Q: What do the panelist think of moral hazard question? Are borrowers likely to default in order to qualify for a loan modification?

David Moskowitz: The moral hazard issue has always been a hot topic behind scenes. I personally think that the threat of strategic default is not substantial. I believe that at the end of the day people tend to do the right thing.

Paul Leonard: The moral hazard question often leads to the distinction of responsible and irresponsible borrowers. I think the borrower’s responsibility is not the key to determine the foreclosure crisis’ primary causes. Bad underwriting standards and lending on future appreciation have to be regarded as the starting point of malfunction. Therefore the evaluation of responsibility of borrowers alone is misdirected. Most loan modification programs are too concerned about moral hazard. The basic question is how far are people willing to go – are they going to quit their jobs in order to meet the requirements for a modification? I believe it is possible to construct the programs in a way that mitigates the risk of moral hazard.

James Rhyne: Borrowers can be broken down in the group of people that have knowledge and can scam the system and those that make decisions out of ignorance that results either from cultural norms or simple imitation. This ignorance of  the system works and what may happen if they default on paying their loans made them believe that they can afford to buy a house and made them trust the people that offered the loans. I think we should find a middle ground between putting too many restrictions on people and precluding them from owning a home ever and letting them make their imprudent decisions.

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Q: What percentage in dollar volume of loans can be modified in a way that benefits both borrower and lender/owner?

David L. Moskowitz: I don’t have a percentage, but I know a lot of this is driven by employment and life claims. With these denominators, there is a higher percentage of win-win loans, as we have learned.

Q: Is it unethical or immoral for a borrower to walk away from an underwater home borrowing loan? There was recently a news section about somewhere in Cleveland where many people, even though they knew they were way under water, said that they really believed in the sanctity of their contract and that they were going to continue to pay and not go in default. Why would this be?

David L. Moskowitz: I saw that piece, it was quite compelling. In fact, 60% of underwater customers have never missed a payment. It is just not something that people want to do. I do not really have the psychology on this. People have seen the housing market go up and down and don’t know how they will behave at a high or low point. In the end, it all comes down to affordability: if you can afford to pay, you will.

Nancy E. Wallace: I mostly look at subprime pools, and even in there people are making very steady payments. The loans are 3-400% over the value, and yet they carry on making periodic payments. And we are talking about by far the majority of people in these pools. The large majority of borrowers are making steady payments on interest rates that are so high they cannot refinance. This speaks to the point of people’s willingness to hang on no matter what.

Paul Leonard: I am continuingly amazed by the phenomenon described here: homeownership as a sociological phenomenon rather than just a financial investment. Homes are where people live, where their kids go to school, etc. There is a sense of morality that comes with making your mortgage payment. On the other hands it surprises me that we haven’t seen more people say that they are subject to a foreclosure proceedings when they cannot make their payments anymore. From the people that are underwater, I have been surprised that there haven’t been more who have decided: this is not a situation that is financially good for me.

Laurence Platt: As a lawyer, I think it is interesting that if a borrower was to do that voluntarily, it is very hard for them to get to that next task. Rental housing is scarce and going up in price. There is a bit of a cost-calculus of what is going to happen next.

James Rhyne: That cost-calculus is driven by a lot of ignorance. The current legal system is not giving them a lot of security.
As a footnote, there is a subdiscipline in economics called behavioral economics, which has discovered a lot of non-rational economic behavior. I strongly recommend a book Daniel Kahneman, Nobel Prize winner in economics, called Thinking, Fast and Slow.

David L. Moskowitz: Don’t underestimate the economic calculus that goes into the impact on your family. People want to preserve the stability of their families. This is why co-ownership is so important. This is why people might continue to pay loans even if they are underwater, just because they can. People will rather opt for that.

Paul Leonard: From what limited evidence exists about strategic default, there have been some studies that the most likely strategic defaulters are people with higher incomes. It is not the average Joe, it is those who are most sophisticated about it. I would suggest that if you are counting on being able to qualify for a loan modification on the basis of defaulting, you would be taking a huge risk that you will not get the modification and loose your house. This is another mitigating factor for this behavior.

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James Rhyne, gave very valuable insights on constructing a 21st century information processing system for recording titles. In context of National Registry the most significant issue is transparency. Transparency in the mortgage marketplace is valuable for two reasons: a) valuation of the instrument and b) seizure of the underlying asset can be difficult if the legal standards are not followed.

Any future design must cater to improved access to records. Today, in order to trace a record one has to visit the county where the real property is situated in, while instruments are sold worldwide. Also the prospective design should retain compliance with statute and judicial pronouncements.

Recording, as it exists today, is an incomplete view of what actually happened in the transaction. These voids severely effect the pricing of the instruments. It is interesting today’s records, largely paper documents are manufactured from computer software, making the software very vital for the purposes of analysis. Mr. Rhyne added that, software also enables the production of two forms a) physical and electronic, but the system must work towards ensuring consistency. He stressed on taking practical and pragmatic step to build systems, which allow access to documents instead of waiting for a legislative change.

Requirements of title records vary across jurisdiction. Hence a national registry shall require an economical form of representation of information. Since, in the United States, State real estate law cannot be sidelined by a federal fiat – he suggested creation of some third form of reporting to a national agency. A similar harmonization exercise shall also have to be undertaken for transfer of notes.

Though creation of a future national registry would be an expensive proposition, associated economic benefits justify the exercise. For instance, a uniform identifier shall also contain a large variety of secondary sources of information about the property – reducing the cost of title insurance, reduce risk in real estate transactions and increase efficiency.

The brief questions and answer session addressed the problems with foreclosure. The panel identified that the main problem was political in nature as borrowers should be kept in their homes for obvious reasons. California has created several barriers for foreclosure. Furthermore, the panel reached a consensus that the one-off documentation problem was not the cause of the foreclosure crisis. Indeed, the panel highlighted the issue of uncertainty over the authorization of public records as well as the quality or lack thereof of loans.

In addition, the panel addressed whether there is a benefit to synchronizing loans. It was concluded that there is indeed a benefit and that this hasn’t been a controversial issue in most states. It has been clear that the mortgage follows the note and there is no need for mortgage assignments. However, the interpretation and application of law is changing under lenders who are trying to foreclose.

Prof Wallace, highlighted that right now there is no house price index – representing what is actually happening in the marketplace. Hence making the data incredibly expensive to obtain. Mr. Platt, however emphasized that if the goal was never to foreclose – then why not a have an unsecured loan? On being questioned on enormous costs of foreclosure and therefore need explore alternative, Platt responded that foreclosure is a rare occurrence

Prof. Nancy Wallace of the Haas School of Business, UC Berkeley gave a presentation titled Beyond the Mortgage Electronic Registration System (MERS). She explained the mortgage-securitization process as well as the mortgage supply chain. She posits that the efficiencies from the bond market working electronically have a conflict with the lien market which works on paper. This led to the hope of MERS in order to make the system more efficient.

However, MERS has led to very little transparency over how notes and liens travel down the highway because MERS shows up as the only recorded owner. Furthermore, MERS can look up a true owner but the internal database entry is not the same as the recorded assignment even within MERS. In this way, MERS does not maintain a comprehensive database.

Prof. Wallace articulates that the MERS predicament is a symptom of a recording utility that became too greedy. She put forth three alternative proposals: (1) having a more modest private utility, (2) establish a federal recording system that would accept electronic filings, and (3) invest in new infrastructure for existing land title systems to accommodate electronic recording.

She concluded by stating that there is evidence that significant damage may have already occurred in publicly available real property records. Securitized mortgage markets and the efficiencies they afford require a modern electronic and verifiable lien transfer, recording and assignment system that is consistent with the real property laws of states. Indeed, this will affect the cost of mortgage debt.

James Rhyne, Consultant and Partner at Thematix Partners, just discussed the role of information asymmetry throughout the mortgage creation process. There are two asymmetries, said Rhyne. First, homeowners are not s sufficiently informed about their real estate purchase. Investors also did not have proper information to value the later securitized bundle of mortgages. Rhyne said that these asymmetries need to be addressed both by incentivizing the production of information by those that have it and by encouraging those who need the information to become better informed. The government has been attempting to do the former through regulating what information banks must disclose both with regard to mortgages and financial products. However, says Rhyne, there has yet to be much movement in the area of encouraging consumers to become better informed.

Laurence E. Platt, nation’s leading real estate and consumer finance lawyer, gave a very precise presentation on the issues associated with title recording and transfer in the mortgage market. His address was truly a practitioner’s guide and focused on four points.

The starting point was transfer of enforceable interest. Two pieces of legal documents are relevant for the purposes of mortgage transfers – promissory note and mortgage document. While the note is an actual promise to pay, the mortgage represents an interst in real property. Both these documents are dictated entirely by state law. The Uniform Commercial Code (‘UCC’), accepted by most state jurisdictions has dealt with the transfer of note in two provisions:

a)     Article 3 – applicable when the note qualifies as a negotiable instrument. Transfer in such cases is effected by delivery – actual or constructive and endorsement.

b)    Article 9 – applicable when the note falls short from qualifying as negotiable instrument. Transfer is effected by a purchase agreement that identifies with particularity the note being transferred.

UCC has clarified that mortgage follows the note, i.e. if note is properly transferred mortgage follows. However, Mr. Platt pointed out that a series of questions remain in real property law applicable in different State jurisdictions.

Next, he attended to the Securitization document (‘Sec Doc’) creating a special, sometimes higher standard of effective transfer. The Sec Doc may impose contractual requirements that exceed the applicable state law. The question arises, what shall be the consequences of not satisfying the standard for effective transfer – whether it is legal or transactional. In case of note transfers, UCC contains cures that can be adopted. For instance, if Article 3 is not followed, there exists a safety net in Article 9. However a real problem exists in the area of state property law. A few have argued that the higher contractual replaces the applicable legal standard, i.e. UCC and property law, to become the governing law, nonetheless, as Mr. Platt mentioned there is not enough support for this proposition. In fact he remarked, a mortgage-backed security might be nothing more than a security backed by air.

The other issue he spoke about is a scenario where enforceable interest is acquired but still there is failure to foreclose. This is a major problem in the current crisis and he illustrated by means of an example of Virginia state law. Under Virginia state law, assignment of real property interest is not required. However a recent law introduced a requirement of prior assignment to successfully foreclose. This constitutes a real problem for creditors.

The final step in the enquiry is where does Mortgage Electronic Registration System (MERS) stand? MERS was created to establish stock holding like depository holding only electronic interest. The idea was to make mortgage loans seem like securities. However a numerous problems have surfaced with MERS:

a) Consumer issues: borrowers cant find out who owns the mortgage on their property

b) Local recording office do not receive fee when assignment were not required by law

c) Third party purchasers might not know who owns – nevertheless, it is not a market protection issue but an inherent risk.

MERS sort of acts like a nominee for the lender. If that were so, can it so also act in such capacity in a foreclosure proceeding? A few cases have held no for absence of an actual economic interest.

Finally, he attributed the alleged failure of servicers to record an assignment to the absence of the requirement in State Law.

Mr Benjamin Weber of the Office of the San Francisco Assessor-Recorder (‘SF ASR’) gave a presentation on Reforming Title Recording and Transfer. He explained what land records and recording are and what their existence is intended to do, as well as reviewed the non-judicial process (another route in addition to judicial foreclosures available in California). The Recorder’s Office is charged with certifying documents from a variety of sources. Indeed, a certified copy of land record constitutes constructive notice and performs an evidentiary function. The SF ASR explains the foreclosure process for all to understand, informs the necessary legislative change that updates California law for the modern mortgage market and ensures compliance with laws to protect the integrity of the system. He also talked about MERS which is a registry that attempts to track servicing rights and loans as well as investors’ beneficial rights and loans. Additionally, he summarized the non-judicial process in California which starts with a notice of default, followed by a notice of trustee sale and a trustee’s deed upon sale. Finally, he concluded with some thoughts on future considerations, in particular the use of digital documents and submissions as opposed to paper/scanned documents in order to facilitate the transfer of documents. He posited that this is what recorders are moving towards in California.