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Monday, October 18, 2010

"For What its Worth - In Print...

As the current mortgage crisis unfolds its very interesting to see the friction between modern electronic technology and our old friend print burn up the country.

"Print?"  you say.  What does print have to do with the new mortgage crisis?

A lot.

At least here in the northeastern US much of real estate is bound up in paper - paper with printing.  Physical mortgage documents, deeds, tax liens, all of these are legally required to be documented on paper.  There must be a physical mortgage document - signed (these days in blue ink), sealed with whatever mechanical seals the state requires, and delivered to the proper county offices.

I would be willing to bet that in my state there are still counties that have written ledgers - yes, big smelly old books in the courthouse basement with ink-ruled lines where scribes wrote down - with ink pens - information about deeds, liens, mortgages, and so on. 

No matter how its recorded if recording of a mortgage is not done or not done correctly there is a legal argument to be made that the mortgage isn't valid.  If its not valid it means that the bank or company holding the mortgage does not have "standing".

Standing means that if you default, i.e., not pay, your mortgage, the mortgage holder can foreclose on the property and take it back.

So in the real world this means that when someone takes you to court over a foreclosure the plaintiff (bank or mortgage holders) must produce these documents and show that they are true and correct.  You can't just show up and say "your honor, Mr. X has not paid his mortgage I want the property back" - you have to prove it.  If you cannot produce the mortgage that says you, the plaintiff, are the mortgage holder what will the judge do?  If the mortgagee produces documentation that says you sold the mortgage to Joe's Dinner then you will lose - you do not have standing with regard to the mortgage.

Prrinted paperwork provides a detailed trail of the entire mortgage process - who owns what, when and how they bought it, how much was paid, and so on.  As long as every i is dotted and t crossed - no problem.  That's why counties record all of this on paper: There is no question.

For hundreds of years this has been how everything worked - until about thirty or so years ago when banks and financial institutions realized that a mortgage had intrinsic value in and of itself.

So what do I mean by that?

Well, if you buy my property and I hold the mortgage, i.e., you agree to pay me some amount, say $142.86 a month, for say, 14 years, the actual paper mortgage is worth 12 x $142.86 x 14 = $24,000.00 (excluding interest and other details for the sake of example here).

Me as the mortgage holder will get me $24,000 over the next fourteen years - but what if, as the commercial on TV says, I need my money now?  Grandma gets sick, I want to go to college, etc.?

Well, I might sell the mortgage to someone who has $10,000 cash today.  That person will collect the $24,000 over twenty years less the $10,000 they paid me - or $14,000.

(This is just an example.  The point here is the type of transaction - not the specific details as we will see.)

While the buyer of the mortgage could simply pay me and walk away with his payment stream he probably won't.  The reason is what if the payer defaults, i.e., stops paying?  If the person buying the mortgage has no standing as the mortgage holder and just a contract that says they bought the mortgage from the person who sold it to him, then it may be very hard to get their money during a default.

(Joe sells Suzy a mortgage taken out by Ruby.  Ruby stops paying.  Suzy has no standing. Joe does.  So to collect in a default Joe must do it.  But Joe now hates Suzy because the has a new...  you get the idea.)

So in the ancient world of pre-1980 the transfer of the mortgage from person A to B (or from a bank to a pool of investments) requires that the proper legal paper work be filed changing the mortgage holder.

(As in our example Suzy becomes the legal mortgage holder when she buys the mortgage from Joe.  If Ruby defaults Suzy has standing and Joe is out of the picture.)

Thirty years ago financial wizards began "pooling" mortgages together into investments.  This is all very complicated but the bottom line is that investors and not banks could "own" mortgages without having to handle the details of directly buying one.

These pools of mortgages caused the 2008 financial melt down - not because of paper work, though.  In 2008 the issue was no one knew which mortgages weere in a particular pool sold to investors (specifically there was missing information about which pools might have bad mortgages) and no one knew if the insurance they took out on these mortgages pools from AIG among many was sufficient if there were too many defaults.  One could anticipate this new problem from all this, though, because if you don't know exactly which mortgages are in a pool its likely that paperwork to put them there is missing.

The problem now is that the proper legal paperwork to transfer ownership of the mortgage into the various pools of investment may not have been properly completed.   So the investors or new owners may not actually have ownership in the mortgages.

So if an investor shows up to foreclose they must have standing.  If not, the court may throw them out, and the property holder will continue to keep the property without payment.

So back to print.

All of this is not a problem in a world where transfers and deed are physical, printed documents filed away in a folder in an office and held by the original owner.  Like an old Jimmy Stewart movie the old Savings and Loan in town holds your mortgage and its written down in the dusty binder in the basement of the local courthouse.

This problem is mortgages were sold to investors in pools with the claim that the seller had the right to do so.  The question is was the proper paperwork filed legal to make it so.

Paper documents make it difficult to bypass required legal steps.  You cannot, for example, go to the county court house with a laptop and an email and "claim" you own something.  They, and the legal system, will not recognize it.  (Little old ladies won't write this down in the big binder in the basement.)

Unfortunately, it may have been the case that some of the investment mortgage pools did not have the underlying mortgage ownership properly documented.  So what was sold to investors as a pool of mortgages may not actually have ownership in the mortgages.

(Don't worry - someone still owns the mortgage - things just have to be sorted out.)

Physical possession of something like a mortgage with the proper corresponding chain of ownership is what's required for the legal system to work.  Electronic documents, IDs, and amorphous investment pools are very difficult to convert to underlying documents.

Print plays a vital role in moderating this system - it makes tracing ownership clear.  Without it out get this kind of crisis because people play fast and loose with the rules - its the modern age and print is passe.

And its not just mortgages.  Its car titles, RV titles, and all the rest.

Personally I experienced a bit of this a few years ago when I switched to a new mortgage company.  Many years previously a second mortgage with, no surprise here, CountryWide, had been paid off but the note in the county office was not satisfied.  (CountryWide did not send a minion to the county where my second mortgage was recorded and record the payoff.)  Nice, huh?
This threw a monkey wrench into things for a week or two while it got sorted out.

The legal system likes paper and printing.  Judges, lawyers, home owners, car owners, and so on like to know that they own something by having a piece of paper.  No hacker can wiggle their way into your house and steal your car title.

Print and paper offer a very specific kind of security that electronic IDs and databases cannot.

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