There are rules but you don't have to follow them

The rules

The cheat goes on
The subprime crisis did not end with fraudulent valuations. It is still going strong, with forged documents and assorted accommodating agencies. To understand what happened, you have to know how to handle and how not to handle different types of documents.

A mortgage is two documents
What's called a mortgage is normally two documents: the note which is the borrowers IOU, and the mortgage or the lien on the property. In 45 states, the mortgage is a mere accessory to the note. It is the note that gives the right to foreclose; it is the note that is important.

The note has to be handled in a prescribed manner
Most mortgage securitizations are made according to New York law. This means that the parties to the securitization can operate only as stipulated in the pooling and servicing agreement that created that particular deal. Outside of what the trustee is specifically authorized to do, actions are "void acts"; they have no legal force. The notes (the borrower's IOUs) have to be transferred to the trust in a prescribed manner (endorsed with wet ink signatures through a particular set of parties), before a cut-off date which typically is no later than 90 days after the trust closing. The banks seemed to take the position they could do the transfer right before foreclosure. Kosher if not securitized, no-go with a New York trust. There is no legal way to remedy the problem after the fact.
If you don't have to follow the law, there is no problem. And that's what has happened. The U.S. Securities and Exchange Commission (SEC) has declared that following the law is not necessary.

Originators quit conveying the note
Starting in 2004, maybe even earlier, originators quit conveying the note; it was converted to electronic storage while the original was destroyed or kept with the originator. Formally the trust does not have the note; formally it does not have the right to foreclose. Even if the trust gets the note at the time of foreclosure, it is too late; it did not receive the note within prescribed time. Besides, has the loan gone bad at the time of foreclosure, the trust cannot legally accept the note; IRS rules forbid a Real Estate Mortgage Investment Trust (REMIC) to accept a non-performing asset. This could mean that investors who thought they bought mortgage-backed securities instead got securities without any backing.

Robo-signing, affidavits and allonges
With proper documents missing or without correct ratification, the banks had to do something. They resorted to robo-signing, to creating forged documents. Two popular types of forged documents were affidavits and allonges.
An affidavit is a legal document that can be used in court, in place of live witness testimony. As such it has to be sworn to tell the truth; the signer must be competent and have personal knowledge about what it is testifying about. A notary has to attest to the oath and to the identity of the signer. Lying in the affidavit might lead to a charge of perjury.
An allonge is used to add signatures to a document. It should only be used if the original document does not have place for all signatures needed; on documents questioned, there always was place. The allonge should always be attached to the original document, still it has a habit of suddenly showing up like from nowhere.

At first does not hurt borrower
A physical document, properly endorsed, is difficult to forge. Without proper controls it is easy to change electronic documents, deliberately or through carelessness. Maybe at first robo-signing was only a method to circumvent the faulty handling of securitized mortgages. Maybe that would be worth a fine of a couple of thousand dollars apiece. Whether it is legally possible to fix retroactively is another question; the courts seem wonderfully selective when it comes to enforcing the law. If it was only about being late with document transfer, morally it would not be a big thing; it would not hurt the borrowers. But again and again, we shall see how forged documents and other devices are used for illegal gains.

© Anders Floderus