The Other School of Economics

Foreclosuregate: Antonio ‘Homer’ Ibanez brings the US banks one step closer to insolvency

The name of Antonio Ibanez of the city of Springfield, Massachusetts might not be familiar, but what he is about to do the US banking industry could have been written by the script-writers of The Simpsons series.

Unless the banks pull a magic trick or get help from some form of divine intervention, the scenario they are about to face is simply one of the biggest financial scandals of modern history. CNBC’s Larry Kudlow called it the Foreclosuregate, others dubbed it the “Robo-Signers scandal”. The Maddoff case will look like shoplifting in comparison.

The short story is that Antonio Ibanez recently won a court case against the banks that repossessed the house he lost during the financial crisis. (1) The reason this case is likely to set a precedent for millions of wannabee Homer Simpsons is that it revealed profound flaws and fraudulent practices in the way the entire banking industry has been handling millions of mortgages across the US. If all the disgruntled bankrupt homeowners sue and win, the impact could be well in excess of the $700Bn we’ve seen for TARP.

So what happened?

The story begins like an American suburban dream: “On December 1, 2005, Antonio Ibanez took out a $103,500 loan for the purchase of property at 20 Crosby Street in Springfield.”

According to the court case:

The mortgage was originated with Rose Mortgage Inc., which assigned it to Option One Mortgage Corporation (the record holder). They in turn assigned it to Lehman Brothers, who assigned it to Lehman Brothers Holdings Inc., which packaged it with about 1,000 other mortgages and sold them as a security.

These mortgages were then placed with Structured Asset Securities Corporation which became the depositor and was set up explicitly for the purpose of protecting the bondholders who bought the securities. This company then assigned the mortgages to US Bancorp N.A., which became a trustee.

When the media tried to explain to the general public how the GFC happened we read copious articles detailing how banks had created ‘synthetic products’, ‘mezzanines vehicles’, and ‘packaged securities’. What was not always clear in the heat of the crisis was how this could ‘physically’ happen. The Ibanez case illustrates it in a frightfully practical manner: their mortgage – i.e. the right to repossess and sell the house – was passed around and resold like in a chain reaction. Whoever was at the end of the chain got the right to foreclose if Ibanez could not repay.

However, what the Ibanez case also reveals is that when those banks were busy reselling millions of mortgages between themselves, they neglected the paper work. This might turn out to be their Achilles Heel. Indeed the US law is understandably very strict when it comes to real estate title transfers and personal bankruptcy. It requires due process to be followed scrupulously in order to protect the parties.

Instead the banks sold mortgages to other banks without bothering to transfer to the buyer a proper document of assignment evidencing the sale. Mortgages were bundled up into trusts to be sold as securities to investors, but the trusts were never given proper legal evidence of the assignment of the mortgages. Then, even worse, when the housing market blew up and banks pursued millions of foreclosures, they created the assignments after the fact. They used legal firms to sign and certify legal documents. Employees who mass processed millions of files spending no more than a few minutes on each case became “robo-signers”. In one case the ‘official’ signer had been dead for over five years. Millions of falsified notarizations and other frauds made their way to the courts.

The consequence for the banks is so mind-blowing, you might read the following lines with serious incredulity…

The first consequence is a potential burst of legal actions against the banks, which will face significant penalties.
For instance “In Ohio, penalties include fines of up to $25,000 per violation, with each false affidavit or document considered a violation, according to state law enforcement officials. In Iowa, fines rise to a maximum of $40,000 for each violation.” (2)

But that is not all. The second consequence is that banks might not be able to get their money back for those mortgages that have defaulted.

This is the real financial Armageddon. The right of the banks to foreclose on residential property is now being contested in every state. This means that for the last 10 years the US banks have been selling their main product – the residential home mortgage – with a fatal flaw that renders it uncollateralized. In other words, the very concept of the mortgage has been nullified.

It is important to remember that it is because of the ‘security’ provided by the ability to repossess the house to get its money back that the bank consents to a lower interest rate (typically between 5% to 10%). It is what makes this type of loan different from an ‘unsecured’ credit card (usually closer to 20%).

There are no two ways to spell this problem: not being able to get their money back in a mortgage market of $6 trillions and 55 million borrowers will send the US banks straight into insolvency.

Survivor’s tribal council US Supreme Court

How will they get out this mess?

Only a magic trick and some serious lobbying can save the banks from this crash. They would need the law to be changed to have all potential legal actions dropped. The trouble is that ex post facto laws are strictly forbidden by the US Constitution.

Will the US Supreme Court or Obama intervene and impose a measure of exception on financial grounds against the spirit of the constitution? Will this looming crisis provide another example of the consequences of moral hazard that is deeply engrained in the way financial markets work?

The way things will unfold in the next months will tell us a lot on what the US government has learnt from the crisis of the past 3 years and whether it seriously intends to change its attitude and governance towards the finance industry.

{ NKN & leLaissezFaire }

References:

(1) US Bank National Association (as trustee) vs. Antonio Ibanez

(2) http://www.bloomberg.com/news/2010-10-06/jpmorgan-bank-of-america-face-hydra-of-state-foreclosure-investigations.html

OneWest Bank employee: ‘Not more than 30 seconds’ to sign each foreclosure document: http://voices.washingtonpost.com/political-economy/2010/09/onewest_bank_employee_not_more.html

‘Robo-signers’ add to foreclosure fraud mess: In testimony ‘experts’ admit they rushed paperwork, didn’t know law:
http://www.msnbc.msn.com/id/39641329/ns/business-real_estate/

U.S. BANK NATIONAL ASSOCIATION, trustee, vs. Antonio IBANEZ (and a consolidated case): http://www.universalhub.com/2011/us-bank-national-association-trustee-vs-antonio-ib