RESCISSION: What will MBS Rating Agencies Do Now?

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EVEN IF THE TRUST DID BUY LOANS WHAT IS THE VALUE OF THE BONDS IF THE LOANS CAN BE CANCELED AT ANY MOMENT BY THE BORROWER?

This is going to be interesting. When investors realize that the “securitization” of loans, even as designed is contingent upon the power that a borrower has to cancel the loan things are going to change.

Think about it. We know with certainty that the notice of rescission is effective by operation of law when a borrower drops it in the mail. That means it is the same thing as a contested legal action in which the borrower won the case. Nothing can stop a borrower from dropping a notice of rescission into a mailbox.

We also know that there are two time limitations in TILA rescission. The first is the right of three day rescission where the duties of the “lender” are spelled out. We have seen a multitude of cases in which the “loan” was assigned out before the expiration of the 3 days. So if the borrower wants to cancel the deal, who does he notify? Thanks to Dodd-Frank and the FCPB Rules, notice to anyone in the chain is notice to all.

We also know that there is a three year period in which the borrower can cancel the deal. And we know that there is a common law right of rescission. The rules for enforcing TILA rescission and the rules for enforcing common law rescission are very different. The main difference is that TILA rescission is EFFECTIVE (by operation of law) on the date the notice was sent.

And we know that equitable tolling can extend the three years to many more years than three.

And we know that most REMIC Trusts never were funded, never acquired any loans, never were operational even during the 90 day cutoff period. BUT even if the REMIC trust was funded and purchased the loans, what exactly did they get? The answer is that they received an interest in loans that were underwritten by banks who had no risk in granting the loans. The kicker is that all that “bad” (intentional) underwriting can be undone at the stroke of a pen; and this time it isn’t a Judge or government official that has that power. It is the pen of the borrower that has all that power.

Lastly we know that upon TILA Rescission, the parties in the chain must cough up the canceled promissory note, file a satisfaction of mortgage, and return all monies paid by or on behalf of the borrower. That is a huge liability. Who pays that? Is it the investor because they are now the creditor? Investor appetite for that kind of liability is virtually nil because most of them are stable managed funds (e.g., pension funds that require Triple AAA rated investments). Is it the bank or servicer claiming the right to foreclose or otherwise enforce the note? Banks and servicers won’t like that since they don’t consider themselves the lenders. But under Dodd-Frank, they have trapped themselves. They foreclose and claim all the “benefits” of foreclosure, including deficiency judgments. How can they now say they are not liable for disgorgement required under TILA rescission?

Which brings us to the title of this article. Virtually every loan is subject to a notice of rescission, right or wrong, PLUS the fact that it creates a contingent liability, plus interest, plus attorney fees and maybe treble damages. What investor wants to put money up for an investment that could be canceled anytime by any consumer? What investor wants to put up money for an investment that could create a monstrous liability, relying on the banks to (1) handle the money properly and (2) underwrite and manage the loans properly. There are a lot of “if” in there. And rating agencies don’t like uncertainty.  Under such circumstances rating agencies should either give no rating or give a very low rating.

I don’t know whether the US Supreme Court realized that when they handed down the Jesinowski decision they were utterly destroying the value of mortgage backed and related securities. Knowing what we now know, who would want to buy the old ones, much less touch anything new being offered in the MBS market?

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