Observations and Concerns of a Californian Over the New Federal Home Loan Department

Secondly – and this is something I know about given my prior life - in terms of “securitization” of mortgages, under the Uniform Commercial Code (“UCC”) [which in this State is the Commercial Code] which has been in effect in every US State since the 1960’s while the trust deed is a security instrument allowing someone to foreclose on the property, the underlying obligation that the trust deed secures is the promissory note.

Promissory notes under the Commercial Code can be given as collateral for an obligation and is reflected in a security agreement which is perfected by either filing a UCC 1 with the Secretary of State or depending on the type of collateral taking possession thereof. If someone defaults on an obligation secured by the security agreement, the holder of the security interest can and should foreclose on the collateral which can include the promissory note. That simply means that the person who ends up owning the promissory note secured by the trust deed becomes the person who the homeowner pays. That does not mean that the homeowner is in default.

As such, collateralization of the note secured by the trust deed via the UCCC has existed for many years. The problem is when one gets so many steps removed in terms of what obligations are secured by what it is impossible to figure out what exactly the debt instrument is that one is buying or the risk in doing so.

This leads me to my main concern over this proposal which is implementation because conceptually this sounds easy but actual implementation is a nightmare.

One of the underlying issues in any government acquisition of assets is what the Government is acquiring and who is the person who the Government is looking at in terms of paying off what is the underlying loan.

As everyone knows, over the past few years mortgages have changed hands regularly as they have been securitized and traded on Wall Street and other exchanges. One of the biggest problems in getting a grip on this and restructuring these loans is that who owns what to whom is as clear as mud.

I should add that a number of the experts in this area – at least in California - who you may start hearing about in terms of financial legal experts are really former Comrades in Arms of mine dating back to the early 1980’s. It was the early 1980’s when the last foreclosure crisis really existed.

After I graduated from law school, the late great Abe essentially arranged and insisted that I go to work for a commercial litigation firm in LA to get “real world training”. That firm did a lot of creditor’s work. It was there that I got my experience in a boutique law firm that had a niche in what I would call commercial finance, business tort and contract litigation.

At the firm I became the defacto foreclosure expert for a series of reasons. In the course of that work I came into contact with title companies, junior bank officers, other attorneys who were then rising up the food chain, as well employees of personal property brokers, factors, etc.

Many of these people were age wise either slightly younger than I or maybe 8 years older max. These people are now the type of people 23 to 28 years later who are now the lead and key people who will have to grapple with this in this State. In fact, I have spoken to several of them in this state and New York.

While these veterans will make a lot of money on this, they also realize it will also be a nightmare because it will in many cases involve actually doing substantial research and litigation to get to the point where the Government is in direct privity of contract so it can tell someone we own this or you have to pay this mortgage -deed of trust payment to us.

It still remains the fact that in order to collect on a note you have to show that you own the note and the person who is doing the foreclosing has to actually own the note secured by the deed of trust as well as the trust deed aka be the real party in interest. Given the “slicing and dicing” of these loans and converting them into God knows what this is a lot of work.

This issue came to the fore last November when Judge Christopher A. Boyko of Federal District Court in Cleveland dismissed 14 foreclosure cases brought on behalf of mortgage investors, ruling that they had failed to prove that they owned the mortgages on the properties they were trying to foreclose on. The reason they could not is no one knew who did.

Anyone facing foreclosure should ask to see documentation and if there is none should sue for malicious prosecution and bring a quiet title action to remove all liens off the property by. With some levels of securitization, 2 or 3 funds may own part of the loan and documentation has turned into a digital record, not a note and deed of trust.

As such, my concern over this is not the amount of money globally committed but the specifics of the program. It is not clear if anyone can decipher what the Treasury is acquiring given all the mishagoss that occurred.

As such, this is not simply writing a check for $700 billion. It is the Treasury just committing itself to spend that much, if necessary. But the bottom line is, yes, this takeover could cost American taxpayers a lot of money in terms of cash flow need. To minimize the risk, the Government should be engaging in a reverse auction where the sellers have to show that: (i) they in fact can show a legal chain to the person who owns 1 Elm Street owes them the money and (ii) that the owner at 1 Elm Street is at risk of default.

These mortgages should then be purchased at a deep discount and the Government should then rewrite-replace the mortgages-deed of trust so that they are sellable in a secondary market as mortgages – not as mortgage backed securities – with that being banned as a term or condition of the mortgage’s assignability with the Government being able as a third party beneficiary or a defacto party to enforce that.

Also, if the Government is going to buy up assets and given the pressures I believe that will be made to show results, extra protections should be imposed by Congress on the Treasury before it starts demanding payments and doing foreclosures. First off, there should be no non-judicial foreclosures allowed with all of these actions brought in a US District Court. Secondly, as a condition of any complaint are specific allegations showing on what basis that the Government in fact owns the debt. This is what we do in California now [and what Title Insurers insist upon] and is a minimum.

That leads me to what Congressman Barney Frank is talking about. Barney has three issues before he will “sign off” on ay deal. Given his role as the “the chair” AKA the House Democrats point person on this, Barney has a lot to say about this.

One, Barney wants the Comptroller General, who serves as director of the Government Accountability Office, and other GAO officials would have access to financial records, have audit powers and would report findings to Congress, under Barney’s measures. The GAO is Congress' financial watchdog. I agree with that and it should be insisted upon by Republicans as well. With kind of money at risk, as much as I may like Hank Paulsen [I believe he was a friend of the family], a guy – even for 4 months – walking around with a potential $700 billion in other people’s money is not healthy and needs to be under Roz Nowick [enhanced Barbara Greenwald] Rules.

Two, Barney is also recommending limits on executive compensation of companies participating in the debt purchase plan. While this is advertised as more in the nature of a prevention of future mishagoss, it is actually an ounce of flesh legitimately demanded by the Democratic Party base to punish Republican CEO’s who caused this problem. Corporate directors should be doing that now. However, if Barney wants people like my sister reviewing corporate compensation packages and being under what I refer to as “Barbara Greenwald Rules” its fine with me.

Finally, and this is designed to protect taxpayers and prevent overbearing government, the Treasury would be required to help homeowners avert foreclosures on mortgages, mortgage-backed securities and other assets it acquires that are secured by residential real estate. They should of course be doing this in any event. As I have said repeatedly, who wants to acquire a foreclosed home unless you want a “fixer upper.” I suggest that people go to West Sacramento and other areas in this region to see what a couple of foreclosed on homes do to a neighborhood.

What Barney wants includes - I assume - that using its authority that those loans not purchased but are from the same institution that makes the sale to take advantage of a new Federal Housing Administration program. The FHA program, created under the foreclosure-prevention law Congress enacted in July, is aimed at insuring up to $300 billion in refinanced 30-year fixed-rate loans for about 400,000 borrowers after loan holders agree to forgive some of the balance to help struggling homeowners. In effect, what Barney wants the Treasury to say “If you want us to buy loans 1 to 100, as a condition of the deal thereof you have to rewrite loans 101 to 200 and if you don’t then we get to do X as a remedy for the breach or we wont’ buy these loans.”

I also wanted to comment on “short selling”. Short selling is the practice of selling things the seller does not own, in the hope of repurchasing them later at a lower price. Often the sold item is “borrowed” or “rented” for the period of sale and re-purchase. As a number of people and commentators have noted this was essentially banned after the Stock Market Crash of 1929 and came back entirely under regulated under recent SEC leaders. If John McCain claims Chris Cox should be fired for not prohibiting this, then he may have a point.

What we do know is that short selling was seen as a contributing factor to undesirable market volatility and subsequently was prohibited by the SEC for 799 financial companies in an effort to stabilize those companies. One of the companies protected was Berkshire Hathaway which is controlled by the Sage of Omaha Warren Buffet. That the sharks are after Warren who is clearly not a whack job shows short selling running amok. This was done after bankers ran to the Federal Government demanding protections from these sharks. At the same time the British Government prohibited short selling for 32 financial companies.

I am not an expert on when and how “short selling” is appropriate but it smacks of something wrong or it is at least subject to substantial abuse. I just don’t like the notion of someone selling something they do not own at the time of the sale.

My bias against “short selling” activity is also based on what we saw during the electricity manipulation during 2001. One of the main problems was that people were buying and selling electricity that they did not own and thus created a purely speculative market, which lead to all sorts of hanky panky.

While this abuse was part of “direct access” issues – direct access is A buying power from B who was not a retail service provider assigned that territory by the PUC but was a generator of power with it’s own plants traveling over the relevant retail utilities lines – it was not a direct access issue BUT it was direct access related. In 2005, former Speaker Nunez – and the Governor signed the bill because there was an initiative to somehow totally “re-regulate energy” – carried AB 380.

In effect, AB 380 [which is law] requires the California Public Utilities Commission (PUC) in consultation with the California Independent System Operator (CAISO) to establish resource adequacy requirements and requires PUC to implement and enforce the resource adequacy requirements on ALL electricity providers, or load-serving entities (LSEs) to ensure that each LSE has enough reasonably-priced power to serve their customers reliably. If you do not meet those requirements, you can be part of the energy provider network and sell power.

AB 380 eliminated any doubt about the PUC’s power and duty to apply and enforce resource adequacy for all providers. Assuming that the PUC does its job, AB 380 should be a major protection to avoid Enron hanky panky down the road.

It is true that in the US that in order to sell stocks short, the seller must arrange for a broker-dealer to confirm that it is able to make delivery of the shorted securities. This is referred to as a "locate," and it is a legal requirement that U.S. regulated broker-dealers not permit their customers to short securities without first obtaining a “locate”.

Brokers have a variety of means to borrow stocks in order to facilitate locates and make good delivery of the shorted. Most brokers will allow retail customers to borrow shares to short a stock only if one of their own customers has purchased the stock on margin. Brokers will go through the "locate" process outside their own firm to obtain borrowed shares from other brokers only for their large institutional customers. Some have argued that restoration of the “up-tick rule” abandoned in 2007 would solve the abuse.

However, as noted above, instinctively, I just think “shorting” is speculation not investing and I am viscerally livid over people selling something they don’t own. Given modern computer technology, I fail to see what the rational for this is given that there is no reason not to have instantaneous funds transfers and stock ownership as soon as trades are executed. If this wipes out Hedge Funds or restricts Hedge Funds going forward, oh well. Given what we just have been through, this is not a high price to pay.

Since the mid 1980's Irwin Nowick has worked for the California State Assembly and State Senate on a plethora of policy issues, most notably firearms legislation. He has been described as "The Assembly's resident genius" by a former Speaker of the Assembly and is seen frequently in the Capitol hallways and offices assisting legislators in drafting and amending pending legislation.