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Foreclosure Fix: Why a Massachusetts Court Decision Could Rock Banks

Banks that foreclose on a home must first prove they own the mortgage. So affirmed the top Massachusetts court today in ruling against U.S. Bancorp (USB) and Wells Fargo (WFC) in a decision could boost homeowners fighting foreclosure and end up costing banks billions.

One financial expert told Bloomberg the ruling could "open the floodgates" to similar suits in the state and bolster cases around the nation. Financial pundit Barry Ritholtz also called the ruling a victory for the rule of law and property rights, noting in a related post discussing the case:

This is more than a technical issue; at risk is whether we, as a nation, are going to allow corporate entities to violate existing law, or even worse, attempt to create their own, extra-legal, non democratic policies.
Certainly investors seem worried. U.S. Bancorp and Wells shares immediately dipped on the news, with broader bank stocks also tumbling. It's no secret why. As the "robo-signing" furor has shown, banks for years have flouted legal requirements to document their right to seize homes. Foreclosure affidavits were rubber-stamped or even faked. Local laws regarding property transfers were ignored. Financial firms eager to mince mortgages up into securities violated rules intended to establish a clear chain of title in foreclosure cases.

The result? Rampant violations of housing law, including people wrongly getting kicked out of their homes. Systematic fraud, and the lawsuits that inevitably follow. State and federal investigations. And fear among bank shareholders waiting for the other shoe to drop. And well it should, because at bottom the U.S Bancorp-Wells case is about a bedrock legal principle that applies to real estate nationwide: Only the mortgage owner has the right to foreclose.

In essence, banks contend that what matters most in foreclosure is that the process be efficient. If mortgages aren't legally assigned to a given owner, the thinking goes, such details can be filled in later. Today's decision rejects that defense. The court is telling bankers that they must respect state real-estate law, whatever the business challenges of securitizing loans.

Some background:

The Massachusetts cases started in 2005 when Rose Mortgage Inc. lent Antonio Ibanez $103,500 and Option One Mortgage Corp. lent Mark and Tammy LaRace $129,000, according to the banks' brief to the high court. Ibanez and the LaRaces stopped paying on their adjustable-rate subprime mortgage loans and were foreclosed on in 2007.

By that time, U.S. Bancorp and Wells Fargo & Co. said they controlled the loans, which had been subsumed in mortgage-backed trusts. The banks bought the homes in foreclosure auctions in July 2007.

A lower-court judge in Massachusetts rescinded the foreclosures in March 2009. He ruled that the mortgages had been transferred to the two banks long after the houses were sold. In other words, neither U.S. Bancorp nor Wells owned the properties.

In appealing the decision, the banks argued that because they held the promissory note securing a mortgage, that proved ownership of the loan. Supreme Judicial Court Justice Ralph Gants rejected that notion. He wrote in his opinion:

In Massachusetts, where a note has been assigned but there is no written assignment of the mortgage underlying the note, the assignment of the note does not carry with it the assignment of the mortgage.
A fellow justice on the court added his two cents about U.S. Bancorp's and Wells's foreclosure practices. And while it applies only to this case, it's likely to be chilling for banks across the country:
I concur fully in the opinion of the court, and write separately only to underscore that what is surprising about these cases is not the statement of principles articulated by the court regarding title law and the law of foreclosure in Massachusetts, but rather the utter carelessness with which the plaintiff banks documented the titles to their assets.
Carelessness is certainly one word for it.

Thumbnail from Wikimedia Commons, CC 2.0
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