A Telling Foreclosure Story

In my previous post, I looked at the legal complications of using mortgage debts as collateral for additional debt. From the time I first heard about this practice--creating collateralized debt obligations or mortgage-backed bonds--in Thomas Friedman's book The Lexus and the Olive Tree (1999), I was troubled. Friedman takes a "gee-whiz-isn't that-cool" tone and looks forward to a day when "everything will be for sale" and can be turned into a bond.

But a story from Thursday's New York Times business section illustrates why turning mortgages into collateral is, in practice, a mess. At the end of the piece, the authors, Andrew Martin and Motoko Rich, tell the all-too-typical story of one family:

Charlotte and Thomas Sexton, of Carlisle, Ky., fell behind on their mortgage payments because the payments on their adjustable-rate mortgage spiked upwards and Ms. Sexton lost her job.

They tried unsuccessfully to sell the home, to refinance it and to modify their mortgage payment. When the Bank of New York Mellon filed a foreclosure notice last summer, they went to a local lawyer, Brian Canupp, who, with the help of a forensic accountant, found a problem in the foreclosure filing.

Last month, a judge tossed out a foreclosure judgment after Mr. Canupp argued that the mortgage trust that claimed to own the Sextons’ promissory note —Mortgage Pass-Through Certificates Series 2002-HE2 — did not exist.

Instead, another trust, called IXIS Real Estate Capital Trust, Series 2005-HE2, claimed to own the Sextons’ note, court records show.

Ms. Sexton said that regardless of who owns her promissory note, she just wants to stay in her home and hopes that the bank will eventually agree to a loan modification.

“We found a mistake,” she said, “that gave us a light at the end of the tunnel.”

So who owns their mortgage (or, more specifically, their promissory note)? The Bank of New York? The bondholders who own IXIS Real Estate Capital Trust Series 2005-HE2? Both? Neither?

The wizards didn't quite think through the simple question of who owns what. So our real estate market is a mish-mash of unclear title ownership, clogged courts, and messed-up foreclosures. It's going to take a long time to sort this all out--and nobody is happy about that (except maybe the Wall Street wizards who cashed out their profits a long time ago).