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Mortgages, in theory, part 5 of N
blaisepascal
So we've discussed a bunch of complications which can happen with mortgages when everyone is above-board and acting in good faith to make things work (acting in their own self-interest, which may not be beneficial for everyone, mind you, but in good faith).

What happens when people aren't acting in good faith? What happens if someone is acting fraudulently?

Cases 1-2: Fred fraudulently sells some property...

So Fred goes to Henry, and sells Henry a house at a great price, for cash, without a mortgage involved. This comes as a real surprise to Hortense, who actually owns the house.
Fiona has a house with a mortgage, and a year later, sells it to Hank, also for cash without a mortgage involved. Fiona neglects to pay off her mortgage but takes the money and runs. The first Hank hears about the mortgage is when Bob forecloses and kicks him out. Hank is, naturally upset.

The reason why it was important for me to specify that these sales were without a mortgage is because otherwise the scam won't work -- because while Henry and Hank may be suitable marks for this sort of fraud, the banks aren't. They know that this sort of scam is centuries old, and the law has worked to make them hard to pull off.

The Statute of Frauds, a 17th century English Law (and thus a part of US legal history), requires that every change of ownership of real property must be in writing, and similar laws require that every legal claim of an ownership right in a piece of real property must be recorded as a public record. Thus Henry could have gone to the Courthouse and checked the title on the property and found that Hortense actually owned it. Hank may not know to do that, but Barbara would check before lending Hank the money.
A mortgage counts as a legal claim of an ownership right, and thus needs to be recorded as well. If Hank went to Barbara for a mortgage, Barbara would have found about the mortgage, and would have refused to lend Hank the money until the mortgage was cleared up.

That, by the way, is the reason that there is a "closing" in a house sale. Henry has a house with a mortgage from Bob. Hyacynth wants Henry's house, and has talked to Barbara about financing. Barbara won't lend Hyacynth the money to pay Henry until Bob lifts the mortgage, which he won't do until Henry pays him, which he can't do until Hyacynth pays him, which can't happen until Barbara lends her the money, and we're back to where we started. So at a closing, Henry, Hyacynth, Bob and Barbara get together at one place with a bunch of paperwork (deeds, mortgage releases, promissory notes, mortgage leins, contracts, etc) and checkbooks. After verifying that all the contingencies of the sales contract are met, the four start signing things and passing things around. At the end, Bob has a check satisfying the outstanding balance of his loan, Henry has a check for the remainder, Barbara has a mortgage signed by Hyacynth, and Hyacynth has a deed. And, most likely, everyone has copies of everything they signed.

If you've been carefully reading, you'll note I've said that 'the mortgage' can be sold by Barbara to Thomas to Mike, etc and I've said that 'the mortgage' is a legal claim of ownership and must be recorded as a public record. You might be wondering how it can both be on file as a public record and passed around from lender to investor. The answer is, "it" can't, because "it" isn't an "it". In reality, "the mortgage" is a combination of two things: a loan document, called a "promissory note" (because it's a written note that effectively says "Henry promises to pay Bob..."), and another document which serves as a record of the lender's claim to the property. This second document goes by different names in different jurisdictions. In many places it's a "mortgage lein", and in others it's called a "deed of trust". In either case, they serve the same purpose: to allow the loaner to claim the property in the event of a default on the loan.

Where it's important, I'm going to call the two parts the "note" and the "lein", regardless of the actual form of the two.

Case 3: Fenton forecloses.

So Fenton goes to court, with affidavits claiming that Hillary defaulted on her loan, and Fenton wants to foreclose. Fenton knows the county Hillary lives in is very foreclosure-friendly, so everything goes through really quickly. Pretty soon, Hillary is kicked out of her house, it's sold at auction, and Fenton walks away with the majority of the sale price. The trouble is, Fenton lied to the court about having the note on the house, and is counting on Hillary not being able to convince the court otherwise. A good trick for this is to improperly serve Hillary with notice of the foreclosure, so she doesn't show up in court to challenge it.

Or Fenton finds a judge who feels that homeowners who fight foreclosure are deadbeats and refuse to listen to their challenges. Something like this happened recently when the "Foreclosuregate" scandal erupted. A man in Florida had his house foreclosed, despite not having a mortgage at all. It wasn't a case of intentional fraud -- the bank believed (incorrectly) that his house was in a bundle of mortgages it had bought -- but the same legal protections against fraud should have helped him. Instead the foreclosure went to a judge who handles literally hundreds of foreclosures a day and refused to listed to the "there is no mortgage" argument.

There are supposed to be protections against this. Fenton can be required to prove the he legally holds the note, which means he can be required to present the actual paper with Hillary's signature on it, and a chain of ownership transfers from Mike to him, and he can be required to prove that the note he holds is tied to the lein on the property. If he can't do that, then no foreclosure should happen.

Case 4: Fenton sells a note twice.

This is something which is being suggested as part of Foreclosuregate: Fenton buys a bunch of notes from Bob, Bill, Bruce, Brian, etc on houses owned by Harry, Hortence, Hiroshi, Hubert, Herbert, Hideyoshi, Hypatia, Harriette, Henry, and Hermione. He sells them on, with Trent getting Harry, Hiroshi, Herbert, Hypatia, Henry, and Harriette's, and Thomas getting Hortence, Hubert, Hidyoshi, Hermione, Hypatia, and Henry's. A careful check will show that Fenton bought 10 notes and sold 12, with both Trent and Thomas getting Hypatia and Henry's notes. If tracking of paperwork is lax, it's possible he can get away with this, and it's even possible that nobody will notice for a while.

The way that the paperwork can get lax is if there is a very fluid market in mortgages, especially bundles. While one would expect that the paperwork would get signed and transferred as part of the sale, it doesn't necessarily happen that quickly. A bundle of 100 notes is quite a lot of paper to be pulled from the files, signed off on, and sent to the buyer. By the time it's done, the buyer could have sold the notes again, and so the buyer would barely glance at them before sending them along. The eventual "holder" Trevor or Ichabod could be reasonably expecting the servicer to be notifying him of problems, and doesn't carefully check to ensure that the $50K check he's getting each month for the 80 mortgages actually includes Hypatia's $600. So at the end of the day, when Hypatia stops paying, and Sam notifies the holder he knows about (Trevor), Trevor prepares for foreclosure, and discovers that the note never made it to him, so he contacts Ivan (who should have sent it to Trevor), who doesn't have it either, so he talks to Isabella, who tracks back to Irene, who then discovered that Fenton is no longer in business, so the trail stops there. Meanwhile, Ichabod has the note, and might eventually notice that he's never actually been paid anything from Hypatia. He can foreclose, but Trevor is out what he paid for the note.

I'm sure there are other ways to commit a fraud on the system. I'll think about it and continue this series soon.

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