In a nearly $13 billion settlement with the US Justice Department in November 2013,
JPMorganChase admitted that
it, along with every other large US bank, had engaged in mortgage fraud
as a routine business practice, sowing the seeds of the mortgage
meltdown. JPMorgan and other megabanks have now been caught in over a
dozen major frauds, including LIBOR-rigging and bid-rigging; yet no
prominent banker has gone to jail. Meanwhile,
nearly a quarter of all mortgages nationally remain
underwater (meaning the balance owed exceeds the current value of the
home), sapping homeowners’ budgets, the housing market and the economy.
Since the banks, the courts and the federal government have failed to
give adequate relief to homeowners, some cities are taking matters into
their own hands.
Gayle McLaughlin, the bold mayor of Richmond, California, has gone
where no woman dared go before, threatening to take underwater mortgages
by eminent domain from Wall Street banks and renegotiate them on behalf
of beleaguered homeowners. A member of the Green Party, which takes no
corporate campaign money, she proved her mettle standing up to Chevron,
which dominates the Richmond landscape. But the banks have signaled that
if Richmond or another city tries the eminent domain gambit, they will
rush to court seeking an injunction. Their grounds: an unconstitutional
taking of private property and breach of contract.
How to refute those charges? There is a way; but to understand it,
you first need to grasp the massive fraud perpetrated on homeowners. It
is how you were duped into paying more than your house was worth; why
you should not just turn in your keys or short-sell your underwater
property away; why you should urge Congress not to legalize the MERS
scheme; and why you should insist that your local government help you
acquire title to your home at a fair price if the banks won’t. That is
exactly what Richmond and other city councils are attempting to do
through the tool of eminent domain.
The Securitization Fraud That Collapsed the Housing Market
One settlement after another has now been reached with investors and
government agencies for the sale of “faulty mortgage bonds,” including a
suit brought by Fannie and Freddie that
settled in October 2013 for $5.1 billion.
“Faulty” is a euphemism for “fraudulent.” It means that mortgages
subject to securitization have “clouded” or “defective” titles. And that
means the banks and real estate trusts claiming title as owners or
nominees don’t actually have title – or have standing to enjoin the city
from proceeding with eminent domain. They can’t claim an
unconstitutional taking of property because they can’t prove they own
the property, and they can’t claim breach of contract because they
weren’t the real parties in interest to the mortgages (the parties
putting up the money).
“Securitization” involves bundling mortgages into a pool, selling
them to a non-bank vehicle called a “real estate trust,” and then
selling “securities” (bonds) to investors (called “mortgage-backed
securities” or “collateralized debt obligations”).
By 2007, 75% of all mortgage originations were securitized. According to investment banker and financial analyst Christopher Whalen,
the purpose of securitization was to allow banks to avoid capitalization requirements, enabling them to borrow at unregulated levels.
Since the real estate trusts were “off-balance sheet,” they did not
count in the banks’ capital requirements. But under applicable
accounting rules, that was true only if they were “true sales.”
According to Whalen, “most of the securitizations done by banks over the
past two decades were in fact secured borrowings, not true sales, and
thus potential frauds on insured depositories.” He concludes, “bank
abuses of non-bank vehicles to pretend to sell assets and thereby lower
required capital levels was a major cause of the subprime financial
crisis.”
In 1997, the FDIC gave the banks a pass on these disguised borrowings
by granting them “safe harbor” status. This proved to be a colossal
mistake, which led to the implosion of the housing market and the
economy at large. Safe harbor status was finally withdrawn in 2011; but
in the meantime, “financings” were disguised as “true sales,” permitting
banks to grossly over-borrow and over-leverage. Over-leveraging allowed
credit to be pumped up to bubble levels, driving up home prices. When
the bubble collapsed, homeowners had to pick up the tab by paying on
mortgages that far exceeded the market value of their homes. According
to Whalen:
[T]he largest commercial banks became “too big to fail”
in large part because they used non-bank vehicles to increase leverage
without disclosure or capital backing. . . .
The failure of Lehman Brothers, Bear Stearns and most notably
Citigroup all were largely attributable to deliberate acts of securities
fraud whereby assets were “sold” to investors via non-bank financial
vehicles. These transactions were styled as “sales” in an effort to
meet applicable accounting rules, but were in fact bank frauds that
must, by GAAP and law applicable to non-banks since 1997, be reported as
secured borrowings. Under legal tests stretching from 16th Century UK
law to the Uniform Fraudulent Transfer Act of the 1980s, virtually none
of the mortgage backed securities deals of the 2000s met the test of a
true sale.
. . . When the crisis hit, it suddenly became clear that the banks’ capital was insufficient.
Today . . . hundreds of billions in claims against banks arising from
these purported “sales” of assets remain pending before the courts.
Eminent Domain as a Negotiating Tool
Investors can afford high-powered attorneys to bring investor class
actions, but underwater and defaulting homeowners usually cannot; and
that is where local government comes in. Eminent domain is a way to
bring banks and investors to the bargaining table.
Professor Robert Hockett of Cornell University Law School is the
author of the plan to use eminent domain to take underwater loans and
write them down for homeowners. He
writes on NewYorkFed.org:
[In] the case of privately securitized mortgages,
[principal] write-downs are almost impossible to carry out, since loan
modifications on the scale necessitated by the housing market crash
would require collective action by a multitude of geographically
dispersed security holders. The solution . . . Is for state and
municipal governments to use their eminent domain powers to buy up and
restructure underwater mortgages, thereby sidestepping the need to
coordinate action across large numbers of security holders.
The problem is blowback from the banks, but it can be blocked by
requiring them to prove title to the properties. Securities are governed
by federal law, but real estate law is the domain of the states.
Counties have a mandate to maintain clean title records; and legally,
clean title requires a chain of “wet” signatures, from A to B to C to D.
If the chain is broken, title is clouded. Properties for which title
cannot be established escheat (or revert) to the state
by law, allowing the government to start fresh with clean title.
New York State law governs most of the trusts involved in
securitization. Under it, transfers of mortgages into a trust after the
cutoff date specified in the Pooling and Servicing Agreement (PSA)
governing the trust are void.
For obscure reasons, the REMICs (Real Estate Mortgage Investment
Conduits) claiming to own the properties routinely received them after
the closing date specified in the PSAs. The late transfers were done
throu gh the fraudulent signatures-after-the-fact called “robo-signing,”
which occurred so regularly that they were the basis of
a $25 billion settlement between a coalition of state attorneys general and the five biggest mortgage servicers in February 2012. (Why all the robo-signing? Good question. See my earlier article
here.)
Until recently, courts have precluded homeowners
from raising the late transfers into the trust as a defense to
foreclosure, because the homeowners were not parties to the PSAs. But in
August 2013, in
Glaski v. Bank of America, N.A., 218 Cal. App. 4th 1079 (July 31, 2013), a California appellate court ruled that the question
whether the loan ever made it into the asset pool could be raised in
determining the proper party to initiate foreclosure. And whether or
not the homeowner was a party to the PSA, the city and county have a
clear legal interest in seeing that the PSA’s terms were complied with,
since the job of the county recorder is to maintain records establishing
clean title.
Before the rise of mortgage securitization, any transfer of a note
and deed needed to be recorded as a public record, to give notice of
ownership and establish a “priority of liens.” With securitization, a
private database called MERS (Mortgage Electronic Registration Systems)
circumvented this procedure by keeping the deeds as “nominee for the
beneficiary,” obscuring the property’s legal owner and avoiding the
expense of recording the transfer (usually about $30 each). Estimates
are that untraceable property assignments concealed behind MERS may
have
cost counties nationwide billions of dollars in recording fees. (See my earlier article
here.)
Counties thus have not only a fiduciary but a financial interest in
establishing clean title to the properties in their jurisdictions. If no
one can establish title, the properties escheat and can be claimed free
and clear. Eminent domain can be a powerful tool for negotiating loan
modifications on underwater mortgages; and if the banks cannot prove
title, they have no standing to complain.
The End of “Too Big to Fail”?
Richmond’s city council is only one vote short of the supermajority
needed to pursue the eminent domain plan, and it is seeking partners in a
Joint Powers Authority that will make the push much stronger.
Grassroots efforts to pursue eminent domain are also underway in a
number of other cities around the country. If Richmond pulls it off
successfully, others will rush to follow.
The result could be costly for some very large banks, but they have
brought it on themselves with shady dealings. Christopher Whalen
predicts that the FDIC’s withdrawal of “safe harbor” status for the
securitization model may herald the end of “too big to fail” for those
banks, which will no longer have the power to grossly over-leverage and
may have to keep their loans on their books.
Wall Street banks are deemed “too big to fail” only because there is
no viable alternative – but there could be. Local governments could form
their own publicly-owned banks, on the model of the state-owned Bank of
North Dakota. They could then put their revenues, their savings, and
their newly-acquired real estate into those public utilities, to be used
to generate interest-free credit for the local government (since it
would own the bank) and low-cost credit for the local community. For
more on this promising option, which has been or is being explored in
almost half the state legislatures in the US, see
here.
Ellen Brown is an attorney, president of the Public Banking Institute, and a candidate for California State Treasurer running on a state bank platform. She is the author of twelve books including the best-selling Web of Debt and her latest book, The Public Bank Solution, which explores successful public banking models historically and globally.
