On monday the American Banker ran a well written story by Jeff Horwitz on the document problems slowing down foreclosures. It focuses on whether document custodians actually have the possession of key documents, including especially promissory notes. The article (subscription requried; 2010 WLNR 21191843) quotes document custodians insisting that they have all the documents they need, but it also includes some scepticism from Diane Thompson, April Charney, and Max Gardner. It is good to see financial journalists paying more carefull attention to consumer rights advocates.

This being said, I think the story is still missing some important points. Because I have a million other things to do today, I’ll limit myself to three thoughts that jump to mind. First, one reason some originators may have been lax in sending proper documentation on to the depositor (and in turn the document custodian or trustee) is a false belief that designating MERS as the mortgagee or deed of trust beneficiary would facilitate quick foreclosures without all the proper documentation. MERS is an important partial driver of the affidavit problems. Some financial institutions convinced themselves that MERS would be a cradle-to-grave proxy eliminating the need for them to keep the collateral jackets with blue ink documents that old-fashion lenders once maintained. Why keep track of paperwork if MERS is just going to do your foreclosures for you? This is an easy thing to believe when (1) they really wanted to believe it and (2) the motto of company is “process loans, not paperwork.” Should we be surprised that the paper might not have actually changed hands?

Second, the representations the document custodians are making in Mr. Horowitz’s article are inconsistent with what some mortgage bankers themselves have admitted. A brief the Florida Bankers Association submitted to the Florida Supreme Court takes the totally opposite view on whether the promissory notes are lost. It states, “The reason ‘many firms file lost note counts as a standard alternative pleading in the complaint’ is because the physical document was deliberately eliminated to avoid confusion immediately upon its conversion to an electronic file.” Yikes! Memo to all bankers: destroying promissory notes is a bad idea. But don’t trust me. Instead very carefully read this next sentence recently written by two Judges on the American Bankruptcy Institute’s Uniform Commercial Code Committee: “for the note to be enforced, the person who asserts the status of the holder must be in possession of the instrument.”

But wait, there’s more…

Third, the lost note problem is not the financial institutions’ only legal problem. The security agreements used in MERS registered loans state: “MERS is the mortgagee.” Three state supreme courts have now held that MERS is not a mortgagee. The ultimate outcome of this basic legal discrepancy is not yet known and has the potential to be different in various states. Just focusing on one potential implication from this very basic discrepancy, it is legally unclear that recording a mortgage with MERS listed as a mortgagee is sufficient to create a perfected security interest. A basic objective in recording mortgages is to establish priority vis-à-vis other lenders, lienors, and buyers. With the exception of Minnesota, every state land title act—the statutes that set out the rules granting priority through recording—was written before MERS came into being. The legislatures that drafted these statutes did not contemplate the possibility that every lender in the country would record their loans in the name of one shell company owned by banks. Any state supreme court (except for Minnesota) is currently free to decide that recording in the name of this proxy-mortgagee-shell-company does not perfect the mortgage. Will any state supreme court have the guts to insist on transparent real-party-in-interest recording? Unfortunately, there is no crystal ball on my desk. Before the financial crisis and all of the documentation problems I probably would have guessed that the industry would get away with this power grab that privatizes the record keeping system. But now….? I’m not so sure.

The MERS folks and their lawyers will continue to point to the occasional case from our history where one court or another has allowed some form of recording where there was some unusual agency relationship involved. They will say that these occasional cases prove their concept is “legal.” But just step back and think about it for a minute. Is there really a case that proves that their concept is legal? No. Obviously there is not because their concept was totally new in the history of the country. So many people I talk to seem to think that hidden in the bowels of our country’s case law there is some nexus of complicated cases that must—surely must—make this quirky idea perfectly OK. However, every case the MERS folks cite to will have the potential to be distinguished by a state Supreme court that believes its legislature did not authorize this type of change to the system. And those courts will be on solid ground because—let’s be honest—state legislatures simply did not willfully grant permission for this radical change in recording. The land title statutes contemplate recording by many different actual mortgagee’s and deed of trust beneficiaries, not by one single a shell company that stands in the place of the entire industry. They will not find a case that binds a state supreme court to hold otherwise.

This is, of course, not to say that the MERS folks cannot win on this question. Many judges will be willing to look at the occasional case MERS’ lawyers drag up and hold that: “yes, behold, the land title laws DO allow one shell company to be the national mortgage proxy.” My own impulse is that a judge that takes this route is either clueless or a wee-bit intellectually dishonest. But maybe that’s too harsh. I suppose I could understand a judge saying to herself, “Well, … I’m going to let them interpret the statute this way because I don’t want to cause a crisis—and let the legislature’s original meaning of the land title act be damned.” I suppose there is something of a cynical virtue in this position. The thing I don’t like about that is that Supreme Courts ought not to get in too far into the business of macro economics. Their job is to enforce transparent rule of law. We are counting on them to do that. Plus, they are lousy economists. The truly conservative position on these cases will be to insist that radical changes to the legislatures’ land title acts be made by legislatures, not by bank sponsored financial snake oil salesmen. I actually think that the greatest exposure of the industry on this question could be in republican, civic virtue oriented courts that are not particularly impressed by Fannie Mae or Goldman Sachs bling-bling. There are smart judges in Wyoming, in Kansas, in Oregon, in Ohio, in Florida that will resent turning over the county recorders democratically maintained recording system enshrined in law by the democratically elected legislature to this bank owned short cut made for the convenience of the Wall Street investment banks out of control GSEs that trashed our economy.

Ultimately, these problems, and the present uncertainty they are creating, will not be resolved quickly.

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Bank of America said it’s extended its review of foreclosure documents to all 50 states, and will stop all foreclosure sales until the review is completed.

The ongoing assessment, previously confined to 23 states where courts have jurisdiction over foreclosures, “shows the basis for foreclosure decisions is accurate,” Bank of America said in a statement.

Bank of America had identified the 23 states where it is delaying foreclosures as Connecticut, Delaware, Florida, Hawaii, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Nebraska, New Jersey, New Mexico, New York, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Vermont and Wisconsin.

Meanwhile, PNC Financial Services Group Inc. says it’s halting most foreclosures and evictions in 23 states for 30 days, bringing to four the number of lenders who have publicly acknowledged potential problems in their handling of foreclosure paperwork. PNC said it took the step so it can confirm its foreclosure procedures are in compliance with state laws.

In what’s become known as the robo signing scandal, GMAC Mortgage and JP Morgan Chase are also reviewing foreclosure proceedings in judicial foreclosure states, following allegations that workers processing files for the companies signed affidavits that contained information they had not personally verified.

Although attorneys for homeowners have mostly succeeded in delaying, rather than stopping, foreclosures when challenging lenders on such procedural grounds in the past, the robo signing scandal threatens to put the brakes on hundreds of thousands of foreclosures nationwide.

State attorneys general, federal regulators and lawmakers are putting lenders on notice that they should discontinue foreclosures unless they are sure their procedures are in full compliance with the law.

The resulting slowdown in foreclosure actions could slow the flow of properties into bank’s REO (real estate owned) inventories. Lenders have also begun holding back properties they have already foreclosed on from the market, because of fears that their former owners could file lawsuits questioning the legality of the court proceedings in which they lost their homes.

The American Land Title Association, a trade group representing title insurers, has said homeowners who have purchased foreclosed properties have “numerous defenses” against any claims by former owners.

It’s unlikely that a court will take property from an innocent current homeowner and return it to a previous homeowner who failed to make payments on the loan subject to the foreclosure, the group said.

But some lenders and at least one title insurer appear to be seeking more certainty before moving forward with the sale of foreclosed properties.

Old Republic National Title Insurance Co. has reportedly stopped insuring title for properties foreclosed on by JP Morgan Chase and GMAC Mortgage (the company refuses to confirm or deny reports based on internal company memos, citing a “policy of not speaking to the press”).

The Center for Responsible Lending and civil rights groups including the NAACP and National Council of La Raza on Thursday renewed their call for a national moratorium on foreclosures, citing doubts about procedures followed by lenders filing foreclosure proceedings.

Attorneys general in states including California, Florida, Massachusetts, Delaware, Connecticut, Texas, Ohio, Colorado, Illinois, Iowa and North Carolina are examining lenders’ foreclosure procedures, and Ohio Attorney General Richard Cordray has filed suit against GMAC Mortgage (GMAC Mortgage says it expects to prevail).

Although Democrats have been the most critical of lenders’ foreclosure procedures, the issue cuts across party lines.

Sen. Richard Shelby of Alabama, the ranking Republican on the Senate Banking Committee, has called on federal banking regulators to review the mortgage servicing and foreclosures activities of JP Morgan Chase and Bank of America, and GMAC Mortgage parent company Ally Financial.

Shelby said the Senate Banking Committee should also launch its own investigation, saying he was “highly troubled that once again our federal regulators appear to be asleep at the switch.”

Exercising a “pocket veto” for only the second time in office, President Obama Thursday rejected a bill, HR 3808, that critics said would help banks push homes through the foreclosure process by making courts recognize notarizations made in other states.

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Allegedly, Wachovia Corporation and Golden West Corporation failed to fully explain that the minimum payment due in the first years of the loan would not cover the full amount of accrued interest, which in turn would increase the amount of the loan, or negatively amortize the loan. Borrowers eventually faced higher monthly payments, as well as higher loan balances, when they began making full monthly payments.

Wells Fargo, in a settlement with Florida, Arizona, Colorado, New Jersey, Washington, Texas, Illinois and Nevada, agreed that between December 1, 2010, and June 30, 2013, the bank will offer modifications to eligible qualified residential POA borrowers who are either 60 days delinquent or facing imminent default. Borrowers will first be considered for the federal Home Affordable Modification Program (HAMP) and if the borrower cannot qualify under HAMP or elects not to accept a HAMP modification, Wells Fargo will consider the borrower for its new modification program, known as Mortgage Assistance Program 2 (MAP2R).

The agreement also makes a number of substantial servicing commitments for its POA borrowers including ensuring adequately staffed help lines to serve consumers, providing a single, primary point of contact to assist borrowers seeking modifications, making decisions on modifications within 30 calendar days of receiving a complete application, establishing a formal second look or appeal process for borrowers who are turned down for a modification, and more clearly communicating with borrowers to avoid confusion during the process.

Wells Fargo will also offer other foreclosure alternatives, including short sale, deed-in-lieu, and relocation assistance. The agreement provides for a compliance monitor and quarterly reporting to the eight Attorneys General. Wells Fargo will also pay more than $10.2 million to the Florida Attorney General’s Office to assist with the state’s efforts to prevent or mitigate foreclosures and prevent mortgage or loan modification fraud, along with investigative costs.

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This foreclosure halt was instituted after it was discovered that Ally employees were signing affidavits on foreclosures cases yet having no personal knowledge of the information contained in the files. The Court also heard testimony from a Ally Financial/GMAC employee that they were not signing the affidavits in front of a notary, as required by law. These types of employees have been labeled “robo-signers”.

In light of the evidence in these cases, John Walsh, acting director of the Office of the comptroller of the currency has directed a review to be done of Ally Financial/GMAC, JP Morgan Chase, Wells Fargo, US Bank, Citibank, HBSC and Bank of America.

Industry experts believe that more banks are likely to follow the example of Ally Financial/GMAC and JP Morgan Chase. However it took the national media uncovering leaked information before anyone involved would even comment on it.

Surprisingly enough, this is not GMAC’s first round with its employees submitting falsified information to a court of law. In 2006 Florida circuit Court Judge, Bernard Nachman, sanctioned GMAC because it had found that they “submitted false testimony to the court in the form of affidavits of indebtedness”. Judge Nachman ordered GMAC to confirm to the court that their internal policies had changed.

After being sanctioned in 2006, the Legal Department of GMAC issued a memo to its employees “not to sign verifications of court pleading documents unless you have independently reviewed and checked the facts”. However the same executive that was sanctioned in 2006 went on to supervise a department of 13 people, one of whom confessed that his department was doing just that. This department has been, according to Jeffrey Stephan, signing foreclosure documents at the rate of approximately 10,000 per month, none of which he told the court were properly reviewed.

The foreclosures that have been placed on hold are currently in the 23 states that have a judicial foreclosure process. However, Attorney General of California Jerry Brown has ordered a cease and desist letter to Ally Financial/GMAC. California is not currently a judicial foreclosure state, yet according to Brown, California law forbids a lender from issuing a notice of default-the first step in the California foreclosure process- unless it can show it has tried to contact the borrower. This law governs mortgages that were originated between 2003 and 2007.

If you are unsure of the foreclosure laws of your state or are facing foreclosure with Ally Financial/GMAC or JP Morgan Chase, industry experts say you should contact an attorney immediately to understand your rights as a consumer.

Written by Jamie Brace, Staff at US Loan Auditors, the premier California-based forensic real estate loan auditing firm serving victims of predatory mortgage lending abuse.

While Stockton is the deepest underwater market reported by CoreLogic, it has plenty of company.

• In Modesto, 59.6 percent, or 58,892, of all residential properties with a mortgage were in negative equity for second quarter 2010. An additional 4.9 percent, or 4,875, were in near negative equity in Modesto.

• In Stockton, 62.4 percent, or 80,505, of all residential properties with a mortgage were in negative equity for second quarter 2010. That’s nearly three times the national average. An additional 4.1 percent, or 5,257 homes, were in near negative equity in Stockton.

• In Fresno, 46.8 percent, or 71,850, of all residential properties with a mortgage were in negative equity for second quarter 2010. An additional 4.6 percent, or 6,985, were in near negative equity in Fresno.

• In metropolitan Sacramento, 43.4 percent, or 214,468, of all residential properties with a mortgage were in negative equity for second quarter 2010. An additional 4.6 percent, or 22,726, were in near negative equity in Sacramento–Arden-Arcade–Roseville.

• In Visalia-Porterville, 44.8 percent, or 31,027, of all residential properties with a mortgage were in negative equity for second quarter 2010. An additional 4.8 percent, or 3,346, were in near negative equity in Visalia-Porterville.

• In Bakersfield-Delano, 52.0 percent, or 79,891, of all residential properties with a mortgage were in negative equity for second quarter 2010. An additional 4.8 percent, or 7,298, were in near negative equity in Bakersfield-Delano.

(Figures for the Hanford-Corcoran and Chico metro areas were not immediately available.)

CoreLogic (NYSE: CLGX) says that nationally, the second quarter showed a decline in negative equity rates.

According to its figures, that 11 million, or 23 percent, of all residential properties with mortgages were in negative equity at the end of the second quarter of 2010, down from 11.2 million and 24 percent from the first quarter of 2010.

Foreclosures, rather than meaningful price appreciation, were the primary driver in the change in negative equity, says CoreLogic.

An additional 2.4 million borrowers had less than 5 percent equity. Together, negative equity and near-negative equity mortgages accounted for nearly 28 percent of all residential properties with a mortgage nationwide.

Other highlights from the CoreLogic report:

• Negative equity remains concentrated in five states: Nevada, which had the highest percentage negative equity with 68 percent of all of its mortgaged properties underwater, followed by Arizona (50 percent), Florida (46 percent), Michigan (38 percent) and California (33 percent).

• The biggest declines in negative equity were concentrated in the hardest hit states. Nevada experienced an 11.8 percentage point decline in negative equity share, followed by California (-1.3), Florida (-1.3), and Arizona (-1.3). About two-thirds of all states experienced a decline in negative equity share. Since peaking in Q4 2009, the number of borrowers in a negative equity position has declined by about 350,000.

• The largest decrease in negative equity occurred among those with loan-to-value (LTV) ratios in excess of 125 percent, where the number of negative equity borrowers fell to 4.8 million, down from 5 million last quarter.

• Homes with more equity are appreciating faster than underwater homes. The average values of properties with 50 percent or more equity increased over 1 percent between Q4 2009 and Q2 2010. Properties with 25 to 50 percent in equity increased an average of 0.2 percent in that period.

• Values fell for every segment in negative equity, with the biggest value decline occurring for properties that are 50 percent or more in negative equity.

In addition to driving foreclosures, negative equity reduces homeowner mobility, says CoreLogic. Since the peak in home sales in 2005, non-distressed sales have dramatically declined and there is a clear relationship between the decline in non-distressed sales and the level of negative equity at the zip code and state level, the report says.

At low levels of negative equity there are moderate and varied declines in non-distressed sales across most states as it reflects state macroeconomic fundamentals.

At higher levels of negative equity, the non-distressed declines have been much larger, which implies that that the 11 million negative equity properties have reduced homeowners ability to move.

The 11 million negative equity properties are backed by $2.9 trillion in mortgage debt outstanding (MDO). On an MDO dollar basis, the negative equity share was 33 percent percent and the total dollar value of negative equity was $766 billion.

Negative equity, often referred to as “underwater” or “upside down,” means that borrowers owe more on their mortgages than their homes are worth. Negative equity can occur because of a decline in value, an increase in mortgage debt or a combination of both.

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New data suggests that mortgage fraud—which got tougher to pull off after the collapse of the U.S. real estate market—is returning in a big way.

Data prepared for The Wall Street Journal by research firm CoreLogic, examining about seven million home loans made by hundreds of lenders, show that losses from mortgage fraud—ranging from falsified credit reports to identity theft—rose 17% last year after declining 57% in the two years after its 2006 peak.

In 2009, $14 billion in loans, or about 0.7% of all mortgage loans made in the U.S., were originated with fraudulent application data.

The figures are a fraction of the mortgage market, but the increase is sharp.

CoreLogic, which tracks fraud only by mortgage value, examines about 7 million loans each year using a proprietary computer program that detects discrepancies in loan documents and predicts the likelihood of fraud. The real losses to banks won’t be known for several years when banks are forced to write off the value of the loans’ value.

Some of CoreLogic’s profits come from selling market research to lenders aiming to cut losses from mortgage fraud.

Investigators and lenders say they are seeing a similar upswing in fraud.

The Federal Bureau of Investigation in June indicted a Phoenix man for mail and wire fraud among other alleged crimes when the agency says he tried to steal a house from his landlord. Also in June, federal prosecutors in New Jersey charged 29 defendants—including 12 real-estate agents, four mortgage consultants, an appraiser, a bank employee and a mortgage broker—with wire fraud in an alleged scheme involving 17 properties in the state and losses of $5.5 million.

“Even though we have certain compliance measures in place, people will adapt whatever scheme,” said Sharon Ormsby, the FBI’s section chief for financial crimes. “It doesn’t matter if the market is going up or down.”

The kinds of fraud that contributed to the mortgage crisis and the collapse of the housing market were relatively simple. Crooks took advantage of the size of mortgage loans and the lax rules governing who qualified for them.

In one common con, they would recruit as accomplices “straw buyers” with good credit to apply for “no-doc” loans, which required no documentation or proof of income, to buy their house. Good credit was required because lenders generally did check a borrower’s credit score, even if they didn’t require pay stubs or bank statements.

When the bank sent funds, typically to make a down payment or for a home-equity loan, the schemers and the fake buyer would split the profits and walk away, leaving the house to fall into foreclosure and the bank stuck with the loss.

Since the mortgage crisis, banks and the government-sponsored entities that underwrite or insure mortgages, including Fannie Mae, Freddie Mac and the Federal Housing Administration, have tightened lending standards and closely scrutinize mortgage applications.

No-doc loans are a thing of the past, and many lenders now require borrowers to furnish proof of employment, tax forms, credit reports, bank statements and other documents.

Fraudsters have adapted to the new restrictions. With banks less apt to lend to borrowers with shaky finances, criminals rely more on falsifying documents, recruiting loan officers and other bank insiders to work for them, and stealing identities to get loans, federal investigators and mortgage industry research reports.

In the Phoenix case, prosecutors allege, Jose Victor Buencamino did all three. Some people who knew Mr. Buencamino describe him as a large, friendly man devoted to his children, the life of many a party and a passionate golfer. Gary Weaver, who rented a home to Mr. Buencamino last year, has a different impression. He said the Arizona businessman tried to snare him in an elaborate mortgage scheme.

According to a federal indictment unsealed in June, while Mr. Buencamino was renting Mr. Weaver’s house on the golf course at Moon Valley Country Club, he intercepted mail intended for Mr. Weaver and obtained his social security number, then applied for a driver’s license in Mr. Weaver’s name.

Then, the indictment alleges, with the help of a friend who worked as a loan officer at a local branch of Compass Bank, a unit of Spanish bank Banco Bilbao Vizcaya Argentaria SA, Mr. Buencamino obtained a $245,000 cash-out mortgage on the property. A homeowner using a cash-out mortgage refinances the home loan for more than the mortgage is currently worth and pockets the difference in cash.

A Compass Bank spokesman didn’t respond to requests for comment. Mr. Buencamino, who couldn’t be located for comment, has not responded to the charges.

A federal agent said he had been tracked to Vancouver, where the agent said he is applying for Canadian residency. Prosecutors involved in the case said he didn’t have an attorney on whom they could serve court papers. U.S. authorities said they were seeking his extradition.

“Fraud continues to be a pervasive issue, growing and escalating in complexity,” said an April report from LexisNexis’s Mortgage Asset Research Institute, which cited as reasons easy access to records via the Internet and, in many cases, though not Mr. Weaver’s, the vulnerability of cash-strapped homeowners.

MARI’s breakdown of the numbers reflects the shift in technique. Fraud related to falsified credit reports has declined each year since the boom years, MARI reports, while the share of mortgage fraud involving false appraisals jumped 50% between 2008 and 2009.

Application fraud—in which borrowers lie about their names, where they live, how much money they earn, their employment, their debt or their assets—remains high, accounting for 59% of all mortgage fraud.

One of the defendants in the New Jersey dragnet, a mortgage consultant with Newark-based Invest & Investors LLC named Viviane Bernardim, allegedly paid accomplices $15,000 apiece to steal the identities of several New Jersey residents who earned $90,000 or more and had good credit ratings. She used those identities to obtain second mortgages on a number of homes in the Newark area, according to U.S. Attorney Paul J. Fishman, head of the office prosecuting the case.

But since good credit ratings are no longer enough to get a mortgage, Ms. Bernardim also needed friends who worked for the lenders to pull off the caper.

“Having players at every level of a conspiracy makes it easier to carry out fraud,” said Mr. Fishman. “But each bad actor and criminal act is also another chance for law enforcement to find a way in.”

Maria Delgaizo Noto, an attorney for Ms. Bernardim, said that she had no comment until an indictment was unsealed, but that her client “maintains her innocence of any criminal activity.”

In Phoenix, Mr. Buencamino’s alleged fraud was assisted by an insider, but also by easy access to public documents on the Internet. After intercepting mail intended for Mr. Weaver and obtaining his Social Security number, Mr. Buencamino applied online for an Arizona driver’s license in Mr. Weaver’s name, according to the criminal complaint and law enforcement agents involved in the case.

When he received the permit, he submitted mortgage application documents by mail to Compass Bank and, with the help of co-conspirator William Baxaveneous, the Compass loan officer, obtained a second mortgage on Mr. Weaver’s home—which had no mortgage—without ever having to meet any bank officials face to face, Mr. Weaver said. He said he learned this from the federal agents investigating the case.

Mr. Baxaveneous’s attorney said he was trying to settle the case and declined to comment further.

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WASHINGTON (AP) — Nearly half of the 1.3 million homeowners who enrolled in the Obama administration’s flagship mortgage-relief program have fallen out.

The program is intended to help those at risk of foreclosure by lowering their monthly mortgage payments. Friday’s report from the Treasury Department suggests the $75 billion government effort is failing to slow the tide of foreclosures in the United States, economists say.

More than 2.3 million homes have been repossessed by lenders since the recession began in December 2007, according to foreclosure listing service RealtyTrac Inc. Economists expect the number of foreclosures to grow well into next year.

“The government program as currently structured is petering out. It is taking in fewer homeowners, more are dropping out and fewer people are ending up in permanent modifications,” said Mark Zandi, chief economist at Moody’s Analytics.

Besides forcing people from their homes, foreclosures and distressed home sales have pushed down on home values and crippled the broader housing industry. They have made it difficult for homebuilders to compete with the depressed prices and discouraged potential sellers from putting their homes on the market.

Approximately 630,000 people who had tried to get their monthly mortgage payments lowered through the government program have been cut loose through July, according to the Treasury report. That’s about 48 percent of the those who had enrolled since March 2009. And it is up from more than 40 percent through June.

Another 421,804, or roughly 32 percent of those who started the program, have received permanent loan modifications and are making their payments on time.

RealtyTrac reported that the number of U.S. homes lost to foreclosure surged in July to 92,858 properties, up 9 percent from June. The pace of repossessions has been increasing and the nation is now on track to having more than 1 million homes lost to foreclosure by the end of the year. That would eclipse the more than 900,000 homes repossessed in 2009, the firm says.

Lenders have historically taken over about 100,000 homes a year, according to RealtyTrac.

Zandi said the government effort will likely end up helping only about 500,000 homeowners lower their monthly payments on a permanent basis. That’s a small percentage of the number of people who have already lost their homes to foreclosure or distressed sales like short sales — when lenders let homeowners sell for less than they owe on their mortgages.

Zandi predicts another 1.5 million foreclosures or short sales in 2011.

“We still have a lot more foreclosures to come and further home price declines,” Zandi said. He said home prices, which have already fallen 30 percent since the peak of the housing boom, would drop by another 5 percent by next spring.

Many borrowers have complained that the government program is a bureaucratic nightmare. They say banks often lose their documents and then claim borrowers did not send back the necessary paperwork.

The banking industry said borrowers weren’t sending back their paperwork. They also have accused the Obama administration of initially pressuring them to sign up borrowers without insisting first on proof of their income. When banks later moved to collect the information, many troubled homeowners were disqualified or dropped out.

Obama officials dispute that they pressured banks. They have defended the program, saying lenders are making more significant cuts to borrowers’ monthly payments than before the program was launched. And some of the largest mortgage companies in the program have offered alternative programs to those who fell out.

Homeowners who qualify can receive an interest rate as low as 2 percent for five years and a longer repayment period. Those who have successfully navigated the program to reach permanent modifications have seen their monthly payments cut on average by about $500.

Homeowners first receive temporary modifications and those are supposed to become permanent after borrowers make three payments on time and complete all the required paperwork. That includes proof of income and a letter explaining the reason for their troubles. But in practice, the process has taken far longer.

The more than 100 participating mortgage companies get taxpayer incentives to reduce payments. As of mid-June only $490 million had been spent out of a potential $75 billion the government has made available to help stem the wave of foreclosures.

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Mortgages bundled into securities were a favorite investment of speculators at the height of the financial bubble leading up to the crash of 2008. The securities changed hands frequently, and the companies profiting from mortgage payments were often not the same parties that negotiated the loans. At the heart of this disconnect was the Mortgage Electronic Registration System, or MERS, a company that serves as the mortgagee of record for lenders, allowing properties to change hands without the necessity of recording each transfer.

MERS was convenient for the mortgage industry, but courts are now questioning the impact of all of this financial juggling when it comes to mortgage ownership. To foreclose on real property, the plaintiff must be able to establish the chain of title entitling it to relief. But MERS has acknowledged, and recent cases have held, that MERS is a mere “nominee”-an entity appointed by the true owner simply for the purpose of holding property in order to facilitate transactions. Recent court opinions stress that this defect is not just a procedural but is a substantive failure, one that is fatal to the plaintiff’s legal ability to foreclose.

That means hordes of victims of predatory lending could end up owning their homes free and clear-while the financial industry could end up skewered on its own sword.

California Precedent

The latest of these court decisions came down in California on May 20, 2010, in a bankruptcy case called In re Walker, Case no. 10-21656-E-11. The court held that MERS could not foreclose because it was a mere nominee; and that as a result, plaintiff Citibank could not collect on its claim. The judge opined:

Since no evidence of MERS’ ownership of the underlying note has been offered, and other courts have concluded that MERS does not own the underlying notes, this court is convinced that MERS had no interest it could transfer to Citibank. Since MERS did not own the underlying note, it could not transfer the beneficial interest of the Deed of Trust to another. Any attempt to transfer the beneficial interest of a trust deed without ownership of the underlying note is void under California law.

In support, the judge cited In Re Vargas (California Bankruptcy Court); Landmark v. Kesler (Kansas Supreme Court); LaSalle Bank v. Lamy (a New York case); and In Re Foreclosure Cases (the “Boyko” decision from Ohio Federal Court). (For more on these earlier cases, see here, here and here.) The court concluded:

Since the claimant, Citibank, has not established that it is the owner of the promissory note secured by the trust deed, Citibank is unable to assert a claim for payment in this case.

The broad impact the case could have on California foreclosures is suggested by attorney Jeff Barnes, who writes:

This opinion . . . serves as a legal basis to challenge any foreclosure in California based on a MERS assignment; to seek to void any MERS assignment of the Deed of Trust or the note to a third party for purposes of foreclosure; and should be sufficient for a borrower to not only obtain a TRO [temporary restraining order] against a Trustee’s Sale, but also a Preliminary Injunction barring any sale pending any litigation filed by the borrower challenging a foreclosure based on a MERS assignment.

While not binding on courts in other jurisdictions, the ruling could serve as persuasive precedent there as well, because the court cited non-bankruptcy cases related to the lack of authority of MERS, and because the opinion is consistent with prior rulings in Idaho and Nevada Bankruptcy courts on the same issue.

What Could This Mean for Homeowners?

Earlier cases focused on the inability of MERS to produce a promissory note or assignment establishing that it was entitled to relief, but most courts have considered this a mere procedural defect and continue to look the other way on MERS’ technical lack of standing to sue. The more recent cases, however, are looking at something more serious. If MERS is not the title holder of properties held in its name, the chain of title has been broken, and no one may have standing to sue. In MERS v. Nebraska Department of Banking and Finance, MERS insisted that it had no actionable interest in title, and the court agreed.

An August 2010 article in Mother Jones titled “Fannie and Freddie’s Foreclosure Barons” exposes a widespread practice of “foreclosure mills” in backdating assignments after foreclosures have been filed. Not only is this perjury, a prosecutable offense, but if MERS was never the title holder, there is nothing to assign. The defaulting homeowners could wind up with free and clear title.

In Jacksonville, Florida, legal aid attorney April Charney has been using the missing-note argument ever since she first identified that weakness in the lenders’ case in 2004. Five years later, she says, some of the homeowners she’s helped are still in their homes. According to a Huffington Post article titled “‘Produce the Note’ Movement Helps Stall Foreclosures”:

Because of the missing ownership documentation, Charney is now starting to file quiet title actions, hoping to get her homeowner clients full title to their homes (a quiet title action ‘quiets’ all other claims). Charney says she’s helped thousands of homeowners delay or prevent foreclosure, and trained thousands of lawyers across the country on how to protect homeowners and battle in court.

Criminal Charges?

Other suits go beyond merely challenging title to alleging criminal activity. On July 26, 2010, a class action was filed in Florida seeking relief against MERS and an associated legal firm for racketeering and mail fraud. It alleges that the defendants used “the artifice of MERS to sabotage the judicial process to the detriment of borrowers;” that “to perpetuate the scheme, MERS was and is used in a way so that the average consumer, or even legal professional, can never determine who or what was or is ultimately receiving the benefits of any mortgage payments;” that the scheme depended on “the MERS artifice and the ability to generate any necessary ‘assignment’ which flowed from it;” and that “by engaging in a pattern of racketeering activity, specifically ‘mail or wire fraud,’ the Defendants . . . participated in a criminal enterprise affecting interstate commerce.”

Local governments deprived of filing fees may also be getting into the act, at least through representatives suing on their behalf. Qui tam actions allow for a private party or “whistle blower” to bring suit on behalf of the government for a past or present fraud on it. In State of California ex rel. Barrett R. Bates, filed May 10, 2010, the plaintiff qui tam sued on behalf of a long list of local governments in California against MERS and a number of lenders, including Bank of America, JPMorgan Chase and Wells Fargo, for “wrongfully bypass[ing] the counties’ recording requirements; divest[ing] the borrowers of the right to know who owned the promissory note . . .; and record[ing] false documents to initiate and pursue non-judicial foreclosures, and to otherwise decrease or avoid payment of fees to the Counties and the Cities where the real estate is located.” The complaint notes that “MERS claims to have ‘saved’ at least $2.4 billion dollars in recording costs,” meaning it has helped avoid billions of dollars in fees otherwise accruing to local governments. The plaintiff sues for treble damages for all recording fees not paid during the past ten years, and for civil penalties of between $5,000 and $10,000 for each unpaid or underpaid recording fee and each false document recorded during that period, potentially a hefty sum. Similar suits have been filed by the same plaintiff qui tam in Nevada and Tennessee.

By Their Own Sword: MERS’ Role in the Financial Crisis

MERS is, according to its website, “an innovative process that simplifies the way mortgage ownership and servicing rights are originated, sold and tracked. Created by the real estate finance industry, MERS eliminates the need to prepare and record assignments when trading residential and commercial mortgage loans.” Or as Karl Denninger puts it, “MERS’ own website claims that it exists for the purpose of circumventing assignments and documenting ownership!”

MERS was developed in the early 1990s by a number of financial entities, including Bank of America, Countrywide, Fannie Mae, and Freddie Mac, allegedly to allow consumers to pay less for mortgage loans. That did not actually happen, but what MERS did allow was the securitization and shuffling around of mortgages behind a veil of anonymity. The result was not only to cheat local governments out of their recording fees but to defeat the purpose of the recording laws, which was to guarantee purchasers clean title. Worse, MERS facilitated an explosion of predatory lending in which lenders could not be held to account because they could not be identified, either by the preyed-upon borrowers or by the investors seduced into buying bundles of worthless mortgages. As alleged in a Nevada class action called Lopez vs. Executive Trustee Services, et al.:

Before MERS, it would not have been possible for mortgages with no market value . . . to be sold at a profit or collateralized and sold as mortgage-backed securities. Before MERS, it would not have been possible for the Defendant banks and AIG to conceal from government regulators the extent of risk of financial losses those entities faced from the predatory origination of residential loans and the fraudulent re-sale and securitization of those otherwise non-marketable loans. Before MERS, the actual beneficiary of every Deed of Trust on every parcel in the United States and the State of Nevada could be readily ascertained by merely reviewing the public records at the local recorder’s office where documents reflecting any ownership interest in real property are kept….

After MERS, . . . the servicing rights were transferred after the origination of the loan to an entity so large that communication with the servicer became difficult if not impossible …. The servicer was interested in only one thing - making a profit from the foreclosure of the borrower’s residence - so that the entire predatory cycle of fraudulent origination, resale, and securitization of yet another predatory loan could occur again. This is the legacy of MERS, and the entire scheme was predicated upon the fraudulent designation of MERS as the ‘beneficiary’ under millions of deeds of trust in Nevada and other states.

Axing the Bankers’ Money Tree

If courts overwhelmed with foreclosures decide to take up the cause, the result could be millions of struggling homeowners with the banks off their backs, and millions of homes no longer on the books of some too-big-to-fail banks. Without those assets, the banks could again be looking at bankruptcy. As was pointed out in a San Francisco Chronicle article by attorney Sean Olender following the October 2007 Boyko [pdf] decision:

The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates. The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.

. . . The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail . . . .

Nationalization of these giant banks might be the next logical step-a step that some commentators said should have been taken in the first place. When the banking system of Sweden collapsed following a housing bubble in the 1990s, nationalization of the banks worked out very well for that country.

The Swedish banks were largely privatized again when they got back on their feet, but it might be a good idea to keep some banks as publicly-owned entities, on the model of the Commonwealth Bank of Australia. For most of the 20th century it served as a “people’s bank,” making low interest loans to consumers and businesses through branches all over the country.

With the strengthened position of Wall Street following the 2008 bailout and the tepid 2010 banking reform bill, the U.S. is far from nationalizing its mega-banks now. But a committed homeowner movement to tear off the predatory mask called MERS could yet turn the tide. While courts are not likely to let 62 million homeowners off scot free, the defect in title created by MERS could give them significant new leverage at the bargaining table.

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