March 14, 2018

Book Review: Chain of Title: How Three Ordinary Americans Uncovered Wall Street's Great Foreclosure Fraud

Reviewed by Howard Darmstadter

Chain of TitleDavid Dayen, Chain of Title: How Three Ordinary Americans Uncovered Wall Street’s Great Foreclosure Fraud

(New Press, 2016, 320 pp.).

In 2005, about 1% of U.S. mortgages were in foreclosure, a number that had remained fairly steady for at least 15 years. Four years later, foreclosures had more than quadrupled, to 4.6%. Nearly 2.5 million American families were in the process of losing their homes, and an additional 5 million were delinquent on their loans.

Most foreclosed families simply hand over the keys to the lender and move on. Chain of Title tells the story of three who chose to stand and fight. A cancer nurse, Lisa Epstein, a car salesman, Michael Redman, and a solo lawyer, Lynn Szymoniak, not only contested their own foreclosures but also organized a grassroots movement designed to stop the Great Foreclosure Machine in its tracks. The three did not deny that they were in default on their mortgages. But they claimed that in a huge number of foreclosures (including their own) the mortgage documentation had been so bungled that no one had a clear title to the mortgage and therefore no one had standing to foreclose. Moreover, in attempting to fix the documentation, the foreclosing banks resorted to fabrications, modifications, and forgeries of the promissory note and other key mortgage documents. All in all, says Dayen, it was "the largest consumer fraud in American history."

Before plunging into the jungle of foreclosure law and practice, it would be wise to give ourselves a shot of reality. Each of our three homeowners had been making regular payments on their mortgages. Each month they received computer-generated statements showing the previous month's payment, the current amount of principal and interest owed, and the remaining principal balance. If these figures weren't correct, the homeowners would have contested them. Moreover, at no time before or after foreclosure did any third party claim to be entitled to the mortgage payments. So, in reality, the three homeowners (and the overwhelming majority of other homeowners suffering foreclosure) owed exactly what was claimed to exactly the people making the claims. All the rest is legal technicalities and confusions. And therein hangs a tale.

Beginning in the 1990s, savings banks and other mortgage lenders, instead of holding on to their mortgage loans, frequently sold them off to investment banks or to the government-sponsored entities Fannie Mae and Freddie Mac. These buyers assembled mortgage pools that were transferred to securitization trusts, which in turn issued mortgage-backed securities that passed through the principal and interest payments on the pooled mortgages to the securities holders.

Although the securities are issued by a trust, the trustee—almost always a bank with little connection to the mortgages—usually contracts out the management of the mortgages and the securities to a servicer—often a bank associated with the organizer of the mortgage pool—who calculates the monthly principal, interest, and real estate tax escrow payments due from the homeowner, checks that the payments are made, sends monthly statements to the homeowners, contacts homeowners who miss payments, and forecloses when the loan becomes seriously delinquent. The servicer in turn often farms out certain specialized tasks such as document storage and foreclosure.

Mortgage servicing is a business with economies of scale, and most servicing today is done by large companies that service millions of loans. Servicers typically earn annual fees on securitized mortgages equal to 0.25% of the unpaid principal amount of fixed-rate mortgages and 0.375% of adjustable-rate mortgages.

At a house closing, the homebuyer signs many documents (the "mortgage file"), including the mortgage and a promissory note. As the mortgage is transferred to the securitization trust through the investment bank and possibly other intermediaries, other documents, such as mortgage assignments, may be added to the file, and the note may be endorsed. The mortgage file is then sent off to a document warehouse, usually managed by a document custodian subcontractor. The document warehouse may be thousands of miles from the servicer's offices, because there is seldom any need to consult the mortgage file.

If a mortgage enters foreclosure, servicers may be reluctant to go to the bother of retrieving the mortgage file. It's expensive and time-consuming, and documents may be missing, incomplete, or lacking some requisite formality. So the practice grew of shortcutting the legally mandated foreclosure procedures by filing an affidavit stating that the promissory note had been lost, when in fact no one had bothered to look for it. The affidavits were prepared, signed, and notarized in bulk, without anyone reviewing their contents. This practice came to be known as "robosigning."

Okay, they shouldn't have done it. Filing false affidavits is a practice that should not be encouraged, but aside from denying the homeowners a few weeks or months delay, no one was harmed by these extralegal shortcuts. Who owes what to whom on a mortgage loan is determined primarily by the servicer's records, which had been available to the mortgage owners and the homeowners all along. In the absence of anyone questioning the monthly statements, they can be regarded as dispositive. And if servicing personnel had reviewed a mortgage file, what would it have told them? The promissory note is likely to be endorsed to "bearer" rather than to the current owner of the mortgage loan, and will almost certainly not reveal how much of the loan has been paid. A person signing an affidavit prepared by a computer is more likely to get things right than someone who muddies the waters by insisting on reviewing the documents. For the servicers and their subcontractors who had to deal with a quadrupling of foreclosures in the years after 2005, the extralegal shortcuts must have seemed a straightforward way to evade the formalities of a paper-based system that had been superseded in fact, if not in law.

Dayen claims that the securitization trusts were often not entitled to enforce the mortgage because of missing, inadequate, or forged endorsements on the mortgage note. Who owns a mortgage note and who is entitled to enforce the mortgage are governed in large part by the Uniform Commercial Code, versions of which are the law in every state. But many lawyers and judges are unfamiliar with the UCC rules. This ignorance reached a Gilbert-and-Sullivan-esque apogee in the Ibanez case, cited approvingly by Dayen, in which the Massachusetts Supreme Judicial Court held—incorrectly—that a mortgage was unenforceable because it had become separated from the note. Neither the court nor, judging from the briefs, the plaintiff, the defendant, nor numerous friends of the court on both sides, seemed to be aware that the question was controlled by the UCC, the court instead relying on a 19th century precedent.

The situation was bad enough that in November 2011 the Permanent Editorial Board (PEB) for the UCC saw fit to issue a 14-page report (www.uniform explaining the basic mortgage note rules. The PEB is a creature of the two organizations that promulgate the UCC, and several of the PEB's members have been involved in drafting parts of the UCC. It's as close to an unimpeachable authority as you get.

There are an unlimited number of fact patterns involving notes, mortgages, endorsements, and assignments, but under the UCC rules, as explained by the PEB, in most cases (including the ones Dayen covers) the securitization trust will own the note and be entitled to enforce the mortgage, regardless of how the endorsements (which may be important for other purposes) read. Written mortgage assignments are also unimportant, although some states with nonjudicial foreclosure require a person enforcing a mortgage to record the assignment or other evidence of ownership.

The fuss about notes and endorsements raises a question about the role promissory notes play in the modern world. As a lawyer I worked on numerous loan agreements in which lenders were issued promissory notes. I usually represented the borrower, and early in my career, when a deal terminated, I would call up the bank and ask for our note back. I seldom succeeded, and soon gave up asking. I often asked more seasoned lawyers why the promissory note was important, but never got a convincing answer. Eventually, I drafted loan agreements that provided that the lender could have a promissory note only if it asked. Few did. Not for the last time in this tale, an artifact of a paper-based era would prove irrelevant for a computerized world.

Chain of Title asserts that the bungled or doctored paperwork cast a shadow on every homeowner's claim to his or her home, because it prevented anyone from establishing a clear chain of title. But I haven't read, and I suspect you haven't either, about widespread difficulties with home sales, or about title companies being unable to issue policies. Whatever problems the sloppy paperwork may have created, they seem manageable.

Dayen claims that homeowners were driven out of their homes even though they were current on their mortgages, or were advised by servicers to stop paying their mortgages so that they would be eligible for loan modifications, or were victimized in other ways. With millions of foreclosures, one assumes that horror stories like this must have happened on occasion, but I doubt they were common, no matter what the Internet says. (Although Dayen is writing about a nationwide problem, Chain of Title is mainly about events in Florida; perhaps Florida really is different.)

The best numbers we have (Dayen doesn't give any) come from an interagency review of foreclosure policies and practices released in April 2011 by the Federal Reserve System, the Comptroller of the Currency, and the Office of Thrift Supervision. Interagency Review of Foreclosure Policies and Practices (Apr. 2011), The review noted that "some servicers failed to accurately complete or validate itemized amounts owed by [defaulting] borrowers," and that "the percentage of errors at some servicers raise[d] significant concerns regarding those servicers' internal controls."

These conclusions were based on a review of 2,800 files of foreclosed mortgages from 14 companies that in the aggregate serviced more than two-thirds of the nation's mortgages. The files were not chosen randomly—one of the criteria for selection was that a consumer complaint had been raised—so one might expect the sample to exaggerate the extent of errors. Nonetheless, the review found that

borrowers subject to foreclosure in the reviewed files were seriously delinquent on their loans. . . . [S]ervicers possessed original notes and mortgages and, therefore, had sufficient documentation available to demonstrate authority to foreclose. Further, examiners found evidence that servicers generally attempted to contact distressed borrowers prior to initiating the foreclosure process to pursue loss-mitigation alternatives, including loan modifications.

Errors in computing the amount owed were small—"typically less than $500"—and in more than half the cases favored the borrower. The review did note, however, "cases in which foreclosures should not have proceeded due to an intervening event or condition, such as the borrower (a) was covered by the Servicemembers Civil Relief Act, (b) filed for bankruptcy shortly before the foreclosure action, or (c) qualified for or was paying in accordance with a trial modification."

Dayen assumes that the mortgage holders wanted to foreclose, even though he admits at several points that modifying the mortgages by reducing principal and interest payments would have been better for the holders. But for mortgages held in a securitization trust, the trust had little choice: the governing document—the pooling and servicing agreement, or P&S—did not allow the trustee to reduce principal or interest payments without the consent of a supermajority—often 100%—of investors, which was totally impractical. So the foreclosures went ahead even though the investors would have done better by modifying the mortgages.

I wasn't present at the creation of the P&S, but I would guess that investors feared that servicers would reduce principal and interest payments, rather than foreclose, so as to hang on to their servicing fees. The investors no doubt assumed that foreclosure sale proceeds would usually exceed the amount due on the mortgage, so prohibiting modifications made economic sense. The investors had never seen a nationwide decline in housing prices and didn't consider the possibility that reducing principal or interest payments might yield a better return than foreclosure. I myself drafted dozens of P&S agreements without appreciating until too late the danger inherent in the no-modification provisions.

Much of the work of foreclosure was given over to subcontractors—Dayen labels them "foreclosure mills"—and Dayen suggests that they forced through foreclosures just to earn fees. But even a foreclosure mill could proceed only when so directed by the servicer, and the servicer would have no economic reason to foreclose if it thought the homeowner might be able to cure the delinquency.

A shadowy player in the foreclosure drama was MERS—the Mortgage Electronic Registration Systems—an entity Dayen suggests was part of some nefarious plot. And indeed, there has been a good deal of confusion about MERS's role. Homeowners frequently alleged that MERS did not have standing to foreclose. In 2011, MERS was the record holder of about half the nation's mortgages—about 60 million loans—and a decision in favor of the homeowners could have thrown the entire foreclosure system into chaos. Michael Powell & Gretchen Morgenson, MERS? It May Have Swallowed Your Loan, N.Y. Times, Mar. 5, 2011,

MERS was set up in 1995 as a membership organization owned by major players in the mortgage origination, securitization, and servicing industries, including Fannie Mae, Freddie Mac, and the big banks. Its 3,000 members include almost all mortgage lenders as well as many companies that trade or service mortgage loans.

MERS was designed to solve a particular problem: as mortgage loans became securitized, the paper routines that had worked when mortgages stayed in one place became onerous. The journey to the securitization trust might involve a half dozen stops, and documenting the transfers, and possibly having to record at least some of the assignments, was expensive, time-consuming, and error-prone.

MERS changed all that. Mortgage agreements now usually authorize the mortgage lender to record the original mortgage in MERS's name as nominee for the original mortgage lender and for all subsequent owners of the mortgage loan who are MERS members. When a MERS member investment bank assigns a mortgage loan to a member securitization trust, MERS remains the named party on the recorded mortgage, but now as the nominee of the trust. Since MERS remains the nominee, the assignment of the mortgage need not be recorded. MERS keeps an electronic database of the real owner and the servicer of each mortgage loan for which MERS acts as nominee, although the accuracy of the database depends on members keeping MERS informed of transfers.

When a mortgage loan defaults, the mortgage usually permits MERS to bring a foreclosure action in its own name—that is, MERS can initiate judicial foreclosure proceedings and conduct the foreclosure sale. MERS has few employees but has appointed thousands of non-employees—almost always employees of the real owners or servicers of the mortgage loans—as MERS officers to act for MERS on foreclosures and other matters. Dayen seems to think that having a person be an officer of multiple entities is something shady, but it's perfectly legitimate.

There has been some legal confusion about how to categorize MERS's role in foreclosure actions. Legal theory distinguishes between legal title and beneficial ownership. The classic case is the trust, in which the trustee has legal title to, but no economic interest in, the trust assets. The trustee acts for a beneficiary who is the beneficial owner of—that is, has the real economic interest in—the trust. There is no doubt that a trustee can bring a legal action in its own name as trustee, and the same reasoning might seem to apply to MERS, except that MERS is neither a trust nor a trustee. Sometimes MERS seems to function as a nominee or agent (other familiar legal categories), and sometimes as the legal owner. It's all very confusing to the legal theorist.

As a result of these conceptual difficulties, homeowners and their lawyers have argued that MERS does not have standing to bring a foreclosure action, and a few courts have been sympathetic. In one case, a New York court declared that MERS did not have the power as a nominee either to foreclose or to assign the mortgage back to the note owner. Since the court also held that the note owner could not foreclose unless the mortgage was assigned back to it, this holding would have raised an insuperable barrier to any foreclosure for those mortgages MERS held in New York. Happily, the decision was overturned on technical grounds.

Of course, for nonlawyers the important practical questions are: does the homeowner owe the money, and will the foreclosure proceeds be paid to the appropriate person? The answer to both questions is almost always "yes." But the advent of MERS has raised those cloudy legal questions one would expect when a real-world system outpaces its legal conceptualization.

The creation of MERS was partly inspired by developments in the securities industry. In the early 1960s almost all stock or bond trades required the physical transfer of a paper certificate. It was a system devised for a quieter era; back then, an active day on the New York Stock Exchange might involve the transfer of 5 million shares. But then the volume of trading expanded rapidly, and before the end of the decade 10 million-share days were common. Brokerage back offices were overwhelmed by the paper crunch, and many old and established firms went under.

Within a relatively short time, the industry devised a solution: a depository was set up—The Depository Trust Company (DTC)—to hold the stock certificates (actually, through DTC's nominee, Cede & Co.). All the major brokerage houses and banks were participants in DTC, and DTC kept records of which of its participants was the beneficial owner of the share certificates held in DTC's vault. The participants, in turn, kept records of which of its customers (some of whom were themselves financial institutions) were the beneficial owners of the shares the brokerage house held through DTC, and so on down the chain until at the end one found the true beneficial owners of the securities—those persons who were not holding for someone else. When a beneficial owner bought or sold shares, his securities firm would indicate the change by appropriately marking its records (a "book entry"), and corresponding book entries would be made at the firms further up the chain and finally at DTC; no paper certificate would change hands.

This strategy of "immobilizing" the paper certificates at the depository and doing all the transfers by book entry has worked remarkably well. The New York Stock Exchange now routinely handles billion-share days without fuss or panic. Most investors hold their shares through their brokers; they receive a brokerage statement that shows their stock holdings without realizing that these holdings are evidenced only by a chain of computer records, culminating in an actual stock certificate issued to Cede & Co., an entity they have never heard of.

While the depository system has solved the practical problems of securities transfer, it was for some time a legal orphan. Transfers of investment securities, like transfers of promissory notes, are governed by the UCC, and for roughly a quarter-century that statute provided only minimal guidance as to the status of a financial institution holding shares for its customers through a depository: Was the broker an agent, a trustee, or a bailee? What duties were owed by the depository or the broker to persons further down the chain? None of the familiar legal categories seemed to quite fit the situation, yet the choice of category could carry important legal and financial consequences.

It was only in 1994 that a new version of the UCC became available—quickly adopted by all 50 states—that resolved the legal categorization problem. The solution consisted in realizing that the relation of the various parties in the chain of security ownership did not fit into any existing legal category. Instead, a new category was invented—the "security entitlement"—and rules propounded for the new way of doing business.

MERS seems to be suffering the same sort of legal uncertainties that afflicted the securities depository system before 1994. Unfortunately, it could be some time before we have a legal structure that is responsive to the new realities of the mortgage market.

But Chain of Title isn't about logic or reality. It's not even, primarily, about foreclosure. Its true subject is anger and obsession, with a dash of paranoia. Two of the three protagonists ended up sacrificing their jobs and their marriages to a 24/7 battle against imagined wrongs. In Dayen they found a writer willing to take their obsessions at face value.

Dayen apparently believes that foreclosure itself is wrong. He harks back to the Great Depression of the 1930s, praising the efforts of farmers to stop foreclosures by violence and intimidation. "Farmers simply would not allow their neighbors to get swallowed up by the side effects of rampant speculation and greed." Nor does he question that the Great Recession was caused by criminal acts of the denizens of Wall Street. With these starting points it's easy for him to write that "[h]olding banks accountable for proper chain of title wasn't a trick or a technicality; it was the only way to put an end to the thievery." In Chain of Title's 320 pages, the words "fraud" and "crime," and their cognates, appear over 550 times. I've written elsewhere ( that fraud wasn't the driving force in the Great Recession, and I won't rehash those arguments here.

Something terrible happened to the American economy in 2008 and after. Millions lost their homes and jobs. It's not clear yet just what the causes were, and how they might be fixed. The jury is still out on Dodd-Frank. But anger, demonology, and paranoia can only hinder serious attempts to find a solution.

Reviewed by Howard Darmstadter

Howard Darmstadter is a retired lawyer and philosophy professor who lives in Stamford, Connecticut, and writes on law, philosophy, and public policy.