In 2008, I blogged about mortgage foreclosures. I was concerned that foreclosing lenders were unable to produce the notes to the loans they were foreclosing. I was concerned because once a real estate title is clouded by uncertainty, the property becomes difficult (or impossible) to sell, mortgage or lease. Real estate transactions that were once routine suddenly become impossible to complete without a law suit requiring attorneys, notices, discovery (depositions and document production), hearings on motions, sometimes trials and filing and attorneys fees.
In my 2008 post, I compared the situation to the Chicago Fire. After the fire, people were unable to produce evidence of title to their property and boundary line markers were gone, so, even if you could produce title to something, it was unclear what exactly that was.
Major lending institutions, Ally (formerly GMAC mortgage), Bank of America and Chase have suspended mortgages in 23 states, including Illinois. Some say Citi will follow suit. Attorney Generals from both Connecticut and Massachusetts are investigating. Massachusetts' Coakley has called for a moratorium on foreclosures. Those of California, Colorado, Illinois and Ohio are investigating.
Don't be lulled into security by the limitation of the issue to 23 states. Those are just the judicial foreclosure states where lenders have to prove they own the mortgages. In other states, non-judicial foreclosure states or states that use non-judicial foreclosure sometimes, this problem is worse. Worse because no one has to prove anything and no one will easily be brought to justice.
Now, at least one title company has awaken to the problem. Old Republic Title has issued an underwriting memo to its agents stating that the company will no longer write new policies for homes foreclosed upon by J.P. Morgan Chase and Ally Financial's GMAC Mortgage unit. That includes homes under foreclosure and homes previously foreclosed. To put this into perspective, consider that 1,285,873 property foreclosures were filed in 2007, 2,330,483 in 2008, 2,824,674 in 2009 and 1,961,894 in the first half of 2010. I expect the other title companies to follow suit and all title companies to add additional lenders as more lenders reveal their own foreclosure problems.
To put this into further perspective, you have to understand that title is a chain. The health of title to your property depends on the title of your predecessor in title (the person who sold your property to you), and the health of their title depends on the health of their predecessor's title and so on. Title companies insure you in the health of the chain of all previous owners before you. You can read more about title insurance here.
Once a property becomes un-insurable, it's out of the system unless the break in the chain is cured. For new foreclosures, title can be cured in the foreclosure when the court determines the party entitled to foreclose and terminates the interests of parties with junior interests. The problem is not solved for properties that went through invalid foreclosures (invalid due to insufficient or fraudulent evidence of loan ownership) or non-judicial foreclosures in which loan ownership was never established judicially.
Curing invalid foreclosures is a long and difficult process. It was done once before, in Chicago after the 1871 fire, with a land system called Torrens. Torrens is a land registration system under which titles are judicially determined, a title certificate is issued and all future sales, mortgages and other liens and other interests in title such as easements and land restrictions are registered on the certificate.
Torrens was phased out in Illinois beginning in 1992. The system had become difficult to manage and delayed title transfer. There was alsoconcern about corruption in the system. Ironically, one of the biggest complaints about Torrens was that it was slowing down transfers in the secondary mortgage market, the same market that helped create our current mortgage lending problems.
Another possible cure for the problem is akin to the end of a round of musical chairs. The feds could simply declare that all properties previously foreclosed are owned by the parties who purchased from the foreclosure, whether valid or not. That would solve the title issues for real property. However, that would cheat investors who purchased loans or securitized loan bundles. It would also cheat the mortgage GSEs, Freddie Mac and Fannie Mae, that funded loans and have now lost their collateral to servicers who are foreclosing.
In any event, this isn't just a problem for those being foreclosed or for the big lenders now in the news. This is a Main Street problem, even though it was caused by Wall Street. Potential cures will be difficult and selling a home isn't going to be easy.