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Residential Department: BackSpace: March 2011



Yep, technology can save you money and make life easier. But what do you do when the technology you embraced is at the center of one of the largest debates facing the mortgage market and the larger economy? That's the question staring down banks that filed mortgage records and servicing rights with the Mortgage Electronic Registration Systems (MERS).

Legal challenges

Federal officials are investigating the Mortgage Electronic Registration Systems (MERS). Two of the issues they're looking at are:

  1. Whether MERS assigned and tracked mortgage notes properly; and
  2. The practice of naming bank executives as vice presidents of MERS, thus allowing them to bring foreclosure action in MERS' name.

The battle over MERS also has been prevalent at the state level. State courts are considering:

  • Whether MERS owns specific mortgages; and
  • Whether MERS can proceed with foreclosures.

With national attention increasing, an ultimate decision on MERS' processes and future seems likely to come at the federal level.

Meanwhile, this past January, MERS' CEO R.K. Arnold retired. In a press release announcing his departure, Arnold said he was "proud of the important value that MERS provides to our nation's housing finance system."

If you haven't read something about MERS in the past two months, you're probably following the mortgage market about as well as ESPN follows the California Cricket League. Just in case, here's a crash course: The largest players in mortgage finance — this includes the big banks, Fannie Mae and Freddie Mac, and the Mortgage Bankers Association — founded MERS in the mid-1990s. Its main purpose was to facilitate securitization by tracking the ownership rights of mortgages behind mortgage-backed securities.

But MERS, whose processes circumvented filing updated property records with county officials, broke the chain of title, according to University of Missouri-Kansas City economics professor L. Randall Wray, who has advocated against MERS and predicted its doom vociferously. In and of itself, Wray says, the destruction of a transparent title chain makes it impossible to foreclose.

If that's true, then the U.S. foreclosure mess thus far might ultimately prove a speck preceding the true disaster yet to come. To get an idea of how big this potential problem could get, consider this: MERS' registry includes about 62 million mortgages — about two-thirds of all mortgages in the secondary market. If its processes were failed from the start, not only can nonpaying borrowers evade foreclosure by casting doubt on who owns their mortgage, but investors can dump mortgage-backed securities back on their creators or sellers.

Wray hasn't pulled his punches, writing in The Huffington Post this past January that "it is very difficultto believe that MERS was not fraudulent by design. " And if you believe him — his commentaries, incidentally, lean toward zealous and favor the word "toast, " as in "the banks are toast" — MERS will be kaput by the time this article rolls off the press. Should that occur, you can stop reading now.

Then again, if MERS persists, you might be interested in the flip side.

MERS supporters — and there are many — counter claims that the system breaks the chain of title. They say it relies on established legal principles pertaining to real property, negotiable instruments and basic contracts. Writing in Clark's Secured Transactions Monthly, Barkley Clark and Barbara Clark say the system "intentionally names MERS as the original mortgagee while the originating lender remains as the payee on the note. "

They cite the Uniform Commercial Code (UCC), writing "there is no need to record a mortgage assignment when the note is transferred" and that "the principle that the 'mortgage follows the note' is a common law principle" codified in the UCC.

In other words, when a note transfers ownership, so does the right to initiate foreclosure proceedings when the mortgage securing the note goes unpaid.

Did MERS lower interest rates?

Some supporters of the Mortgage Electronic Registration Systems (MERS) say mortgage-interest rates would skyrocket if the system were dissolved. They claim the ease of transferring assignments through MERS helps keep rates low. That may be true, but MERS likely only saves banks about $50 per loan, according to Georgetown law professor Adam Levitin, estimating a typical county fee for recording a real estate assignment.

"It's hard to believe that interest rates would be different in any material way if MERS did not exist," Levitin says.

Not only that, but mortgage-backed securities — credited by many for lower interest rates — existed before MERS. A look at average 30-year fixed interest rates from 1990 through 2010 shows a marked shift since MERS' inception in 1995. That doesn't necessarily show cause and effect, however.

"If costs increase for the mortgage industry, there are two possibilities," Levitin says. "Pass them along to consumers or live with reduced profit margins. There's enough competition in the industry that I'd expect the costs to come out of profits."

Ironically, MERS detractors also point to the inseparability of mortgages and notes. In written testimony delivered to the U.S. House of Representatives Committee on the Judiciary late last year, Christopher L. Peterson, a law professor at The University of Utah, points out that MERS simultaneously claims to be the mortgagee (i.e., owner) and nominee (i.e., agent) of the same mortgage.

Not only is this a legal impossibility, he says, but it allows MERS to justify foreclosure actions initiated in its name by claiming legal ownership of mortgage liens and also to hide behind its claim of nominee status. According to Peterson, "MERS represents the mortgage finance industry's best effort to create a single, national foreclosure plaintiff that always has foreclosure standing, but never has foreclosure accountability."

In a best-case scenario, MERS appears to double-dip into legal diction. In a worst-case scenario, its entire existence will be deemed illegal and rupture the foundation of 62 million mortgages, the securities they back and the investment funds that purchased those securities.

So where do we go from here? And more important for readers of this magazine, what does it mean for mortgage brokers and others trying to originate loans and defibrillate an economy in which the next surprise always seems near?

The latter question will likely prove easier to answer. In fact, for brokers who manage to steer clear of lawsuits and other troubles tied to the swirl of doubt surrounding MERS, the answer might be as simple as avoiding transactions involving foreclosures. This tactic should, at the least, keep you clear of future issues related to dubious title claims that may stem from possible illegal foreclosures related to MERS. Then again, with so many investors looking to tap the distressed-property market and needing financing, this approach could have you ditching a boatload of business.


As for the other question — Where do we go from here? — you might listen to legal financial expert and Columbia Law School professor Ronald Mann. Much of Mann's work focuses on ensuring the legality of electronic documentation in mortgage finance. Ideally, that would include digital records and an encoded chain of note-ownership transfer records that's easily accessible and legally enforceable.

"We legal academics need to make sure that the legal infrastructure is there to make that incontrovertibly valid, " Mann says.

He admits people have lost confidence in MERS — "because of the difficulty [of] producing original paper notes, whicharguably is a separate question " — but doesn't think killing the system is the answer. To the contrary, he says, "there are enough people now who are saying it doesn 't work that there's justification for legislation to make it clearly valid."


Darrick Meneken was an associate editor at Scotsman Guide. For questions on this article, call (800)297-6061 or e-mail

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