Mortgage Foreclosure: The Disaster of Unintended Consequences


This blog post’s discussion of the law has been updated in a subsequent post on this blog.  See “Mortgage Foreclosures, Missing Promissory Notes, and the Uniform Commercial Code: A New Article,” February 11, 2013, at



Foreclosures two years ago (click on photo to enlarge)
Nobody knew what the rules were, and nobody cared. So the traditional mortgage transaction (home buyer signs promissory note at closing in favor of the bank which takes a mortgage on the property, and then the buyer either pays off the debt or that same bank forecloses) became a tangled network of new players, who invented things as they went along. The note and the mortgage were bundled together with hundreds of others, sold to an investment bank which put them into a trust, which in turn sold bonds to investors, promising them a nice return. Moreover, this proved so lucrative that banks started granting loans to buyers who weren’t able to afford them, for properties that appraisers had been bribed to overvalue, in a market that rose to cloud levels and beyond, year after year. Things were fine as long as that property bubble kept expanding, but millions of mortgages later came the spectacular “pop,” and chaos ensued. Collapse of the housing market led to collapse of credit, bankruptcies of the businesses which depended on that credit, and then collapse of the job market, and now we’re all flopping around in the mud trying hard to breathe.

When the destitute buyers quit paying, the only recourse available to the banks was grabbing the properties covered by the mortgages. That was so routine a result that it surprised no one, and few questions were asked as millions of foreclosures began. Florida set up special courts to handle foreclosures, and the “judges” appointed to run them mysteriously asked no questions. Want to foreclose? Sure? It didn’t seem to matter that the foreclosing entity was not the original lender and merely claimed to have some loose connection with that entity—who could possibly care about that? Deadbeats who had failed to pay off the mortgage debt forfeited their homes to the first claimants to file. So what if they had defenses (“I did pay the debt,” “The bank agreed to an extension,” “I filed for bankruptcy and thought that stopped the foreclosure,” “The bank lied to me when it assured me the property was worth far more than the mortgage amount,” etc.)? Most of the home owners had no money to hire an attorney (duh), so they either gave up and walked away from their dreams, or tried to get the attention of a judge who had to clear over a hundred cases that day and who had no patience for an actual exploration of what had happened.

But the sloppiness with which it was all done—lack of a paper trail, inconsistent claims of assignment, no records of who received the payments, loss of important documents—eventually caught the attention of the media, who were alarmed by horror stories told by tearful and pathetic people now living on the street, or with family, or in some dump next to a crack house. Then the reporters did what the best of their kind have always done: shined a bright light on the dark corners, and the rats have been scurrying ever since.

I’ve explained in a prior post (and am travelling the country giving speeches about this) that no foreclosure is possible unless the foreclosing entity possesses the original promissory note (see “The Sexy Promissory Note,” August 17, 2010). A copy won’t do (there could be hundreds of copies, but that wouldn’t mean a hundred banks would each have the right to foreclose)—only the original. Some banks have carefully preserved the notes, so for them this is no issue. But many notes cannot be found (some were, incredibly, stupidly, deliberately destroyed in a paper-reduction effort!!!). The banks pooh-poohed state statutes requiring production of such notes (mere “legal technicality”), and emphasized that they can prove that the mortgage debt was assigned to them. Surely that’s enough. Well, no, as it happens, and I say this as a law professor who has taught these laws for over 40 years, and who can explain in tedious detail why the rule exists and why it is fair to everyone.

But the missing notes are only one of many problems for the foreclosing bank. They also often have trouble proving the validity of the assignment of the mortgage if challenged on that, or—witness the recent ugly headlines about robo-signers employed by the banks who swore that they had examined all the paperwork in detail and found it in order when that was quite impossible—can’t even prove that the debt is in truly in default so that foreclosure is in order. As a consequence of this sudden attention to rules that should have been followed all along, foreclosures are suddenly a legal nightmare.

On some level, I’m delighted that the feeding frenzy of greed and fraud the bankers pigged out on over the last decade is over and now it's their famine time. Why aren’t these people in jail? They committed crimes that are easily proven (among other things they lied to the investors who bought the bonds, telling them the properties were worthless, and then turned around and foreclosed on those properties, keeping the resulting monies for themselves instead of repaying those investors—that’s both fraud and theft and a number of other crimes). One criminal activity that’s still a booming business is foreclosure scamming (“Just pay me $1000 and sign this paper giving me temporary title to your home, and I’ll help you avoid foreclosure and save your property!”). In the 1980s savings-and-loans scandal which cost the U.S. Government (then under the first President Bush) $125 billion dollars, many of the perpetrators went to prison (the photo is of the star criminal of the day, Charles H. Keating, Jr., who spent five years in a cell, finally getting out in 1996). Let’s have some of that now—hell, let’s have a lot of it! The trials would be eye-popping with revelations of the fraud that was the daily breakfast, lunch, and dinner for these villains. Why aren’t we all demanding prosecutions?

But when I cool down and think about what’s coming, I start having trouble sleeping at night. And that is really the topic of this post: unintended consequences that are going to make things even rougher than most people understand.

Consider title insurance companies. At all real estate closings the buyer has to pay for such insurance, but it’s not common for title insurance companies to actually have to pay off; the title normally is flawless. But if judges start invalidating foreclosures and ruling that the house belongs to the original owner, buyers of foreclosure homes are going to be filing claims. Title insurance companies might have to pay out millions, leading them to raise rates, cut down policies, layoff employees, or declare bankruptcy. Certainly no respectable title insurance company is going to issue a policy for the resale of a foreclosed-upon home where there are legal issues about missing notes or improper documentation in the foreclosure proceeding, and, without title insurance available, what will the foreclosing bank do with an unsalable property?

Bank failures used to be rare, but banks, and particularly small banks, are falling like badly balanced dominoes. The FDIC (busier than it has ever been, in the red and feeling the pinch) steps in, cuts off all lines of credit to everyone, consumer and businesses alike, fires employees, and starts foreclosing on both homes and businesses. Do you have any idea what it does to a small town to have the local bank fail? The lives that are ruined? The businesses that collapse in tandem with their bank across the street? The families that break up? The suicides?

Urban blight is already a major problem in many communities, even upscale ones, as house after house sits abandoned, leading to dropping real estate value of others, and a vicious cycle of neighborly collapse. What do municipalities do about the resulting crime, fire hazards, disease, etc.? They can’t raise taxes in today’s economy. Chapter Nine of the United States Bankruptcy Code provides for municipal bankruptcies, but we never teach those rules in law school because actual cases were rare in the past. To keep up adoptions of the book at law schools, I may have to rewrite my casebook to include a major new section on Chapter Nine (about which, alas, I know almost nothing, so get out the midnight oil, Doug, a very unpleasant unintended consequence of this mess).

If you are a respectable bank official caught up in all this, how many new mortgages would you be willing to make? Without readily available mortgage loans, what will happen to home ownership? The ability to move to take a job in another town? The economy? The American Dream of a better life than one’s parents? If you are considering buying a new home, think again. Doing so can be asking for trouble even if you can afford to pay cash—will the neighborhood self-destruct? Could you sell it if you have to? How good is the title on this new property?

If banks can’t foreclose, doesn’t that mean that the home owner gets away without paying the mortgage? Not quite. The mortgage deed is still filed in the real property records, and unless it’s removed the property can never be sold, not even if the home owner dies and the heirs want to dump it. The home remains collateral for the debt, and that won’t go away until the mortgagee agrees to remove it from the records.

Deep breath.

I do have a solution to offer. The foreclosure mills are grinding to a halt, but legitimate foreclosures with proper documentation and possession of the original promissory note can go forward without pause. For troublesome transactions (the paperwork is a mess, the note is missing, the home owner alleges he/she has defenses) it’s time to sit everybody around a table and work out a satisfactory solution through negotiation. All involved need a resolution that will end in a resumption of the payments, or an agreed-upon foreclosure with indemnities to the home owner against future troubles (say from the real owner of the original promissory note), or some contractual arrangement that ends up with a salable property in the local community.

Will this be easy? No. But it’s possible if a serious effort is made to set up the protocols. If the banks will start putting their money into creating efficient settlement procedures instead of funneling it into the robo-mess of the past few years, perhaps all these unintended consequences will be avoided and I can finally get some sleep.

Related Posts:
“How I Became a Law Professor,” January 27, 2010
“The Socratic Dialogue in Law School,” January 31, 2010
“Clickers,” March 17, 2010
“The Summer Bar Review Tours,” June 15, 2010
“The Sexy Promissory Note,” August 17, 2010
" Update: Mortgage Foreclosure and Missing Notes," November 16, 2010
"Women in My Law School Classroom," January 8, 2011
"I Threaten To Sure Apple Over an iPad Cover," April 8, 2011
"The Payment-In-Full Check: A Powerful Legal Maneuver," April 11, 2011


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