The Mortgage Machine Backfires

Published: September 26, 2009

WITH the mortgage bust approaching Year Three, it is increasingly up to the nation’s
courts to examine the dubious practices that guided the mania. A ruling
that the Kansas Supreme Court issued last month has done precisely
that, and it has significant implications for both the mortgage industry and troubled borrowers.

The opinion spotlights a crucial but obscure cog in the nation’s lending machinery: a privately owned loan
tracking service known as the Mortgage Electronic Registration System.
This registry, created in 1997 to improve profits and efficiency among
lenders, eliminates the need to record changes in property ownership in
local land records.

Dotting i’s and crossing t’s can be a
costly bore, of course. And eliminating the need to record mortgage
assignments helped keep the lending machine humming during the boom.

Now,
however, this clever setup is coming under fire. Legal experts say the
fact that the most recent assault comes out of Kansas, a state not
known for radical jurists, makes the ruling even more meaningful.

Here’s
some background: For centuries, when a property changed hands, the
transaction was submitted to county clerks who recorded it and filed it
away. These records ensured that the history of a property’s ownership
was complete and that the priority of multiple liens placed on the
property — a mortgage and a home equity loan, for example — was accurate.

During
the mortgage lending spree, however, home loans changed hands
constantly. Those that ended up packaged inside of mortgage pools, for
instance, were often involved in a dizzying series of transactions.

To avoid the costs and complexity of tracking all these exchanges, Fannie Mae, Freddie Mac
and the mortgage industry set up MERS to record loan assignments
electronically. This company didn’t own the mortgages it registered,
but it was listed in public records either as a nominee for the actual
owner of the note or as the original mortgage holder.

Cost
savings to members who joined the registry were meaningful. In 2007,
the organization calculated that it had saved the industry $1 billion
during the previous decade. Some 60 million loans are registered in the
name of MERS.

As long as real estate prices rose, this system ran
smoothly. When that trajectory stopped, however, foreclosures brought
against delinquent borrowers began flooding the nation’s courts. MERS
filed many of them.

“MERS is basically an electronic phone book
for mortgages,” said Kevin Byers, an expert on mortgage securities and
a principal at Parkside Associates, a consulting firm in Atlanta. “To
call this electronic registry a creditor in foreclosure and bankruptcy
actions is legal pretzel logic, nothing more than an artifice
constructed to save time, money and paperwork.”

The system also
led to confusion. When MERS was involved, borrowers who hoped to work
out their loans couldn’t identify who they should turn to.

As
cases filed by MERS grew, lawyers representing troubled borrowers began
questioning how an electronic registry with no ownership claims had the
right to evict people. April Charney, a consumer lawyer at Jacksonville
Area Legal Aid in Florida, was among the first to argue that MERS,
which didn’t own the note or the mortgage, could not move against a
borrower.

Initially, judges rejected those arguments and
allowed MERS foreclosures to proceed. Recently, however, MERS has begun
losing some cases, and the Kansas ruling is a pivotal loss, experts say.

While
the matter before the Kansas Supreme Court didn’t involve an action
that MERS took against a borrower, the registry’s legal standing is
still central to the ruling.

The case involved a borrower named
Boyd A. Kesler, who had taken out two mortgages from two different
lenders on a property in Ford County, Kan. The first mortgage, for
$50,000, was underwritten in 2004 by Landmark National Bank; the
second, for $93,100, was issued by the Millennia Mortgage Corporation
in 2005, but registered in MERS’s name. It seems to have been
transferred to Sovereign Bank, but Ford County records show no such
assignment.

In April 2006, Mr. Kesler filed for bankruptcy. That
July, Landmark National Bank foreclosed. It did not notify either MERS
or Sovereign of the proceedings, and in October, the court overseeing
the matter ordered the property sold. It fetched $87,000 and Landmark
received what it was owed. Mr. Kesler kept the rest; Sovereign received
nothing.

Days later, Sovereign asked the court to rescind the
sale, arguing that it had an interest in the property and should have
received some of the proceeds. It told the court that it hadn’t been
alerted to the deal because its nominee, MERS, wasn’t named in the
proceedings.

The court was unsympathetic. In January 2007, it
found that Sovereign’s failure to register its interest with the county
clerk barred it from asserting rights to the mortgage after the
judgment had been entered. The court also said that even though MERS
was named as mortgagee on the second loan, it didn’t have an interest
in the underlying property.

By letting the sale stand and by rejecting Sovereign’s argument, the lower court, in essence, rejected MERS’s business model.

Although
the Kansas court’s ruling applies only to cases in its jurisdiction,
foreclosure experts said it could encourage judges elsewhere to
question MERS’s standing in their cases.

“It’s as if there is
this massive edifice of pretense with respect to how mortgage loans
have been recorded all across the country and that edifice is creaking
and groaning,” said Christopher L. Peterson, a law professor at the University of Utah.
“If courts are willing to say MERS doesn’t have any ownership interest
in mortgage loans, that may eventually call into question the priority
of liens recorded in MERS’s name, and there are millions and millions
of them.”

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