Fannie Mae, Freddie Mac, and MERS

Given the legal questions about the validity of assigning mortgages to and immobilizing them at MERS while the promissory notes continue to be transferred among MERS members and may be put into a trust backing a security, one wonders why the Federal Housing Finance Agency continues to permit Fannie Mae and Freddie Mac to use this system. After all, if it turns out that the GSEs cannot foreclose on property, the losses assumed by the taxpayers will be all that much greater.

Fannie Mae and Freddie Mac are now sending out letters notifying borrowers that they have bought their mortgages. The Fannie Mae letter states: "The transfer of ownership of your mortgage loan has not been publicly recorded." The Freddie Mac letter has similar language. (Fannie Mae and Freddie Mac are sending these letters in voluntary compliance with the 2009 amendments to the Truth in Lending Act. See Fannie Mae's explanation here.)

There currently is a set of confusing decisions about MERS, many with differing facts, and some by federal bankruptcy judges and others by state judges or justices. No one knows where this will end up, but there appears to be a growing willingness of judges to opine that MERS does not work, even if it does hold half the home mortgages (but not the notes) in the U.S. For example, in the Agard case discussed in the previous post, Judge Grossman writes:

"The Court recognizes that an adverse ruling regarding MERS's authority to assign mortgages or act on behalf of its member/lenders could have a significant impact on MERS and upon the lenders which do business with MERS throughout the United States.  However, the Court must resolve the instant matter by applying the laws as they exist today.  It is up to the legislative branch, if it chooses, to amend the current statutes to confer upon MERS the requisite authority to assign mortgages under its current business practices.  MERS and its partners made the decision to create and operate under a business model that was designed in large part to avoid the requirements of the traditional mortgage recording process.  This Court does not accept the argument that because MERS may be involved with 50% of all residential mortgages in the country, that is reason enough for this Court to turn a blind eye to the fact that this process does not comply with the law."

While Judge Grossman invites the "legislative branch" to remedy the issue, it is not clear whether he means the legislature of New York State or the U.S. Congress. There is a constitutional issue about whether the federal government has authority in this area.

It may turn out that MERS ultimately prevails or, at least, prevails in most states, but that is far from certain. In the meantime, one hopes that the Federal Housing Finance Agency, the Treasury Department, and the other regulators of the Financial Stability Oversight Council created by the Dodd-Frank Act are looking at this issue. If they believe that it is all right for Fannie Mae and Freddie Mac, as well as major mortgage lenders, to continue to use MERS, I hope this is based on a careful legal analysis. They should not be relying on the belief that MERS must be legal because this small outfit holds such a large share of outstanding mortgages.

One gets the impression that this issue is being dismissed without the careful legal analysis it requires. I hope that impression is wrong.

MERS – Contrasting Bankruptcy Court Decisions in New York (Agard) and Kansas (Martinez)

The legal foundation on which MERS (Mortgage Electronic Registration System) is based looks increasingly rickety, with two U.S. Bankruptcy Courts issuing contrasting decisions last week.

First out of the box on February 10 was a much remarked on decision issued by Bankruptcy Judge Robert E. Grossman of the U.S. Bankruptcy Court for the Eastern District of New York. The debtor, Ferrel L. Agard, argued that U.S. Bank and its servicer, Select Portfolio Servicing, lacked standing to seek relief from the automatic stay in order to proceed with the foreclosure process on Agard's house "owned with son." Agard lost, because the Court decided it could not overturn a New York State court decision granting U.S. Bank the right to proceed with foreclosure. Nevertheless, the bulk of the opinion, which lawyers would classify as "dicta," is devoted to detailing why the Court does not agree with the state courts. Essentially, the judge does not believe that the MERS system works as a legal matter. The problem is that the note and the mortgage do not travel together; while the note is transferred among MERS members, MERS continues to hold the mortgage in its name, and there is no documentation supporting its argument that it is an "agent" of each holder of the note. The judge further opines that MERS does not have the right to assign the mortgage based on its nominee status because it has no ownership interest in the note. Grossman dismisses with less than hidden disdain MERS' argument that its status as the "mortgagee of record" gives it the right to assign the mortgage: "Aside from the inappropriate reliance upon the statutory definition of 'mortgagee,' MERS's position that it can be both the mortgagee and an agent of the mortgagee is absurd, at best." The judge concludes that "in all future cases which involve MERS, the moving party must show that it validly holds both the mortgage and the underlying note in order to prove standing before this Court."

The next day, February 11, Bankruptcy Judge Janice Miller Kaplan of the U.S. Bankruptcy Court for the District of Kansas, issued a very different opinion in the case of David Martinez (deceased) and his common law wife, Michelle Graham. The Court decided to grant MERS and Countrywide relief from the automatic stay in order to proceed with foreclosure. MERS had initially commenced the foreclosure action in its name. The Court reasoned that MERS is in fact an agent of Countrywide. This case differs from the Agard case since Countrywide was the original lender and kept the note. Naturally MERS is pointing to this case to justify its legal basis and to argue that the New York case is an outlier. However, it is not clear where this leaves the foreclosure issue. While Countrywide and MERS were granted relief from the automatic stay, the Court of Appeals of the State of Kansas decided in an April 2010 opinion that "MERS lacks standing to bring a foreclosure action." Perhaps this is being appealed to the Kansas Supreme Court or perhaps Countrywide has or will commence foreclosure action using its own name. (Maybe a reader of this blog knows and could post a comment or send me an email.)

Meanwhile, MERS issued a press release on February 16 announcing its intent to propose an amendment to its membership rules prohibiting members from foreclosing in MERS' name.

Government Shutdown and Interest Payments on the Public Debt

As mentioned in the correction to the last post, the current continuing resolution permitting much of the federal government to spend money only runs through March 4. Absent legislation being enacted by then, much of the federal government will shut down on March 5. Some agencies will not be affected, but much of the government will be.

The political situation suggests that a government shutdown is not a remote possibility, though everyone involved should be trying to avoid it. If it were to persist more than a day, there would likely be public anger at all incumbents, regardless of party. Who would get the lion share of the blame is not clear; the last time this happened in the 90s, it did not work to the benefit of the Republicans in Congress, a fact that must weigh heavily in John Boehner's thinking.

There still seems to be some confusion regarding a government shutdown and the debt limit. The March 4 date does not involve the debt limit, and payments of interest and principal on the public debt are not affected. There is a "permanent and indefinite" appropriation to pay interest on the public debt, and principal payments are not viewed as a budget outlay.

While a government shutdown should be avoided, consideration of legislation dealing with the budget, appropriations, and taxes is the appropriate venue to debate government spending, tax, and deficit issues. The debt limit, which will hit later this year, is not.  

A Quick Note on Debt Limit Posturing

When it comes to the debt limit, it is difficult to tell whether some politicians really believe what they are saying. For example, one idea that is being put forward is that hitting the debt limit would not be catastrophic, since the government could make it a priority to pay interest and principal of the public debt before making any other payments. This sounds much simpler than it is.

One thing proponents of this idea are ignoring, willfully or not, is that receipts and outlays are not neatly matched, and that some particular days have large outlays. At the beginning of the month there is a very large withdrawal of Treasury cash to make Social Security payments. For example, on November 3, 2010, the outlay for Social Security was $22.2 billion. This was the bulk of total withdrawals of operating cash of $34.6 billion. The net decrease in operating cash was $27.2 billion. (Data in this post come from issues of the "Daily Treasury Statement.")

Another big withdrawal day, interest on notes and bonds, takes place in the middle of February, May, August, and November. For example, on November 16, interest on the public debt amounted to $21.4 billion. Operating cash increased that day by $27.1 billion, but this was due to issues of new securities of $92.3 billion more than offsetting redemptions of $54.5 billion. If the Treasury were up against the debt limit, it could not have raised cash in this manner.

Now if a big interest payment date is coming up and Treasury is near the debt limit, what is it supposed to do? Should it assume that Congress will not pass the debt limit and hoard cash by not making payments? This would be of doubtful legality, and, in any case, imagine the political firestorm that would result if Treasury did not make Social Security payments. I doubt that Congress would pass a law making it legal for the Administration to conclude that the Congress will be irresponsible and therefore has the right to withhold payments, such as Social Security.

In other words, the Congress will enact debt limit legislation. The current theatrics are an attempt by some in Congress to force concessions from the Administration by seeming to be irresponsible. It is pretty clear that senior politicians, such as John Boehner, do not want to carry this too far. Politically, this has not always worked that well.

In any case, the Congress will have to deal by the end of March with keeping the government funded when the continuing resolution expires, or there will be a government shutdown. The Treasury says that the debt limit will be hit in April or May. We can expect a lot of political posturing, and when it comes to funding the government, perhaps some meaningful decisions.

(An earlier post on the government shutdowns, the debt limit, continuing resolutions, and appropriations can be found here.)


Correction:  The current continuing resolution funds the government only through March 4, not until the end of March.