There has been much digital ink spilled on the Foreclosuregate (or if you prefer, Fraudclosuregate) story over the last couple of years, but one thing has been only touched upon lightly – if at all.
That is the underlying “low-level” fraud that is unspoken in many of these actions.
There’s a general principle under the law when one desires to bring a lawsuit – the principle of injury. That is, you can’t sue me because you think I’m ugly. You need to show actual economic damage in order to obtain the relief you seek. There are many examples where civil courts have reached a conclusion that indeed the facts support the case but there’s been no showing of economic harm and thus the plaintiff gets awarded one penny.
There has been an astounding lack of credulity on this matter of economic injury in these foreclosure suits. In fact, I’ve yet to see a foreclosure complaint that alleges actual economic injury.
Instead, they all allege it’s cousin, lack of payment.
But lack of payment isn’t necessarily economic injury.
Let’s say that you hit me in your car. You have insurance and so do I. My medical treatment costs $20,000, and you’re ruled entirely at fault in the collision. We’ll assume for the moment I have no “pain and suffering” damages nor lost time at work and thus no lost income – that is, we have a neat and tidy case where the total economic harm is $20,000. I cannot sue you unless my economic injuries are not paid for through some other means.
If your insurance company pays the medical bill, I no longer have economic harm, thus I cannot win anything in a lawsuit. Likewise if my insurance company covers the bill (unless it jacks up my insurance rates or somehow otherwise damages me.) Finally, you might just hand me $20,000, which moots my pending lawsuit immediately as once again, I have no economic harm.
When a mortgage loan is packaged into one of these “securities” and then all sorts of protection and credit enhancement are taken against it, it is no longer a simple matter of saying that because you didn’t pay, there are economic damages in the amount of your lack of payment. In fact, there may be no economic damage sustained by the entity that is suing you at all!
Take the instance of a “credit default swap.” Remember that a CDS is not an insurance contract. That is, it typically will not contain things like a right of subrogation or set-aside (the ability to go after the cause(s) of the payment under the CDS contract or pursue other assets of the defaulter in court) but rather is a pure “payment for event” sort of agreement. Well, if that CDS payment moots the economic damage, does the alleged foreclosing party still have standing to eject you from your house?
Let’s follow this through an MBS. For simplicity sake we will assume it is comprised of 1,000 loans. Let us further presume that 10% of those loans default.
Ok, can you foreclose on those homeowners?
Remember, to be able to sue for a remedy in civil court, you must show economic harm. A breach without economic harm brings no right of recovery! Being pissed off is not economic harm, and neither is non-payment unless the party suing you, directly or through an agent, suffers a loss.
Well, in the base case you’d probably say “yes”. But who can sue? Normally the PSA delegates this authority to the servicer or their agent. Again, however, the underlying facts to be pled in a lawsuit that permit recovery must demonstrate economic harm.
The key question: Were the certificate holders economically harmed when all of the payment flows are accurately accounted for?
Well, that does depend now, doesn’t it? The super-senior holders might not be, because of their credit protection. More-junior holders might be harmed, but then the question turns on an accounting – was there credit protection bundled with the tranche or did they purchase it individually? Was their position actually damaged as a consequence of your non-payment?
Hmmmm…. looks like we need an accounting here of the trust and the actual economic harm, right? This does not mean, by the way, that one must show any particular amount of harm, beyond the general threshold of “materiality”, to sustain a foreclosure.
But what if there is no harm at all because of these credit enhancements and swaps, and in fact foreclosure is actually a double-dip – that is, double recovery?
In that case all such foreclosures are fraudulent. Not because of a lack of paperwork and not because someone “should” or “should not” get a free house – but simply because the entity bringing the suit not only didn’t suffer a loss, they stand to gain rather than recover a loss through doing so.
Can I ask why we don’t see both pleadings where a securitized loan defaults alleging actual economic harm and an accounting of how that’s arrived at, rather than its surrogate – the allegation that you didn’t pay?