The "Mortgagegate" Scandal: Congratulations America, You're Now in the Title-Insurance Business

[Editor's Note: On Wednesday, in the latest development in the "Mortgagegate" scandal, Fidelity National Financial Inc., the largest U.S. title-insurance firm, reversed course and said it wouldn't require an indemnity agreement before insuring individual foreclosed properties. Money Morning's Shah Gilani, a retired hedge-fund manager, warns that there's a deep game being played, and provides investors with detailed insights, and advice on the steps to take.]

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U.S. taxpayers already own pieces of such problem-plagued companies as General Motors Corp., Chrysler LLC, American International Group Inc. (NYSE: AIG), Fannie Mae (OTC: FNMA) and Freddie Mac (OTC: FMCC). Now the increasingly problematic "Mortgagegate" saga could land American taxpayers in the trouble-ridden title-insurance business.

On Oct. 8, Bank of America Corp. (NYSE: BAC) indemnified Fidelity National Financial Inc. (NYSE: FNF) against any losses that Fidelity might sustain in litigation over title insurance it writes on foreclosed homes – the same homes, coincidentally, that Bank of America wants to sell to new buyers.

This arrangement amounts to U.S. taxpayers, who are the ultimate backers of the Federal Deposit Insurance Corp. (FDIC), backstopping a giant, publicly held title-insurance company, which is backstopping a huge commercial bank, so that the bank can sell properties that it might not have proper title to.

It sounds like a Wall Street version of the "Six Degrees of Kevin Bacon," but it's no game – it's a daisy-chain scheme that once again sets American households up as the biggest losers.

As more and more of the dirty laundry of "Mortgagegate" gets aired, it's becoming increasingly obvious that the usual trio of victims – U.S. homeowners, investors and taxpayers – face risks that are far worse than we ever before imagined.

In fact, the fallout potential is so numbing and the actions that birthed it so scandalous that commentators have given the crisis such Watergate-esque titles as "Mortgagegate" (or, as some prefer, "Mortgage Gate"), "Foreclosuregate" and "Foreclosure Gate."

Here's how the dirty business of insuring clean titles is transforming Mortgagegate into a full-fledged inferno of political intrigue and financial controversy.

There are basically two types of title insurance:

  • An "owner's policy," which protects the property purchaser from claims against their rightful title to the insured property.
  • And a "lender's policy," which is purchased by mortgage lenders to protect their interest in a property as collateral for the loan they've made against it. The lender's policy, sometimes called a "loan policy," follows the assignment of the mortgage when it is sold from one lender to another.

Anytime a mortgage is made with the purchase of real estate, both the lender and buyer purchase title insurance.

With all the problems being uncovered surrounding Mortgagegate, one of the most prevalent issues has to do with titles to foreclosed properties. Foreclosures can only be pursued by the party named on the title, meaning that's the only person or company who is recognized as having the legal right to take back the property for non-payment of the mortgage.

When lenders sell the mortgages that they've made to homebuyers to other lenders, banks or mortgage-pool securitizers, they are supposed to record the "transfer" of the loan and essentially document the process in what becomes the recorded chain "chain of title."

However, the reality is that most lenders didn't bother to properly document and record changes to titles when they traded loans back and forth. So when the time came to start foreclosing on delinquent borrowers, the real trouble began: Lawyers, courts, investors, title insurers and in-arrears homeowners began to discover – en masse – that titles were often improperly recorded, were never re-recorded, or were missing altogether.

Investors, regulators, lenders and others are now beginning to see just how widespread these egregious oversights actually were.

When Risk Comes Home to Roost

What's important to understand now is that when foreclosed homes are sold to new buyers by the banks that took them back, buyers (and lenders, too) want title insurance to protect themselves against past owners, lenders, or the servicers and trustees of mortgage-backed securities pools challenging their free-and-clear ownership of the purchased property.

Imagine having a huge inventory of foreclosed homes that you can't sell because buyers can't get title insurance. After all, why would any title insurance company write a policy when there's a good chance it will later be involved in costly litigation with potentially severe damages from making good on the policies that it writes?

The secondary market for almost any foreclosed home would come to a screeching halt without title insurance. And we're not talking about a small market, either: Currently, about 2.5 million people have already lost their homes and there are estimates that as many as 5.7 million more face imminent foreclosure.

That brings us back to the BofA/Fidelity National deal.

Bank of American wanted Fidelity National Financial – America's largest title insurance company, with an estimated 50% of the market – to write title-insurance policies on the foreclosed homes that BofA wanted to sell. To get Fidelity to agree, Bank of America agreed to indemnify the title-insurance firm on any title-insurance policy written on the homes that the bank sold from its inventory of foreclosed properties.

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Needless to say, the indemnification deal was a complex one. It amounts to backstopping an entire insurance company's risk by subjecting U.S. taxpayers to liability if the title company is sued until it's insolvent and then Bank of America can't make good on the claims it's agreed to cover.

All the too-big-to-fail banks have proven once again that they run America for their own financial gain.

I say "all the too-big-to-fail banks" because the scheme doesn't work unless all the big banks indemnify all the title insurance companies. Why? Because the legality of what Bank of America is doing is highly questionable and the bank has to make sure it's done in an across-the-board fashion to eradicate any and all questions about this strategy.

Where We Go From Here

Try not to get sick, but here's what will likely happen next:

Because forcing a buyer to buy title insurance from any one company is illegal under the federal law known as the Real Estate Settlement Procedures Act, or "RESPA," Bank of America will have to indemnify other title insurance companies that offer insurance to buyers and lenders.

By law, buyers have to be offered a choice when they must purchase title insurance. So in order to make other title-insurance companies step up and write policies, those companies might have to be offered the same indemnification that Fidelity was granted.

Fidelity National Financial, after getting its indemnification from BofA, pressed other banks, servicers and sellers of foreclosed properties to follow suit – and required an indemnity agreement before insuring any individual foreclosed property.
For the time being, however, that hard-nosed play didn't fly. Other title-insurance companies didn't follow the industry leader's lead. They didn't immediately demand their own indemnification deals. And since Fidelity was afraid it would lose business to its competitors, Bloomberg News reported that on Wednesday Fidelity reversed course and withdrew its demand to be indemnified on any property it provides a title policy to.

But Fidelity National still kept its BofA indemnification agreement in its front pocket and has no intention of ever giving that up.

According to the memo issued by Fidelity and cited by Bloomberg, Fidelity "may make individual agreements with other lenders."

And why not? It's only going to take a few victories in court – or for any of the class-action lawsuits being filed to gain traction – before the rest of the title-insurance companies demand the exact type of indemnification that Fidelity got BofA to agree to.

If all the too-big-to-fail banks end up backstopping title insurance to this degree, the sins of Wall Street will once again reach all the way to Main Street: The banks will be in the business of underwriting insurance risk on the collateral they already own, and we – the U.S. taxpayers – will discover that we're the backstop of last resort in this latest chain of financial incompetence and deceit.

Once again, it's the banks that are being protected from the mess they made so they can go back to making profits to fill their corporate coffers and bolster their balance sheets so that they can finance American capitalism. In reality, all we're doing is financing a bunch of institutionalized Bernie Madoffs – none of whom will ever see the inside of a jail cell.

With every new Mortgagegate disclosure, the American public is getting an eyeful of how Wall Street and Washington have collaborated to play it again.

What's important now is for investors and homebuyers to be vigilant, to make sure that this mess is cleaned up, and to make sure reforms are enacted to keep this from happening again.

Otherwise, sometime down the road, we taxpayers will wake up and discover that we're again on the hook for billions, thanks to another scheme that Wall Street's serial scammers have pulled off. And we will discover that we're in yet another new "business" – perhaps something even more inappropriate than title insurance.

Let's do all we can to keep that nightmare from coming true.

Actions to Take: In a recent e-mail alert to subscribers of his Capital Wave Forecast advisory service, Gilani detailed his "Mortgagegate" concerns, and concluded by recommending that readers maintain tight stop-loss orders on their investment positions.
That's a stance that Gilani continues to advocate. By using stop-losses, investors will be able to stay in the market, and reap any upside – while also protecting themselves against the fallout should this controversy turn into a full-blown crisis. We like this analysis and strategy so much that we've now presented it twice here in Money Morning, wanting to make sure that our readers all benefit from the wisdom of this retired hedge-fund manager.

Says Gilani: "Banks still own most of their toxic assets. They're just buried (with the consent of the U.S. Federal Reserve and Treasury) waiting for an economic recovery and low rates to let borrowers re-finance and pay them back. Speculators, assuming low rates will generate economic growth have leveraged themselves up buying everything in sight, including mortgage-backed securities for their high yields.

Because of moratoriums put in place, if homes can't be foreclosed on until this mess is straightened out, inventories will build up, and prices could crash again later when that inventory hits the market. If homeowners who bought foreclosed homes find that the validity of the titles they now hold are challenged, lawsuits will fly. People who were foreclosed could sue to get their homes back. Title insurance companies that protect buyers of their insurance policies from title lawsuits could never make good on their policies, and would go belly-up. Governments could (and will) sue banks for potentially hundreds of billions of dollars of recording fees they were cheated out of. Criminal fines could add hundreds of billions of dollars more to their tabs.

What happens if there's widespread panic that this new round of mortgage-related stress won't be fixed quickly?

Markets could tank as leveraged players see their holdings drop and get margin calls. All the speculative, leveraged momentum trades based on a slow- but- upward recovery (especially hoped for in housing) could get upended as speculators rush for the doors.

Is this going to happen?

I certainly hope not. But it is a real, very real, possibility.

If the U.S. Federal Reserve is worried, I'm worried. And you should be, too.

If I'm wrong, great. Markets should continue their recent uptrends. But my job, first and foremost, is to protect you from devastating capital losses.

Here's hoping that I'm wrong."

[Editor's Note: Shah Gilani, a retired hedge-fund manager and renowned financial-crisis expert, walks the walk. In a recent Money Morning exposé, Gilani warned that high-frequency traders (HFT) were artificially pumping up market-volume numbers, meaning stocks were extremely susceptible to a downdraft.

When that downdraft came, Gilani was ready - and so were subscribers to his new advisory service: The Capital Wave Forecast. The next morning, because of that market move, investors were up 186% on a short-term euro play, and more than 300% on a call-option play on the VIX volatility index.

Gilani shows investors the monster "capital waves" now forming, and carefully demonstrates how to profit from every one.

But he doesn't stop there. He's also the consummate risk manager. As the article above demonstrates, Gilani also makes sure to highlight the market pitfalls that can ruin years of careful investing and saving.

Take a moment to check out Gilani's capital-wave-investing strategy - and the profit opportunities that he's watching as a result. And take a look at some of his most-recent essays, which are available free of charge. Those essays can be accessed by clicking here.]

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About the Author

Shah Gilani is the Event Trading Specialist for Money Map Press. He provides specific trading recommendations in Capital Wave Forecast, where he predicts gigantic "waves" of money forming and shows you how to play them for the biggest gains. In Short-Side Fortunes, Shah shows the "little guy" how to make massive size gains – sometimes in a single day – by flipping large asset classes like stocks, bonds, commodities, ETFs and more. He also writes our most talked-about publication, Wall Street Insights & Indictments, where he reveals how Wall Street's high-stakes game is really played.

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  1. yousuf | October 29, 2010

    good reading

  2. Richard | October 29, 2010

    Like most analysts you seem to miss the obvious. A mortgage issued in the past 8 years that is fully current is just as likely to have been sliced and diced as one that happens to be in foreclosure. When the legitimate owner attempts to sell his property he will have even more difficulty providing clear title than a BOA that has done a political deal to backstop their title insurance.

  3. Kevin Beck | October 29, 2010

    I think one other culprit needs to be identified: The credit-rating businesses. One of their "crimes" in the whole mess was to strip the mortgages of the note, to enable them to be pooled, securitized and re-sold in tranches. This was thanks to their lawyers advising them the products could not be rated with the note attached.

  4. Ron | October 29, 2010

    This article misses at least two important points. First, the scale of the size of BofA compared to Fidelity is like an elephant compared to a flea. Consumers are not at risk if Bof A indemnifies the flea. By the way, the flea has 38% of the title insurance market, not 50%. Second, the lenders are already liable under the law for their negligence. The agreement does not create liability for the banks, because it's already there. What it does is to protect the title company from having to incur expensive defense costs in litigation which it would later seek to recover from the banks anyway. This just short-circuits that process and puts the loss where it belongs anyway, on the wrongdoer. It's not a ripoff or threat to consumers, but an acknowledgment of actual legal liabilities that already exist. Hope y'all feel better now.

  5. William Patalon III | October 29, 2010

    Kevin….great point. Shah Gilani has written about that issue extensively, but you're absolutely on target in mentioning it again in this context.

    Keep the thoughts and comments coming. Thanks for taking the time to write.

    William Patalon III
    Executive Editor
    Money Morning

  6. Cristhian Pirazzoli | October 29, 2010

    Es una pesadilla de nunca acabar y me pregunto. Cómo se les pasó a las autoridades de la administración anterior y no controlaron y pusieron atajo a este tremendo fraude que está haciendo temblar al mundo. Dificil encontrar escusa.

  7. Michael | October 29, 2010

    I wish to correct you with regard to your second type of insurance where you say;

    "…a "lender's policy," which is purchased by mortgage lenders to protect their interest in a property as collateral for the loan they've made against it."

    The lender has in fact not made a loan themselves. The "lender" borrows money, using the strength of the signature (and credit worthiness) of the borrower, some of which they "lend" back to the borrower.

    It's another part of the surreal financial world in which we live.

  8. Jose Palli | October 29, 2010

    When the Financial Services Modernization Act (FSMA) — repealing the Glass–Steagall Act, which for almost seventy years had protected the US banking industry from its own folly — was passed by the US Congress at the very turn of the past century, I thought I had hit pay-dirt.

    The FSMA was hailed as the key to a “globalized” world for US financial institutions. Back then, I was engaged in a persistent effort to promote the use of US real estate transactional (and financial) practices — including title insurance- abroad. The premise behind my job was, as it is in so many other cases, a very US one: “what works for us, should work for everybody else”. The CFMA validated the world-wide viability of the title insurance I was trying to sell: a little known, and arguably little needed (beyond our US borders) financial product that could hardly fit into a legal system or framework where the risks it covered were allocated, even if not fully protected, in a totally different fashion.

    Bob Rubin and Larry Summers, who both served as heads of the Treasury Department under President Clinton, were credited as the brains behind the FSMA, which together with the Commodities Futures Modernization Act (the CFMA), passed in 2000, allowed US banks to do pretty much whatever they cared to do. It was an orgiastic climax to the de-regulation feast which began during President Reagan years.

    This setting opened the door to the subsequent credit orgy orchestrated by Alan Greenspan, and, eventually, to the “unavoidable” socialization of the “un-foreseeable” financial losses, cooked under Tim Geithner’s recipe.

    I remember that day in 1999 vividly because I should have known that what is now happening with our crumbling mortgage “market” was bound to happen. Although at the turn of the century I had already accumulated fifteen years of experience as a member of the Florida Bar, I was originally trained as a lawyer in Argentina. And over twenty five years and counting in the international title business, I have directly experienced the contrast between our way of doing things — which many held as “best practices” but are now deservedly under question — and that of countries where they resort to more sophisticated and mature methods of control, review, and supervision for real estate transactions, methods commonly used in places where the same Civil Law I studied in Argentina is in force.

    These methods go from better developed and sounder recording systems than the very rudimentary public record systems we have in the US, to the assistance and guidance the parties to a real estate transaction receive from professionals called “notarios” or “escribanos” (the real notaries, that is, not the ones we call notaries stateside, and whose attestations under the parties signatures are available at ten dollars a pop at our pharmacies, together with an anti-flu vaccine).

    The deficiencies in our hallowed real estate transactional system are in plain view, clearly discernible from the aforementioned contrast with other foreign practices. So, rather than engaging in the kind of finger-pointing we are presently witnessing, I believe it is high time for us to humbly begin recognizing the significance of those comparative deficiencies and, eventually — and after a big gulp of pride- seek, at the very least, a middle ground between what we thought “worked for us” and what seems to “work for everybody else”.

    And the need to re-think this very narrow — though most pressing, since it affects the housing needs of many — aspect of our financial crisis also applies to the many other “innovations” that have turned the US into a financial asylum.

    We need some creativeness, a fresh team of heads and hearts. If we cannot do what we need to do because of the many vested interests that prevent us from moving ahead, our “mortgage-gate” will end up playing in theaters as “Bob & Larry & Tim and & Alan”, a nail-biting remake of the sixties movie (Bob & Carol & Ted & Alice) where everybody ended up in the same bed.

    * José Pallí is a Coral Gables based member of the Florida Bar Association and of the “Colegio de Abogados de la Capital Federal”, he works in cross-border transactions and international real estate investment and is President of World Wide Title.

  9. Jim Martin | October 29, 2010

    Ron,
    You said it all. BOA or any lender for that matter is responsible for any of it's negligent acts. If BOA is indemnifying Fidelity, then why is the bank title insurance needed at all? Just another expense that the borrower pays. It seems we continually expand this industry to perpetuate fees without regard to the conflicts of interest or value of services. Yes Kevin, where is the accountability of the rating agencies?

    What bothers me most is the fact that affiants are submitting affidavits (they don't even actually sign) swearing under penalty of perjury" statements of account", as facts "personally known to me" (not to the best of my knowledge or upon information and belief) that have not been verified and may or may not be true without consequences. These are being presented in our most sacred institution charged with protecting every citizen's right to justice. Those responsible for supervising and have knowledge of these account executives proffering the fraudulent affidavits, they attorneys that affix these facially defective affidavits and the judges that permit or fail to question these affidavits should be held accountable. Wrongs are not committed by Wall Street, the Banks or the Legal System; they are committed by people and until such time as there are personal consequences for illegal acts, the cancer will only grow.

  10. Jarvis | October 29, 2010

    This is a very good reading that gave me a greater understanding of what has been going on with foreclosures. I myself am facing foreclosure whose mortgage has been traded three times. So if I am reading correctly ,they( PNC) has no right to foreclose on my property because thier not on the title insurance. If that is so, what must I do to stop the foreclosure which is scheduled for November 22, 2010.

    Thanks,
    Jarvis

  11. Carlos Comesana | October 29, 2010

    From my particular pont of view makes no sense to continue to plug trillons in the market to help the financial industry. Other could be the situation with a temporary nationalization.

  12. John Hall | November 4, 2010

    Jarvis I would pay my monthly mortgage payment every month.I am afraid this will be the only way any one will be able to stop forclosure.

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