Slade Smith's Blog

Punished for trying to fix a flawed mortgage

Slade E. Smith — Tue, 27 May 2014 00:28:09 EST

A bank lost another mortgage because they made an error in recording their mortgage-- as is all too common, they attached the wrong legal description. However, in this unusual case, the bank caught the error before anybody else and applied to the court to get the incorrect legal description fixed, but a judge still voided it.

In reading the facts of the case, I thought the court got it wrong, resulting in a very unfair decision. See what you think.

In this bankruptcy case, In re Simmons, the mortgage lender, Full Spectrum Lending, made its mortgage loan to a Mississippi homeowner. In the mortgage document itself, the correct address parcel ID number are included. However, they attached an incorrect legal description to the mortgage document, and recorded it.

Full Spectrum later assigned the mortgage to Bank of New York Mellon, which later discovered the error. They filed a case with the court to have the deed reformed to show the correct legal description. On the same day, they filed a lis pendens, which included the correct legal description.

One month later, the homeowner filed for bankruptcy.

When a bankruptcy is filed, the bankruptcy trustee takes ownership of the debtor's property as if they bought it from the debtor. If an ordinary buyer of the debtor's property would be able to have a lien invalidated because of some flaw in the lien, the trustee can also have that lien wiped out, so that there's more money to pay off the creditors with valid liens.

Here, the trustee became aware of the incorrect legal description on the mortgage, and applied to the bankruptcy court to have the mortgage voided.

Naturally, BNY Mellon objected. After all, they had applied to the court to get the problem fixed a full month before the bankruptcy was filed, and they had filed a lis pendens to give notice to the world that they were seeking to have this mortgage fixed so that it would show the correct legal description.

But despite the bank's protest that they had applied to fix the defect in time, the bankruptcy judge wiped out the mortgage, based on its interpretation of Mississippi's lis pendens statute.

Mississippi's lis pendens statute states:

When any person shall begin a suit in any court, whether by declaration or bill, or by cross-complaint, to enforce a lien upon, right to, or interest in, any real estate, unless the claim be founded upon an instrument which is recorded, or upon a judgment duly enrolled, in the county in which the real estate is situated, such person shall file with the clerk of the chancery court of each county where the real estate, or any part thereof, is situated, a notice containing the names of all the parties to the suit, a description of the real estate, and a brief statement of the nature of the lien, right, or interest sought to be enforced.

The court interpreted the phrase "unless the claim be founded upon an instrument which is recorded" to be an exception which prohibited the filing of a lis pendens in a situation where a claim is based on an instrument which is recorded. Finding that BNY Mellon's attempt to reform the legal description was based on a recorded instrument, the court found that the lis pendens was prohibited by the statute and therefore invalid and not effective at preserving the mortgage at least until the court in the reform action had a chance to issue its decision in that case.

I think the judge's interpretation must be wrong.

I think what the statute is saying is that if your claim in your suit is expressed in something already recorded so that the world has proper notice of the claim, including the property it concerns, you do not have to file a lis pendens.

Here, the incorrect recording does not have the correct legal description, and therefore the bank was properly concerned that anyone interested in the property would not have notice of their potential interest. How else was BNY Mellon supposed to provide notice of their potential interest in the property? The bankruptcy judge does not say.

* * *

The court noted that even if it had not struck down the bank's attempt to fix the mortgage based on the lis pendens statute, it would have struck it down because the bank's attempt to fix the mortgage shortly before the bankruptcy amounted to a "preferential transfer" that the bankruptcy trustee can reverse.

Normally, the term "preferential transfer" refers to payments the debtor makes to creditors shortly before it files bankruptcy. Say that a debtor, Sam, knows he is going to file for bankruptcy. He owes his best friend John $10,000, so he pays him off completely the day before he files. Under the law, this is considered unfair Sam's other creditors, so the bankruptcy trustee can make John pay the $10,000 he received back into the bankruptcy estate so that it can be distributed among all the creditors.

In this case, the court decided that the bank's attempt to turn its defective mortgage into a valid mortgage was an attempt to make a preferential transfer to itself. I am not an expert in bankruptcy law and I did not extensively research the application of the preferential transfer rule in this sort of situation, but I tend to doubt that the preferential transfer rule was intended to apply in a situation like this.

* * *

I think there are other grounds whereby the court could have ruled that the mortgage was still valid. The error in the legal description is somewhat unusual in that the legal description attached to this particular mortgage could not possibly be correct, because the property described is not in the state of Mississippi! The attached property description begins:

All that certain parcel of land situated in the Township of Dingman, County of Pike, and Commonwealth of Pennsylvania...

So, we have a mortgage for a property with a Mississippi address, recorded in Mississippi, with a legal description which obviously describes property in Pennsylvania.

To my thought, this situation is distinct from the more frequent occurrence where the legal description attached to a mortgage is for the wrong property, but it's not obvious from looking at the recording itself that anything is wrong. In that case, you may find out from looking at other documents that the legal description is wrong but you can't tell but just looking at the document itself. Here, it's very obvious from just looking at this mortgage document that the legal description must be wrong!

So I wondered if the court would make that distinction, and perhaps treat the situation more like a situation where the legal description was simply missing, because in both situations, the document obviously does not contain the correct legal description.

As I discussed in an article last week, an incorrect legal description may have different legal consequences depending on the county, because some counties index legal descriptions and others don't. In a county that indexes legal descriptions, a title search may not be expected to even look at documents with incorrect legal descriptions, and so a court may rule that they fall outside the chain of title, even if there are other elements within the document that indicate that it might have been intended to apply to the subject property. But here, unlike the case I wrote about last week, there was no legal description index in the county. In other words, a searcher would not be eliminating this document from the scope of their search because of the incorrect legal description without looking at the legal description.

I've also recently discussed how a legal description that is entirely missing on a recorded document may have an entirely different legal effect than an incorrect legal description-- it will depend on the state. Some states have statutes that flatly state that certain recorded documents must have legal descriptions, period. If the state does not explicitly declare documents without legal descriptions to be valid, a court is probably going to look at the rest of the document and make some determination as to whether the property can be identified with enough certainty as to give the document the desired legal effect. Courts will look for previous court rulings as to whether an address or a tax or parcel ID or other information on a document sufficiently identify a property and give the document effect.

As it turned out, the court didn't even come close to making this distinction. According to the court, the law in Mississippi is that the absence of the correct legal description makes a mortgage ineffective in providing notice of the mortgage as to a bona fide purchaser, or in this case, a bankruptcy trustee-- even though the court cited no Mississippi statute that requires this, and there are prior Mississippi cases, brought up by the bank, that arguably indicate otherwise.

All in all, I do not think this mortgage should have been voided. Yes, the lending bank or whoever did its paperwork was sloppy and they recorded an obviously flawed mortgage. But the bank holding the mortgage (not the same bank that recorded the defective mortgage) ultimately did what it should have done-- it tried to fix the problem. Perhaps the bankruptcy trustee wouldn't have even become aware of the defect if the bank hadn't tried to fix it. At any rate, the result seems unduly harsh for the bank. Nobody in this case disputes that the homeowner intended to mortgage their property, and mortgage debt is generally subject to elimination in bankruptcy under current law. Now, with the mortgage eliminated, the debt will likely be discharged in the bankruptcy.

What do you think?

A Stunningly Bad Court Decision on Affiliated Business Arrangements

Slade E. Smith — Wed, 04 Dec 2013 04:07:40 EST

In a stunning decision, the Federal 6th Circuit Court of Appeals has ruled that under RESPA, sham affiliated business arrangements are legal. Apparently referrers of settlement service business, prohibited by RESPA from receiving kickbacks for referrals, can now cash in on referrals by setting up shell businesses which serve no other purpose than to distribute money for referrals to the referrer, There's no longer any need to make the affiliated business even look like a bona fide business with employees, an office, and work being performed.

Can this decision possibly be correct? I certainly do not think so. I think the court missed something that was right under its nose.

In the case, Carter v. Welles Bowen, the plaintiff, Erick Carter, had alleged that the affiliated business that supposedly provided the title services for his real estate purchase-- Welles Bowen Title, co-owned by Chicago Title and the owners of Welles Bowen Realty-- was just a sham, a shell company with no meaningful function other than to funnel money from Chicago Title to the owners of Welles Bowen Realty in return for referrals of title business.

This arrangement, according to Carter, amounted to Chicago Title paying Welles Bowen Realty a kickback for referrals. Providers of settlement services, including title companies, are prohibited from paying kickbacks for referrals under the federal Real Estate Settlement Procedures Act, or RESPA. Violators are subject to civil penalties of up to three times the charge for the services, and possible criminal penalties as well.

There was a lot of reason to believe that Welles Bowen Title was a sham, if the allegations are taken at face value According to Carter, Chicago Title did all the substantive title-related work-- performing the title search, conducting the underwriting, curing any title defects, and handling the closing and escrow. Welles Bowen Title did none of this work, despite the fact that many of these tasks would typically have been performed by a non-affiliated title agency. Yet Welles Bowen Title still reaped the same share of the title insurance premium that a non-affiliated agency that did all the typical tasks would garner.

Welles Bowen Title allegedly didn't even have its own employees or its own office space-- that was all supplied by Chicago Title or its corporate parent, Fidelity National Financial. And how could it possibly have much of its own? The company had been formed with a capital investment of only around $30,000.

What's more, virtually all of the work supposedly done by Welles-Bowen Title was for Welles-Bowen Realty customers-- it was all work referred to it by Welles Bowen Realty, in other words. Of course the work was actually done by Chicago Title.

The agency charged with administering RESPA had made it clear through a policy statement that sham affiliated businesses would not be tolerated, and had formulated a list of ten criteria that it would used to judge whether a particular arrangement was a sham. The ten criteria corresponded to the factors that allegedly made Welles Bowen Title a sham-- paltry capitalization, a lack of an independent location or employees, and other factors all pointing to a general one-sidedness in the arrangement in favor of the referrer of business, a deal too good to be true for one side and a terrible deal for the other... unless the value of referrals was taken into account.

But according to last week's appeals court ruling, HUD was never allowed to evaluate affiliated businesses by these criteria, or require them to satisfy any other test of its legitimacy. The court said that an affiliated business arrangement only needs to meet three bare requirements explicitly listed in the statute in order to be given safe harbor from RESPA's anti-kickback provisions. Those requirements are:

the arrangement must be disclosed to the client
the client must be free to reject the referral
the person making the referral cannot receive any thing of value from the arrangement other than a return on the ownership interest in the arrangement.

To have an additional requirement that the arrangement not be a sham amounted to a fourth, government-agency-imposed requirement not in the statute, according to the court. An agency is not allowed to create such additional requirements, the court ruled. "[A] statutory safe harbor is not very safe if a federal agency may add a new requirement to it through a policy statement," the court said. Therefore, the sham test was ruled invalid, and Welles Bowen Realty's relationship with Welles Bowen Title was ruled to qualify as an affiliated business arrangement, without even considering the characteristics that would seemingly indicate that it was little more than a conduit for referral money.

Was the court right that a government agency can't impose a new and different requirement on par with those in a statute? Probably, unless the statute authorizes it-- agencies are allowed to make rules and regulations, but only to "fill in the gaps" within the statutory framework. But in this case, it's very arguable that the requirement that affiliated businesses not be shams is right in the RESPA statute-- in the statutory definition of an affiliated business arrangement. RESPA defines an affiliated business arrangement as

...an arrangement in which (A) a person who is in a position to refer business incident to or a part of a real estate settlement service involving a federally related mortgage loan, or an associate of such person, has either an affiliate relationship with or a direct or beneficial ownership interest of more than 1 percent in a provider of settlement services; and (B) either of such persons directly or indirectly refers such business to that provider or affirmatively influences the selection of that provider.

There's no question that affiliated businesses can be legal if they meet the requirements of the statute. But to even be an affiliated business arrangement in the first place, the affiliated business must be "a provider of settlement services". In the arrangement at issue here, there seems to be a strong argument that Welles Bowen Title was not actually providing the settlement services in a meaningful way. Chicago Title was providing the settlement services in all material respects, performing all the substantive work and providing the facilities where the work was performed.

This is not my original legal argument. Courts that have previously examined allegations of sham affiliated business arrangements have found that HUD's policy statement was clarifying what constitutes a legitimate provider of settlement services. (In fact, one such case was cited in the lower court's decision in Carter v. Welles Bowen, but for other reasons.) This kind of reasonable interpretation of a statute is precisely the kind of "filling in the gaps" that government agencies typically are and should be allowed to do. But in its decision last week, the appeals court did not even acknowledge the argument that the "additional requirement" they disallowed was actually just a requirement that the statutory definition be met.

But the appeals court ruling is what it is, and the decision is binding on the federal district courts in the 6th Circuit-- Kentucky, Michigan, Ohio, and Tennessee. At least in these states, if you are a referrer of title business, you can apparently now set up your affiliated business arrangement without any capital contribution at all. The office and employees for the venture can all be provided by your title company partner. There doesn't have to be any pretense that the venture is handling any business other than the business you refer to it. In short, it doesn't even have to pretend to look like a real, stand-alone business.

This is a decision that cries out for a fresh look from the Supreme Court.

For workers, the title industry recovery may be over almost before it began

Slade E. Smith — Mon, 18 Nov 2013 14:23:04 EST

Welcome to another recession, title industry workers! While the profits and stock prices of the big title underwriters have risen in recent months to their their highest levels since before the housing crash, the companies are laying off title workers, not hiring them.

It's no secret that the number of residential refinance transactions is down sharply in 2013-- while mortgage interest rates are still historically very low, they've been low for so long that most everybody who was interested in refinancing has already done so. Plus, interest rates have crept up a bit. Home sales are up from last year, but not enough to pick up the slack from the refinance slump.

Fewer refinances equates to fewer orders of title insurance for refinances. Still, the refinance bust has not been a total disaster from the title insurers' perspective... refinance orders are the least lucrative orders for them, so with fewer of them, and with purchase orders and commercial orders generally holding up, a greater percentage of the companies' orders are more lucrative residential purchase transactions and commercial orders.

Other factors have further benefited the title insurers. Claims losses continue to moderate as the disastrous fallout from the housing bubble continue to diminish in the rear view mirror. And the companies' investments have continued to do well in a favorable market. Combine all these factors, and even during the refinance slump, the big four title underwriters have been posting robust profits.

The line-level employees of these companies do not appear to be participating so much in the good times, however-- or should I say former employees?

Fidelity National Financial's CEO, George Scanlon, proudly told investors of the 'good' news on the company's third quarter earnings conference call: the company was quickly and proactively cutting employees even as the company's title insurance business had another "strong" quarter:

The third quarter was another strong quarter for our title insurance business. The market has made a noticeable shift to a purchase-dominated market, as the level of refinance activity has come down dramatically. We generated a 14.2% adjusted pretax title margin, nearly equal to the 14.4% title margin in the third quarter of 2012, despite a 15% decline in closed orders. The combination of a 23% increase in the fee per file and nearly 1,650 staffing reductions since the middle of June helped offset the decline in order volume. As we enter the seasonally slower time of the year, we have made additional reductions of approximately 300 positions in the first 3 weeks of October.

First American made similar reductions in employees, according to its Q3 earnings press release:

In response to lower refinance activity during the third quarter, headcount was reduced by 715 employees, including temporary staffing.

Stewart, in sanitized corporate-speak, indicated in its third quarter earnings press release that it too was looking at trimming title workers from its payrolls:

"As newly opened title orders decline, we are actively managing employee costs in the title segment to counteract the expected revenue decline."

In the corporate world, loyalties generally run to shareholders, not so much to employees, who are seen as expenses to be eliminated whenever possible, even when a corporation is quite profitable. If these corporations felt they would need these workers in the near future, they would probably not lay them off, but they evidently do not see a pickup in orders coming in the near term.

The Title Industry: The Ethical Rock in the Cesspool of Mortgage Finance?

Slade E. Smith — Fri, 28 Dec 2012 15:42:41 EST

Last year, a senior vice president at First American made the following claim:

In my opinion, during the boom years leading up to the real estate crash, government regulators, lending institutions, appraisers and ratings agencies, loosened their risk management criteria or relaxed their standards of ethical business conduct. The title insurance industry did not.

The claim was made by S.H. Spencer Compton, senior vice president and special counsel at First American Title Insurance Company, New York division. The claim was made in an article published in the New York State Bar Real Property Law Journal, entitled Underwater Underwriting: Title Insurance in the Post-Lehman Era. Compton went on to say:

That said, as in every period of economic decline, there was an increase in embezzlements by title insurance agents and even a bankruptcy filing by the holding company of one of the largest title insurers arising out of the misuse and loss of funds entrusted to its 1031 Exchange division. Nonetheless, the crucible of trust created by the due diligence and subsequent issuance of title insurance products backed by the deep reserves of Fortune 500 insurance companies remains unbroken and largely unblemished.

Compton characterized "Wall Street and its related service industries" as "drunks facing their families after an all-night bender." So he had no trouble seeing failings and excesses in the housing and financial meltdown.

He just could not find failings and and relaxed standards in his own industry.

The only relaxed standards in the title industry that this First American executive could cite were things that happened at another title underwriter (LandAmerica) that is no longer in existence, and the bad acts of agents. In other words, in all the excesses of the housing bubble, First American and the other remaining "Fortune 500" title underwriters-- the only ones that apparently matter!-- did nothing to damage the "crucible of trust created by the due diligence" of those big underwriters.

To be sure, the four remaining large title insurers should be congratulated for making it through the housing meltdown intact. But I have to question whether this "crucible of trust" remains intact-- if it ever existed in the first place.

I wonder, for instance, how Compton would argue that "due diligence" was not relaxed during the boom years, when Compton's own company, along with its competitors, began issuing title insurance with no title search at all! The title search is the cornerstone of due diligence in the title insurance industry. How is eliminating title examinations from title underwriting not a loosening of risk management criteria? Does Compton really believe that the due diligence for title insurance is not weakened when underwriting consists of credit reports and statements made by the borrower? [See Bank of America Sues First American for Over $500 Million, Source of TItle, 3/17/2010]

Then, there's the small matter that Compton didn't even acknowledge that banks were suing his own company for hundreds of millions of dollars over denied claims on those no-search title policies, as was the case at First American as Compton wrote this article. I've read the complaints of Bank of America and KeyBank in their multimillion dollar suits against First American, and while an argument can and has been made that First American was legally justified in denying the claims, it's hard to reconcile headings in KeyBank's complaint such as "FIRST AMERICAN'S BAD FAITH SETTLEMENT PRACTICES" with "crucible of trust". [See First American Still Haunted by No-Search Title Policies, Source of Title, 11/15/2012]

And this is not the only time where I've seen "bad faith" and a title insurer's name closely linked recently. Perhaps motivated by the passage of tort reform laws which limit their potential liability from punitive damages in many jurisdictions, title insurers appear to be increasingly aggressive in denying claims, to the point where courts are not only finding that the title insurers improperly denied claims, but that they failed to operate in good faith in doing so. A Wisconsin appeals court, for example, recently upheld a $1M award of punitive damages against First American for denying a claim despite knowing it had no reasonable basis to do so. [See How to Turn a $40k Loss into a $1M Loss, Source of Title, 10/16/2012]

Perhaps a more blatant example of bad faith in resolving a claim came earlier this year courtesy of Old Republic subsidiary Mississippi Valley Title, which had the bright idea of resolving claims arising from a title fraud by subdividing a tract in violation of local law and conveying to its bank policyholders unsellable lots. This aggressive strategy, which was crafted to technically fulfill the insurer's duty under the policy at minimum cost, provided no benefit whatsoever to the policyholders and was roundly batted down by the courts and ruled not to have been in good faith. [See Too Clever by Half, Source of Title, 12/17/2012]

None of these things are compatible with Mr. Compton's claims about the high underwriting and ethical standards of the major title insurers, including the one that employs him. It appears to me that the title insurance industry has a ways to go to live up to the high praise that Compton gives it.

Edwards v. First Am: good news for independents, a bust for me!

Slade E. Smith — Thu, 28 Jun 2012 14:01:31 EST

And here I was all excited because I thought there was GUARANTEED big news to write about today.

Well, so much for the notion that our little industry might make headlines for once. The Supreme Court did not reach a decision in the RESPA Section 8 class action case First American v. Edwards. The "decision" consisted of nine words: "The writ of certiorari is dismissed as improvidently granted."

With the Supreme Court ObamaCare decision being released at the same time, I think it is safe to say that there will not be a lot of ink spilled in the national press over this decision. This is still newsworthy in the title industry, however, in that the 9th Circuit Court of Appeals decision in favor of Edwards stands, along with a couple other appeals court rulings, as the highest court rulings on the general matter.

To review, Edwards alleges that she obtained title insurance from a title agency that was effectively paid an illegal kickback for referrals through a partial ownership arrangement between the agency and First American that overvalued First American's stake in the agency. Edwards made no allegation that she was overcharged, that the title insurance she obtained was defective, or that she was personally harmed in any other way. The defendants in the case, led by First American, asked the courts to dismiss the case, claiming that without claiming an injury to herself, Edwards lacked standing to bring a lawsuit.

The 9th Circuit Court of Appeals decision in the matter of Edwards' standing held that a plaintiff need not allege an injury to themselves in order to bring suit against a settlement service provider under RESPA's anti-kickback laws. The plaintiff only needs to allege that the settlement service provider violated those laws. According to the court, the injury is, in effect, established by the law, not by any particular damages established by the plaintiffs. As far as how much a plaintiff can collect, RESPA establishes the amount by establishing statutory damages: three times the amount of the charge for the affected service. This amount substitutes for a showing by the plaintiff attempting to establish how much they have been damaged.

I see this decision (or lack thereof) as the best possible outcome here for the independents who favor a strong interpretation of RESPA Section 8 in order that undue referrer influence and control in the title industry be kept as low as possible. With the makeup of the court, a broad decision in favor of Edwards was not in the cards here. As I have said before, I do not think Edwards has a particularly compelling case; the nature of the arrangement alleged does not contain the obvious conflict of interest inherent in many affiliated business arrangements, that makes these arrangements troubling to me. If an underwriter wants to buy a title agency outright or pay any amount for any stake in an agency, I think it should be allowed to do so, because there is no unhealthy misalignment of the natural interests of an underwriter and an agent with respect to insuring title-- both have an interest in ensuring good title, all else equal-- and therefore there is no need to regulate such arrangements. If the court was inclined to issue an affirmation of the statutory damages in RESPA Section 8 or a sweeping endorsement of the concept statutory damages overall, surely it could have chosen a more compelling case such as Carter v. Welles Bowen. Actually, one can hope that the court punted on this case because they have decided to take up that case next session-- but that is dreaming on my part!

Why the court took up the case in the first place remains a puzzle. Were the conservatives on the court planning to use the case to gut class actions, but one of the conservatives defected? Did the liberals on the court have a majority, but not want to write a decision in support of Edwards, given her weak case? All speculation on my part, but when the Supreme Court gives you one sentence non-decisions, what can you do but speculate?

Demotech's escrow fraud analysis doesn't pass muster

Slade E. Smith — Fri, 08 Jun 2012 22:29:09 EST

This week, title insurance rating agency Demotech published a study, "Escrow Theft: Today's Challenge in Title Insurance", in which Demotech compares title insurance claims ratios for each state from 2004 to 2011 to its own ranking of the strength of each state's title agent regulations. From that data Demotech concludes that states with stronger title agent regulation have lower rates of escrow theft.

Unfortunately, the study falls well short of actually showing any link between title agent regulations and lower losses due to escrow theft.

Demotech's data is not strong evidence for its claims, even taken at face value

Demotech originally conducted similar analysis in 2003, saying that it originally conducted the analysis because it "observed the impact of escrow theft on the industry and noticed a significant correlation between the strength of states’ title agent regulations and loss ratios reported by title underwriters. In light of this observation, Demotech undertook a study to analyze the relationship between the strength of state regulations and loss ratios for title insurance."

There are statistical methods to analyze ranked data, but Demotech did not present such analysis, providing no graphs, nor any measures to indicate that the data actually supports their conclusion. Instead, it took averages of the average of the groups of states for each regulation strength ranking value from zero to six, and bases its conclusion on these seven averages of averages. Calculating averages of averages like Demotech did is a questionable analytical step, but it enabled Demotech to report that the group of states with the lowest regulation had a relatively high average claims ratio of 9.32%, when the actual cumulative claims ratio of those lowest ranked states was only 6.25%-- lower than the cumulative claims ratio of the two groups with the strongest regulation (6.78%)!

Below is a scatterplot of the data:

Looking at the data, it appears there is some correlation between a higher state ranking and a lower claims ratio-- notice how dots nearer the top tend on average to be a little left of the dots nearer the bottom. The data set is small, which would tend to weaken the statistical significance of any detectable patterns. But is the correlation significant?

Not necessarily.

Just because there is some detectable correlation between two variables in a data set does not mean that there is a significant cause and effect relationship between the variables, especially in small data sets. In the graph below, I ranked the states alphabetically and graphed their alphabetical ranking against their claims ratios. Does the distribution of the data points look pretty similar to the graph above?

The data appears to show that states with names that start with letters late in the alphabet have claims ratios that tend to be lower than states that start with letters early in the alphabet. In fact, alphabetical rank is about as good a predictor of a claims rate as Demotech's regulatory ranking. But obviously, there is no cause and effect relationship; otherwise, Alabama could fight escrow fraud by simply changing its name to "Zalabama"!

Simply put, the correlation shown in Demotech's data is weak-- weak enough that it could be suspected to be entirely coincidental, even if we accept the basis for the rankings and all of Demotech's assumptions. As I'll discuss below, those assumptions further undercut Demotech's conclusions.

Demotech's ranking of state regulation of title agents is subjective

In the process of trying to analyze if "strong" regulations are superior to "weak" regulation in preventing escrow theft, Demotech had to make very debatable value judgments regarding what is strong regulation and what is weak regulation. For example, Demotech gave no weight whatsoever to state regulation that requires title agents to be a licensed attorneys, despite elsewhere stressing that a "barrier of entry to the profession" was "of primary importance" in its analysis.

In Kentucky, anyone who can fog a mirror can be a title agent tomorrow-- they do not regulate title agents. In Massachusetts, you apparently need to fog a mirror AND have a law license. Demotech ranked them equally in the weakest group. In its reasoning for ranking Massachusetts as a 0 on its scale of 0 to 6, Demotech says:

Massachusetts is rated a 0 because it has no express regulations pertaining to title agents, escrow agents, or the closing process. While Massachusetts imposes a de facto regulation by limiting closing activities to attorneys, such an enforcement mechanism is ill-defined and the scope of this limitation is currently disputed. An essential element of a strong regulation is clarity. Although Massachusetts is similar to Connecticut in that attorneys generally act as title agents and escrow agents, the lack of clarity of Massachusetts’ regulation renders it very weak.

Other states that require title agents to be licensed attorneys were given low regulation scores. In Connecticut, where Demotech says there is no dispute that only attorneys can be title agents, they only rank the state as a 1 out of 6, the second weakest possible ranking.

In many other respects, the methodology used to rank the states in term of the strength of the title agent regulations seems subjective to the point of near uselessness. In fact, any such ranking would be so subjective as to be really "for entertainment purposes only".

It perhaps would have been somewhat more useful to isolate one key regulation at a time, separate the states with that one regulation from the states without it, and then see if any patterns emerged.

Demotech did not consider differences in title insurance rates among the states

Consider two hypothetical states, State A and State B. The states are virtual clones of each other-- both states have identical laws governing title agents and are therefore given the same ranking by Demotech. The transaction volume in each state is virtually the same, and so is the claim volume. There is one difference however: in State A, the title insurance rate is set twice as high as State B, so twice the amount of premiums is collected. Since the claims ratio is premium amount divided by claims amount, the claims ratio in State A is half that of state B.

Obviously, the difference in claims ratios between State A and State B is not due to better regulation of title agents that is preventing escrow theft, since the states' regulations governing title agents are identical. Only the title insurance rates are different. The difference in claims ratios is solely due to title insurance rates.

A real world example: of all states, Missouri had the highest claims ratio during the study period, according to Demotech. But Missouri also appears to have among the lowest title insurance rates in the country. New York has among the lowest claims ratios, but their title insurance rates are among the highest. Missouri's claims ratio looks worse than it actually is, and New York's looks better, for reasons that have nothing to do with title agent regulations.

Laws, customs, and other factors can significantly affect claims rates

Title agency regulations are simply not the only state laws that affect claims rates. A good example just recently is the situation in North Carolina, where the largest underwriter was experiencing unusually high claims rates due to state law regarding construction liens, which I happened to write about just a few days ago.

But state laws are not the only thing that varies from state to state. In its analysis, Demotech explicitly states:

Demotech operated under the assumption that almost all states require title insurance agents and title insurance companies to make an exhaustive search of public records and that those individuals performing title searches had reasonable experience and conducted a reasonably thorough search. Accordingly, Demotech assumed that variations in loss experience from state to state are based upon dynamic occurrences rather than static occurrences. In short, we assumed that each state would incur losses inherent in the business of title insurance and that such losses would be relatively consistent from state to state. Therefore, any variation in the loss ratios would correspond with an occurrence apart from a typical title insurance loss, namely escrow theft. Limitations on the readily available public information on the title insurance industry preclude verification of this critical assumption.

This assumption about the quality of title search being relatively equal everywhere may very well be false. In some states, land records are online for all counties, and searches can be performed out of state, overseas, or even by automated systems like NextAce. In other states, few counties are online, and title searching is mostly performed locally. In a few states, searchers must be licensed.

Any study of this kind will require assumptions... but an abundance of "critical" assumptions will just completely undermine any conclusions, and that is the case here.

Other variables probably affect claims ratios. On a hunch, I graphed peak to trough house price declines against claims ratio, suspecting that states where house prices had fallen a lot would tend to have higher claims ratios, due to more fraud during the bubble, greater losses per mortgage, more foreclosures, and more folks looking for deep pockets to bail them out of losses. Surprisingly to me, there was almost no correlation. Since the period under study dates back to 2004, it could be that all the bubble area premiums that title companies collected have offset the losses since then.

Small sample size

While we're talking about sample size: in a small state, one or two clever criminals can really rack up the claims and skew the data! Mississippi was one of only two states with a claims ratio over 20%, but that was likely mostly due to one criminal enterprise, the Evans brothers' fraud, which caused tens of millions in losses. Perhaps there is lessons for Mississippi legislators to learn from that crime that involve changes to its title agency regulations, or perhaps it was an isolated incident unlikely to be repeated under existing law.

Confirmation bias?

Confirmation bias is a well known and proved tendency of human beings to interpret information in ways that confirms what they believe. Demotech explicitly says that when it undertook the study, it did so believing that there was a correlation between stronger regulation and lower claims ratios. When the analysis requires so much subjective judgment, there are hazards in anticipating a particular outcome of the analysis. There is a danger of the analyst subconsciously noticing that a state has a high or low claims ratio, and ranking that state higher or lower on strength of regulation in order to bolster the apparent correlation.

Conclusion

By no means am I dismissing strong title agent regulation. The NAIC Title Insurance Agent Model Act, which Demotech seems to favor, seems to be a sensible starting point for title agent regulation. But time after time, we have seen title agents meet every state licensing requirement and then turn around and succumb to the temptation of stealing from their escrow account, even in states which Demotech says have strong regulations. I do not see anything in this paper to convince me that title agent regulations necessarily have much of an effect on that particular problem.

How the major home price indexes could be completely misleading

Slade E. Smith — Mon, 09 Apr 2012 15:33:06 EST

Releases such as the Case-Shiller home price index and the CoreLogic Home Price Index, which both report data on average sales prices for residential properties, provide some insights into the strength and direction of the housing market. But there's something unique about the nature of the current housing market that could cause the headline numbers reported by the major house price indexes to be distinctly misleading.

The residential housing market is at present a distinctly two-tiered market-- the two tiers being the distressed market (REO sales, short sales, etc.) and the non-distressed market (voluntary sales by private property owners). The average sales price for distressed sales is a steep discount to the average sales price for non-distressed sales... in some markets, the average discount is or has been 50% or more at times!

While the major home price indexes often break down the numbers into both distressed sales and non-distressed sales, the headline numbers they report are based on averages across all sales. In a two tiered market, this creates a possibility that the house price index can decline, seemingly showing weakness in the housing market, even when average prices in both the distressed and non-distressed markets are increasing.

Let me demonstrate with a hypothetical example. Suppose in May we had the following data:

100,000 non-distressed sales at an average sales price of $250,000
100,000 distressed sales at an average sales price of $150,000

Crunching the numbers, 200,000 total homes would have sold in May for a total of $40 billion dollars. The average sales price for May would be $200,000.

Then, suppose that in June, average house prices for both distressed and non-distressed properties rose 2%. And since the non-distressed market was strengthening, banks decided to release and sell significantly more of their foreclosure inventory. We have the following data for June:

100,000 non-distressed sales at $255,000 (up 2% from May)
130,000 distressed sales at an average sales price of $153,000 (up 2% from May)

230,000 total homes would have sold in June for a total of $45.39 billion dollars. The average sales price for June would be $197,348. That's would be down over 1% from May. In other words, in this scenario the headline numbers reported by the house price indexes would show that home prices had fallen in June despite the fact that the average sales price in all areas of the market had increased in June.

This seeming paradox can happen because the overall home price indexes represent the average selling price of apples and oranges, and the mix of what is sold can change. When the ratio of distressed to non-distressed sales changes, month to month comparisons of overall average selling prices are quite literally a comparison of apples to oranges.

This seemingly far-fetched scenario is not far-fetched at all; in fact is it likely to occur. Banks have significant discretion over when they release their inventory to market and are likely to quickly take advantage of any strength in the market to sell more of their property.

By the way, just the reverse of this hypothetical scenario can happen-- the housing market can weaken, causing banks to sell less of their foreclosure inventory, shifting the overall mix away from lower priced distressed sales, which will tend to boost overall average sales prices even when both distressed and non-distressed markets are weakening.

So, if you follow the trends and read the reports the monthly house price indexes, be sure to pay close attention the movement in average sales prices of distressed properties and non-distressed properties, rather than just the overall average.

When your cable goes out, you start a title agency

Slade E. Smith — Wed, 14 Mar 2012 02:49:26 EST

When your cable goes out*, you start a title agency.

in early 2001, Lisa Rotolo got her title agent's license and opened her own firm.

When you start a title agency, you help close shady deals for free.

[Rotolo], the title agent key to Southwest Florida's expansive flipping fraud scheme acknowledged Monday that she helped close millions of dollars in fraudulent deals, though unlike others in the conspiracy only for her standard fees.

When you close shady deals for free, you leave a paper trail in the hands of scumbags.

Rotolo assisted in [fraudulent] transactions by allegedly preparing dual sets of HUD-1 settlement statements, sending falsified versions of those settlement statements to lenders, and disbursing money to co-conspirators.

When you leave a paper trail in the hands of scumbags, scumbags snitch on you.

Craig Adams fulfilled his four-year-old bargain with government prosecutors on Monday, testifying against the remaining defendants accused of taking part in the flipping fraud conspiracy that he masterminded.

When scumbags snitch on you, you lose your legitimate business and go to prison.

Rotolo told jurors that 90 percent of the deals her firm Diamond Title closed at that time were legitimate.

Despite her cooperation and her guilty plea, Rotolo will serve at least some prison time for her crimes-- the judge made it clear to her at her plea hearing that probation was not an option for her because of the seriousness of the crimes to which she admitted.

When you lose your legitimate business and go to prison, you make a hot mess of your life.

...Rotolo — a sharp contrast to the cerebral and collected Craig Adams, the mastermind of the scheme — took time to compose herself before she was able to describe her role to a panel of jurors.

Looking pale and exhausted in a red sweater and black slacks, the 48-year-old Rotolo told the jury how she helped doctor closing statements so that Adams, his lieutenant Rich Bobka and their associates could defraud lenders by inflating sales prices and misrepresenting the source of their downpayments.

Don't make a hot mess of your life... get DirecTV**!

*I have no idea whether Lisa Rotolo's current mess occurred because her cable went out... but it's probably as good an explanation as any for committing a crime for which you 1.) get next to nothing, and 2.) are nearly certain to get caught.

**or, better yet, don't close shady deals for free-- or for a cut of the "profits", for that matter!

Bank logic: logical, but maybe not so ethical

Slade E. Smith — Mon, 05 Mar 2012 16:36:16 EST

How do you "change perceptions" of yourself if you're a bank? Apparently, by hiding the fact that you're a bank!

In an article yesterday in the Palm Beach (Florida) Post, "Agents advised to keep 'bank-owned' quiet" , it was reported that Wells Fargo's REO division, Premier Asset Services, which sells REO properties owned by Wells Fargo and other banks, specifically instructs real estate agents not to disclose in listings that its properties are bank-owned. Other banks have apparently adopted similar policies. Apparently, under this policy, even when there is a category in the Multiple Listing Service for bank owned property, the agent will choose another category, and the owner is listed as "Owner of Record", rather than the name of the bank.

When asked about the policy, a Premier Asset Services vice president-- a real VP, not a robosigner pretending to be VP-- acknowledged that this was indeed the company's listing policy in jurisdictions where such a disclosure is not specifically required by rule. If a local MLS requires the disclosure that the property is bank-owned, they abide by the rule, according to the VP. Otherwise, they prefer not to disclose.

The VP said that bank-owned properties suffer from a "negative connotation" and that Wells Fargo "want[s] to change the perception" that bank-owned properties are always damaged goods. He says that they want people to come out and see the properties without these pre-conceived notions. They want to be seen as "no different than the neighbor who is selling their home," according to the VP.

I bet they do! Distressed properties sell at a 29% discount to non-distressed properties, according to the latest data from RealtyTrac. That probably makes Wells Fargo very sad!

The thing is this, though: this negative perception did not just magically appear out of thin air and fall unfairly on the banks. It's not just the houses that have a bad reputation; it's the banks themselves, thanks to the corner cutting in foreclosure and the uncertainty in title out of foreclosure which results from it. There is the perception, based firmly in reality, that you're safer buying a property from a regular homeowner.

Banks hiding information from potential buyers to benefit themselves is not going to fix that perception. Concealing that a property is bank-owned from potential buyers just furthers the banks' bad reputation that contributes to the steep discount that bank-owned properties already suffer compared to what the non-distressed market commands.

Wells Fargo says that they have recently instituted an aggressive policy of fixing up their properties before selling them. All fine and good, and maybe over time they can fix the perception that their properties are run down and have maintenance problems. But banks need to recognize that they need to repair their own reputations as well. This will require time and a sustained commitment to doing the right things.

Oh, and by the way-- to the credit of regional MLS that serves the Palm Beach area, this little strategy has been put to a halt. As of Tuesday (tomorrow), agents in the Palm Beach area will now be specifically required to disclose that a property is bank-owned. Hopefully, other MLSs around the country who do not require this will follow suit.

As a side note, this reminds me of the fairly recent California court case in which the real estate agent failed to disclose to the buyer that the sale would actually be a short sale, subject to rejection by the seller's lenders. [See Realtors' Duty to Disclose in a Short Sale, Source of Title Blog, 11/27/2010] The court ruled that the agent had a duty to disclose the short sale. It's not quite the same issue as here-- in fact, failing to disclose a short sale is probably far more serious on an individual basis than what happened here-- but there are some similarities, in that it seems that a lot of people in the real estate industry have the mentality that it is fair to hide material information from buyers unless there is a black-letter rule somewhere that specifically requires it to be disclosed.

More on the Vieiras-- would their case have been a winner in Arizona?

Slade E. Smith — Wed, 29 Feb 2012 13:51:28 EST

In a blog yesterday, I wrote about the Vieiras, a family which appears to be on a legal crusade against Wells Fargo over a mortgage made on their second home in Nevada which the Vieiras say was fraudulent because the appraiser hired by Wells Fargo inflated the appraisal. (If you haven't read my blog from yesterday, this blog will probably make more sense if you read that one first.)

I've since looked into the Vieiras' case a little more. I learned that the Vieira's case has already been decided against them (I should have thought that the courts might have acted since the writeup I linked to was published-- duh! Certainly, no definitive adverse outcome in the courts would deter these single-minded crusaders!) As it turned out, the Vieiras took their case all the way to the Nevada Supreme Court, and lost every step of the way on summary judgment-- the decision against the Vieiras was clear to the courts based on the facts alleged by the Vieiras, without the necessity of a trial.

In its short and sweet decision, the Nevada Supreme Court said:

[The Vieiras] failed to provide sufficient evidence to support their claims. As
the district court properly noted in its order, appellants failed to show any basis for reliance or causation based on respondents' conduct, as was necessary, because appellants entered into the contract to purchase the home well before the appraisal occurred and nothing in the contract provided for cancellation of the contract based on failure to obtain financing or for an appraisal value lower than the sale price.

I read through the Vieiras' brief to the Supreme Court. [You can find that document and other documents the Vieiras have posted on their website, wellsfargomortgagefraud.com.] Though the Vieiras' argument is still not convincing to me by a long shot, I did find it interesting that they did find a similar case in another state (Arizona) where a court ruled in favor of the homeowner-- against the appraiser, not the bank-- that the lender's appraiser owed a duty of care to a homeowner, and to the extent that an appraiser inflated an appraisal, they would have failed to deliver on that duty.

The framework of the case was similar to the Vieiras. Shari Sage signed a contract to purchase a home in Scottsdale, Arizona for $605,000. Sage's purchase contract was a standard form Arizona Association of Realtors "Residential Resale Real Estate Purchase Contract", which states that the buyer's obligation to complete their purchase is "contingent upon an appraisal of the Premises by an appraiser acceptable to the lender for at least the sales price".

She applied for a loan with Security Mortgage. On the advice of the seller, Sage asked Security Mortgage to use Blagg Appraisal Company as the appraiser and they agreed. Sage signed a form requesting that Security provide her with a copy of the appraisal. Blagg came in with a value of $620,000 based on a finding that the home was 2,440 square feet. The loan was made, and the sale closed.

In fact, the square footage of the home was only 1,871 feet-- a fact revealed when Sage tried to refinance a year and a half later. Sage sued Blagg for negligent misrepresentation over the flawed appraisal.

The trial court that heard the case ruled against Sage. Sage could not show that she had relied on the appraisal in purchasing the property, and further, could not show that the appraiser owed them a duty, the court ruled. The trial court relied heavily on the appraisal itself, which stated that the appraisal was "for use by [the lender] for a mortgage finance transaction only". The appraisal was a short form appraisal, "a quick estimate for lending purposes", according to the words on the appraisal.

But the appeals court reversed the ruling that a bank appraiser owes not duty of care to the borrower. In its 2009 decision, the court said in part:

We reject Blagg's argument that an appraiser owes no duty to the buyer/borrower ... because the loan transaction by which the buyer/borrower acquires the funds to purchase the home is distinct from the purchase transaction... [T]he appraisal the lender orders typically is the foundation of the home purchase transaction. Although Blagg argues that, as the appraiser, he served only the mortgage/lending transaction and not the separate transaction by which Sage purchased her home, we believe that distinction is without difference. A lender in Security's position will not finance the buyer's purchase if its appraiser concludes the home is not worth the financed amount. Likewise, in many cases, as here, a form residential purchase contract empowers the buyer to cancel the contract if the appraisal falls short. Whether the purchase will be made undisputedly hinges on the appraisal; we would blink at reality to conclude otherwise.

There's definitely some differences in the facts of the Vieira case and the Sage case-- most notably, the language in the purchase contracts. As was noted above, in the Vieira case in Nevada, the Supreme Court found "nothing in the contract provided for cancellation of the contract based on failure to obtain financing or for an appraisal value lower than the sale price." The Vieira's contract, which was apparently also a standard contract, apparently contained no language that the contract was "contingent on an appraisal", as the Sage contract did. I am not familiar with all the state contracts, so maybe that clause is just an Arizona thing that is not common elsewhere-- I have not investigated.

Even that being the case, I don't know that I agree with the Sage decision in Arizona. To repeat, the clause in the contract says that the contract is "contingent upon an appraisal of the Premises by an appraiser acceptable to the lender for at least the sales price." In the case of the Sages, this clause seems to have at least arguably been satisfied. An appraisal by someone acceptable to the lender made an appraisal, and it was for at least the sales price. If the buyer is supposed to be protected by the appraiser, shouldn't the appraiser have to be acceptable to the buyer also?

Nevertheless, the conception that I had that the bank appraisal was there to protect the bank and not the buyer seems to not apply in at least one state.

Occupy Protester Almost Makes Bank CEO Look Sympathetic

Slade E. Smith — Tue, 28 Feb 2012 15:38:06 EST

I saw a story that Occupy protesters were picketing outside the home of the CEO of Wells Fargo today. Little did I know that after I read the story, I'd actually almost think that the CEO ought to be picketing one of the protesters!

What caught my eye was the fact that the protester interviewed for a story in the San Francisco Business Times was protesting because she had been foreclosed on her second home:

San Leandro residents Donna and Nuno Vieira and their 7-year-old son Leonardo each carried a placard discussing an element of their story about losing a second home in Reno, Nev., through a Wells Fargo foreclosure.

Donna Vieira says a fraudulent appraisal meant her Reno house was $243,000 under water on the day she took out her Wells Fargo mortgage. The Vieira family later lost the home to foreclosure after pouring $350,000 into a down payment and monthly mortgage payments.

That sounded like an awful lot of coin for a typical 99 percenter to plunk down for a second home! So I was intrigued by the fact that someone who was apparently living the lifestyle of a rich person just a few years ago was picketing amongst the Occupy protesters.

After researching the matter, I found a writeup on the Vieira's story, entitled Profiles: Family Won't Give Up. I found out that this was a purchase mortgage-- the Vieiras are claiming they bought a home for $243,000 more than it was worth, and blame a fraudulent appraisal by the bank who made their mortgage, instead of blaming themselves for overpaying.

The thing is, when the bank gets an appraisal, that's for the benefit of the bank-- to make sure that the value of the collateral covers the amount of money they are lending. It's the bank that is damaged by an inflated appraisal-- if the borrower defaults, as happened in this case, the collateral is not worth as much as it was purported to be, and the bank will have a larger writeoff. The borrower saw the property and knew what the price was. If they had paid cash, there wouldn't have been a bank appraisal.

Should they have known all this? Well, there's the fact that the Vieiras were appraisers themselves, owning a "successful real estate appraisal business"! I find it hard to believe that the Vieiras were ignorant of the fact that some appraisers would work with the numbers to ensure that an appraisal would conform to a desired purchase price.

But anyway, the Vieiras stopped paying on their mortgage-- not for any financial hardship or inability to pay, but because the appraisal was allegedly inflated:

"Knowing the mortgage was fraudulent, we just couldn't keep on paying," Nuno said, adding that they stopped making mortgage payments in September of 2009.

This is what a classic strategic default looks like:

"Despite the foreclosure, both of us still maintain near perfect credit scores," Vieira said, "but due to something that is completely not our fault, we can't take advantage of the low mortgage rates now and switch to a 30-year fixed. It just creates so much uncertainty in our life."

They can still send their son to private school-- bet that isn't cheap!

They send Leo — a first-grader with a fourth-grade reading ability — to a private school, despite the good public schools in the area. "We can't send Leo [to the public school], because I don't have the time to help him with his homework or to track his progress in school," she said.

And why doesn't she have time for her son, you ask?

Now Vieira spends an average of five hours a day, seven days a week, in a legal fight with Wells Fargo over the mortgage fraud issue.

If the Vieiras' story were presented in a story to highlight strategic default and contrast it with foreclosure out of true hardship, it would not be that remarkable. But that is not the case. The site on which the article appears is entitled "What went wrong: The Betrayal of the American Dream". The article that tells their story is presented as a profile of "those hardest hit by the foreclosure crisis". This is being presented as if I am supposed to feel sorry for the Vieiras!

If folks strategic default, that is their decision-- I wish that people would feel a strong obligation to pay their debts if they can reasonably do so, but if the law allows for it, and it is to their advantage, I can't say that I blame a person for a strategic default. The banks screwed up badly during the housing bubble-- including in their appraisal process-- and I see strategic defaults as chickens coming home to roost in a sense. But when someone overpays for a second home, strategically defaults on their mortgage, and then not only has the audacity to blame the bank for the fact that they can't refinance because of a mark on their credit report, but makes a full time job out of pursuing the bank over a loss that they have already stuck the bank with, I end up almost feeling sorry for the bank CEO. Almost.

Views on the National Mortgage Settlement

Slade E. Smith — Fri, 10 Feb 2012 11:20:50 EST

Disclaimer: The actual final language in the national mortgage settlement is not yet available, so the details in this agreement are yet unknown. The devil, as they say, is often in the details. What information is available comes largely from summaries of the settlement published by the Administration, and as the Administration has a motive to make the deal sound as tough as possible, these summaries have to be viewed with a little bit of skepticism. I tried to read the available information from that skeptical perspective.

With that out of the way, here are my initial thoughts on the national mortgage settlement announced yesterday:

From what information is available, my overall take is that it does not punish the banks greatly. It's clear that the $26 billion headline number overstates the true financial impact of the settlement on the banks. The majority of the $26 billion dollars in the settlement is for modifications from which the banks derive benefits: they prevent defaults and foreclosures, and preserve value in second mortgages that the same banks own in many cases. Some of this modification activity may have occurred without the settlement. Only about $6 billion of the $26 billion will be in the form of cash outlays by the banks.

I personally don't think it's a bad thing that the deal does not extract a severe financial toll on the banks. We bailed out the banks at great cost because their failure would have caused an economic crisis even more severe than the one we have just faced. It would be absurd to then turn around and extract such a huge toll over robosigning as to put the banks back to the brink of collapse. I did want to see robosigning and the other foreclosure abuses addressed, but I didn't want the cure to cause another financial crisis! I think the settlement amount strikes a reasonable balance in this regard. The amount of the settlement is more than a "rounding error" to the banks, as some have characterized it.

Some aspects of the deal appear to be pretty weak, however. For example, one facet of the agreement touted by the Administration is a set of national servicing standards that apply going forward, along with independent monitoring, paid for by the banks, that supposedly will help ensure that the abuses of the past do not occur in the future. But, at least on robo-signing, there does not appear to be much new in the summary of the "new" standards that was not the law already in virtually every state.

For example, according to the summary of servicer standards provided by the Administration, foreclosure affidavits "must be accurate as to the amounts owed and the standing of the bank/servicer to file for foreclosure and must be based on the signor’s personal knowledge of the facts." Bu in what state was that not the case previous to now? "The affiant must actually review the bank/servicer records before signing." Don't affidavits themselves already state that the signer has personal knowledge of the facts contained in the affidavit or something similar?

"Affidavits shall be signed in the presence of a notary." Wasn't this already the law... everywhere?

And missing is anything which explicitly bars surrogate signing-- signing someone else's name with their permission. Is that permissible under the settlement?

The settlement summary says that "banks/servicers shall not pay incentives to employees or third parties to encourage speed in the signing of affidavits." Okay, but actually I do not recall any instance where that exact thing was done. The banks simply used the document mills that could churn these documents out the fastest, and the document mills simply employed people who were willing to sign all day without looking at the documents.

Perhaps when the final settlement is published, some of these issues will be cleared up, but for now I am skeptical-- I suspect that the Administration simply wanted a laundry list of requirements to publish here.

One of the criticisms of the settlement, which I think has some merit, is that by short-circuiting the investigative process into robosigning, it may help the banks hide other, more important abuses that may have been uncovered in the process of those investigations.

For example, some observers suspect that the purpose of the many and often robosigned "lost note" affidavits during the foreclosure crisis has not been due to neglectful archiving of mortgage documents, but rather to cover up defective transfers of mortgages into securitization trusts. To the extent that these mistakes are revealed or concealed, it could be the difference between banks and investors eating the losses on the mortgages that may or may not have been successfully transferred into these trusts, according to this theory.

And if the banks are systematically deceiving the investors regarding the true nature of these transfers, crimes may have occurred. But according to this theory, since the robosigning will now not receive a full investigation, investigators have now lost this golden opportunity to conduct discovery which would likely reveal why these affidavits were used so routinely, and clues as to the true nature of the banks' motivation to use them will not be uncovered.

On the other hand, there are things in the settlement that are not so generous to the banks.

It has long been reported that the settlement will provide no criminal immunity, but this fact has been lost on many critics of the settlement. If you do not like the fact that bank executives have not been hauled into court in handcuffs over the foreclosure abuses of the banks, blame the Attorneys General, blame the laws... but don't necessarily blame this settlement. To the extent that criminal investigations and prosecutions are under way, they are not affected by this settlement. For example, the indictment of the former president and founder of DocX that was just handed down in Missouri will be unaffected.

MERS was not protected in the settlement. All the county lawsuits alleging that MERS illegally avoided recording fees are untouched and will proceed. A lawsuit filed by the Delaware Attorney General alleging that MERS violated the state's deceptive business practices laws goes untouched, and will also proceed. MERS has stated that its member banks have indemnified it on these claims, so if MERS loses, its member banks will presumably be on the hook for the damages.

Private lawsuits go untouched. Unfortunately, a lot of consumer lawsuits into robosigning are apparently filed with the sole intent of settling, so I have not seen a lot of significant consumer class actions involving the foreclosure mess proceeding to the satisfying conclusion of a trial and a decision, but every single homeowner who had a viable case yesterday morning still has a viable case this morning.

In conclusion, the mortgage settlement is a mixed bag. It will provide a number of former homeowners with a check they would have not otherwise gotten. It will give some homeowners a chance to refinance that they would have not gotten otherwise. It will provide some other borrowers with a break on their principal. But it will not solve the deep, systemic flaws in our mortgage finance system. It will not stun the banks into reforming their ways. It won't remove the stumbling blocks to foreclosure in states with huge backlogs due to their own particular problems. It will not heal the housing market.

Observations from my short career as a real estate investor

Slade E. Smith — Wed, 01 Feb 2012 12:20:18 EST

In late December, my brother and I bought a house to fix up and "flip" on the north side of Columbus, Ohio. This is the house:

The house was owned by HUD, which means that the former owner probably defaulted on an FHA mortgage and was foreclosed. I didn't look back through the chain of title to try to figure out the circumstances of the foreclosure or to investigate whether there ws any shenanigans in the foreclosure process. Maybe I should have, being familiar with some of the horror stories about botched foreclosures around the country over the past couple years. We got a title insurance policy, but if our foreclosure sale somehow got tossed out Bevilacqua-style, it would be financially painful for us, as much work and money we've put in the place since buying it. But I don't think that sort of scenario is likely in Ohio, so I'll accept the risk.

The house is in the neighborhood in which I was born and lived the first twenty or so years of my life. This development was built in the early to mid 1960s and represented the finest in Central Ohio white-bread middle class tract home living back in its heyday, before the Columbus suburbs began to explode in the 70s and 80s, spurred in no small part by desegregation and white flight. My dad still lives with my stepmother in the house he bought new in '62, but he is the exception; most homes in the neighborhood are on their third or fourth owner at least. Nowadays, the neighborhood is a little dated looking and rough around the edges-- 1960s tract housing stock is not old enough to be charming, but yet old enough to be run down if it hasn't been maintained well. The yards, approaching a quarter acre apiece, are a little bigger than the typical post-war lots in neighborhoods closer to downtown, and the houses are a little roomier on average too. This particular house, checking in at a little north of 2000 square feet with 4 bedrooms, 2 1/2 baths, a full basement and a 2 car garage, is on the large end of the spectrum for the neighborhood.

The foreclosure crisis has not bypassed Columbus, and most blocks in this development have one or more foreclosure properties. The government agencies favor selling their seized properties to owner-occupants, but most owner-occupants still need a mortgage, and it's not easy to get a mortgage these days, especially on a foreclosure. If no owner occupant buyer steps up, the government agency will accept bids from investors. On the second try, my brother and I had our bid of just under $50,000 accepted-- far under the $85,000 price at which HUD had the home listed. Such discounts are not unusual; inventory has apparently far exceeded investor demand to this point, and those sparse investors out there are apparently putting in lowball offers and hoping to get lucky, it seems. My brother and I were doing the same.

Having pooled our cash to close the deal without a mortgage, the transaction went off without a hitch. We got to work on the place right after Christmas. The simple stuff, my brother and I planned to do ourselves. We hire pros for stuff like electrical work or hardcore plumbing or installing new windows and doors.

The finished basement had water damage and some mold; at some point we figure the power must have been shut off and the sump pump couldn't do its thing. The basement had to be gutted back to the concrete blocks. Once we got the wallboard off, we were pleased to see that the walls were actually in great shape and showed no water damage, so after the big demolition job and trashing it out, it mostly just needed a coat of paint on the walls and floor. The basement has been primarily my job, and I have to admit I underestimated it a little bit. Gutting a full finished basement and hauling all that debris up a flight of stairs with a dust mask and goggles on will kick your butt a little! I am pleased to say that with it trashed out and with a new coat of paint now, it looks great and the job is basically done.

In the main living area, basically every surface-- ceilings, walls, floors-- needed refinished. My brother did most of the painting, but we hired a guy to paint all the trim to save some time, and also had him paint the outside stucco. There was a lot of prep work, scraping off old wallpaper and borders, and fixing close to five decades of minor damage to the wallboard throughout the house. The chimney was damaged, allowing water to leak into a paneled wall around the fireplace in the den. As we removed the paneling, it became obvious that termites had once been at work on the sodden paneling. Fortunately, the termites only were active on the room side of the plastic moisture barrier in the wall and there wasn't any current termite activity, so the studs were okay and we just had to replace the wallboard. Most of the ceiling and wall paint is now done. Tile, carpet, and refinishing some hardwood floors are tasks still to be done. We're having pros do the tile and carpet installation, that'll be a couple weeks yet.

We had all new windows put in, which was a major expense, and had a new water heater put in. New or nearly new appliances will go in the kitchen; we've got em but aren't ready to install them because we haven't replaced the counter top yet. Several doors needed replaced; that's halfway accomplished. New doorknobs, window treatments, lighting fixtures, faceplates, faucets, plumbing back to the walls in kitchen and baths-- about halfway done there. Sprucing up the yard-- halfway done, just need some decent weather on a weekend!

I'm probably forgetting some things, but you get the picture. When we are done-- hopefully by the end of February-- this house will be in move-in-and-don't-have-to-do-a-thing-for-ten-years condition.

Our estimate of $20k for repairs was a little optimistic; it looks like we're going to come in at a little more like $23k. So our cost basis is going to be approximately $73k. I'd estimate that the house would sell quickly in the $110-$115 range, judging by sales of other comparable houses in the area. Subtract out taxes, utilities, insurance, realtor's commission, etc. and I'd estimate we are likely going to each profit in the range of $15k, maybe a little more. Obviously, there are risks involved here that could affect our profit-- the market could fall further, a sale could fall through, maybe nobody puts in an offer, and so forth, but I think my estimates are fairly conservative.

My brother and I are just basically doing this as a side endeavor-- we both have regular jobs and are getting this house prepared for sale in about two months, without really stretching ourselves too much time-wise (though my brother might disagree-- he has two young kids). An investor who does this kind of rehab flip as his or her full time occupation could easily do the same work in two months. If they could find and turn five rehabs like this per year, that would be $30k x 5, or $150k per year, with maybe a month or two break in there somewhere to take it easy. Not too shabby, in a low cost of living city like Columbus!

The main impediment to such a livelihood is capital related-- unless a flipper can completely self finance, they'd have to take out loans or find someone to put in money, which would both cut into profits and add complications. Working in the flipper's favor are low interest rates and low purchase prices.

This has been a fun experience. I live within five miles of this house, so it is easy to get over there in my spare time and do a couple hours of work in the evenings and on weekends. It's satisfying to see the changes for the better that result from your own labor. We've had a couple nice neighbors give us a thumbs up, people seem to appreciate that the neighboring house is being fixed up, and I am sure they look forward to getting a new neighbor.

I keep pretty close track of the housing market, both locally and nationally. There is obviously still reasons to be cautious in the housing market-- the latest national housing indexes have been showing that house prices are continuing to fall; it is widely known that there is still a large overhang of "shadow inventory" consisting of properties that are already in the foreclosure process or likely will be at some point, which will eventually hit the market; unemployment is still high; mortgage credit is still hard for many to get; and so forth. However, I think the prices that can be had on distressed properties, at least in my area, are now providing a high reward, low risk value proposition for investors, even amateur investors like me, and therefore I would be surprised if not shocked if prices on distressed properties went much lower.

The white collar criminal mentality

Slade E. Smith — Thu, 08 Dec 2011 14:48:55 EST

The white collar criminals who are attempting to profiteer from the foreclosure crisis are just like other white collar criminals... they just don't get that they are criminals, just like pickpockets, burglars and muggers.

Geoffrey Goldman, an owner of a real estate investment business in upstate New York who was just sentenced to 4 to 12 years in state prison this week for a fraudulent multi-million dollar foreclosure rescue scheme that caused many innocent victims to be foreclosed and evicted, seems to exemplify this mentality.

"I am a good person," said Goldman at his sentencing, "and although I've committed crimes, I'm not a criminal."

Goldman's victims would probably dispute that.

Goldman and his co-conspirators used a business owned by Goldman, Rivertown Investments, to defraud various lenders, homeowners, and title insurance companies. Co-conspirators acting on behalf of Rivertown allegedly lured distressed homeowners into signing title over to the company by promising to lease the homes back to the distressed homeowner, with a promise that the homeowner would be able to regain title in the future, and that equity built during the lease period would be saved for the homeowner.

Once Rivertown had title to the properties, straw buyers under the control of the scheme's masterminds would purchase the properties from Rivertown, obtaining fraudulent mortgages with false statements inflating the straw buyers' incomes to finance the sham transactions. The straw buyers would then quickly sign their deeds over to a holding company in Rivertown's control. Griffon Title, a title company owned and controlled by Goldman, was used to facilitate the transactions involved in the scheme, concealing the true nature of the transactions from lenders, homeowners, and their title underwriter.

The scheme involved at least 105 properties in New York, Pennsylvania, and New Jersey between 2003 and 2008. Rivertown defaulted on its promises to many of the homeowners properties, resulting in numerous evictions and cases where willing homeowners were unable to repurchase their homes as promised.

Meanwhile, the co-conspirators used profits from the scheme to buy trips to Europe and the Caribbean, vehicles, jewelry, a wine locker, and gambling sprees at casinos.

The crimes caused millions of dollars in losses to the victims, and untold stress and hardship. But at his sentencing, Goldman had the gall to point out that some of the affected homeowners were able to live rent free in their homes as the mess was being sorted out-- as if he was the only one not profiting from the situation.

I'm sure that Goldman truly believes that he is not a criminal... but he is deluding himself. He stole far more money than most common thieves do in their criminal careers.

Enjoy your time in state accommodations, Mr. Goldman. It sounds like you've earned it.

Title searchers and statutory damages

Slade E. Smith — Mon, 28 Nov 2011 14:47:24 EST

Today, the United States Supreme Court heard oral arguments in the RESPA case Edwards v. First American, which I will be reading shortly. At issue is not just RESPA; the broader issue is the power of Congress to enact laws which specify statutory damages, which relieve would-be plaintiffs of the burden of proving concrete and specific damages to themselves in cases where an entity has engaged in a practice which Congress has outlawed. While I have some issues with the Edwards case in particular, I'd like to say thank you to those who have worked on Edwards' behalf to try to prevent RESPA from being gutted-- and argue one reason why title searchers in particular should care about the issue in the RESPA case.

I'm not a title searcher myself, but I think I've been around searchers long enough to understand the legitimate reason for the frustration of many title searchers over their (lack of) power to collect from non-paying clients or clients who fail to pay them on a portion of their bill. The main gist of the frustration usually is the fact that the unpaid balance is too small for a lawsuit to make financial sense. But that in no way means that the unpaid balances are insignificant to the searcher's business. In fact, if a searcher has the misfortune of being stiffed by several clients, the unpaid balances can add up to an amount that is material to whether they are profitable, or even whether they can afford to stay in business.

In many cases, Congress has passed laws providing groups, usually consumers, with rights to statutory damages-- amounts established by law that may have only slight relation to a person's actual, provable damages-- from violators of certain laws, particularly laws where violations tend to spread small amounts of harm over large numbers of people. In situations where these laws apply, consumers have incentive to pursue lawsuits where they would otherwise have little to no incentive because their damages would be too small to make it worthwhile. In many instances, the situations where these laws apply are similar to the situation faced by title searchers in that the individual amounts of damage may be small, but the aggregate damage is large.

RESPA is such a consumer protection law. In a RESPA decision in 2002, a judge in Georgia succinctly explained the purpose of laws like RESPA:

Consumer protection statutes like RESPA are designed to remedy and prevent harm arising from practices that injure many people but are not, in most instances, sufficiently damaging to outweigh the cost of litigation. Often, these statutes provide for a private right of action and attempt to encourage litigation by allowing "statutory damages." Statutory damages relieve litigants of the burden of having to prove an exact measure of pecuniary harm arising from a violation of their rights under the statute. They also provide litigants with a bounty for acting in the public interest.

That last rationale for consumer protection laws may be off-putting for some, because we have been conditioned as a society to look down on "ambulance chasers" or people who sue for amounts that seem to exceed the damages they have suffered, and this has made us suspicious of trial lawyers and people who sue in general. But the fact is that when a person sues someone who has violated the law, that person is helping to enforce that law, which provides a benefit to the public. A law that is never enforced has no teeth and might as well not exist, and entities which are regulated by such a law can ignore it with impunity.

Consumer protection laws like RESPA are intended to align the incentive to sue with the public interest in private law enforcement. In the case of RESPA, Congress set the damages in RESPA so that a plaintiff could collect an amount that could possibly be far in excess of the amount of damages to themselves that they could reasonably prove (an overcharge). This was intentional, despite the claims of some RESPA opponents who are arguing that Congress intended only to assess damages based on the amount a person was overcharged.

It should be easy for title searchers to see how those who sue violators of the law are serving the public interest. When a stiffed title searcher sues a deadbeat client, the deadbeat client has to endure the time, money, and hassle of defending the claim... or they have to pay the bill. In either case, it takes resources away from the deadbeat to expand its business and to cheat more title searchers out of compensation for their hard work.

In fact, searchers often recognize the public service of lawsuits against deadbeats. When a searcher posts a message in our forums indicating that they have taken legal action against a deadbeat, the post usually garners a few "attaboys" or "attagirls". Any misgivings we have about litigiousness in general seems to be overcome by our recognition that by fighting the deadbeat, our fellow searcher not only fights for themselves, but for all of us.

It's only too bad that there is no RESPA equivalent for title searchers! If title searchers could sue deadbeats for three times the amount of their total bill, there would be a whole lot fewer deadbeats!