Subscribe to Money Morning get daily headlines subscribe now! Money Morning Private Briefing today's private briefing Access Your Profit Alerts

What You Don't Know about "Mortgagegate" Could Crush the U.S. Banking System

[Editor's Note: In the aftermath of the burst housing bubble, in the rush to foreclose upon million s of U.S. homeowners, big U.S. lenders resorted to apparently fraudulent strategies as part of an assembly-line repossession grab. Money Morning's Shah Gilani, a retired hedge-fund manager, warns investors about the possible fallout facing the U.S. financial system and provides detailed advice on the steps to take.]

What most Americans don't know about "Mortgagegate" is that "robo-signing" of foreclosure documents is the tip of the iceberg.

The breadth and depth of this newest mortgage crisis is so dangerous that the U.S. Federal Reserve last month pre-announced another potential round of quantitative easing (pundits are calling it "QE2") to address "potential negative shocks."

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

Here's what the news-story headlines aren't telling you.

Foreclosure Follies

The Fed can't admit that the potential shocks it's worried about have already materialized, because that would trigger the very panic the central bankers hope to avoid.

But the odds that a financial tsunami will result from Mortgagegate are building each day. If this storm strikes with its full fury , it could be the kind of credit-crisis aftershock that undermines the tentative handhold that the U.S. recovery is so desperately clinging to.

On the surface, the problem looks like foreclosures have been conducted based on improperly processed paperwork. That is a gross understatement.

Here's what's wrong. When a homeowner buys a property with a mortgage, the property title lists them as the rightful owner and their lender as the mortgage-holder. The named lender possesses an encumbrance on the title. If the homeowner doesn't pay his or her mortgage, the lender can rightfully repossess the property and sell it.

In order to take the home back, the lender must first foreclose on the property. The problem begins with the fact that lenders, in order to make trading mortgages between themselves easier so they can be packaged into mortgage-backed securities (MBS) pools and sold to investors, assign their rights on titles to a "nominee." (How that happens is the part of the story that news outlets aren't talking about and will both shock and sicken you).

To take homes back, lenders or mortgage services start by filing court documents in "judicial foreclosure states" (most states in the U.S. require foreclosures to be court-processed). Filings against homeowners must include signed affidavits attesting to the relevant facts and demonstrating the lender's legal status to foreclose. Affidavits must be notarized.

But here's what's been uncovered: The people who are signing the necessary documents on behalf of the lenders aren't even reviewing documents – which means there's absolutely no way they followed the pre scribed procedures. It turns out that signers are basically "rubber-stamping" legal documents.

In the case of IndyMac Bank FSB (since purchased by a private equity group and renamed OneWest Bank), The Wall Street Journal reported that Erica P. Johnson-Seck routinely signed as many as 6,000 documents a week. In another instance, employees of GMAC Home Mortgage and the mortgage unit of JPMorgan Chase & Co. (NYSE: JPM) admitted in sworn testimony that they each signed 10,000 documents per month, without properly reviewing and notarizing them.

Similar instances of what's become known as "robo-signing" are now coming to light in relation to hundreds of thousands of other documents. And by the time it's all said and done, it's likely that we'll be talking about millions of documents.

Fraud was clearly rampant in the notarization of documents that were part of the foreclosure process. The fact that document signers weren't reading and reviewing the paperwork, and weren't contacting homeowners – all of which was mandated by lenders – there clearly was no way that the proper due diligence was observed.

Questionable legal notarizations include pervasive findings that documents were notarized even before they were signed and dated. A notary is legally designated to verify the identity of the signer of a document and affix their notary stamp along with their signature that they have witnessed the signer executing the document, and that the signer is who they say they are.

Some notarizations on suspect documents are affixed by notaries that don't live or work anywhere near where documents were signed. Indeed, many of them live across state lines. That makes it highly unlikely that signers were verified or that the documents properly notarized by law.

Congress, in its inimitable way, was made aware of this problem. Legislators tried to solve the problem by ramming through – without debate (highly unusual, but they did it) – legislation that partly addressed some of the notary issues.

In a bill that was supposed to facilitate interstate commerce, our elected representatives made it legal for notarizations to be accepted across state lines. How high up is the knowledge of this crisis? Apparently pretty high. After all, it was none other than U.S. Sen. Patrick Leahy, D-V T, the chairman the Judiciary Committee, who on Sept. 27 rammed through the Interstate Recognition of Notarizations Act, the bill in question.

In case you miss the egregious irony of the timing of the bill, it came up for a vote only a couple of weeks after the initial disclosure in courts around the country that GMAC had robo-signers falsely notarize foreclosure documents. Last Thursday, U.S. President Barack Obama refused to sign the bill.

Circle of Deceit

Here's a key question: If these foreclosures aren't being legally executed, are homeowners being kicked out illegally? And what about the buyers of foreclosed properties: Are they rightful owners if the previous owner still has a legal claim to the home?

 Is everyone going to sue everyone? What will a nationwide moratorium on foreclosures do to the inventory and prices of unsold homes? And what e ffect will all this have on homes situated near foreclosed properties?

What will happen to all the mortgage-backed securities that contain all these properties and that banks still hold? What will happen to the economy if these problems take years to work through? 

And that's not even the worst of it all.

There's actually a much deeper problem that could lead to troubles far worse than anything you can imagine.

The whole mess begins at Square One. And "Square One" is a circle of fraud and deceit so large that if civil and criminal charges and fines were eventually levied against the perpetrators, there isn't a big bank in this country that wouldn't be insolvent.

Naturally, it's about money.

Frightening Fallout

In order to easily buy and sell mortgages between themselves so that these loans might be repackaged, securitized and then sold to investors as mortgage-backed securities, banks and other lenders needed a quick way to "trade" individual mortgages. They created a company called Mortgage Electronic Registration Systems (MERS). This group includes Bank of America Corp. (NYSE: BAC), GMAC LLC (NYSE: GMA), Wells Fargo & Co. (NYSE: WFC), Washington Mutual (now owned by JPMorgan Chase), the United Guaranty Corp. unit of American International Group Inc. (NYSE: AIG), Fannie Mae (OTC: FNMA), Freddie Mac (OTC: FMCC), mortgage-servicing companies and other similarly interested members.

You may not realize it, but at your home-purchase "closing," you sign a document that appoints MERS as the "nominee" for the lender that granted you a mortgage. That gives the nominee the right to flip your mortgage to any other bank or lender it chooses. That's how banks move mortgages around to package them into different securities.

But that brings us to the crux of the controversy: Every time there's change on the title (a change occurs when the nominee switches the lender on your title out for another), local governments require that a new title be recorded. Of course, those governments – the county or municipality that you live in – also charge a "recording fee." MERS also charges a fee, but it's a lot less than government recording fees.

Here's the problem. In creating MERS, these institutions actually changed the land-title system that this country – for much of its history – has relied upon to determine legal ownership status of land titleholders.

Not only did the lenders sidestep (read that to mean avoid) paying billions of dollars in fees to local governments, they paid themselves from the fees that MERS collected.

MERS is facing class-action lawsuits and civil racketeering suits around the country and their members are being individually named in all these suits. One suit alleges that MERS owes California a potential $60 billion to $120 billion in unpaid land-recording fees.

If suits against MERS and all its members are successful, unpaid recording fees and fines (that can be as much as $10,000 per incident) would make every one of them insolvent.

And you wonder what the Federal Reserve meant when it warned of "potential negative shocks?"

The bottom line for investors is that until all these issues are cleaned up (which might take years, or even decades) – or until there's perhaps some sort of legislative clarity that eases uncertainty – investors face the threat of a severe "correction" in any or all of the markets that have risen on the hope that the long-hoped-for U.S. recovery is finally taking hold.

It makes sense, as it almost always does, to have stop orders in place on all your investments and consider the ramifications of these problems whenever your investments have real-estate (or mortgage) exposure.

Actions to Take: On Wednesday, in an e-mail alert to subscribers of his Capital Wave Forecast advisory service, Gilani detailed his "Mortgagegate" concerns, and concluded by recommending that readers "Immediately place a stop loss on all positions, 10% below [Tuesday's] closing prices."

Gilani's logic made sense. By using stop-losses, investors could stay in the market, and reap any upside – while also protecting themselves against the fallout should this controversy turn into a full-blown crisis. In fact, we liked his analysis so much that we've reproduced it here so that Money Morning readers might benefit.

Writes Gilani:

"Banks still own most of their toxic assets. They're just buried (with the consent of the Fed 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.]

News and Related Story Links:

Join the conversation. Click here to jump to comments…

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 Zenith Trading Circle Shah reveals the worst companies in the markets - right from his coveted Bankruptcy Almanac - and how readers can trade them over and over again for huge gains. 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.

Read full bio

  1. Jim McKinley | October 15, 2010

    Truly stunning are the only words to describe this latest mortgage crisis. The fact that MERS unilaterally changed the land and property title system with apparently no checks and balances other than the checks that went into the hands of bankers to fatten their personal balances is criminal. This is right out of a Francis Ford Coppola novel.

    Too big to fail? The banking system or the US? If we keep going down this road I fear the banking system will out live the US as we know it. Time to bite the bullet, be honest and address these structural imbalances for what they are and if that means letting these behemoths fail so be it. All the QE in the world is not going to remedy greed and corruption.

  2. R M'Geddon | October 15, 2010

    If you ever wondered what the Black Swan or Armageddon event that would bring the US economy down would actually be, then Morgategate could well be it!

  3. Owen K. | October 15, 2010

    There will be some fallout. However, Congress and Government can't get anything right and can't manage their own house let alone regulate the banking system to the point where things like this no longer occur. A paradigm shift in the U.S. economy has occurred. Housing is no longer going to support the U.S. economy as it once did. Homeowners used their homes to refinance and pull out equity. They then spent the money on cars, boats, vacations, and other consumer spending. This was unsustainable in the first place. Now, the housing market has crashed. It will take years for some sort of balance to return. And, the more Congress and Government try to intervene, the longer its going to take. Never again will homeowners be able to use their homes as ATM machines as they once did. As to U.S. banks, the big ones will survive. They are a component of the international banking cartel. I would encourage everyone to read "The Creature from Jekyll Island." This is a great book on the banking cartel. It tells how it was formed, and how it continues to operate. The banking cartel is massive, and it has almost unbelievable power. It also has a vested interest in preserving the global fiat money system as well as fractional reserve banking.

  4. Jim Evans | October 15, 2010

    The banks may not have followed proper procedures to foreclose. But if you are not making payments on your loan it will be only a matter of time before the banks do it right and these people will eventurally get forced out of their homes.

  5. richard lamb | October 15, 2010

    Two comments
    Will unlimited liability for bankers ever come back?
    Will the repugnance present and building about the financial and political improprieties, lead to a "more massive" removal of Politicians up for election and re-election? Interesting thought?

  6. drrgp | October 15, 2010

    Interesting article, but I hope its author has a better command of facts than he does of English grammar. Other things equal, poor writing skills signal poor thinking skills.

    • Joel | October 18, 2010

      This is not about writting skills drrgp.. this is about America's economic situation ,so save all your wrong-headed coments that are out of place..Rather I think that you don't want to accept that America , at least the one you used to think it was "great and fair", is about to end… Perhaps as a result of this crisis a new America will arise. A new America not so "powerful" as the previous one, but more free and fair for all.

  7. Mark Richard | October 15, 2010

    Here's the problem. In creating MERS, these institutions actually changed the land-title system that this country – for much of its history – has relied upon to determine legal ownership status of land titleholders

    Are you talking about recording the assumtion of the existing loan?
    That does not transfer title as you lead people to believe in your article. And they have been doing this for years, Its nothing new to find that a new owner of the note has not recorded the assumption. It sounds like everyone is looking for another excuse to pass on blame to the banks for their own stupidity in buying property at the height of the RE market. If I bought a property at the height of the market with 100% financing and with neg am loan teaser rate of 2% adjutable, how can I possibly put all the blame on the bank that gave me the money?

    This is no different than me buying a stock with my equity line that a bank created. The bank lends me the money and I buy the stock….then the stock goes down and I blame the bank for lending me the money to be stupid with. Maybe I should blame the seller too, he sold me the stock because he thought it was going down. I need to blame somebody …it couldn't be me. People need to take resposibilty for their own mistakes. I have been buying and selling property for 25 years. I sold all my property in 2003-2005 except for my home. I only obtained fixed rate mtgs with a large downpatment. I am sick and tired of bailing out people who are losing their homes. They live in them for many months with no payments and trash the building because the bank lent them money to go be stupid with. Now the banks are at fault too no doubt! Greed on both sides is to blame, but it is both sides. Regulate the banks and kick the deadbeats out. The tax payers are getting screwed. The people that did it right and put their own money down and bit the bullet and paid a larger mtg on a fixed rate are getting screwed. We lost our money and paid a higher int rate to do it. People who bought with 100% financing lost the banks money, trashed the house, and lived there for up to 3 years with no payment! Forgive me if I don't feel their pain.

  8. Steve Engle | October 16, 2010


    Has your business reputation been attacked online? In todays business world, maintaining your online reputation is extremely important. We offer solutions to clean up any negative postings that may show up on a Google search and a preventative maintenance program to keep your online name and image clean.

    I look forward to hearing from you and discussing our online reputation solutions.


    Steve Engle

  9. everett buatis perthen | October 16, 2010

    America has lost their dignity as the most powerful country in the world, the greed has taken over for many years and America will varnish from the world stage like the Greeks, Egypt, other great Nations, America is on a path of self-destruction, I loved once America

  10. Barbara Korn | October 16, 2010

    I'm in forecloser now. This is some new information. thanks

  11. John Smyth | October 16, 2010

    Look to the US government to become the US TITLE INSURANCE company.

    The government will "guarantee" the title of foreclosed sales as no insurance company in it's right mind will write a policy for one now.

  12. Bob | October 17, 2010

    Brilliant analysis. This fiasco—compounded by the virtual moratorium on foreclosures until this mess is sorted out, will put not only the US banking industry, but also the real estate and construction industries, in "limbo" for many years…

  13. Jay R | October 17, 2010

    Something that was wrong from the start can never be made right. It was wrong from inception. It started with the Fed and must end with the Fed. Allowing banks to take our Note-security instrument, put it as an asset on their books, trade it meaning get paid for it, loan out against that asset up to 10x's or more, and continue to take the payment revenue stream. It's time to put us back on the gold standard.

  14. Rudy | October 18, 2010

    This scandal has provided a lot of pleasure for the pompous, sneering finger pointers of the world.

    This problem needs to be straightened out as quickly and smoothly as possible to get the foreclosure process back on track. If it gets blown up into a circus US real estate won't be worth pocket change. Financing and confidence in title would vanish for generations. This would wipe out most individuals and governments.

    Cool heads and sensible actions are needed now.

  15. david | October 18, 2010

    Oh dear! Many years ago I heard a prophesy which stated "the millionaire yankee will cease to exist".
    I guess this huge mess, and I dont just mean the morgage senario, I am am speaking of the
    untold greed and grab of mainstream US folk. The banks started it, were bailed out, and now
    heaven only knows where the buck will stop. The president does not govern, the pentagon does. Their recipie is to kill, maim, and destroy. Shares in armament companies are OK. Fear not, our killing machine is still OK. The government knows the printing press is running flat out 24 hrs per day in order to pay these monstrous bills. Never mind the people killed. They will rebound in time. Ask the jews, they were massacred by the nazis, and now look at them.Fighting fit once more, better than ever.
    Ah well, if the prophesy is correct, we have litle time left with a strong dollar. Make way for wooden shacks, and survival of the fittest. History repeats itself.

  16. Gary Wardell | October 19, 2010

    I am PIF, paid in full.

    I do not know about any body else but I am keeping my home.

    • george gest | October 25, 2010

      My home is paid in full as well, so is everything else. We MAY keep them if we can afford the taxes.

      If this obozo mess and other things as well are not stopped and corrected unequal taxation will be one way to "legal" confiscation.

  17. Kt | October 24, 2010

    When people apply for a loan the have the option of putting 20% down on the new purchase/property to avoid paying an additional Mortgage Insurance Premium. If all the people who purchased houses and did not put 20% money down…they should be covered by their MIP. They paid a monthly fee for this mortgage insurance premium added into their mortgage bill for YEARS! Perhaps all this can be corrected and the Mortgage Insurance which we paid every month should be held liable. If you carry house insurance and a tree hits and smashes the roof your homeowner's insurance will cover the damage. So why hasn't the Mortgage Insurance covered the losses – it was insurance?????????? Can somebody explain this to me as I have not read anything on this and I use to pay thousands of $$$$ on MIP's.

  18. Ian McCrudden | October 24, 2010

    The President isn't and never was in charge ! His strings are
    being pulled by a small but very powerful group of bankers
    whose families originate from " another country " – but its politically
    incorrect to name them ! END THE FED NOW !!!!

  19. Tim Bryant | October 27, 2010

    One other major issue that investors face is the liability lenders are putting onto them. Many modifications are being denied based on the investor refusing to allow modification. This imposes liability to the borrower, since the investor is not a party to the contract, and this same act would make the loan a non-negotiable instrument. The end result? The original con
    tract is void, and the investor is liable for tortional interference.

    It is becoming apparent, that many of the lenders claims are untrue. The problem is, the borrowers do not know this, and they have a paper from the lender stating such. They can still be dragged into court. It is then up to the investor to prove that it is untrue. This will further expose the investor to tax liability if, in fact, they were not "passive". It further exposes the investors to liability to local governments by the failure to record the transfer with the local registry of deeds.

    What is the end result? Everyone loses but the bank who committed the fraudulent acts. The only solution is for borrowers and investors to find common ground and work cooperatively to expose these frauds. Ironically, their equity interests were contrary to each other in relation to the initial transaction. The fix may come from a mutual interest to preserve their financial investments which the banks did not seem to believe they had a fiduciary duty to protect.

  20. James | October 29, 2010

    Our financial system is broken. Fix it first. That should be our country's top economic priority. Until our financial system is made right, our economy will not be able to make a long-term recovery. It is an invitation to impending economic disaster!

    The Obama Administration, Congress and the banking system have their heads in the sand. They are in the center of the storm and do not see the swirling, chaotic, whiplashing hurricane whipping the US. They are not addressing the issue. In fact, they are avoiding the issue that our financial system is broken that Shah Gilani so clearly explains.

    The FBI goes after people who create ponzi schemes that defraud innocent people. It does a good job doing investigations and getting the guilty parties put in jail. This is small time however.

    Who goes after the bigger frauds like the big banks? Is it FDIC? Is it doing its job? There must be some federal agency watchdogging the big banks. The damages they do, not only to people, but to our economy are colossal!

    I am glad we live in a country where balance of power rules.

    The States, I mean the attorney generals in individual States, will be taking the mortgage cases to court to prosecute the guilty parties. It is going to be a slow and laborious process, but for now, the only way the problems in our banking system are going to be corrected and partially resolved; not until the federal government wakes up.

    Our country is ruled by law and not by politics. Let justice be served.

    The wheels of governmnent turns no matter how slow.


Leave a Reply

Your email address will not be published. Required fields are marked *

Some HTML is OK