20 Nov Solving the Foreclosure Crisis – Part 2 – How is a mortgage securitized?
As a Jacksonville, Florida lawyer focused on foreclosure defense, I have become intimately familiar with the process of mortgage securitization. As discussed in Part 1, the mortgage-backed security (MBS) is the root of the foreclosure crisis in this country.
In order to combat your foreclosure, you have to understand how your home mortgage travelled from the closing table to the securitized trust. How did your home mortgage become an MBS traded on Wall Street?
The creation of an MBS involves a very complex series of transactions, but I have oversimplified here to help the uninitiated generally understand the path taken by most home loans:
â€¢ Originator: The originator actually loaned the money to the homeowner to purchase a home or refinance an existing mortgage. The originator makes its money at the closing – thousands of dollars of closing costs, including hidden yield spread premiums. At some point, the originator runs out of money to lend, so it must sell the promissory notes and mortgages to raise enough capital to lend more money.
â€¢ Investor: While the originator cares very little about earning interest on the loan, investors seeking safe, high yield returns saw mortgage-backed securities as a way of maximizing their investment dollar. The safety of residential real estate backing the investment made the MBS the most attractive vehicle on Wall Street.
â€¢ Trust: The securitized trust, identified by the I.R.S. as a real estate mortgage investment conduit (REMIC), was designed to provide investors with the average rate of return on thousands of home loans blended together in a static pool. Essentially, the trust is infused with the necessary capital from investors to purchase the loans from the originator. The trust enjoys special pass-through tax-free status for so long as it complies with the REMIC guidelines.
â€¢ Trustee: The trustee is the entity that manages the securitized trust. It is normally a bank like Deutsche Bank, Bank of New York or HSBC, and it owes a fiduciary duty to the investors. It is the entity charged with taking physical possession of the 10,000 loans on behalf of the trust. I envision a room at the trustee’s offices that looks like the room in the picture to the left. This is where the breakdown occurs.
â€¢ Servicer: When the 10,000 loans are sold to the trust, the originator peels off the right to service the loans. The trust pays the servicer, who is often the originator, to field phone calls from homeowners, send bills and collect money, and generally handle the day-to-day obligations created by the mortgage.
â€¢ Pooling and Servicing Agreement: The PSA is the glue that binds all of the players together. It is typically a 400-page document that creates very specific rights for investors and duties of the trustee and servicer. The PSA is designed to comply with the strict REMIC rules to ensure the tax-free status of the trust. Failure to comply with the PSA will destroy the tax-free status of the trust and cause significant losses to the investors.
Many of the issues litigated in foreclosure cases arise from the breakdown in this process and the failure of these partes to comply with the terms, conditions and requirements of the PSA.
Next, I’ll point out some specific characteristics of the Pooling and Servicing Agreement and how the terms are abused by the trustee of the securitized trust.
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