Mortgage Crisis Act II
What You Need to Know... A Primer
"Homeowners can only be foreclosed and evicted from the homes by the person or institution who actually has the loan paper... only the note-holder has legal standing to ask a court to foreclose and evict. Not the mortgage, the note, which is the actual IOU that people sign, promising to pay back the mortgage loan.
"Before mortgage-backed securities, most mortgage loans were issued by the local savings and loan, so the note didn't go anywhere. It stayed in the offices of the S&L down the street.
"But once mortgage loan securitization happened, things got sloppy... they got sloppy by the very nature of mortgage-backed securities.
"The whole purpose of MBSs was for different investors to have their different risk appetites satiated with different bonds. Some bond customers wanted super-safe bonds with low returns, some others wanted riskier bonds with correspondingly higher rates of return.
"Therefore, as everyone knows, the loans were "bundled" into REMICs (Real Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then "sliced and diced"... split up an put into tranches, according to their likelihood of default, their interest rates, and other characteristics.
"This slicing and dicing created "senior tranches" where the loans would likely be paid in full, if the past history of mortgage loan statistics was to be believed. And it also created "junior tranches" where the loans might well default, again according to past history and statistics. (A whole range of tranches was created of course, but for the purposes of this discussion, we can ignore all those countless other variations.)
"These various tranches were sold to different investors according to their risk appetite. That's why some of the MBS bonds were rated as safe as Treasury bonds, and others were rated by the ratings agencies as risky as junk bonds.
"But here's the key issue. When an MBS was first crested, all the mortgages were prisitine... none had defaulted yet, because they were all brand-new loans. Statistically, some would default and some others would be paid back in full... but which ones specifically would default? No one knew of course. If I toss a coin 1,000 times, statistically, 500 tosses the coin will land heads... but what will the result be of, say, the 723rd toss? No one knows.
"Same with mortgages.
"So in fact, it wasn't that the riskier loans were in junior tranches and the safer ones were in senior tranches... rather, all the loans were in the REMIC, and if and when a mortgage in a given bundle of mortgages defaulted, the junior tranche holders would take the losses first and the senior holder last.
"But who were the owners of the junior-tranche bond and the senior-tranche bonds? Two different people. Therefore, the mortgage note was not actually signed over to the bond holder. In fact, it couldn't be signed over. Because, again, since no one knew which mortgage would default first, it was impossible to assign a specific mortgage to a specific bond.
"Therefore, how to make sure the safe mortgage loan stayed with the safe MBS tranche, and the risky and/or defaulting mortgage went to the riskier tranche?
"Enter stage right, the famed MERS... the Mortgage Electronic Registration System.
"MERS was the repository of these digitized mortgage notes that the banks originated from the actual mortgage loans signed by homebuyers. MERS was jointly owned by Fannie Mae and Freddie Mac (yes, those two again... I know, I know: like the chlamydia and the gonorrhea of the financial world... you cure 'em, but they just keep coming back).
"The purpose of MERS was to help in the securitization process. Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially where the digitized mortgage notes were sliced and diced and rearranged so as to create the mortgage-backed securities. Think of MERS as Dr. Frankenstein's operating table where the beast got put together.
"However, legally... and this is the important part - MERS didn't hold any mortgage notes: the true owner of the mortgage notes should have been the REMICs.
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