The financial institutions and their lawyers could not see the big picture, redux

I’ve written before of the failure of our financial geniuses to see the “big picture” when they created their house of cards built of mortgage backed securities, credit default swaps, and the assumption that housing prices wouldn’t crash. But there’s a piece of the picture other than the inevitability of falling markets those geniuses failed to consider — what is required to foreclose on the homes that are the underlying asset giving the mortgage backed securities their value.

In order to foreclose, the owner of the mortgage has to be identified.  But no one knows who owns mortgages that have been packaged into mortgage backed securities.

The mortgages packaged into mortgage backed securities weren’t packaged whole.  In other words, if you are the owner of a mortgage backed security, you were not holding the right to collect on the loans to one or more specific homeowners.  Instead, you were holding the right to collect a portion of an enormous number of loans made to an enormous number of homeowners.  Thus, each homeowner’s mortgage is owned in by an enormous number of buyers of mortgage backed securities, to each of whom some fraction of his loan is owed.

For example, the day after I financed my house my mortgage company sold its rights to collect on my home loan to one of the companies who put together these mortgage backed securities.  Then that company likely took its right to collect on my loan, split it up in littlet pieces, and put those each of those little pieces into different mortgage backed securities along with little pieces form other loans.  Theoretically, if I owed $1000 per month on my mortgage, there could be one thousand people to whom I each owe one dollar,  or one hundred thousand people to whom I each owe one cent, and so on. Could anyone tell me who owns my mortgage? Maybe 1,000 or maybe 100,000 different individuals and institutions.  Could anyone identify them to a court hearing a foreclosure case against me?

I doubt it.

Thus, as the Foreclosure Defense Group puts it:

In Ohio and other states, the inability of the “Lender” or Mortgage Servicer [the company in the above example who purchased my mortgage the day after it was created and subsequently packaged it into mortgage backed securities] to produce the original note and mortgage, combined with their inability to produce the documentation regarding the assignment or sale of the loan has resulted in de-linking the mortgage from the security interest in the home and the cancellation of the note giving the borrower free and clear title to the property that was subject to the original loan transaction.

It’s hard to train good lawyers.  Students just want “the law.”  But practicing law isn’t just a matter of knowing the law.  Knowing the law or, as is more often the case, knowing where to find the law, is of course necessary, but it’s the easy part.  The hard part is making sure your clients make good business decisions based in part on the law and in part on all the other constraints the clients operate within (including financial constraints, constraints established by the client’s aversion or lack of aversion to risk, constraints imposed by market and social conditions, etc.).

In order to do that you always have to have in mind the “big picture,” the implications of any specific decisions to the client’s long-term interests.  Lawyers might have reviewed every single possible regulation pertaining to securities when they approved the mortgage backed securities.  What they apparently didn’t think to look at, however, were the requirements the states impose on foreclosure actions.  Without the power to foreclose, the mortgage backed securities have no mortgages to back them.

The next time someone starts talking about financial geniuses (which I hope at least won’t be for some years), run!