The administration and the banks want you to believe that there is nothing more to foreclosure fraud than just mere paperwork. I point out here that the false affidavits and rocket dockets can rob people of their legal rights. But that was just the first grade primer. When home mortgages are securitized, a whole new level of legal rights and duties are set up that go far beyond the minimal requirements of the Uniform Commercial Code. The interaction of these rights and duties make it difficult to determine who is entitled to enforce securitized mortgage notes.
I am grateful to Yves Smith for introducing me to this set of issues.
We will be looking at a specific securitization, that of GSAMP Trust 2007-NC1, which we will call the Trust. The letters stand for Goldman Sachs Alternative Mortgage Product, and New Century, the giant mortgage originator that collapsed into bankruptcy with an array of fraud claims. The Trust is governed by a Pooling and Servicing Agreement, the PSA, which is here. There are seven parties to the PSA, and the rights and duties of each are described in excruciating detail.
The basic idea of the PSA is that New Century will transfer a specific group of promissory notes secured by residential mortgages to the Trust. The Trust is a special purpose vehicle created for the limited purpose of holding the mortgage loans. It sells debt securities, bonds, to investors. The bonds will be paid solely from the payments made on the mortgage loans. The PSA describes the bonds and how the Trust is to pay out the money it receives. This is the slicing and dicing part of the creation of real estate backed mortgage securities.
First let’s look at some of the critical legal and practical requirements for the Trust. Then we will look at the ramifications of what the banks say is just problem paperwork that needs a few tweaks.
The Trust will receive income from the interest on the promissory notes, and possibly other income. It is crucial to investors that the Trust is not liable for federal or state income taxes. Internal Revenue Code § 860A creates special rules for Real Estate Mortgage Investment Conduit, or REMIC. If the Trust qualifies, it will not be taxed on its income. The PSA contains provisions that, if complied with, should enable the Trust to qualify as a REMIC. That makes compliance with the REMIC requirements essential for the Trust. . . .
The FDIC has rules on accounting for banks, and specifically for the calculation of their net capital. It is crucial to a bank that it sell all of its interest in the mortgage loans with no possibility that the Trust could make it buy them back. If it doesn’t, it will have to show a liability for the possibility that it might have to buy back the mortgage loans. General accounting rules also require a complete disposition to count as a sale. The PSA contains provisions which attempt to insure that New Century is selling with no possibility that it will have to buy back the mortgage loans. See, for example, § 12.04.
All parties want to insure that if one of them or the Trust files bankruptcy, it won’t affect any of the other parties. This is called bankruptcy remoteness. The PSA contains provisions that should insure bankruptcy remoteness.
New York Trust Law
The PSA says that the parties choose to be governed by the laws of the State of New York. § 12.03. New York law governing the operation of trusts and the actions of trustees applies to the PSA. That law is detailed, and well-developed through case law. Speaking very generally, a trustee has only the authority granted by the instruments creating the trust. In our case, the Trustee is LaSalle Bank, which is now owned by Bank of America. LaSalle Bank has no discretion to disregard the provisions of the PSA, and is not allowed to act contrary to the PSA.
The duties of the Trustee are enumerated in § 8.01, along with exculpatory provisions. The main provision is in subsection (a):
(a) the duties and obligations of the Trustee shall be determined solely by the express provisions of this Agreement, the Trustee shall not be liable except for the performance of the duties and obligations specifically set forth in this Agreement, no implied covenants or obligations shall be read into this Agreement against the Trustee, ….
PSA Requirements for Delivery of Mortgage Loans
The PSA is quite specific about the mortgage loans that go into the Trust. § 2.01 goes into great detail about the documents that must be delivered and the form they must take. Here is an example from §2.01(b)(i), which requires delivery of:
(i) the original Mortgage Note (except for up to 1.00% of the Mortgage Notes for which there is a lost note affidavit and a copy of the Mortgage Note) bearing all intervening endorsements, endorsed “Pay to the order of _________, without recourse” and signed in the name of the last endorsee. To the extent that there is no room on the face of the Mortgage Notes for endorsements, the endorsement may be contained on an allonge unless the Trustee (and Custodian) is advised by the Responsible Party that state law does not so allow. If the Mortgage Loan was acquired by the Responsible Party in a merger, the endorsement must be by “[last endorsee], successor by merger to [name of predecessor]“. If the Mortgage Loan was acquired or originated by the last endorsee while doing business under another name, the endorsement must be by “[last endorsee], formerly known as [previous name]“;….
§ 2.01 explains in similar detail the other documents, including the mortgage itself, which must be delivered, and the forms they must have.
These complex provisions are crucial deal points. They are all necessary to achieve REMIC status, bankruptcy remoteness, and outright sale. They are not discretionary with the Trustee.
Who Can Enforce The Note?
If the Trustee has possession (through a custodian) of a promissory note that meets all of the requirements of § 2.01, then the Trustee is the holder and is entitled to enforce the note and to foreclose on the mortgage.
What about a note that is not properly indorsed? The transfer of a promissory note is governed by UCC § 3-203:
(a) An instrument is transferred when it is delivered by a person other than its issuer for the purpose of giving to the person receiving delivery the right to enforce the instrument.
In the case of an improperly indorsed note, there was no transfer, because the PSA does not allow the Trustee to accept delivery of a promissory note that does not meet its requirements. If the note has not been effectively transferred, the Trustee has no rights in it, and cannot enforce it.
Whether or not this comports with the UCC is irrelevant, because the UCC permits parties to contract for more restrictive terms than those in the UCC itself. UCC § 1-302. The PSA contains more restrictive terms regarding indorsement and delivery than those of the UCC, and terms of the PSA are enforceable.
It isn’t clear that this can be fixed by getting the missing indorsements, because the time specified for the closing of the transfers has long since passed. A further problem arises when the originator of the mortgage is out of business.
This is an opportunity for the homeowner, certainly. It also matters to the investor. If the note has not been properly transferred, the Trust might lose its status as a REMIC. It matters to New Century (or it would if New Century was still around) because it might create a liability to take back the mortgage loan. It matters to the IRS, which has to figure out whether the Trust owes taxes. It also matters to the Trustee of the Trust, which may have violated the PSA.
Who can enforce an improperly indorsed note? Good question. This will clog up courts for a long time.
The Administration and the banks and all the other players in the securitization game want us to look ahead, and not back at this disaster. Investors and homeowners should adjust their rear view mirrors and take a careful look at every single document.