Secruitization was the process whereby mortgage loans were turned into securities, or bonds, and sold to Investors by Wall Street and other firms. More specifically, the loans are “sold” into a trust known as a special purpose vehicle (SPV) that holds the loans as collateral on the securities bought by the investors. These “sales” allow the lenders to move the loans off their books, eliminating the need to maintain capital-adequacy reserves against default. The purpose was to provide a large supply of money to lenders for originating loans, and to provide investments to bond holders which were expected to be relatively safe.
The procedure for selling of the loans was to create a situation whereby certain REMIC (real estate mortgage investment conduits, a common securitization vehicle for commercial vehicles) tax laws were observed, and whereby the Issuing Entity and the Lender would be protected from issues regarding either entity going into bankruptcy. The IRS treats residential real estate REMICSs comparably with the ‘reasonably foreseeable default’ standard. For the bankruptcy protection, two “True Sales” of the loans had to occur, when loans were transferred to different entities.
A “True Sale” of the loan would be a circumstance whereby one party owned the Note, and then sold it to another party. An offer would be made and then accepted, with compensation given to the “seller” in return for the Note. The Notes would be transferred, and the Deeds of Trust “assigned to the buyers” of the Note, with an Assignment made every step of the way, and each Note endorsed to the next party.
The parties involved:
- The Originator was the lender who funded the loan. The originator set up the terms of the SPV via trust documents, articles of incorporation, by laws, etc.
- The Sponsor, typically a financial service company or a mortgage loan conduit or aggregator, “collected” or “bought” the loans from different lenders, combined them, and then “sold” the loans to the Depositor.
- The Depositor would “deposit” the loans into the Issuing Entity Trust (the REMIC Trust, or SPV), and then bonds and certificates would be sold.
- The Remic Trust (SPV), via its owner Trustee, holds the mortgage loan in trust for the benefit of the certificate holder, and then issues the RMBS pursuant to the Polling and Servicing Agreement (PSA). The PSA is discussed in the ‘Issues’ section.
This Model below transfers and assignment reflect the minimum conveyance chain for the Note endorsement pursuant to the mandatory conveyance rules under each PSA’s Section 2.
The Reality
The “reality” of the securitization process was much different than projected.
The money for the loans generally came from the Wall Street firm that was organizing the transaction. The firm provided money in the form of “Warehouse Lines of Credit” for each “lender” to use. The funds for the Warehouse Lines of Credit came mostly from two different sources.
- The Wall Street Firm, if large enough, could provide the money from its own accounts initially, but this was a practice not commonly used.
- The Wall Street firm “pre-sold” the Trust, selling the idea to other firms who put up the money and who then would be involved in different parts of the transaction such as typically selling– the certificates and bonds private Investors.
- The lenders were provided the money in Warehouse Lines of Credit.
The lender was tasked with finding borrowers for the money. Lending standards were “tossed out the window” because each Trust had a certain time frame in which the money could be lent to borrowers, allowing the Trust to sell the Certificates and Bonds. As a result, almost anyone above 18 years old could “qualify” for some type of loan. Even if the person was without employment or income, there was a loan for him.
The Issues
Here are significant issues which concern the process:
- When the loan was sold to each entity, there were no Assignments of the Deed of Trust to any entity at the time of the sale. Therefore, “True Sales” could not occur despite there being required a perfected “Chain of Title” by most Pooling and Servicing Agreements (PSAs), though the Agreements try to make “allowances” for MERS loans. The Sponsor and the Depositor were “created” having no assets. Therefore, they were unable to “buy” or “sell” the loans for “True Sales” to occur.
- PSAs are contracts between the SPV and the loan servicers who process the payments and generally manage the loans. The servicers are contractually obligated to act in the interests of the investors.
- The selling of the loans from the lender to the Wall Street entity did not in fact occur. The Wall Street entity who created the Warehouse Line of Credit was in fact the “True Lender”.
- The Originator of the loan simply funded from the “Warehouse Line” and simply acted as a “Table Funder”.
- Again, no “True Sales” ever occurred, and as a result, there are questions as to the legality of the Trusts.
- No Assignments of Beneficiary or Endorsements of the Note to all entities in the transaction ever occurred, reinforcing the argument of no “True Sales” ever occurring. The endorsements are a requirement of the Pooling and Servicing Agreement.
- An Assignment of Beneficiary from the original lender only occurs upon default, and almost always after the Notice of Default is filed, which would mean that the Notice of Default may have defects in it.
- Now, Assignments of Beneficiary are being made to the Servicer and not the Trust, which would pose new issues for foreclosure because the Trust is not receiving the Deed despite the Trust’s being the ”beneficial interest” in the Note.
- The addition of MERS to the equation, as “Nominee for the Beneficiary” to try to get around the requirement of assigning Deeds of Trust, further “muddies the waters” of the transaction. Many courts are ruling that MERS has no ability to foreclose or make assignments, with Chase and EMC in 2007 and Washington Mutual in 2008 ceasing use of MERS in foreclosures. Most recently, as of May 1, 2010, MERS cannot be named as a plaintiff in any foreclosure action on a mortgage loan owned or securitized by Fannie Mae.