Massachusetts Ruling Slams Bank Foreclosure Practices

In a decision that jeopardizes potentially thousands of completed foreclosures in Massachusetts, the state's Supreme Judicial Court affirmed the fundamental and long-established idea that a bank must own the mortgage it's foreclosing on before it forecloses. In this case, because both Wells Fargo (WFC) and US Bancorp (USB) could not prove they owned the mortgages when they foreclosed on two homes, the court held that the foreclosures did not give the banks clear title to the properties.

Moreover, since the legal principles involved were so well established, the court refused to limit its ruling to future foreclosures only. That means all completed foreclosures that had similar flaws also failed to give good title.

How many is that? It'll take a while to figure out, but for the reasons below, it may include any foreclosure of a Massachusetts mortgage securitized in the last several years, which would be thousands. The only sure thing right now is that Massachusetts real estate ownership is a mess, and title companies that have insured the sales of foreclosed properties in Massachusetts might see a flood of claims.

Investors were quick to react: In afternoon trading, the S&P 500's financial sector was off 1.8% vs. a decline of 0.9% for the broader index. In addition to Wells (down nearly 4%) and US Bancorp (down 1.5%) , the biggest losers were JPMorgan Chase (JPM), Travelers (TRV) and Bank of America (BAC).

Banks Couldn't Prove Ownership of Mortgages

As "proof" of their ownership, the banks gave the court three types of unacceptable evidence: documents dated after the foreclosure was done that claimed to transfer the mortgage to the foreclosing bank (something that has been done nationally); a very incomplete set of documents from the securitization of the mortgages that purportedly gave the mortgages to the securitization trust (something that I've heard of happening elsewhere); and assignments of the mortgages "in blank," that is, not naming the person the documents were assigned to.

The court rejected the idea that a mortgage could be foreclosed on first and acquired by the foreclosing bank second. That ruling alone jeopardizes thousands of foreclosures because apparently this was standard practice in Massachusetts. The court also explained why the incomplete securitization docs were insufficient. For example, the banks submitted unsigned copies of key contracts, failed to submit other relevant contracts and generally omitted the attachments to those contracts that would prove the mortgages were governed by those contracts even if the contracts had been signed and otherwise complete.

This failure to submit key documents seems inexplicable -- unless the banks really don't have them -- because at the initial trial the judge allowed the banks a special, extra opportunity to submit the documents.

Assignments "In Blank" Don't Cut It

But perhaps this difficulty in getting complete signed copies of all the deal documents for the securitizations at issue is relatively limited. That is, each securitization deal theoretically is memorialized in a "closing set," binders holding complete sets of all the deal contracts, which are hiding out in law firms' record departments.

So, perhaps all the banks need to do is make a habit of giving the foreclosing attorneys the right documents. But unfortunately for Massachusetts landowners, even if the banks in this case had given complete securitization documents to the court, they still couldn't prove ownership of the mortgages.

For a transfer of mortgage to be valid under Massachusetts law, it has to name the person the mortgage is being assigned to. Assignments "in blank" don't work. But that's what this securitization deal involved. Option One, the last recorded owner of the mortgages, executed assignments in blank, presumably to facilitate the securitization process by obviating the need to reassign them at later stages of the process.

So the biggest question is: How many Massachusetts mortgages were "securitized" by assignments in blank? Today's decision would not only invalidate all completed foreclosures done in the name of securitized trusts that believed they owned the mortgages, but also the very securitization of those mortgages.

Another Reason to Force Banks to Buy Back Loans

Because the assignments in blank of those mortgages failed to give the securitizing trust ownership of the mortgages, the investors in the securities supposedly backed by them had only an unsecured interest in the mortgage loans, that is, an interest in debt akin to credit card debt. If assignments in blank were standard practice, that could mean many or most Massachusetts mortgages in recent years are affected. Usually securitizations included mortgages from across the country, but it's possible at least some had a significant percentage of Massachusetts loans.

What the failure to transfer the mortgages into the trust ultimately means for the securities and for the not-yet-foreclosed loans isn't clear. Perhaps the mortgages can still be transferred into the trust. (The court decision makes clear, however, that the mortgages can't be transferred in by a document signed now that claims to have an earlier effective date.) But if not, investors will surely try to make the banks that issued the securities buy back the Massachusetts mortgages. That's bad news for the banks, as buyback risks are already significant.

Another huge question: Were any other states' real estate transfer laws violated by securitization procedures on any scale?

"Utter Carelessness"

In a concurring opinion, two judges scold the banks, writing:
What is surprising about these cases is not the principles articulated by the court regarding title law or the foreclosure law of Massachusetts, but rather the utter carelessness with which the plaintiff banks documented the titles to their assets. . .[the banks] need to take care to ensure [their] legal paperwork is in order. . . . The type of sophisticated transactions leading up to the accumulation of the notes and mortgages in question in these cases and in their securitization, and ultimately, the sale of mortgage-backed securities, are not barred or even burdened by the requirements of Massachusetts law.
Translation: "Hey big banks, the rules were easy to follow and would have let you do want you wanted to do. But you were too careless to follow them."

We'll have to wait to see how many bad consequences flow from that carelessness.