(Even More) Ominous Clouds for the Mortgage Industry

What if the mortgage industry screwed up its legal right to foreclose on (give or take) 60 million homes? That’s the potential consequence of Landmark National Bank v. Kesler (Kan. 2009). The Kansas Supreme Court can’t issue binding precedent for the rest of the country, but the reasoning here is not to be easily ignored.

I don’t fully understand the ins and outs of this process, so look elsewhere for an authoritative discussion, but generally the issue is that a number of lenders set up an entity called “Mortgage Electronic Registration Systems, Inc.” (MERS – the Wikipedia article seems informative but not neutral.) As I understand it, this entity purports to be the mortgagee of record to a note on a loan secured by real estate. Lenders who are participants in the MERS program can buy and sell interests in mortgages and, I suppose, portions thereof without having to do a lot of paperwork and recording that assigns the mortgage to one person and then another as the financial obligation is traded about. So, Bank A lends the money to a Buyer to purchase a home and has the Buyer sign a mortgage in favor of MERS. As a participant in the MERS program, Bank A can then sell the mortgage to Bank B without having to do a lot of paperwork assigning the mortgage to Bank B and recording that assignment in the county recorders office.

The facts described by the Kansas Supreme Court are probably typical of a MERS mortgage:

The second mortgage lies at the core of this appeal. That mortgage document stated that the mortgage was made between Kesler–the “Mortgagor” and “Borrower”–and MERS, which was acting “solely as nominee for Lender, as hereinafter defined, and Lender’s successors and assigns.” The document then identified Millennia as the “Lender.” At some subsequent time, the mortgage may have been assigned to Sovereign and Sovereign may have taken physical possession of the note, but that assignment was not registered in Ford County.

The problem with MERS is that the mortgage (granting the power to foreclose in the even of default) is severed from the note (creating the obligation by which default is possible). The Kansas Supreme Court describes what can happen when the the mortgage is severed from the note:

The relationship that MERS has to Sovereign is more akin to that of a straw man than to a party possessing all the rights given a buyer. A mortgagee and a lender have intertwined rights that defy a clear separation of interests, especially when such a purported separation relies on ambiguous contractual language. The law generally understands that a mortgagee is not distinct from a lender: a mortgagee is “[o]ne to whom property is mortgaged: the mortgage creditor, or lender.” Black’s Law Dictionary 1034 (8th ed. 2004). By statute, assignment of the mortgage carries with it the assignment of the debt. K.S.A. 58-2323. Although MERS asserts that, under some situations, the mortgage document purports to give it the same rights as the lender, the document consistently refers only to rights of the lender, including rights to receive notice of litigation, to collect payments, and to enforce the debt obligation. The document consistently limits MERS to acting “solely” as the nominee of the lender.

Indeed, in the event that a mortgage loan somehow separates interests of the note and the deed of trust, with the deed of trust lying with some independent entity, the mortgage may become unenforceable.

“The practical effect of splitting the deed of trust from the promissory note is to make it impossible for the holder of the note to foreclose, unless the holder of the deed of trust is the agent of the holder of the note. [Citation omitted.] Without the agency relationship, the person holding only the note lacks the power to foreclose in the event of default. The person holding only the deed of trust will never experience default because only the holder of the note is entitled to payment of the underlying obligation. [Citation omitted.] The mortgage loan becomes ineffectual when the note holder did not also hold the deed of trust.” Bellistri v. Ocwen Loan Servicing, LLC, 284 S.W.3d 619, 623 (Mo. App. 2009).

Or, in short, “If MERS is only the mortgagee, without ownership of the mortgage instrument, it does not have an enforceable right.” But, if MERS does have enforceable rights to the underlying note, it could find itself embroiled in regulations that apply to mortgage bankers.

Matt Taibbi has a blog entry on this likening the mortgage industry to a giant criminal enterprise. He also notes that, more generally, the mortgage industry has been incredibly sloppy with its record keeping. This has allowed debtors to successfully challenge a lender’s right to foreclose in some cases. These are people who have received a benefit from money lent and who have failed on their promises to repay the money, but the lender (or whoever is currently holding the bag) can’t recover because they can’t prove they actually own the debt.

I don’t know if severing the note from the mortgage has a similar effect in Indiana or if MERS mortgages use the same language in Indiana. I suspect we’ll see an increase in challenges along these lines as attorneys become more attuned to the issues and courts analyze evidence about chain of title with a more critical eye. Glancing at some of the cases, I saw a case where the Northern District of Illinois shrugged off a similar challenge based on some affidavits from people associated with MERS and no serious rebuttal or opposition from the mortgage-debtor.

If MERS mortgages were deemed to be unenforceable, it could obviously have major repercussions. I ran a quick and dirty search on the Tippecanoe County court system and found more than 500 cases where “Mortgage Electronic Registration Systems, Inc.” was a party.

Update: Per a comment, here is the link to an entry Advance Indiana did on the subject a month or two ago.