those rules, making the transfer to the trust defective, the Master Loan Schedule establishes whether the subject mortgage was ever transferred to that particular trust. Therefore, while both are essential, if the loan was never transferred to the trust, this is the home run of all foreclosure defense strategies, because the trust, simply put, cannot sue to collect on something it does not own.
Assistant’s Revenge: Liability of the Trustee and Servicer Under the PSA
Although they play no role in actually creating the securitized mortgage bundled loans, the trustee and servicer are in a position to do the most damage to the trust when it comes to establishing proper standing in a mortgage foreclosure action. Once the bundled mortgages are given to a depositor, the PSA and I.R.S. tax code provisions71 require that the mortgages be transId.
69. Levitin and Twomey, supra note 34, at 23.
71. I.R.C. §§860A-860G.
2011] THE SECURITIZATION CRISIS 13 ferred to the trust within a certain time frame, usually 90 days from the date the trust is created.72 After such time, the trust closes and any subsequent transfers are invalid.73 The reason for this is purely economic for the trust.74 If the mortgages are properly transferred within the 90 day open period, and then the trust properly closes, the trust is allowed to maintain REMIC tax status.75 REMIC tax status is essential for trusts because it provides for an entity-level tax exemption, allowing the income derived in the trusts from the payment of mortgage interest to be taxed only at the investor level, whereas most corporations are taxed at both the corporate level and again when income is passed to shareholders.76 However, the largest key to REMICS is that they are required to be passive vehicles, meaning that mortgages cannot be transferred in and out of the trust once the closing date has occurred, unless the trust can meet very limited exceptions under the Internal Revenue
Code.77 Professor Levitin describes the conflict the following way:
The trustee will then typically convey the mortgage notes and security instruments to a “master document custodian” who manages the loan documentation, while the servicer handles the collection of loans. Increasingly, there are concerns that in many cases the loan documents have not been properly transferred to the trust, which raises issues about whether the trust has title to the loans and hence standing to bring foreclosure actions on defaulted loans.
Because, among other reasons, of the real estate mortgage investment conduit (“REMIC”) tax trust of many private-label securitizations (“PLS”)... it would not be possible to transfer the mortgage loans (the note and the security instrument) to the trust after the REMIC’s closing date without losing REMIC status.78
As trust documents are explicit in setting forth a method and date for the transfer of the mortgage loans to the trust and in insisting that no party involved in the trust take steps that would endanger
72. I.R.C. §860G. The 90 day requirement is imposed by the I.R.C. to ensure that the trust remains a static entity. Id. However, since the PSA requires that the trustee and servicer not do anything to jeopardize the tax-exempt status, PSAs generally state that any transfer after the closing date of the trust is invalid. Id.
77. Levitin and Twomey, supra note 34, at 15 n.35.
the trust’s REMIC status, if the original transfers did not comply with the method and timing for transfer required by the trust documents, then such belated transfers to the trust would be void. In these cases, there is a set of far-reaching systemic implications from clouded title to the property and from litigation against trustees and securitization sponsors for either violating trust duties or violating representations and warranties about the sale and transfer of the mortgage loans to the trust.79 It is also crucial to note that under the PSA, the trustee and the servicer bear liability if they transfer mortgages in violation of the PSA requirements, causing the trust to lose REMIC tax status.80 As a recent Reuters Exclusive article on how the IRS is investigating these lapses noted “[i]f the IRS did impose penalties, the REMICs could turn around and sue the banks for causing the problems and not living up to the terms of the agreements establishing each REMIC, thus transferring the costs to the banks.”81
PULLING A RABBIT OUT OF A HAT: THE FUNDAMENTAL CONCEPT OF
STANDING AND HOW SECURITIZATION HAS RUN AMUCK WITH A BASIC
LEGAL REQUIREMENTStanding is one of five traditional legal requirements that a person must meet in order to bring suit in a court of law.82 Of the five requirements, standing is perhaps the most crucial requirement because it requires the aggrieved party to prove that they have the right to seek redress.83 Under Article III of the United States Constitution, standing is often characterized by the statement that a plaintiff must show that there is “a case and controversy,” and there are three requirements one must prove.84 First, they must prove a legally cognizable injury; second, that the injury is concrete and parId.
80. Paltrow, supra note 50. The indemnification provisions of the PSA have not passed the notice of the investors who purchased many of these mortgage-backed securities. See, e.g.
In the matter of the application of The Bank of New York Mellon, 2011-651786, Supreme Court of the State of New York. Over 90 lawsuits have already been filed against servicers and trustees for improper practices in violation of the PSAs which governed their conduct, with claims totaling over $197 billion as of August 2011. Louise Story and Gretchen Morgenson, A.I.G. Sues Bank of America Over Mortgage Bonds, NEW YORK TIMES, August 8, 2011.
81. Paltrow, supra note 50.
82. See generally U.S. V. SCRAP, 412 U.S. 669 (1973); The ‘Lectric Law Library’s Lexicon.
83. See generally SCRAP, 412 U.S. 669.
84. See generally id.
2011] THE SECURITIZATION CRISIS 15 ticularized; and third, a causal relationship between the injury and the conduct of the defending party.85 During the robo-signing crisis where the banks on Wall Street fraudulently “verified” millions of documents in order to fix their mistakes, some of the biggest names in the news media made light of the significant repercussions that such practices have for the history of the American legal and recording system.86 On October 9, 2010 the Wall Street Journal published an editorial titled “The Politics of Foreclosure.”87 The author of the editorial,
with latent sarcasm wrote:
[t]alk about a financial scandal. A consumer borrows money to buy a house, doesn’t make the mortgage payments, and then loses the house in foreclosure – only to learn that the wrong guy at the bank signed the foreclosure paperwork. Can you imagine? The affidavit was supposed to be signed by the nameless, faceless employee in the back office who reviewed the file, not the other nameless, faceless employee who sits in the front.88 The South Florida Law Blog published a response to this outlandish opinion, pointing out the extreme disregard this editorial gives to the legal requirement of standing, and the consequences that such blatant disregard for our constitutional protections could have.89 Your editorial completely disregards an important constitutional concept of legal standing. Standing is the substantive due process notion of what a party must do in order to have the legal right to bring a legal action through our judicial system. Without the protective concept of standing, anyone could sue anyone at any time, ultimately causing legal anarchy. To fabricate standing, the banks used fraudulent assignments, bad notaries, and allowed for perjured documents to be presented to judges. The banks were forced to engage in such conduct because... the bank broke the mortgage into different parts, splitting the Note from the Mortgage by assigning the Mortgages to a third party (MERS) and selling the Notes to another entity. The Notes were than further sold off in tranches [sic]... Questions will be asked for a generation how banks literally hijacked the judicial system turning it into their own collection system while dispensing with the rules of law that have
85. See generally id.
86. Editorial, The Politics of Foreclosure, WALL STREET JOURNAL, Oct. 9, 2010.
89. Oppenheim, Roy Oppenheim to the Wall Street Journal, supra note 3.