First, the elec­tronic mort­gage su­per­high­way. Then, the pileup.

Registry saved banks $1 bil­lion and trans­formed lend­ing; now it’s mired in fore­clo­sure chaos


In the early 1990s, the biggest names in the mort­gage in­dus­try hatched a plan for a new elec­tronic clear­ing­house that would trans­form the home loan busi­ness — and un­lock bil­lions of dol­lars of new in­vest­ments and prof­its.

At the time, mort­gage doc­u­ments were moved al­most ex­clu­sively by hand and mail, a throw­back to an era in which peo­ple kept stock cer­tifi­cates, too. That made it hard for banks to bun­dle home loans and sell them to in­vestors. By con­trast, a cen­tral elec­tronic clear­ing­house would al­low the com­pa­nies to trans­fer thou­sands of mort­gages in­stan­ta­neously, greas­ing the wheels of a sys­tem in which loans could be bought and sold re­peat­edly and quickly.

“As­sign­ments are crea­tures of 17th-cen­tury real prop­erty law; they do not co­ex­ist eas­ily with high-vol­ume, late 20th-cen­tury sec­ondary mort­gage mar­ket trans­ac­tions,” Phyl­lis K. Slesinger, then se­nior di­rec­tor of in­vestor re­la­tions for the­Mort­gage Bankers As­so­ci­a­tion, wrote in paper ex­plain­ing the sys­tem.

OnMarch 4, 1994, theMBAun­veiled its plan to county recorders who were charged with keep­ing track of ti­tles sig­ni­fy­ing the own­er­ship of land. Not ev­ery­one was sold on the idea.

“ There needs to be some out­side con­trol or over­sight,” one recorder said, ac­cord­ing to a tran­script of the meet­ing.

An­other said that if er­ror­swereput into the elec­tronic sys­tem, “ they’re re­ally hard to track fur­ther down the road.”

Six­teen years down the road, the mort­gage busi­ness is a mess. The elec­tronic clear­ing­house has be­come a re­al­ity; Vir­ginia-based Mort­gage Elec­tronic Reg­is­tra­tion Sys­tems, a registry with 67 mil­lion mort­gages on file, has be­come part of the in­dus­try’s stan­dard op­er­at­ing pro­ce­dure.

Crit­ics say prom­ises to in­crease trans­parency and iron out wrin­kles in record­keep­ing haven’t panned out. The firm, which tracks more than 60 per­cent of the coun­try’s res­i­den­tial mort­gages but whose par­ent com­pany em­ploys just 45 peo­ple in a Re­ston of­fice build­ing, is now on the fir­ing line.

MERS is fac­ing law­suits from across

“I think if you didn’t have MERSyou’d have to in­vent it to­day.”

— Kurt Pfoten­hauer, chief ex­ec­u­tive of the Amer­i­can Land Ti­tle As­so­ci­a­tion

— Rick Hohlt, a bank­ing lob­by­ist “They’ve tried to turn the mort­gage busi­ness into ... a pro­duc­tion line. But in re­al­ity you’re deal­ing with hu­mans. You’re not build­ing cars or wid­gets.”

the coun­try seek­ing un­paid county record­ing fees. Sev­eral state courts have re­jected at­tempts by MERS to act on be­half of banks seek­ing to fore­close on delin­quent mort­gages. And Congress is weigh­ing leg­is­la­tion that would bar home loan gi­ant Fan­nie Mae from buy­ing any mort­gage listed in MERS, po­ten­tially a death knell for the registry.

Mer­scorp, the registry’s par­ent com­pany, ar­gues that it helps bor­row­ers. Spokes­woman Karmela Le­jarde said MERS has kept costs low, re­duced the risk of record­keep­ing er­rors and made it eas­ier to keep track of loans.

“MERS plays an im­por­tant role in build­ing and sus­tain­ing con­fi­dence in the mort­gage process,” Le­jarde said.

But in the re­cent up­roar over im­prop­erly pre­pared fore­clo­sure pa­per­work, MERShas­be­comethe cen­tral vil­lain.

“ They’ve tried to turn the mort­gage busi­ness into . . . a pro­duc­tion line,” bank­ing lob­by­ist Rick Hohlt said. “But in re­al­ity you’re deal­ing with hu­mans. You’re not build­ing cars or wid­gets.”

The blue­print

The im­pe­tus for a na­tion­wide elec­tronic data­base of mort­gages orig­i­nally came from the biggest play­ers in the mort­gage busi­ness — the MBA, Fan­nie Mae, Fred­die Ma­can­dGin­nieMae— inthe early 1990s.

“ The orig­i­nal thought was that the process was one of the most man­ual, la­bor-in­ten­sive, town­hall­pro­cesses, and there was a kind of broad in­dus­try ef­fort to im­prove on that,” said Daniel Mudd, for­mer Fan­nie Mae chief ex­ec­u­tive and now chief ex­ec­u­tive of Fortress Cap­i­tal, a pri­vate eq­uity firm.

The sav­ings and loan cri­sis had just passed and the mort­gage busi­ness was pick­ing up again. At the time, an un­con­ven­tional en­tre­pre­neur named An­gelo Mozilo was on the MBA board. Mozilo would even­tu­ally pay $67.5 mil­lion to set­tle Se­cu­ri­ties and Ex­change Com­mis­sion al­le­ga­tions of fraud and in­sider trad­ing. But back then Mozilo was one of the in­dus­try’s most ad­mired ex­ec­u­tives, known for his in­ven­tive­ness and technology in­vest­ments at his firm Coun­try­wide Fi­nan­cial, which in 1992 cat­a­pulted to first place among the nation’s mort­gage orig­i­na­tors.

Mozilo could not be reached for com­ment.

Mozilo be­gan brain­storm­ing with a young MBA technology ex­pert, Brian Her­shkowitz, about ways to com­put­er­ize and cen­tral­ize the way the in­dus­try did busi­ness.

“An­gelo Mozilo loved to think about that,” Her­shkowitz said, call­ing Mozilo “ the in­spi­ra­tion” for­what­would even­tu­ally­be­come MERS.

In the fall of 1993, the MBA be­gan cir­cu­lat­ing a white paper, “a blue­print for the fu­ture” thatHer­shkowitz wrote out­lin­ing a new cen­tral registry for mort­gages.

Her­shkowitz, who would later joinMozilo at Coun­try­wide, mod­eled the newsys­tem on a clear­ing­house for stocks called the De­pos­i­tory Trust Co. That com­pany not only kept track of the stock own­er­ship but kept the phys­i­cal cer­tifi­cates in a vault. Be­fore the DTC had been cre­ated, bro­kers hired thou­sands of mes­sen­gers to ferry cer­tifi­cates across New York City — a process that grew­pro­hibitively ex­pen­sive and in­ef­fi­cient as the vol­ume of stock trades sky­rock­eted.

The mort­gage in­dus­try was fac­ing a sim­i­lar prob­lem. As in­ter­est rates sank and con­struc­tion took off, the num­ber of new mort­gages and re­fi­nanc­ings soared. County recorders’ of­fices, which at that time were not au­to­mated, were hav­ing trou­ble keep­ing up.

Al­though the bankers touted the registry as a way to make mort­gage pro­cess­ing more ef­fi­cient, thus ben­e­fit­ing bor­row­ers, they weren’t shy about ad­mit­ting their main goal: more prof­its. They es­ti­mated that the cost of pre­par­ing, record­ing and mail­ing 11.1 mil­lion loan doc­u­ments to­taled about $210 mil­lion in the pre­vi­ous year alone.

Inad­di­tion, the­mort­gage­bankers had greater am­bi­tions of hyper-charg­ing the mar­ket for mort­gage-backed se­cu­ri­ties. In­vented in the late 1970s by a trader at Salomon Broth­ers, these in­vest­ment pack­ages pooled to­gether thou­sands of mort­gages. They were then sold not only to banks but to pen­sions, in­surance com­pa­nies and other big in­vestors.

The only thing hold­ing back wider se­cu­ri­ti­za­tion, they be­lieved, was the time-con­sum­ing and costly chore of record­ing and re-record­ing own­er­ship of the in­di­vid­ual mort­gages.

Inthe years to come, the growth of MERS and se­cu­ri­ti­za­tion went hand in hand.

Coun­try­wide, which had be­come a pi­o­neer in se­cu­ri­ti­za­tion, saw its prof­its soar from $60.2 mil­lion in 1992 when MERS was still just an idea to $2.67 bil­lion by 2006 at the peak of the boom.

By 2007, MERS had more than 60 mil­lion mort­gages on file and said that it had saved the bank­ing busi­ness $1 bil­lion in record­ing fees and other costs. Mean­while, the vol­ume of se­cu­ri­tized mort­gages soared, mak­ing them the nation’s largest as­set class and con­tribut­ing to a $12 tril­lion bub­ble in the real es­tate mar­ket — be­fore it all broke down.

The doubters

From the be­gin­ning, the clear­ing­house idea had its doubters.

At the March 1994 meet­ing be­tween mort­gage giants and the county recorders, the recorders ran through their list of con­cerns: whether con­sumers would be able to get ac­cess to their own in­for­ma­tion; how data er­rors would be cor­rected; whether the registry was con­sis­tent with state laws; whether the chain of ti­tle­wouldbe bro­ken if doc­u­ments weren’t recorded prop­erly; and whether too much­power would be con­cen­trated in the hands of those who would man­age and own the clear­ing­house.

“ This one group of peo­ple, the in­vestors, the peo­ple that ben­e­fit, are in to­tal con­trol,” one county recorder warned, ac­cord­ing to min­utes of the meet­ing.

An­other com­mented that “it seems tomeit cre­ates a whole new sys­tem — dif­fer­ent than any­thing that has been be­fore.”

The bankers brushed off such ques­tions.

The chair­man of the in­dus­try’s le­gal team, Ed­mondR. Browne Jr., said the sys­tem would com­ply with the land record­ing laws in all 50 states.

“I don’t think it can re­ally hurt as long as things are­han­dled­ef­fec­tively,” he said. “It doesn’t take any­thing away from the ex­ist­ing sys­tem . . . but it’s an ad­di­tional layer that has some economies of scale and some ef­fi­cien­cies.”

But some­where along the way MERS be­came a stripped-down ver­sion of the orig­i­nal idea. The first thing to go was the vault for keep­ing doc­u­ments. MERS in­stead be­came a gi­ant elec­tronic card cat­a­logue that tracked who was man­ag­ing a par­tic­u­lar loan as it was sold and resold, but it left the com­pa­nies re­spon­si­ble for guard­ing the mort­gage (or deed of trust) and the prom­is­sory note (or IOU) — the two crit­i­cal pieces of paper that prove who owns a loan.

Next to go, crit­ics say, wastrans­parency.

When a home loan is se­cu­ri­tized, at least a half-dozen par­ties are typ­i­cally in­volved. The loan might be orig­i­nated by amort­gage fi­nance firm, then sold to acom­pany that ag­gre­gates them into a pool and sells them to an in­vestor such as a pen­sion fund. Ad­if­fer­ent “ser­vicer,” of­ten a ma­jor bank such as Bank of Amer­ica orWell­sFargo, is usu­ally re­spon­si­ble for col­lect­ing pay­ments. Most loans are bough­tand­sold sev­eral times, and the ser­vicer can change, too.

The mort­gage bankers de­cided that to sim­plify record­keep­ing, MERS would be listed as a “nom­i­nee” for the mort­gage holder in lo­cal land records of­fices. When the loans changed hands, the new owner or ser­vicer would reg­is­ter the trans­ac­tion elec­tron­i­cally in the MERS sys­tem with­out hav­ing to re-record the trans­ac­tion across the coun­try.

Mark Mona­celli, a county recorder in Du­luth, Minn., who was the lead negotiator for the as­so­ci­a­tion rep­re­sent­ing recorders from most of the nation’s 3,600 coun­ties, said that prac­tice makes it dif­fi­cult for home­own­ers to trace the chain of own­er­ship of their loan.

“MERS turned out to be some­thing com­pletely dif­fer­ent than what we orig­i­nally thought,” Mona­celli said.

MERS in­sists that it has not kept in­for­ma­tion from the pub­lic.

“The MERS Sys­tem ac­tu­ally fills an in­for­ma­tion void in the county land records sys­tem,” said Le­jarde, the spokes­woman. She said that al­though county land records list in­for­ma­tion about only the owner of loans, MERS tracks both the owner and the ser­vicer.

Le­jarde ac­knowl­edged, how­ever, that­some­bor­row­ers­don’t have ac­cess to all that in­for­ma­tion. MERS gives in­vestors the right to withhold their names from be­ing dis­played in the data­base, and about 3 per­cent do so.

In the mid-1990s, some of the recorders lob­bied states and Congress for leg­is­la­tion to block the cre­ation of MERS but failed. By 1999, just two years af­ter MERS went live, the num­ber of loans in the MERS sys­tem hit the 1 mil­lion mile­stone and Lehman Broth­ers is­sued the first “AAA”-rated se­cu­rity with MERS-reg­is­tered loans.

The roof falls in

The col­lapse of the hous­ing mar­ket over the past three years has drawn back the cur­tains on MERS.

As mil­lions of homes fell into fore­clo­sure, MERS found it­self in a tricky le­gal po­si­tion be­cause its name was listed as the mort­gage holder in lo­cal land records. Be­cause the law al­lows only the mort­gagee to fore­close, MERShad to ei­ther file court pa­pers in its own name or trans­fer the mort­gage back to the real owner. Both sce­nar­ios re­quire huge amounts of pa­per­work.

But with only a hand­ful of em­ploy­ees— most of them com­puter tech­ni­cians — MERS was in no po­si­tion to do so. So MERS au­tho­rized em­ploy­ees at mort­gage ser­vicers, debt col­lec­tors and fore­clo­sure law firms — 22,000 in the most re­cent count — to iden­tify them­selves in records or court pa­pers as “vice pres­i­dent” or “as­sis­tant sec­re­tary” of MERS.

Dis­tressed home­own­ers have bom­barded MERS with hate mail. And thou­sands of bor­row­ers have chal­lenged the right of MERS and these agents to act on be­half of len­ders or ser­vice firms, ef­fec­tively call­ing into ques­tion the com­pany’s busi­ness model.

“MERS is both a cause and a symp­tom of cava­lier doc­u­men­ta­tion prac­tices in the mort­gage in­dus­try,” said Uni­ver­sity of Utah pro­fes­sorChristo­pherL. Peter­son. “It goes back to a slo­gan of theirs: ‘Process loans not pa­per­work.’ ” He said MERS cre­ated the “il­lu­sion of record­keep­ing.”

In a re­cent paper, Peter­son wrote, “As a prac­ti­cal mat­ter, the in­co­her­ence of MERS’ le­gal po­si­tion is ex­ac­er­bated by a cor­po­rate struc­ture that is so un­ortho­dox as to ar­guably be con­sid­ered fraud­u­lent.”

Some state courts agree. The Mis­souri Court of Ap­peals said in June 2009 that MERS lacked the author­ity to as­sign a mort­gage from one ser­vice com­pany to an­other. Be­cause the trans­fer by MERS “ had no force,” the court ruled, the owner of the loan lacked “a legally cog­niz­able in­ter­est” and could not pur­sue the delin­quent bor­rower.

The Kansas Supreme Court ruled in Au­gust 2009 that MERS did not have any in­ter­est in the un­der­ly­ing prop­erty of a bank­rupt bor­rower whose home was auc­tioned — even though MERS was listed as the­mort­gagee. More­over, the court said that the MERS trans­fer of the mort­gage was in­valid be­cause the owner, Sov­er­eign, had never recorded its in­ter­est in Ford County, Kan.

In Oc­to­ber, a fed­eral judge in Ore­gon is­sued an in­junc­tion pre­vent­ing Bank of Amer­ica from fore­clos­ing on a home, be­cause of the use of MERS.

In tes­ti­mony be­fore Congress, Mer­scorp pres­i­dent R.K. Arnold said­he­be­lievesMERS“is­base­don sound le­gal prin­ci­ples” and that its role in such cases will be up­held on ap­peal.

More than half a cen­tury ago, the uni­form com­mer­cial code en­sured that com­mer­cial trans­ac­tions didn’t need to com­ply with count­less state rules. But real es­tate trans­ac­tions re­mained pro­tected.

Now, in the wake of the fore­clo­sure wave, states are as­sert­ing them­selves in ways that un­der­cut ef­forts to make MERS a tool for uni­fy­ing the mort­gage busi­ness. A key bone of con­tention is whether MERS can be listed as the mort­gage holder with­out ac­tu­ally own­ing the loan.

In the District, At­tor­ney Gen­eral Peter J. Nick­les in Oc­to­ber said that all trans­fers of mort­gages should be in­scribed in the land records within 30 days and that list­ing MERS does not meet this re­quire­ment. In Mas­sachusetts, a county recorder has called on the at­tor­ney gen­eral to in­ves­ti­gate whether MERS failed to pay the proper record­ing fees.

MERS says it be­lieves it is in com­pli­ance with District law and that in Mas­sachusetts “no fee is due, be­cause there is noth­ing to record.”

Vir­ginia Del. Bob Mar­shall, who has pro­posed tighter record­ing re­quire­ments, said that “ the prac­tice of MERS is go­ing to de­stroy 400 years of guar­an­tees that Amer­i­can law has sought to give peo­ple.”

Prob­lem or ‘so­lu­tion’?

MERS was a key com­po­nent in a ma­chine that was tear­ing up the tra­di­tional mort­gage busi­ness. It both fur­thered and em­bod­ied the grow­ing au­to­ma­tion and anonymity of the boom­ing home loan in­dus­try.

Whether MERS was a flawed con­cept or whether it was sim­ply poorly con­structed re­mains am­at­ter of dis­pute.

“Per­haps the vi­sion I had might have­been­bet­ter if ithad­been­fully seen through,” said Her­shkowitz, author of the orig­i­nal white paper.

He said that fore­clo­sures were far from the minds of mort­gage in­dus­try of­fi­cials in the early 1990s— they­w­eres­im­ply try­ing to boost the vol­ume of mort­gages they could han­dle.

Kurt Pfoten­hauer, chief ex­ec­u­tive of the Amer­i­can Land Ti­tle As­so­ci­a­tion, said MERS is an “el­e­gant so­lu­tion” to the in­ef­fi­cien­cies of pa­per­work. Al­though he would wel­come more reg­u­la­tory over­sight, he said ti­tle com­pa­nies have found the data­base to be ac­cu­rate and that its main flaw is that it doesn’t con­tain ev­ery mort­gage in Amer­ica.

“I think ify­ou­didn’thaveMERS you’d have to in­vent it to­day,” he said.

Wil­liam E. Kelvie is a for­mer chief in­for­ma­tion of­fi­cer for Fan­nie Mae who was a found­ing board mem­ber of MERS in 1997 and is­nowchief ex­ec­u­tive of Over­ture, a soft­ware com­pany for the mort­gage in­dus­try. He said the real prob­lem is not that the in­dus­try au­to­mated too fast; it’s that it went too slowly. If ev­ery com­po­nent of a mort­gage were dig­i­tized then there­would­benopa­per­work con­tro­versy, be­cause there wouldn’t be any pa­per­work in the first place. Oth­ers have the op­po­site view. “In the­ory it’s a good idea be­cause it saves ev­ery­one a lot of money,” saidHowardA. Lax, a real es­tate ex­pert at the law firm of Lip­son, Neil­son, Cole, Seltzer & Garin. But in prac­tice, he added, MERS “re­lies on all these peo­ple from dif­fer­ent fi­nan­cial in­sti­tu­tions to give them ac­cu­rate in­for­ma­tion.

“No­body at MERS is re­spon­si­ble for due dili­gence, to go back and ques­tion whether the in­for­ma­tion they’re get­ting is ac­cu­rate. It’s just like a com­puter pro­gram. If you’re go­ing to put garbage in, you’re go­ing to get garbage out.”

Phyl­lis K. Wal­ters, a recorder from Illi­nois who led the op­po­si­tion to MERS in the 1990s, said that in her district the chain of ti­tle for a par­cel of land goes back to 1839 — and that never was bro­ken un­til banks started record­ing, and fore­clos­ing, in the name of MERS.

“If things had been recorded in our of­fices,” she said, “we wouldn’t be in this mess.”


An­geloMozilo, for­mer chief ex­ec­u­tive of the mort­gage ser­vicer Coun­try­wide Fi­nan­cial, is de­scribed by a one­time col­league as “the in­spi­ra­tion” for what would be­comeMort­gage Elec­tronic Reg­is­tra­tion Sys­tems.


R.K. Arnold, pres­i­dent and chief ex­ec­u­tive ofMer­scorp, MERS’s Re­ston-based par­ent com­pany.

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