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Yale Law Journal: “In Defense of ‘Free Houses'”

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The Yale Law School Journal has published a new article, “In Defense of ‘Free Houses'” (hat tip Deontos), which makes an argument that I wish had gotten an airing when the foreclosure crisis was national news. From the opening section:

When addressing faulty foreclosures, courts are afraid to bar future attempts to foreclose—that is, afraid of giving borrowers “free houses.” While courts rarely explain the reasoning behind this aversion, it seems to arise from a reflexive belief that such an outcome would be unjust. Courts are therefore quick to sidestep well-established principles of res judicata in favor of ad hoc measures meant to protect banks against the specter of “free houses.”

This Comment argues that this approach is misguided; courts should issue final judgments in favor of homeowners in cases where banks fail to prove the elements required for foreclosure. Furthermore, these judgments should have res judicata effect—thus giving homeowners “free houses.” This approach has several benefits: it is consistent with longstanding res judicata principles in other forms of civil litigation, it provides a necessary market-correcting incentive to promote greater responsibility among foreclosure litigators, and it alleviates the tremendous costs of successive foreclosure proceedings…

So what should courts do when banks lose their foreclosure cases? As described above, one approach—that taken by the Florida and Maine Supreme Courts—is to bend the rules of res judicata to avoid a windfall for homeowners. This approach creates few benefits and significant economic problems…[We argue that further subsidizing banks’ poor litigation practices results
in deadweight loss by contributing to negative public-health outcomes and by disincentivizing banks from improving their servicing and litigation techniques. We also explain how granting winning homeowners “free houses” will not negatively affect the mortgage market.

Authors Megan Wachspress, Jessie Agatstein and Christian Mott argue that state courts have been systematically violating a basic premise of the law, res judicata, in foreclosures, by bending the rules to favor banks. When the parties to a case have had a “full and fair” opportunity to present their arguments and evidence fully, the judge should issue a verdict “with prejudice,” meaning barring the losing party from trying to file suit again. The Restatement (Second) of Judgments points out why it is important to shut down the opportunity to re-litigate when both sides have had their say:

Indefinite continuation of a dispute is a social burden. It consumes time and energy that may be put to other use, not only of the parties but of the community as a whole. It rewards the disputatious. It renders uncertain the working premises upon which the transactions of the day are to be conducted. The law of res judicata reduces these burdens even if it does not eliminate them, and is thus the quintessence of the law itself: A convention designed to compensate for man’s incomplete knowledge and strong tendency to quarrel.

The writers point out that the amount of evidence that a lender needs to provide in order to foreclose is not difficult to satisfy. Moreover, when a lender of servicer initiates a foreclosure, it accelerates the debt, meaning it comes due in full at present. But in fact, in many states, the acceleration of a debt is irrevocable, and before the crisis, courts respected that principle with foreclosures. If a bank lost, it was not allowed to pretend that it could wind the clock back and keep dunning the homeowner for monthly payments.

Some readers may take umbrage at the fact that the article fails to mention servicing fraud and abuses, and also underplays the failure to convey mortgages to securitization trusts and the use of fabricated documents to try to remedy that fact as mere “errors” and sloppiness. But rhetorically, the authors don’t need to make that argument, which many bystanders regard as controversial, to substantiate their position, which is that by not issuing judgments on failed foreclosures with prejudice, banks are getting an unjustified windifall, and that is subsidizing their substandard practices and producing unnecessary social harm.

I encourage you to read the article in full.

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Yale Law Free Houses

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26 comments

  1. Larry

    That’s a rather remarkable article from the authors. It’s a common sense point as well, though one that I was not aware of. It makes me wonder if defense attorneys for those being foreclosed upon are aware of this principal and if it has been argued in the court?

    1. diptherio

      The pessimist in me thinks this doesn’t matter at all. These cases are not about legal reasoning or ethics (Goddess forbid!), they are about making sure the “right” people come out on top — and the “right” people in foreclosure cases is always the bank. Trying to get judges (who are, by nature, conventionalists) to overturn centuries of judicial practice (the rich guy wins) on the basis of something as flimsy as the plain meaning of the law is…well, optimistic.

      Banks are big business, and big business is right next to God and Fightin’ Jesus in the pantheon of American Deities, while borrowers are sinners who must be punished. This way of thinking is so deeply ingrained in the American psyche that it will take much more than a paper from a couple of Yalies to overcome it (however welcome such papers may be).

      I’d like to think this will do some people some good, but I ain’t holding my breath.

      1. perpetualWAR

        In addition, most public pensions, including JUDGES’ pensions, have invested in “mortgage backed” securities. I use quotation marks because the evidence proves that none of these “trusts” are backed by anything. The crooks have rehypothecated the notes into multiple “trusts” and therefore not collateral for any of them!

        Who in their right mind would rule against their own self interests? Unfortunately these judges believe their pensions are on the line. They dont realize the only winners in this third card monty is the crooks on Wall Street.

        Its the biggest shit show in town.

        1. reslez

          Anyone who cares about their pension should care more about cleaning fraud and abuse out of the financial system, because that is what will ultimately cause the market to meltdown. Covering up the rot will only make the final reckoning more costly.

        2. Yves Smith Post author

          The only securities at risk are “private label” MBS. The overwhelming majority of the market is government guaranteed.

          Moreover, investors lose more in the event of foreclosure than they do in the event of a modification, which as the article points out, would happen much more often if judged respected res judicata, which in turn would give borrowers more power when the securitization was messed up (often). And the fact is that when banks owned mortgages, they would modify the mortgage if the borrower had a decent level of income.

          Plus in many states, those government pensions are sacrosanct. If the investments don’t perform, the taxpayer coughs up the difference.

          So you can’t argue that this is judges acting out of self interest. It really is good old fashioned misplaced moralizing.

  2. Andrew Anderson

    “When addressing faulty foreclosures, courts are afraid to bar future
    attempts to foreclose—that is, afraid of giving borrowers “free houses.” While
    courts rarely explain the reasoning behind this aversion, it seems to arise from
    a reflexive belief that such an outcome would be unjust.”

    As if a government-subsidized/enabled/enforced usury cartel which cheats savers and drives people into debt is just?!

  3. Thomas Cox

    For the benefit of Larry,

    We defense attorneys are very much aware of and are making these arguments. The Yale Law School students, who wrote this fine article, drew from their work in preparing an amicus brief for me in the now notorious Bank of America v. Greenleaf case (2015 ME 127, 124 A.3d 1122 for those interested in legal citation) where the Maine Supreme Court refused to apply the res judicata doctrine and dismissed a totally botched Bank of America foreclosure action without prejudice. The Court used the excuse of lack of standing as the route to that unfortunate result, but Maine is a “prudential standing” not a constitutional standing jurisdiction, and the Maine Supreme Court did not have to dismiss this case without prejudice on standing grounds. The Court just seemed unwilling to enter an order that would close the door on the mortgage servicers’ misconduct.

    1. perpetualWAR

      Tom,
      We foreclosure fighters salute you. Thank you for your diligent work to expose this shit show.

      I appreciate your continued fight.

  4. Jim A.

    ” If a bank lost, it was not allowed to pretend that it could wind the clock back and keep dunning the homeowner for monthly payments.”
    But my understanding is that most of the paperwork problems that the banks created were with the deed of trust or mortgage (depending on the state). Those are the special class of legal paperwork necessary to foreclose on real property, and thus make the loan “secured.” The Note for the original debt usually doesn’t have nearly as many special registration requirements. This is why the lenders have pressed hard on the idea that “the mortgage follows the note.” as a way of avoiding* the extra paperwork required to maintain the right to foreclose for non-performance. So to my mind, the idea that finding that the DoT or mortgage unenforceable invalidates the note plays directly into the idea that they are inextricably linked. I would argue rather that the lenders by their willful ignoring of requirements HAVE separated the two, rendering the debt unsecured, but not invalid.

    *more accurately as a way to remedy ex post facto their failure to file the note, or even keep a copy of a note that can be filed.

    1. Yves Smith Post author

      No, that is absolutely not correct, and we’ve written about that at length. As bad as MERS is, it’s a sideshow.

      The mortgage securitization agreements required that the note be transferred through a series of intermediary parties. We described how this works repeatedly. An example from 2012:

      …the agreements that govern these deals, called pooling and servicing agreements, were carefully crafted to satisfy a number of legal requirements, including securities law, local real estate law, tax law (REMIC, for Real Estate Mortgage Investment Conduit, set forth as part of the 1986 Tax Reform Act), the Uniform Commercial Code, and trust law.

      The PSA requires the note (the borrower IOU) to be endorsed (just like a check, signed by one party over to the next), showing the full chain of title. The minimum conveyance chain in recent vintage transactions is A (originator) => B (sponsor) => C (depositor) => D (trust).

      The correct conveyance of the note is crucial, since the mortgage, which is actually the lien (this is often a cause of confusion, since in lay usage, “mortgage” refers to the the note + the lien, when they are separate instruments), is a mere accessory to the note. The lien can be enforced only by the proper note holder (the legalese is “real party of interest”). The investors in the mortgage securitization relied upon certifications by the trustee for the trust at and post closing that the trust did indeed have the assets that the investors were told it possessed.

      The PSA also very clearly provided for an unbroken chain of assignments and transfers though the parties (the A-B-C-D or more cited above). The use of intermediary parties between the originator and the trust, with a “true sale” occurring at each step, was intended to create FDIC and bankruptcy remoteness. The investors (who are called the certificate holders in the PSA) did not want a creditor of a bankrupt originator to be able to seize notes back out of the trust.

      Some PSAs allowed for each party to endorse in blank (as in each owner simply had to have an authorized party sign it), but the note still had to have endorsements by all the parties in the conveyance chain, while others stipulated that each endorsement had to be to the next party in the chain. However per NY trust law (and New York law was chosen in the vast majority of cases to govern the trust), the final endorsement had to be to the trust, not in blank.

      The last bit, and this is the source of considerable tsuris, is that all the notes had to be conveyed to the trust by a date certain, usually 90 days after the closing of the deal or after an aggregation period. Only very limited exceptions were permitted. The reason was to conform with REMIC rules. As indicated, the overwhelming majority of trusts elected New York law to govern the trust because it is very well settled. But New York trust law is also unforgiving. Trusts can operate only as stipulated; any move that deviates from its instructions in its governing documents is deemed to be a “void act” and has no legal force.

      Law professors Anna Gelpern and Adam Levitin have described PSAs not just as prototypical rigid contracts, but as “Frankenstein contracts” and “social suicide pacts.” Normally, if there is a significant deviation from a contract, the parties can use waivers, sometimes with penalties if one party looks to have behaved badly, to remedy the breach. But the use of New York trusts, the REMIC requirement of passivity, plus the way the relationship among the parties was set up (bad incentives for the servicers, demotivated trustees because they are indemnified by the servicer and have no reason to watch out of the investors, formal consent requirements among dispersed investors, when they sometimes have conflicting interests) make changing the PSA well nigh impossible.

      To put it more simply: if notes were not conveyed to the trust in the stipulated time frame, it means that someone other than the trust has the right to foreclose, presumably one of the parties earlier in the securitization chain. But no one is willing to admit that since it would mean that investors had been sold what Adam Levitin has called “non-mortage backed securities.” There is no clean way for a party earlier in the securitization chain to foreclose and transfer the proceeds to the trust. So the trust HAS to be the one to make the foreclosure, at least in the minds of everyone involved with these deals, whether it actually is the right party or not.

      Thus when lenders show up in court with a note that does not show the correct party, they have this nasty way of showing up at a later hearing with a different “original” note, or an allonge (a piece of paper attached to the note) that fixed the problem. The problem with the magical allonge is that allonges are used only in the normal course of events when there is no more room on the original note for signatures (and you can use margins and the back for signatures). And most important, an allonge is required under the UCC to be “affixed” to the note, so it should be impossible for a valid allonge to show up later.

      In other words, there has been widespread fabrication of documents and judges have for the most part waived them through.

      1. Scott

        As a layman, what you describe is what always confused me the most. I know there’s a different set of rules for the privileged classes, but this seems particularly blatant, especially considering the entire foreclosure orgy is really just round two of the Securitization orgy.

        I can’t wrap my head around how a little linguistic kneading results in “robosigning” when the starting point is forgery.

        It seemed to me so egregious, so illegal, so extensive, and so rotten with entitlement and contempt it was palpable. And in the midst of it, nobody I saw seemed to be making any attempt to deny or lie about what they were doing. It was like Bizarro world. Robosigning was presented as necessary because a lot of the required documents were missing or incomplete. As if to ask, “What else could we do?” Sometimes I just chuckle at how people only see the things that affirm their worldview.

        1. susan the other

          It is interesting to think about collateralized debt obligations as well. My guess is that the complexities of separating the income stream into risk tranches devastated the integrity of both note and mortgage – because in a blow up how do you sort it out? And it is easy to conclude that the securitizers, in their mania to reduce the risk and skim profits, got themselves so damned confused they decided to destroy the note to both cover their tracks and force a prolonged standoff in the courts. When all else fails just make a huge mess of it.

  5. divadab

    During the depression, my grandfather was shocked to discover that of the 10 houses in the row he lived in, only he was paying his mortgage. The rest were living in houses that had been foreclosed and were now owned by the banks, but living rent-free if they would maintain the houses and heat them in the winter. A practical move by the banks as an empty unheated house soon becomes a wreck if unheated in the winter, and there were just not enough people with any money available as paying tenants.

    Incidentally, my Dad says pigeons completely disappeared from the parks during the depression because people were eating them.

    1. TomD

      I’m not even sure the banks want money out of this situation. They’ve illegally foreclosed on many homes instead of trying to extract mortgage payments. What kind of sense does that make for a bank?

      3. bob

        They game it out. In lots of cases, instead of foreclosing on negative equity properties, they’ll go after positive equity mortgages.

        In the case of the row houses, that’s not surprising, but I’d love more details on that. Who’s holding the paper on all those houses? Is it the same person/entity?

        If they foreclose on just one of the units, and get some sort of price discovery, they might have to write down the value of all the others.

        Smells like some sort of fraud.

        1. bob

          To break it down-

          Bank stops getting paid.

          Positive equity mortgage- 50k remaining on a 200k mortgage on a house that could sell at auction for 100k.

          Foreclosure can make money for the bank.

          Negative equity mortgage- 200k remaining on a 250k mortgage on a house would sell at auction for 150k.

          Foreclosure looses money. No hurry to foreclose and take the loss. Drag feet.

          This is all further complicated by the mortgage servicers, and the so called MBS market, where there are different incentives at work, for the different middlemen parties. It’s been detailed well here in other posts.

    1. perpetualWAR

      Yes, we are seeing the same thing happening right now with the self appointed king and queen clinton.

      1. Arizona Slim

        Here in Arizona, we’ve seen how the King and Queen want to rule. Case in point: Our primary election mess on Tuesday. #AZfixed

  7. Alex morfesis

    In defense of the judiciary…maybe will ask the queen bee to publish a full retort (if I actually write it)…but…and not to direct this at atty cox at all because my support work has been mostly in florida(with some ny, nj, ct, il, tx and mass thrown in)…the truth is hardly ever what it appears to be…the lawyer in florida who got greedy and forced the florida supreme court to dig up that 2004 ruling that had little to do with most homeowner foreclosure cases created this oppty for fidelity in jacksonville and their morgan and lewis friends to claim “victory” against the forces of good… is the one to blame…I know because I snorted at him that he should not do it while he was planning it…and before it got to the supreme court…

    Res j is not and has never been what is suggested…lenders have had historically at least two swipes at bringing colection suit…in the florida case the statute of limitations would have prevented further litigation but the florida atty was arguing that the mortgage had to be removed so his client could cash in…the case law in florida is well set…one must wait 20 years…and if one is asking for new case law one must say so in florida at the outset…so the homeowner had a home that was no longer in foreclosure and only the homeowners greed led to the ruling…and quite frankly the supreme court probably pulled this rabbit from a hat since the bank lawyers briefs were a mess…

    The truth is hardly ever what it appears to be…yours truly is the person who taught the famous april what gsamp was…as she was teaching a course with funding from john paulson(yes him…)using his infamous gsamp loan pool and did not even realize it…but again the truth is hardly ever what it appears to be…there is a female atty in florida who claims she could not pay her mortgage and stepped forward and slightly mentioned that she did what she called insurance anti fraud work…what actuallyseems and appears is that she was part of insurance industry organization working to deprive workers of legitimate coverage…and she also forgets to mention that the law firm she was part of…and I think an actual partner in the firm…that law firm was Adorno…one of the biggest foreclosure mills in florida…details details…and a lawyer who is from the Tampa bay area who regularly took the stage with april in florida events…was on cnbc and other media…complaining that judges were not giving him rulings…blaming the judges but forgot to mention a minor detail…he and his law partner would handle loans to desperate homeowners with last minute foreclosure rescue loans at 15% plus points…or no credit hard money loans at 35 cents on the dollar…and at 15 % plus points and junk fees…and so one minute he was cutting corners like the banksters and the next minute making the exact opposite argument for homeowners…so…the reason he was not getting rulings for homeowners had more to do with the other side of his practice…

    Loans were historically syndicated…there is plenty of case law on it in most states…case law favorable to homeowners…there is plenty of case law on lost financial instruments…bank checks…that are favorable to homeowners…the florida supreme court ruling bringing up that 2004 case actually helps homeowners if attys actually read the ruling top to bottom…so even though they thought mike alex was being too clever…the state supreme court gave defense lawyers in florida a gift…

    What disturbs me about the article…and yes they are only students… is it legitimizes the notion that affidavits are an acceptable proof…not exactly…and that the lenders and the lawyers were sloppy or taking short cuts…neither sloppy not short cuts…regular business practice designed to mislead the courts…

    Res j does not create a free house…it creates a convertable zero note bond…convertable at the lenders adjustment via renegotiation…

    Lunch is getting cold…

  8. change agent

    Was hoping this article would be followed by a Florida Supreme Court decision in US Bank v. Bartram, wherein the banks are attempting to overturn centuries of common law and a clear statute of limitation prohibition of new foreclosure actions more than 5 years after loan acceleration/foreclosure lawsuit and subsequent non-prejudicial dismissal of same. Oral arguments were first week of October last year, no decision released today on the courts normal Thursday opinion drop. The waiting is the hardest part.

  10. downunderer

    Thanks for this! It’s part of what I’ve been wondering about: now that the worst of the foreclosure tsunami is over, what is happening in the wreckage and remaining wet spots. Like broken chains of title. Like in the county recorders’ offices. Like with the terms and value of title insurance (still legally required? If so, is there an escape clause for the insurer if the title chain was broken by peculiar and maybe untraceable judicial action?)

    Is there, or will there someday be, a premium on housing that was owned continuously by a single party and not subject to a mortgage through the years of lawlessness?

  11. EoH

    Even a McKinsey-advised foreclosure artist might revise its foreclosure malpractices if it faced a string of “with prejudice” final judgments against it. Its owners might even frown upon their managers’ conduct, given the shock to financial forecasts arising from publicly disclosed, permanent write-downs on these assets.

    The cost of a few “free houses” (not so free, either, given the costs to get into them and to keep them) seems a small societal price to pay if it reduces the scope of rampant, largely unaccountable banking and mortgage servicing fraud. Individual state courts need to pay more attention to the systemic fraud being perpetrated here. Res judicata is, after all, a policy designed to protect the integrity of both the judicial system and the social system of which it is a part.

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