Who owns your home?
That seems like a pretty straightforward question. But the answer might not be as clear-cut as you think.
A U.S. District Court judge in Cleveland tossed out 14 foreclosure cases Oct. 31 on the grounds that the bank suing to repossess the properties, Deutsche Bank National Trust Co., didn't actually own them. Deutsche Bank held debt securities that were linked to the mortgage loans on the properties, not the mortgages themselves. And the judge ruled that a security backed by a mortgage is not the same as a mortgage.
That's a distinction that could make all the difference in the world -- especially to the millions of Americans facing potential foreclosure in our crumbling housing market.
Most people in the U.S. buy houses using mortgage loans from banks and other lending institutions. In theory, the firm that issues your mortgage owns your property until you pay off the loan. In practice, however, that's not how the modern mortgage business works.
Instead, mortgage lenders typically pool collections of loans and then sell off pieces of the portfolios to Wall Street investors in the form of mortgage-backed securities. Basically, mortgage-backed securities enable lenders to spread the risk so one institution isn't on the hook when a few people can't make their monthly payments.
Overall, the development of mortgage-backed securities has been a boon for Americans. By reducing the risk of writing mortgages, lenders have been encouraged to offer more loans, enabling countless people who'd previously been shut out of homeownership to get financing.
As a result, we've seen an explosion in mortgage securities. In 1981, there were $367 billion of these debt instruments outstanding; by the end of last year, there were roughly $6.5 trillion. Mortgage-related securities account for nearly a quarter of today's total U.S. bond market, more than any other debt sector, including Treasuries and corporate bonds.
Naturally, as the number of mortgage securities has increased, so has their complexity. There are simple "pass-through" securities, where the payments on the mortgages in a pool go directly to the investors. There are more complicated collateralized mortgage obligation securities, which essentially are bonds that carry different maturity dates and repayment rates based on the quality of the loans in each pool. Then there are "strips," or stripped mortgage securities, which intricately tear apart the loans and create separate payoffs based on the interest and principal payments generated by the pool.
The trouble is, these securities are now so complex that it's become nearly impossible to know who actually owns the underlying properties in a typical mortgage pool. The mortgages are like sticks of chalk pounded into powder. When the dust settles, no one can tell what the original pieces looked like.
This, in effect, is why Judge Christopher A. Boyko of the federal District Court in Cleveland dismissed those foreclosure cases. Boyko had asked Deutsche Bank to produce documentation proving that the company held the mortgages on each property it wanted to seize. But after reviewing the paperwork, Boyko ruled that "none [emphasis his] of the assignments show [Deutsche Bank] to be owner of the rights, title and interest under the mortgage at issue."
Essentially, Boyko found that the people who believed they owned the rights to the mortgages couldn't prove it. And without a legal owner, there was nobody to foreclose on the properties, even if the borrowers had violated the terms of their loans. Case dismissed.
Boyko's decision challenges one of the central tenets of mortgage-backed securities: The holders have the right to foreclose on delinquent properties. Since the ruling, other Ohio judges have thrown out more than 50 other foreclosure cases on similar grounds.
If the ruling holds up, it's sure to reverberate far beyond the Cleveland area, which is already reeling from one of the highest rates of foreclosure in the nation. California cities been hit as bad or worse, including Stockton, Sacramento, Oakland, San Bernardino, Riverside, Los Angeles and Long Beach. A congressional report issued last month estimated that there could be a nationwide wave of as many as 2 million foreclosures by 2009. It's hard to see how this won't end up in a legal showdown.
Mortgage-backed securities have proved far too valuable to banks, investors and homeowners for the entire class to be legislated out of business. But a ruling like this has been overdue. The structure of these securities needs to be reexamined so investors can get a clearer understanding of what they're buying. Ultimately, this could result in an overhaul of our financial laws and the mortgage market as a whole.
But until that happens, if you're having trouble making your mortgage payments, before you start preparing for the worst, you might want to do a little digging and see who actually owns your home. Because you never know, it may turn out to be no one.
Eric J. Weiner is the author of "What Goes Up: The Uncensored History of Modern Wall Street as Told by the Bankers, CEOs, and Scoundrels Who Made It Happen."