Wall Street Back-Office Blues: No Clerical Solution

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EDITOR’S NOTE: In a few of my recent articles I referenced the great paperwork crisis that brought down several large brokerage firms in the late 1960’s. The article below gives more details and comparisons with the current situation. I agree with everything he is saying except that there exists a giant hole in the fact pattern underlying his assumptions and for that matter what everyone is reporting.

The giant hole is that in the 1960’s there was no question that common stock and preferred shares and other securities existed and were valid representations of ownership in the many companies that issued these securities. The problem then was truly simply a matter of matching trades in the market and determining the identity of the current owner.

The current situation is the same PLUS two fatal variables: (1) the equivalent of a “trade” does not exist because the transfer of mortgages never was executed and worse (2) the obligations, mortgages and notes can NEVER match up because the parties were different. This fatal defect in the origination of the the loans wherein the obligation was documented with essentially false paperwork is a facet that is not comparable to the 1960’s. Back then there were real shares of real companies. Now we have no shares in trusts that for the most part don’t exist based upon a loan that was advanced but never documented in favor of the lender.

Hence the conclusion that this entire affair can  be wrapped up without the megabanks crumbling is at least weakened by the reality of what they did. The 1960’s paperwork shake-down was not based upon fraud and deceit, it was the result of negligence. The current “paperwork” problems are the result of intentional acts to cover-up and withhold information that if it was disclosed would have resulted in no “trade” at all. There is no clerical solution to this mess. Regardless of how the matter is concluded (if it is ever concluded) it will be a legal solution either arbitrarily changing long-standing law that has governed commerce for centuries, or by application of the law without regard to the consequences at the megabanks (blind justice).

The Financial Page
Back-Office Blues
by James Surowiecki November 8, 2010

In the late nineteen-sixties, Wall Street was crippled by an unlikely nemesis: unfinished paperwork. Thanks to a booming stock market, trading volume had soared in the course of the decade; between 1960 and 1968, the number of shares traded daily quadrupled. This should have been wonderful news for brokerage houses—more trades mean more commissions—but it ended up wrecking many of them instead. Because brokerages were slow to add workers and update back-office operations, they were literally buried beneath all the new business—offices were full of stock certificates, and trade documents were stacked halfway to the ceiling. Amid the chaos, dividend checks went unsent, trades were credited to the wrong accounts, and fraud spread; hundreds of millions of dollars in securities were stolen. And since the firms often didn’t process trades quickly enough, billions of dollars’ worth of transactions a month were simply cancelled. In 1968, the stock market started closing one day a week to let firms catch up on their work, but the brokerages’ bookkeeping woes caught up to them first, and more than a hundred firms went under. It took years—and the passage of an investor-protection bill—for the crisis to abate.

You’d think the Street would have learned its lesson. Instead, it’s now threatened by an even bigger back-office crisis: Foreclosuregate. Banks, faced with a flood of delinquent mortgages resulting from the bad loans they made during the housing bubble, have done exactly what the brokerages did forty years ago: they’ve cut corners. They’ve foreclosed on homes without having the proper documentation, and relied on unqualified people to sign affidavits attesting to things they didn’t know—so-called “robosigners.” In a few cases, they seem to have actually tossed people who didn’t have mortgages out of their homes. As a result, federal regulators and attorneys general in all fifty states are now investigating. And, in the weeks since the scandal first erupted, other issues have appeared, calling into question the legitimacy of the way mortgages were packaged and sold, and raising the possibility that the banks might have to buy back piles of bad mortgages. Forecasts of “catastrophe,” “Armageddon,” and “apocalypse” have now become routine.

There’s no doubt that it’s a brutal mess. The banks have been servicing mortgages and chasing delinquents with the same carelessness and indifference to due process that they demonstrated when they underwrote and securitized the mortgages in the first place. A foreclosing bank should be able, at a minimum, to produce the original mortgage note to demonstrate that it has the right to foreclose. But many banks have been unwilling or unable to do so. The same goes for other documentation: in a study of seventeen hundred cases of foreclosure in bankruptcy, Katherine Porter, a law professor at the University of Iowa, found that necessary documents were missing in more than half of them. Servicing mortgages well means hiring and training lots of workers to help customers, modify loans, and insure that documents are in order. But that costs money, and since mortgage servicing is already a low-margin business, banks have preferred to do things on the cheap, which is an open invitation to trouble, including fraud. To those responsible, a bit of sloppy paperwork probably seemed like no big deal, but when you’re talking about taking away people’s homes paperwork and due process should matter quite a bit.

All the same, the widespread proclamations of Armageddon seem overblown. The banks’ behavior has been appalling, but the crisis probably won’t be fatal for them, however much some of them might deserve that. Criminal charges are likely, and justified. And judges are already looking more skeptically at banks’ legal claims. But we aren’t going to see a Jubilee for debtors. The actual debts are almost all real, and the records of most of them presumably exist somewhere. So some financial institution will eventually end up with the right to foreclose, even though getting there will be expensive and time-consuming. And while banks may suffer considerable losses—having to spend tens of billions of dollars to buy back mortgages that violated the warranties they made to investors—forcing them to do this will take a long time, and enable them to spread the pain out over years. Nor is the uproar going to lead millions of homeowners to stop paying their mortgages. Predictions of catastrophe are understandable—the memory of the banking crisis is fresh, and it seems like poetic justice—but we’re probably not going to see apocalypse redux.

Indeed, there’s a chance that in the long run the banks’ travails could make things better for the economy, not worse. For a start, all the sand in the gears of the foreclosure mills will make it easier for delinquent borrowers to stay in their homes—not so bad an outcome, in economic terms, as the banks would have us believe. There are eleven months of existing-home inventory for sale right now; dumping another million foreclosed homes onto the market hardly seems economically essential. More important, making foreclosures tougher to get and more expensive to process could push banks to get serious about modifying mortgages, which at this point is the best route to getting the housing market back in reasonable shape. Up to now, it’s often been easier and cheaper for banks to foreclose, and mortgage servicers commonly make more in foreclosure than in modification. But being forced to follow the law before foreclosing, and having the threat of criminal investigation over their heads, may change that calculus. (More government pressure wouldn’t hurt, either.) The back-office crisis of the nineteen-sixties compelled Wall Street to do a better job of protecting and serving investors. It’d be fitting if Foreclosuregate ended up doing the same for homeowners. ♦

Read more http://www.newyorker.com/talk/financial/2010/11/08/101108ta_talk_surowiecki#ixzz14iT7tVRa

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