Bank Holiday is Best Solution for Epidemic of Mortgage Fraud

by L. Randall Wray, Professor of Economics at the University of Missouri-Kansas City, Research Director with the Center for Full Employment and Price Stability and Senior Research Scholar at The Levy Economics Institute.

We have long known that lender fraud was rampant during the real estate boom. The FBI began warning of an “epidemic” of mortgage fraud as early as 2004. We know that mortgage originators invented “low doc” and “no doc” loans, encouraged borrowers to take out “liar loans”, and promoted “NINJA loans” (no income, no job, no assets, no problem!). All of these schemes were fraudulent from the get-go. Property appraisers were involved, paid to overvalue real estate. That is fraud. The securitizers packaged trash into bundles that ratings agencies blessed with the triple A seal of approval. By their own admission, raters worked with securitizers to provide the rating desired, never looking at the loan tapes to see what they were rating. Fraud. Venerable investment banks like Goldman Sachs packaged the trashiest securities into collateralized debt obligations at the behest of hedge fund managers–who were allowed to choose the most toxic of the toxic waste—then sold the CDOs on to their own customers and allowed the hedge funds to bet against them. More fraud.

Indeed, the largest financial institutions were run by their management as what my colleague Bill Black calls “control frauds”. That is, the banks used accounting fraud to manufacture fake profits so that they could pay huge bonuses to top management. The latest data out on Wall Street bonuses show that these institutions are still run as control frauds, with another record year of bonuses paid by cooking the books. The fraud continues unabated.

This is the biggest scandal in human history. Indeed, all previous scandals from around the globe combined cannot even touch this one in terms of scale and scope and stench. This is the mother of all frauds and it will be etched into the history books for all time.

Many have called for a national moratorium on foreclosures. Even some of the banks that have been run as control frauds have voluntarily stopped foreclosing. And yet President Obama, ever the centrist, has taken sides with the Securities Industry and Financial Markets Association, which warns that “it would be catastrophic to impose a system-wide moratorium on all foreclosures and such actions could do damage to the housing market and the economy”.

No, it would expose the securities industry, itself, as the chief architect of the biggest scandal in human history.

Now we know that it was not just the mortgage brokers, and the appraisers, and the ratings agencies, and the accountants, and the investment banks that were behind the fraud. It was the securitization process itself that was fraudulent. Indeed, the securities themselves are fraudulent. Many, perhaps most, maybe all of them.

Some are trying to argue that this is just a matter of some missing paperwork. A moratorium would allow the banks to get all their ducks in a row so that they can supply all the documents needed to foreclose.

However, as reported by Ellen Brown (at Web of Debt) and by Yves Smith (at Naked Capitalism), the paperwork does not exist. Worse, as Yves has discovered, the banks are furiously working to manufacture documents, aided and abetted by companies like DocX that specialize in “document recovery solutions”—for a fee they will create fraudulent documents that banks can use in court.

The banks would like us to believe that in the speculative frenzy of the real estate boom they “forgot” to do some of the required paperwork. That is not likely. The absence of the documents was required to run the scam.

Recall that the banks invented “no doc” mortgages. This was not at the behest of no-account borrowers, high school dropouts with bad credit histories who were duping investment bankers into making mortgage loans they could not repay. No, these mortgages were created and endorsed by originators and securitizers and credit raters to create a patina of “plausible deniability” to be used later in court when they were sued for fraud by investors who bought the securities and by the borrowers who could not possibly service the mortgages. Because if the originators had ever requested the documentation from borrowers it would have demonstrated that the mortgages and the securities were frauds.

Similarly, the paperwork required for the securities was never done because the securities were fraudulent. Yves helps to explains why. The trust that purportedly underlies a mortgage backed security must hold the “note”—the borrower’s IOU (in 45 US states the mortgage that is a lien on the property is an “accessory” to the note, and is not sufficient to do a foreclosure). If the note is not conveyed to the trustee (usually before closing but sometimes up to 90 days after signing) the securities are no good.

This is not just some pesky little rule imposed by a pin-headed regulator. This is IRS code. As reported by Brown, MBSs are typically pooled through a Real Estate Mortgage Investment Conduit (REMIC) that must according to the Internal Revenue Code hold all the paperwork demonstrating a complete chain of title. Done properly, taxes are avoided. Since a number of intermediaries are usually involved from the mortgage originator through to the trustee of the REMIC, there must be endorsements all along the line. However, it now appears that most of the original notes are still held in the loan originator warehouses. There are no endorsements. The trustees do not have the notes. Can anyone say “tax fraud”?

So why weren’t the notes conveyed to the REMICs? There seem to be two possibilities—probably both of them correct. Karl Denninger at MarketTicker believes it was because the REMIC trustees feared an audit by investors in the securities. If the documentation existed, it would show that the mortgage loans were fraudulent. Far better to “lose” the docs, then later manufacture new ones for the foreclosure.

According to Brown (quoting Steve Liesman and Neil Garfield), the other possibility is that the tranching process actually prohibited assignment of the notes to the REMICs. Bundles of mortgages of varying quality would be tranched into a variety of securities, say from AAA to BBB. But no individual mortgage is actually assigned to a particular tranche—until it defaults. When one defaults, it is assigned to a lower tranche security and then the foreclosure process begins. This means that from inception of that BBB security, there was no way to assign a note to the trustee because the trustee did not know in advance which mortgage would default. The REMIC trustees tried to get around that by using a dummy conduit called MERS (Mortgage Electronic Registration System) that would “hold” the mortgages and assign them to the proper tranches later. But they do not have the paperwork either, and some courts have rejected their claims as owners.

This is a complete mess. What President Obama must understand is that fraud is endemic at every level of the home finance food chain. We were long told that securitized mortgages cannot be modified because of the complexity involved—modification of most mortgages would require consent of the holders of the securities that each have a piece of the mortgage. But actually it is impossible to tell how many—if any—of these securities holders have a legitimate claim on any of the mortgages. Simply imposing a moratorium will not be enough—it will just give the banks time to manufacture false documents, encouraging even more fraud. Meanwhile, half of all homeowners with mortgages are already underwater or are within spitting distance of being underwater. Many of these are drowning because the epidemic of fraud perpetrated by financial institutions destroyed our economy and caused housing prices to collapse.

The President needs to try a different approach, consisting of the following series of steps:

  1. Declare a national bank holiday that would close the biggest financial institutions—say, the top dozen or so. Send in the supervisors to examine their books to uncover fraud. Determine which ones are insolvent and resolve them. While resolving them, net their claims on one another (including derivatives). Do not allow any insolvent institutions to reopen, and do not use the resolution process to merge institutions (we don’t need even bigger “too big to fail” banks). Prosecute the crooks and jail the guilty.
  2. Stop all foreclosures. Investigate and prosecute all institutions that have been selling or buying fake documents to be used in foreclosures. Prosecute the crooks and jail the guilty.
  3. Announce that all homeowners who occupied their homes on October 1, 2010 will be allowed to remain in their homes indefinitely. Create a national mediation board to adjust all mortgage payments to “owner’s equivalent rent”—the fair value of rent for the home. Establish a fund to provide rental assistance to keep low income homeowners in their homes.
  4. Give purported mortgage holders 30 days to produce the original notes; if they cannot find them, hand the homes over to the owner-occupants—free and clear of debt.
  5. Create a process to allow securities holders to sue for recovery of value. This must be national—state courts will not be able to handle the case load.
  6. Direct the GSEs to refinance mortgages at a low fixed rate. Mortgages would be provided against real estate appraised at fair market value to any borrower for a primary residence. The GSEs would pay holders of existing mortgages only current fair market value. Those holding these mortgages can seek redress through the process outlined in step 5. Only in the case of borrower fraud would the homeowner be held responsible for losses attributed to the refinancing.
  7. There will be fall-out from losses. It is better to deal with the collateral damage directly than to prop up the control fraud banks. For example, pension funds hold toxic waste securities as well as equities in the control fraud banks, and by all reasonable accounting the Pension Benefit Guarantee Corporation is already insolvent. But it is better to directly bail-out pensions than to maintain the charade that fraudulently created securities have value.

Bill Black likes to joke that economists are afraid to use the “F” word (fraud). The President must come to realize that there is no other word that can be applied to the US home finance system. Until we deal with the fraud we will never resolve this financial crisis.

(Go to for Yves Smith, “4ClosureFraud posts lender processing services mortgage document fabrication sheet”, October 3, 2010; and to for Ellen Brown, “Foreclosuregate and Obama’s ‘pocket veto’”, October 7, 2010.)

Professor Wray also blogs at New Economic Perspectives, and at New Deal 2.0.

  1. ESM says

    Disappointing to see Randall Wray write such a hyperbolic and ill-informed screed. The title documentation issues that are in the headlines today have nothing to do with the fraud committed at the loan origination level. And the idea that a mortgage loan is assigned to a particular tranche of a securitization (either before or after it defaults) is so stupid that it’s obvious Wray has no clue how mortgage backed securities work. The mortgage loans are owned by the trust backing the deal, and tranche owners own interests in that trust which entitle them to get paid according to various formulas. No tranche owner owns a mortgage loan directly.

    1. Eja28451 says

      If mortgage notes and titles were not legally transferred to the trust then the trust cannot legally prove ownership of the loan. The the loan originators failed to legally transfer the titles and notes and the trust failed to do due diligence to make sure the title and notes were legally transferred. The trust then sold securities for which they knew they had no legal proof of ownership. Fraud up and down the line.

      1. Edward Harrison says

        100%. There are multiple points within the MBS chain at which the transfer of ownership can be questioned because of fraud. In my view, this is less about the home owner and more about the problematic legal structures in MBS mortgages and fraud. This is the line government should pursue – at the state level and using criminal charges where appropriate.

        Moreover, it is clear that robo-signers were acting at the behest of their firms. The states should grant them immunity and have them reveal everything they know. Only when we have a complete accounting, can we move forward.

        As far as the home owner goes, to the degree they believe they should not be foreclosed – and should be given a loan modification, they should contest and judges should grant these cases a hearing, specifically requiring the foreclosing party to produce documentary evidence. That is the only way to clear this out.

        See what Josh Rosner says about this here:

        1. Urban Sprouts says

          Keep up the great work, Edward. This is the best solutions-driven examination of this fraud morass I have seen yet. Can we send you to Washington?

        2. L Randall Wray says

          Edward thanks to the link to Rosner. Excellent.
          I see some of your readers have a very strong will to believe…that Wall Street’s business model is NOT based on screwing all customers. I wonder how many years of revelations will it take to shake that believe?
          As to the argument that closing the top dozen banks is foolhardy:
          1. it is the law. if insolvent they must be resolved
          2. they serve no visible public purpose; have not done so for decades
          3. they continue to party like it is 1999, digging the hole bigger every day
          4. they have completely corrupted Washington
          5. there is no hope for capitalism that is nothing but a kleptocracy that would make the Russian mafia simultaenously blush and envious

          And keeping Americans in their homes is somehow unpatriotic? Give me a break. Why should rapacious Wall St, which has already put 2.5 million out of their homes and 10 million out of their jobs, and literally hundreds of millions of people around the world into starvation get to collect the houses?

    2. AndyB says

      The Rule of Law on the state and local levels requires an original note. The banks cannot produce this note; according to testimony in various courts (under oath), many of these notes were, on purpose, destroyed. Prof Wray is correct; you are either a bank troll or delusional.

    3. emptyfull says

      umm… but isn’t his point that the trusts don’t have the NOTES? Which means they don’t have the right to foreclose? And that the basic contractual language of the securities were thus violated? If so, his basic propositions about why this occurred seem plausible.

      As to his remedies? Maybe FDR would have listened, but certainly not Obama. Obama seems to want to find an easy, technocratic solution to everything that keeps “the system” working basically as-is, with the same folks in charge, and no heads rolling. After all, the system is dominated by smart, ambitious “savvy businessmen” who earned their way to the top, a lot like him. They couldn’t really be the bad guys, could they?

      1. ESM says

        Wray, citing other people, claimed that the title transfer issues to the MBS trusts were intentional. That somehow things wouldn’t work right, or some fraud could not be perpetrated, if title was actually transferred properly. This is pure tinfoil hattery. There was lots of fraud in the origination process, but this has nothing to do with the issues in the news today.

        And, no, it’s not that the documents were lost. It’s that it is expensive to retrieve the original documents and get them properly signed before filing a foreclosure action. Banks and servicers and their agents cut corners in this process — either by filling in the paperwork after the foreclosure action was already filed, or by getting an affidavit signed by a loan officer who swore that he had inspected the electronic records and confirmed the material facts about the loan even though he hadn’t. The cutting of corners like this is a serious scandal, but the motivation for it was to save money and time in the foreclosure process, not to cover up the fact that the loans weren’t owned by the forecloser, or that the loans were fraudulent from the start.

        There are also some wild claims that electronic transfer of mortgage loan ownership is not legal or valid in many or all states. This is wrong. At the end of the day, though, “i”s have to be dotted and “t”s crossed in order to foreclose, and that has not been happening in many, many cases.

    4. LRWray says

      Ok, so ESM has aligned herself/himself with mortgage fraud. Manufacturing docs for court? OK, fine. NINJAs and no docs, packaged and sold to investors, claiming they met all requirements? OK, fine. Lost the notes? Ok fine. Take houses away from homeowners who have never missed a payment? OK fine. Running your bank as a control fraud? OK fine.

      No fraud is too big. Dismiss it as a little paperwork problem? Ok fine. This is no longer a country of rules, laws, and sanctions. Just keep those bonuses flowing.

  2. Callahan says

    A state such as New York (see 97-385 at link) that piggybacks a REMIC exemption from state taxes by use of the IRS definition could file its own claim for back taxes.

  3. Norma Minnis says

    Mortgage Originators did/do not invent loan programs. They never have. Only banks create loan programs.

  4. Bob says

    I am just baffled that these suggestions are taken seriously.

    While all of these points certainly sound nice, the professor is naive (at best) to suggest that we can just close the top dozen or so banks, have a few auditors go in and figure things out, and maintain a functioning banking system / economy. Does he seriously think this would be just a few days’ worth of work with a few auditors??

    Also, why the hell should any homeowner get the house free and clear, whether or not the original note is found??? Not to mention, should they pay taxes on what would clearly be a windfall, as no one disputes that they do, in fact, owe money on the houses? How exactly would that work? Again, why should someone, whether or not currently paying his mortgage, and whether or not we know exactly who owns the note, get this windfall?

    These solutions are just staggeringly not thought out, remedial, and absolutely ridiculous. I certainly hope this law professor holds his students to a much higher standard of argumentation than he shows here.

    1. Whammer says

      Bob, why do you say “no one disputes that they owe money on the houses”? The lenders can’t prove it, simple as that.

      Hey Bob, I have a mortgage on your house. I misplaced the paperwork. You did borrow money on your house, right? So trust me.

    2. Synoia says

      What you said. After step one, nihilism and Anarchy rule. There will be no step two. With the banks close there will be no money to pay for any further steps.

      This process is just ridiculous. If this is what a learned professors can produce, I suspect its time to join the movement for removing tenure, and measuring the teaching profession.

  5. Tagthatstock says

    1 year mortgage holiday LAW plan-AND IT SHOULD BE NON-QUALIFYING
    it should be set up as a govt website where the HOMEOWNER goes in and fills in a form,, and there,, its a done deal,, the bank gets NO SAY in the matter.

    the KEY is for this to be a website,, and that the BANK gets NO say in the matter,, for too long the banks have screwed up lost the paperwork etc.. they have pushed people to the govt programs IF they qualified,,,,,,,,,,,,it shouldnt be that way,, if you are gonna be ‘granny dumped’ onto the govt program,, then you should not have to qualify for that program too.

    what i really like about the banks not having any say so is that we are going to see a natural market of the homeowners,,, those who choose to keep paying ,, those who simply needed some time.

    regardless of where anyone is in the status of their mortgage payments,, the clock dont start until the law is passed. so if you have been squatting for a year or so,, this IS your final chance,, either sign up for the holiday or get out of the house.

    some people may think im too liberal on that last line,, maybe,, but would you rather have that house go into foreclosure and into decay?–sometimes you have to look the other way if you want progress for the ‘whole’

    and the plan also PUTS the POWER OF DESIRE back into the PEOPLES hands by making the plan ‘a done deal’.

    yes there is opportunity for fraud,, simply send all cases to the DOJ since they seem to be able to prosecute and collect fines. (they have a great record of late of going after companies,, let them loose on the private sector fraudsters)

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