By Robert Brannum
The already-battered mortgage industry now faces a crisis that has been hidden in plain view for 14 years.
Mortgage Electronic Registration System (MERS), an electronic document recording service with all of 50 employees (at present), has managed to displace an entire segment of the nation’s local government, taking $2.4 billion away from county coffers by bypassing the typical $30 county recording fee. It’s being taken to court in 17 states, including New York state, not for depriving the counties of revenue, but for its de facto role in obscuring the line of provenance that establishes title to property.
MERS, corporately named Merscorp Inc. and based in Reston, Virginia, was established in 1997 by the nation’s largest mortgage companies and Fannie Mae and Freddie, at a time when the federal government was pushing expansion of homeownership. To date, according to a recent Associated Press report, it has registered 65 million loans, or 60 percent of all outstanding mortgages.
“Shut Up!” They Exclaimed
Public outcry has pushed 17 states to file lawsuits against MERS, which is listed as the mortgagee of record in legal notices, although it is neither lender nor loan servicer. Instead, it’s a repository of records, a digital warehouse, assigned “agent status” by the lenders.
Knowing the lender is a vital piece of information that establishes a clear property provenance and lineage of ownership. Or it did, until mortgages started being packaged into mortgage-backed securities (MBS) and sold in bundles to investors.
This obscured the lineage of ownership, but nobody cared, because the housing market could only go up, and homeowners were told that they could always refinance before their adjustable-rate mortgages reset. It worked for a few years. Then we found out how many borrowers hadn’t done the math. Their mortgage brokers had, but only to figure out which loan product yielded the highest commission.
As the number of foreclosures grew into tens of thousands, industry observers finally began to make a connection – MERS, and not the lender of record, was frequently the mortgagee in legal notices of mortgagee’s sale of real estate.
For that, the role of MERS has come – finally – under legal scrutiny. The suits argue two important points: that MERS does not have the authority to circumvent established county-based recordkeeping practices, nor does it possess the legal authority to act as an agent for the lender, and so therefore cannot start foreclosure actions.
County clerks’ early complaints about MERS lacked a collective voice. Their objections were dismissed by many in a position of governmental influence as another example of public sector turf-wars versus private sector ingenuity.
If MERS, in fact, does not have the legal ability to initiate foreclosure procedures, what do we make of the thousands of loans currently in the foreclosure process? Perhaps worse: what of the loans already foreclosed upon, with their related properties having changed hands? And does MERS owe those registration fees to the county offices they bypassed?
A recent article in The New York Times reported that industry lawyers had researched the MERS-proposition at its inception, and found no restrictions that would prevent it from operating on a national level. The issue, critics of MERS claim, is that real estate is regulated on a local-level, not on a national-level, and that each state carries its own jurisdiction. In November, Karmela Lejarde, a spokesperson for MERS, continued its claim that MERS is an acceptable substitute for the county-based registrations by telling the Associated Press, “These are local fees for service; if no service [by the county] is needed or requested, no fee is appropriate.”
The Gordian Knot That’s
Too Big to Untangle
Fixing the problem may actually be worse than the problem itself. Courts in different states (and different judges within those states) have rendered different opinions on MERS’s authority, further clouding the issues.
In January, a California appeals court ruled in favor of MERS, while a New York bankruptcy court ruled against MERS’s authority. Judge Robert E. Grossman, a federal bankruptcy judge for the Eastern District of New York, ruled that MERS may not serve as an agent for the lender, and therefore cannot itself pursue foreclosures. Realizing his ruling would likely contribute to the anxiety about how to untie the knot, Grossman responded to The New York Times, “This court does not accept the argument that because MERS may be involved with 50 percent of all residential mortgages in this country, that is reason enough for this court to turn a blind eye to the fact that this process does not comply with the law.”
The state, along with the rest of the country, is clearly in the early innings of what might be a drawn-out legal baseball game. What is known is that the uncertainty of MERS will cause increasing disruption in the mortgage market. As MERS tries to sidestep some of the recent issues with new operating procedures and a new CEO, the level of scrutiny continues to rise. Around the country, title companies have started canceling closings of bank-owned homes due to concerns around MERS’s authority to represent the lender and to provide clarity around provenance.
When will this growing issue be resolved, and by whom?
In New York, several organizations are beginning to immerse themselves in the quagmire. Richard Neiman, the state’s outgoing superintendent of banks, after saying the issue of MERS was “not on our priority list” offered that it was likely that regulators would have to get involved in final interpretations. He commented in April, “The issues that have been raised are real and will require guidance in light of diverse judicial opinions.”
The Federal Reserve Bank of New York is also weighing in. In a recent statement, the Federal Reserve said that the Uniform Law Commission and the American Law Institute, “have joined forces with various stakeholders, including the Federal Reserve Bank of New York, to deal with the legal complexity and the fact that much of the applicable law no longer adequately reflects modern financial practice and technological developments.” Said Thomas Baxter, general counsel at the New York Fed, “The New York Fed is committed to addressing these issues and will continue to work on identifying potential changes to the legal framework which will better serve the needs of those who are subject to it.”
Since the flush economic days of the Reagan era, the initiative to privatize formerly public services has taken root, but without a robust economy to support it, the egregious abuses of privatization have emerged, warts and all. In a new book, Beyond Privatopia, author Evan McKenzie revisits the evolution of private housing developments and their governance, about which he first wrote in 1994. He makes a case somewhat parallel to the MERS crisis. Private communities took off when real estate values and demand for new building were on the rise. Private communities won acceptance from municipalities as a better way to finance growth, because their developers provided infrastructure that municipalities would otherwise have to raise taxes to build. The developers displaced public service (and were welcomed to do so at the time), and the towns got new property taxes without some of the cost. But now that the housing market is fraying, so is the fabric that holds private communities together. When a development encounters financial difficulty, the maintenance of its privately-financed infrastructure may become a problem for the municipality – i.e., the local taxpayers.
MERS, designed as a private entity replacement for the public service function of deed recording, not only won acceptance from, it was created by the industry it serves, at a time when that industry was on the rise due to the housing boom. In the interest of getting the mortgage industry’s ticket punched, vital steps in the operations of property transfer were bypassed.
As the legal battle progresses, this crisis could become a constitutional issue. Should private entities have the right to create other private entities that serve them, but in the process, displace a public service without fully replacing what that public service did? Will the entities thus created be required to come under the same regulations as public services they displaced, and if they are, is that restraint of trade? And are federal bailouts of private entities the same as taxation without representation? Just asking.
Robert Brannum is a freelance writer.