Does the Mortgage Electronic Registration Systems ("MERS") Legally Work?

Officials at the Mortgage Electronic Registration Systems (“MERS”) have been attempting to dismiss the concerns that have been raised about whether their system conforms to local laws governing real estate. Though the company, whose motto is “process loans, not paperwork,” is putting on a brave front, one suspects that there are some very worried people at its Reston, Virginia headquarters.

An article in The Washington Post last month, “Reston-based company MERS in the middle of foreclosure chaos,” provides some useful background to this company, which was until recently little-known, even though, according to the Post article, it “tracks more than 65 million mortgages throughout the country.” MERS was created in the 1990s to reduce the paperwork involved in transferring mortgages, especially those which had become securitized. The system started operations in 1997. MERS states that its “mission is to register every loan in the United States” on its system.

Legal issues are now being raised about whether the MERS system actually works. Christopher L. Peterson, a law professor and associate dean at the University of Utah, S.J. Quinney College of Law, has posted online a working draft for a forthcoming issue of Real Property, Trust and Estate Law Journal  – “Two Faces: Demystifying the Mortgage Electronic System's Land Title Theory.”  Floyd Norris of The New York Times has a good summary of the issues in his article: “Some Sand in the Gears of Securitizing.”

Mr. Peterson points out that some boilerplate legal language MERS uses “is confusing to courts, borrowers, and even foreclosure attorneys.” It states that “MERS is a separate corporation that is acting solely as nominee for Lender and Lender's successors and assigns. MERS is the mortgagee under the Security Instrument.” Peterson remarks: “It is axiomatic that a company cannot be both an agent and a principal with the same right.”

He goes on to say that there are “significant legal problems” whether MERS is an agent or the actual mortgagee. If it is the agent, this may run afoul of state land title recording acts, whose point is “to provide a transparent, reliable, record of actual – as opposed to nominal – land ownership.” If it is the mortgagee, then the mortgage has been separated from the promissory note. An 1872 Supreme Court case (Carpenter v. Logan) held that a mortgage assigned without the note “is a nullity.” That would seem to mean that MERS has no right to bring a foreclosure action.

Moreover, in this time of constrained local budgets, local governments are not happy that recording fees have not been paid on mortgages in the MERS system that have been assigned. This issue presents another legal challenge to MERS.

MERS seems to be blowing smoke in defending itself. For example, see its comment to Mr. Norris, which he quotes on his blog.  (Those interested in a detailed summary of court cases involving MERS can find one here.) 

The U.S. Treasury Department, seems to be trying to minimize the MERS issue. In an appearance before the Congressional Oversight Panel, a Treasury official with the peculiar title “Chief of the Homeownership Preservation Office,” Phyllis Caldwell asserted that regarding MERS litigation “at this early stage, it does not appear to be a fundamental legal risk.”

Well, perhaps, but the handwriting on the wall for MERS is becoming clearer; for example, James Dimon has announced that J.P. Morgan Chase will no longer use MERS for foreclosures. Also, in a recent development, the outgoing Attorney General for the District of Columbia, Peter Nickles, has issued a statement saying that MERS does not meet the legal requirements to commence foreclosure proceedings in the District.

It must be galling to officials at the Treasury and at financial institutions that MERS has created this legal problem with foreclosures. After all, the people who are being foreclosed on have defaulted on their mortgage loans.  

But if Peterson is right, at a minimum foreclosures will be slowed down as financial institutions endeavor to prepare paperwork that will satisfy legal requirements. (There are of course other issues such as "robosigning" that have been widely reported on.) In some cases, Peterson argues that the true loan owner could be treated as holding “an equitable mortgage,” but he says “it is likely that an equitable mortgage could be avoided in bankruptcy.” The effect of this will give homeowners in default more bargaining power.  Peterson comments: “The judicial threat of invalidating mortgages and replacing them with less tactically useful equitable mortgages could decrease court's dockets by forcing securitization trustees and servicers to the negotiating table.”

This may not be the worst result, but there may be concern in some quarters on the effect of this on financial institutions. The Treasury Department after all at times gives the impression to have substituted “Wall Street” for “General Motors” in Charlie Wilson's famous statement about what is good for the country, or maybe the Treasury has just added Wall Street to the statement.  (I'm sure, though, that some in the financial community do not have this impression, since they are not happy with some Treasury actions and some provisions of the Dodd-Frank legislation.)    

There is also another possible issue with MERS, though I should note that I have not researched this. There may be questions regarding whether the requirements of tax law facilitating the creation of various types of asset backed securities have been met with mortgage loans where the mortgage is recorded in MERS and not in local offices.  

It is hard to imagine that when MERS was set up that at least some lawyers involved did not recognize that there were some troublesome legal issues. There were probably told, at least implicitly, to keep their reservations to themselves by hard charging business people wanting to set this up because of the efficiencies and lower costs MERS would provide. Now the financial institutions may be betting on the courts not wanting to upset a system this significant to the financial community. There are, however, a lot of local courts and federal bankruptcy courts to convince of this.

Also, it is not clear how much the federal government can do about this if court decisions regarding MERS appear to harm financial institutions. It would seem that laws regarding real property are the province of state and local governments, not the federal government.

For those interested in this subject, another good article can be found in Bloomberg Businessweek, “Mortgage Mess: Shredding the Dream.”