Two States Ask if Paperwork in Mortgage Bundling Was Complete
Published: June 12, 2011
Opening a new line of inquiry into the problems that have beset the mortgage loan process, two state attorneys general are investigating Wall Street’s bundling of these loans into securities to determine whether they were properly documented and valid.
James Leynse for The New York Times
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The investigation is being led by Eric T. Schneiderman, the attorney general of New York, who has teamed with Joseph R. Biden III, his counterpart from Delaware. Their effort centers on the back end of the mortgage assembly lines — where big banks serve as trustees overseeing the securities for investors — according to two people briefed on the inquiry but who were not authorized to speak publicly about it.
The attorneys general have requested information fromBank of New York Mellon and Deutsche Bank, the two largest firms acting as trustees. Trustee banks have not been a focus of other investigations because they are administrators of the securities and did not originate the loans or service them. But as administrators they were required to ensure that the documentation was proper and complete.
Both attorneys general are investigating other practices that fueled the mortgage boom and subsequent bust. The latest inquiry represents another avenue of scrutiny of the inner workings of Wall Street’s mortgage securitization machine, which transformed individual home loans into bundles of loans that were then sold to investors.
It follows months of sharp criticism of the mortgage foreclosure process, which produced an uproar last year over shoddy paperwork and possible forgeries of legal documents by banks, other lenders or their representatives.
The slipshod practices in foreclosures led to further questions about whether all the necessary documents were delivered to the trusts and properly administered by them.
Some of the nation’s biggest mortgage servicers are currently in negotiations with a group of state attorneys general to settle an investigation into foreclosure abuses. The new inquiry by New York and Delaware indicates the big banks’ troubles may not end even if a settlement is reached in the foreclosure matter.
The stakes are potentially high. If the trustees did not follow the rules set out in the prospectus, they may be liable for breaching their duties to investors who bought the securities. That could expose the banks to costly civil litigation.
Spokesmen from Bank of New York and Deutsche Bank declined to comment about the investigation, as did representatives from the offices of both attorneys general.
A complex process that produced hundreds of billions of dollars in securities during the lending boom, the issuance of mortgage securities began with home loans, which were then bundled into investments and sold to pension funds, mutual funds, big banks and other investors. The bundles were created as trusts overseen by institutions such as Bank of New York and Deutsche Bank; they were supposed to make sure the complete mortgage files for each loan were delivered within a specified time and with the proper documentation.
After the securities were sold, the trustees disbursed interest and principal payments to investors over the life of the trusts.
The trusts were governed by the laws of the states in which they were set up. Roughly 80 percent of the trusts are governed by New York law with the rest by Delaware law.
The rules governing the securitization process are labyrinthine, and there are steps required if the investment is to comply with tax laws and promises made by the issuer in its offering document. If the trusts did not comply with tax laws, for example, the beneficial treatment given to investors could be rescinded, causing taxes to be levied on the transactions.
The terms of these mortgage deals varied, but many of them required that the trustee examine each of the loan files as soon as they came in from the Wall Street firm or bank issuing the security. For a file to be complete, it would typically have to include all of the information necessary to establish a chain of ownership through the various steps of the bundling process, as when the originator transferred it to the issuer of the security who then moved it to the trustee.
Complete loan files were supposed to be delivered to the trusts within 90 days in most cases. If the trustee found any missing or defective documents, it was supposed to notify the loan originator so that it could either cure the deficiency or replace the loan. Such substitutions are typically allowed only in the early years of the trust.
This is why homeowners in most cases can in good faith take the aggressive stance that none of the parties seeking to take their home have any valid claim of ownership. Such parties' monetary claims may be enforceable in "equity," but that is not the same as being enforceable by way of foreclosure.