How one woman beat the big banks: The amazing, true story about how Wall Street’s mortgage fraud unraveled

Sued by a giant bank, Lisa Epstein didn’t have many options. Then she found the small print that changed everything

DAVID DAYEN 

(Credit: AP/David J. Phillip)

None of Lisa Epstein’s options for dealing with her foreclosure seemed very attractive. She could try the Home Affordable Modification Program, or HAMP, which President Obama announced from Mesa, Arizona, on February 18, 2009, the day after Lisa was served. She pulled the speech up at the White House website. The idea was that the Treasury Department would give mortgage servicers incentive payments to modify delinquent loans. In the speech, Obama kept stressing borrower responsibilities more than the responsibilities of fraudulent lenders or securitizing banks. Did he not understand how this crisis happened? Plus HAMP involved applying through Chase Home Finance, Lisa’s servicer, which spent nine months losing her paperwork, ignoring her requests for help, and driving her into foreclosure by advising her to miss payments. Common sense dictated they wouldn’t be much better at administering a new program, no matter how many inducements the government gave them.

Lisa could fight it out in court, but the handful of lawyers taking foreclosure cases in Palm Beach County wanted retainers of up to $5,000, and $340 an hour in consultation fees. If Lisa had that kind of money, she probably wouldn’t be in foreclosure to begin with. Legal aid societies and pro bono lawyers working for free were overloaded and unavailable for someone with a decent job, like Lisa. Banks knew troubled homeowners didn’t have the resources to fight foreclosures; that’s why everyone told her most cases never got challenged. Besides, anytime Lisa would meet with a lawyer—and she talked to several, even drove an hour down to Broward County once—she’d explain her operatic theories about the housing crash, and the attorneys would stare at her like she sprouted horns. They all told her there wasn’t much she could do if she didn’t pay. But Lisa pleaded, “You don’t understand. The bank suing me says they have no relationship with me. How could I just give up?”

Without hope of a last-minute intervention, and without funds for legal representation, Lisa had a third option: fight the foreclosure herself, as a pro se litigant. This sounded crazy to her. She had no legal training, picking up bits and pieces in late-night cram sessions. The saying went that anyone who represents herself as a lawyer has a fool for a client. But Lisa’s motivations went far beyond whether or not she would keep that misbegotten house on Gazetta Way.

Something had gone horribly awry at the highest levels of the economy, causing the largest destruction of wealth in eighty years. Wall Street recklessness played the signature role, and Lisa wanted to challenge that in her small way. Maybe she could unearth some novel strategy, share her knowledge, and help spare other unsuspecting Americans from her pain. It would be difficult, no doubt, maybe impossible, maybe preposterous to even try. But Lisa didn’t think it worth her personal comfort to stay silent. Something about the magnitude of the crisis and the constancy of voices tagging foreclosure victims like her as irresolute deadbeats made her more determined to prove everyone wrong, to keep searching until she found something she could call justice.

While running through all this, Lisa kept coming back to Count II, the “Re-establishment of Lost Note.”

A mortgage has two parts. There’s the promissory note, the IOU from borrower to lender, and the mortgage, which creates the lien on the home in case of default. Foreclosure laws vary from state to state and evolve with every court decision, but in the simplest terms, to be able to foreclose, a financial institution must hold the mortgage, the note, or both. This gives you standing, as it would in most judicial contexts: if you accuse someone of stealing your car, you’d need to establish that you actually owned it in the first place.

During securitization, mortgages were transferred from the originator through a series of intermediaries and then to the trustee, who administers the mortgage-backed trust. Lisa’s case featured three parties in all— DHI Mortgage (originator), JPMorgan Chase (depositor), and U.S. Bank (trustee)—but sometimes these deals had as many as seven or eight transfers. The securitizations included intermediaries mostly to reassure investors that they would still get payments if the originator went out of business, which actually happened quite a bit. This desire for “bankruptcy remoteness” drove securitization transfers, and it didn’t hurt that every transfer generated another fee.

At each stage there would have to be documented evidence of transfer, like links in a chain—a chain of title, which lays out the different transactions. You can’t skip a link: the chain must show evidence of transfers from originator to depositor to trustee, and everyone in between, in precise order. Mortgages are assigned with a signed piece of paper affirming the transaction. Notes are endorsed the same way you would endorse the back of a check. Theoretically, the originator could endorse the note “in blank,” so that anyone in possession of the note could enforce it. But that theory ran up against the reality of the securitization agreements.

When Lisa finally found copies of the rules governing securitizations, known as the pooling and servicing agreements (PSAs), they all had roughly the same language about transfers. This comes from the prospectus of Soundview Home Loan Trust 2006-OPT2:

On the Closing Date, the Depositor will transfer to the Trust all of its right, title and interest in and to each Mortgage Loan, the related mortgage note, Mortgage, assignment of mortgage in recordable form in blank or to the Trustee and other related documents received from the Originator pursuant to the Master Agreement (collectively, the “Related Documents”). . . .

The Pooling Agreement will require that, within the time period specified therein, the Depositor will deliver or cause to be delivered to the Trustee (or a custodian on behalf of the Trustee) the mortgage notes endorsed to the Trustee on behalf of the Certificateholders and the Related Documents.

The mortgage and the note had to be physically conveyed into the trust and delivered to the document custodian, with the mortgages assigned and the notes endorsed with a wet-ink signature at every step along the way, culminating in assignments and endorsements to the trustee. And this had to be done within ninety days of the transaction, with no grace period beyond that closing date. Only then would you have a “true sale” of the loans from originator to trustee.

Most trusts were created under New York State trust law, which is unbelievably clear. It stipulates that the pooling and servicing agreements are the governing documents. Any transaction that doesn’t comply with the PSA is void. Failure to convey mortgages and notes would result in noncompliance. That means the trust would be unfunded and effectively not exist. Ownership would revert back to the last verifiable owner in the chain. And under New York law, there was no mechanism to transfer mortgages and notes after the closing date.

There are tax consequences associated with this failure as well. All securitization trusts were set up as REMICs. If the trust closed without the key documents conveyed over, those assets would not qualify for the REMIC tax exemption. They could not be added later, especially in the middle of foreclosure, because REMICs cannot acquire nonperforming assets. As a result, any income derived from the assets would get taxed, under the law, at 100 percent.

Those were the rules, spelled out in governing documents agreed to by all parties. And the Living Lies chatterers were convinced that nobody in the mortgage industry bothered to follow them. If this theory was correct, it would turn mortgage-backed securities into non-mortgage-backed securities. And the trustee, in Lisa’s case U.S. Bank, would not have the right to collect on the promissory note or use the mortgage lien to foreclose on the borrower. As Neil Garfield put it, “There is an 18-minute Nixonian gap in the record that cannot be cured.” Activists took to calling it “securitization FAIL.”

The prevalence of “lost” notes, including Lisa’s, created more suspicion. If the notes were safely stowed away by the trustee’s document custodian, losing them could ………..

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