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Grayson: Banks Caught Up in Mortgage Mess Had Better Hold Lots of Capital

It’s a testament to the measure of Alan Grayson that, on the day before he end see the untimely end of his Congressional career, he was still fighting for his constituents on the foreclosure crisis. Specifically, he penned a letter to the Financial Stability Oversight Council, which includes Timothy Geithner, saying that the recent reports of indemnification of the title insurance industry by the big banks in individual deals should trigger an increase in capital requirements for those banks, because their risk has increased. This is just common sense. If banks are taking on all the risk associated with blighted titles and improper standing to foreclose, and all the costs that may imply down the road, the systemic risk council which is designed to monitor the overall financial system should force them to carry some shock absorbers, in case this is as bad as feared.

And there’s reason to believe it is that bad. In Virginia, a Republican member of the House of Delegates wants an investigation of MERS, the Virginia company which created a database for easier securitizations of mortgages.

Robert G. Marshall, a Republican member of the Virginia House of Delegates, requested that Virginia Attorney General Ken Cuccinelli determine whether the Reston, Va., company violates state law because it doesn’t pay a fee every time a loan changes hands. Opinions differ as to whether MERS must pay local fees every time it sells an interest in a loan.

“There are too many people getting foreclosed on not properly,” said Mr. Marshall, who represents two counties near Washington, adding that he is drafting a Virginia law that would require lenders to pay county fees before being allowed to proceed with foreclosures. “The disdain with which the conditions of law have been treated by those who want to make money too fast is very troubling to me.” […]

The challenge is the latest sign lawmakers and lawyers for borrowers are taking aim at MERS as the foreclosure mess drags on. Created 13 years ago by Fannie Mae, Freddie Mac and several large U.S. banks as an electronic registry of land records, the company’s name is listed as the agent for mortgage lenders on documents for 65 million home loans. But that same streamlining has made MERS a target of critics who say the company might not have the legal right that it claims to foreclose on borrowers.

In a state-court lawsuit filed in Georgia last week seeking class-action status, lawyer David Ates says MERS isn’t a secured creditor, meaning it lacks the power to foreclose on behalf of lenders, mortgage servicers or other parties.

Mr. Ates said he is seeking to have all Georgia foreclosures by the company “be declared invalid and the title be returned to the debtor.”

There’s just no full consensus on this. If every locality across the country rules as the Attorney General for the District of Columbia, Peter Nickles, did last week, and say that no homeowner can be evicted “unless the security interest of the note holder has been physically recorded with the district’s Recorder of Deeds, a condition that electronic assignments through MERS don’t meet,” then virtually every mortgage that has been securitized in America would not meet the requirements that allow a foreclosure. This includes about 60 million homes.

I would say that’s a serious issue, and one that would require enormous capital requirements for banks that would get squeezed by it. At the very least, you’d think the Financial Stability Oversight Council would want to protect against instances of financial instability. And the MERS mess, and the overall mortgage mess, represents some serious potential instability. So this is the right move by Grayson. I hope it’s not the last.

The full letter on the flip.

Dear Secretary Geithner and members of the Financial Stability Oversight Council,

I’m writing concerning the foreclosure fraud crisis and the resulting potential need for a special capital buffer for large systemically significant institutions. I’m particularly worried about the title insurance market, and attempts to lay off title liability onto large banks without corresponding changes in capital requirements.

Recently, Bank of America struck a deal with Fidelity National Title Insurance to indemnify the title insurer should legal problems with foreclosures create unanticipated title liability. Title insurers are clearly worried that they may face higher legal and policy costs if foreclosures are reversed, or should legal ambiguity cloud titles they already have insured. Bank of America’s deal with Fidelity may be necessary to help keep the housing market functioning. Since title insurers have in some cases just refused to insure this market, someone must pay for the liability these insurers have refused to incur.

The extent of this liability is unclear. On October 8, Bank of America CEO Brian Moynihan told the public and investors that, despite the self-imposed foreclosure moratorium, his bank had not “found any foreclosure problems”. He said, explaining the foreclosure moratorium, that “[w]hat we’re trying to do is clear the air and say we’ll go back and check our work one more time.” The bank’s SEC Form 8-K reinforced these comments. Yet two weeks later, the Wall Street Journal just reported that Bank of America, in reviewing 102,000 cases of problematic foreclosures, found problems “in 10 to 25 out of the first several hundred foreclosures it examined.”

Both banks and regulators are claiming that the problems are simply process-oriented document errors that aren’t really causing harm to the public at large. I suspect that no one really knows the extent of the problem, or the potential liability. What we do know is that title insurers are demanding indemnification.

With that in mind, it would seem prudent to require additional capital buffers for systemically significant institutions until the extent of the foreclosure fraud crisis is understood, or until title insurers decide that they no longer need indemnification for increased risk. It may also be useful to conduct a new round of stress tests to determine the resilience of the financial system with respect to these serious problems.

Regards,

Alan Grayson
Member of Congress

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