Posted on Friday, November 5, 2010
U.S. taxpayers already own pieces of such problem-plagued companies as General Motors Corp., Chrysler LLC, American International Group Inc. (NYSE: AIG), Fannie Mae (OTC: FNMA) and Freddie Mac (OTC: FMCC). Now the increasingly problematic "Mortgagegate" saga could land American taxpayers in the trouble-ridden title-insurance business.
On Oct. 8, Bank of America Corp. (NYSE: BAC) indemnified Fidelity National Financial Inc. (NYSE: FNF) against any losses that Fidelity might sustain in litigation over title insurance it writes on foreclosed homes - the same homes, coincidentally, that Bank of America wants to sell to new buyers.
This arrangement amounts to U.S. taxpayers, who are the ultimate backers of the Federal Deposit Insurance Corp. (FDIC), backstopping a giant, publicly held title-insurance company, which is backstopping a huge commercial bank, so that the bank can sell properties that it might not have proper title to.
It sounds like a Wall Street version of the "Six Degrees of Kevin Bacon," but it's no game - it's a daisy-chain scheme that once again sets American households up as the biggest losers.
As more and more of the dirty laundry of "Mortgagegate" gets aired, it's becoming increasingly obvious that the usual trio of victims - U.S. homeowners, investors and taxpayers - face risks that are far worse than we ever before imagined.
In fact, the fallout potential is so numbing and the actions that birthed it so scandalous that commentators have given the crisis such Watergate-esque titles as "Mortgagegate" (or, as some prefer, "Mortgage Gate"), "Foreclosuregate" and "Foreclosure Gate."
Here's how the dirty business of insuring clean titles is transforming Mortgagegate into a full-fledged inferno of political intrigue and financial controversy.
There are basically two types of title insurance:
• An "owner's policy," which protects the property purchaser from claims against their rightful title to the insured property.
• And a "lender's policy," which is purchased by mortgage lenders to protect their interest in a property as collateral for the loan they've made against it. The lender's policy, sometimes called a "loan policy," follows the assignment of the mortgage when it is sold from one lender to another.
Anytime a mortgage is made with the purchase of real estate, both the lender and buyer purchase title insurance.
With all the problems being uncovered surrounding Mortgagegate, one of the most prevalent issues has to do with titles to foreclosed properties. Foreclosures can only be pursued by the party named on the title, meaning that's the only person or company who is recognized as having the legal right to take back the property for non-payment of the mortgage.
When lenders sell the mortgages that they've made to homebuyers to other lenders, banks or mortgage-pool securitizers, they are supposed to record the "transfer" of the loan and essentially document the process in what becomes the recorded chain "chain of title."
However, the reality is that most lenders didn't bother to properly document and record changes to titles when they traded loans back and forth. So when the time came to start foreclosing on delinquent borrowers, the real trouble began: Lawyers, courts, investors, title insurers and in-arrears homeowners began to discover - en masse - that titles were often improperly recorded, were never re-recorded, or were missing altogether.
Investors, regulators, lenders and others are now beginning to see just how widespread these egregious oversights actually were.
When Risk Comes Home to Roost
What's important to understand now is that when foreclosed homes are sold to new buyers by the banks that took them back, buyers (and lenders, too) want title insurance to protect themselves against past owners, lenders, or the servicers and trustees of mortgage-backed securities pools challenging their free-and-clear ownership of the purchased property.
Imagine having a huge inventory of foreclosed homes that you can't sell because buyers can't get title insurance. After all, why would any title insurance company write a policy when there's a good chance it will later be involved in costly litigation with potentially severe damages from making good on the policies that it writes?
The secondary market for almost any foreclosed home would come to a screeching halt without title insurance. And we're not talking about a small market, either: Currently, about 2.5 million people have already lost their homes and there are estimates that as many as 5.7 million more face imminent foreclosure.
That brings us back to the BofA/Fidelity National deal.
Bank of American wanted Fidelity National Financial - America's largest title insurance company, with an estimated 50% of the market - to write title-insurance policies on the foreclosed homes that BofA wanted to sell. To get Fidelity to agree, Bank of America agreed to indemnify the title-insurance firm on any title-insurance policy written on the homes that the bank sold from its inventory of foreclosed properties.
Needless to say, the indemnification deal was a complex one. It amounts to backstopping an entire insurance company's risk by subjecting U.S. taxpayers to liability if the title company is sued until it's insolvent and then Bank of America can't make good on the claims it's agreed to cover.
All the too-big-to-fail banks have proven once again that they run America for their own financial gain.
I say "all the too-big-to-fail banks" because the scheme doesn't work unless all the big banks indemnify all the title insurance companies. Why? Because the legality of what Bank of America is doing is highly questionable and the bank has to make sure it's done in an across-the-board fashion to eradicate any and all questions about this strategy.
Where We Go From Here
Try not to get sick, but here's what will likely happen next:
Because forcing a buyer to buy title insurance from any one company is illegal under the federal law known as the Real Estate Settlement Procedures Act, or "RESPA," Bank of America will have to indemnify other title insurance companies that offer insurance to buyers and lenders.
By law, buyers have to be offered a choice when they must purchase title insurance. So in order to make other title-insurance companies step up and write policies, those companies might have to be offered the same indemnification that Fidelity was granted.
Fidelity National Financial, after getting its indemnification from BofA, pressed other banks, servicers and sellers of foreclosed properties to follow suit - and required an indemnity agreement before insuring any individual foreclosed property. For the time being, however, that hard-nosed play didn't fly. Other title-insurance companies didn't follow the industry leader's lead. They didn't immediately demand their own indemnification deals. And since Fidelity was afraid it would lose business to its competitors, Bloomberg News reported that on Wednesday Fidelity reversed course and withdrew its demand to be indemnified on any property it provides a title policy to.
But Fidelity National still kept its BofA indemnification agreement in its front pocket and has no intention of ever giving that up.
According to the memo issued by Fidelity and cited by Bloomberg, Fidelity "may make individual agreements with other lenders."
And why not? It's only going to take a few victories in court - or for any of the class-action lawsuits being filed to gain traction - before the rest of the title-insurance companies demand the exact type of indemnification that Fidelity got BofA to agree to.
If all the too-big-to-fail banks end up backstopping title insurance to this degree, the sins of Wall Street will once again reach all the way to Main Street: The banks will be in the business of underwriting insurance risk on the collateral they already own, and we - the U.S. taxpayers - will discover that we're the backstop of last resort in this latest chain of financial incompetence and deceit.
Once again, it's the banks that are being protected from the mess they made so they can go back to making profits to fill their corporate coffers and bolster their balance sheets so that they can finance American capitalism. In reality, all we're doing is financing a bunch of institutionalized Bernie Madoffs - none of whom will ever see the inside of a jail cell.
With every new Mortgagegate disclosure, the American public is getting an eyeful of how Wall Street and Washington have collaborated to play it again.
What's important now is for investors and homebuyers to be vigilant, to make sure that this mess is cleaned up, and to make sure reforms are enacted to keep this from happening again.
Otherwise, sometime down the road, we taxpayers will wake up and discover that we're again on the hook for billions, thanks to another scheme that Wall Street's serial scammers have pulled off. And we will discover that we're in yet another new "business" - perhaps something even more inappropriate than title insurance.
Let's do all we can to keep that nightmare from coming true.
Editor's Note: On Wednesday, in the latest development in the "Mortgagegate" scandal, Fidelity National Financial Inc., the largest U.S. title-insurance firm, reversed course and said it wouldn't require an indemnity agreement before insuring individual foreclosed properties. Money Morning's Shah Gilani, a retired hedge-fund manager, warns that there's a deep game being played, and provides investors with detailed insights, and advice on the steps to take.]
October 29, 2010
By Shah Gilani, Contributing Editor, Money Morning