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<div class="timestamp">February 4, 2012</div>
<h1>A Mortgage Tornado Warning, Unheeded</h1>
<span><h6 class="byline">By <a rel="author" href="http://topics.nytimes.com/top/reference/timestopics/people/m/gretchen_morgenson/index.html?inline=nyt-per" title="More Articles by Gretchen Morgenson" class="meta-per">GRETCHEN MORGENSON</a></h6>
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<p>
YEARS before the housing bust — before all those home <a href="http://topics.nytimes.com/your-money/loans/index.html?inline=nyt-classifier" title="More articles about loans." class="meta-classifier">loans</a> turned sour and millions of Americans faced <a href="http://topics.nytimes.com/top/reference/timestopics/subjects/f/foreclosures/index.html?inline=nyt-classifier" title="More articles about foreclosures." class="meta-classifier">foreclosure</a> — a wealthy businessman in Florida set out to blow the whistle on the <a href="http://topics.nytimes.com/your-money/loans/mortgages/index.html?inline=nyt-classifier" title="More articles about mortgages." class="meta-classifier">mortgage</a> game. </p>
<p>
His name is Nye Lavalle, and he first came to attention not in finance
but in sports and advertising. He turned heads in marketing circles by
correctly predicting that Nascar and figure skating would draw huge
followings in the 1990s. </p>
<p>
But after losing a family home to foreclosure, under what he thought
were fishy circumstances, Mr. Lavalle, founder of a consulting firm
called the Sports Marketing Group, began a new life as a mortgage
sleuth. In 2003, when home prices were flying high, he compiled a
dossier of improprieties on one of the giants of the business, <a href="http://topics.nytimes.com/top/news/business/companies/fannie_mae/index.html?inline=nyt-org" title="More information about Federal National Mortgage Association Fannie Mae" class="meta-org">Fannie Mae</a>. </p>
<p>
In hindsight, what he found looks like a blueprint of today’s
foreclosure crisis. Even then, Mr. Lavalle discovered, some
loan-servicing companies that worked for Fannie Mae routinely filed
false foreclosure documents, not unlike the fraudulent paperwork that
has since made “robo-signing” a household term. Even then, he found, the
nation’s electronic mortgage registry was playing fast and loose with
the law — something that courts have belatedly recognized, too. </p>
<p>
You might wonder why Mr. Lavalle didn’t speak up. But he did. For two
years, he corresponded with Fannie executives and lawyers. Fannie later
hired a Washington law firm to investigate his claims. In May 2006, that
firm, using some of Mr. Lavalle’s research, issued a confidential, <a title="Report to Fannie Mae Regarding Shareholder Complaints" href="http://www.nytimes.com/interactive/2012/02/05/business/05fannie-doc.html" target="_blank">147-page report</a> corroborating many of his findings. </p>
<p>
And there, apparently, is where it ended. There is little evidence that
Fannie Mae’s management or board ever took serious action. Known
internally as O.C.J. Case No. 5595, in reference to the company’s Office
of Corporate Justice, this 2006 report suggests just how deep, and how
far back, our mortgage and foreclosure problems really go. </p>
<p>
“It is axiomatic that the practice of submitting false pleadings and
affidavits is unlawful,” said the report, a copy of which was obtained
by The New York Times. “With his complaint, Mr. Lavalle has identified
an issue that Fannie Mae needs to address promptly.” </p>
<p>
What Fannie Mae knew about abusive foreclosure practices, and when it
knew it, are crucial questions as Congress and the Obama administration
weigh the future of the company and its cousin, Freddie Mac. These
giants eventually blew themselves apart and, so far, they have cost
taxpayers $150 billion. But before that, their size and reach — not only
through their own businesses, but also through the vast amount of work
they farm out to law firms and loan servicers — meant that Fannie and
Freddie shaped the standards for the entire mortgage industry. </p>
<p>
Almost all of the abuses that Mr. Lavalle began identifying in 2003 have
since come to widespread attention. The revelations have roiled the
mortgage industry and left Fannie, Freddie and big <a href="http://topics.nytimes.com/your-money/investments/brokerage-and-bank-accounts/index.html?inline=nyt-classifier" title="More articles about banks and brokerages." class="meta-classifier">banks</a>
with potentially enormous legal liabilities. More worrying is that the
kinds of problems that Mr. Lavalle flagged so long ago, and that Fannie
apparently ignored, have evicted people from their homes through
improper or fraudulent foreclosures. </p>
<p>
Until a few weeks ago, Mr. Lavalle, 54, had never seen O.C.J. 5595. He
had hoped to get a copy after helping Fannie’s lawyers, at Baker &
Hostetler in Washington, complete it. He didn’t. </p>
<p>
But after learning about its findings from a reporter for The Times, Mr.
Lavalle said, “Fannie Mae, its directors, servicers and lawyers
appeared to have an institutional policy of turning a willful blind eye
to evidence of mortgage origination and servicing fraud.” </p>
<p>
He went on: “When confronted directly with this evidence, Fannie not
only failed to correct and remedy the abuses, it assisted in continuing
the frauds via institutional practices that concealed fraudulent
foreclosures.” </p>
<p>
A spokesman for Fannie Mae said in a statement last week that the
company quickly addressed several issues that were raised in the 2006
report and that it took action on other issues associated with
foreclosures in 2010. “We want to prevent foreclosure whenever possible,
but when foreclosures cannot be avoided they must move forward in a
timely, appropriate fashion,” he said. </p>
<p>
Fannie Mae would not say whether it had shared O.J.C. 5595 with its
board of directors or its regulator, then known as the Office of Federal
Housing Enterprise Oversight. James B. Lockhart III, who headed that
regulator in 2006, said he did not recall reading the report. “I
probably did not see it as back then foreclosures were not a very big
deal,” he said. </p>
<p>
But <a title="The September 2011 report." href="http://www.fhfaoig.gov/Content/Files/AUD-2011-004.pdf">another report</a>
published last fall by the inspector general of the Federal Housing
Finance Agency, the current regulator, briefly mentioned some of the
problems that Mr. Lavalle had raised. (It didn’t mention him by name.)
It also faulted Fannie Mae, saying it failed to address foreclosure
improprieties that had surfaced years before. </p>
<p>
LIKE most people, Nye Lavalle had little interest in the mortgage
industry until things got personal. Raised in comfortable surroundings
in Grosse Pointe, Mich., just outside Detroit, he began his business
career in the 1970s, managing professional tennis players. In the 1980s,
he ran SMG, a thriving consulting and research firm. </p>
<p>
Then he tried to pay off a loan on a home his family had bought in
Dallas in 1988. The balance was roughly $100,000, and the property was
valued at about $175,000, Mr. Lavalle said. But when he combed through
figures provided by his lender, Savings of America, he found substantial
discrepancies in the accounting that had inflated his bill by $18,000.
The loan servicer had repeatedly charged him late fees for payments he
had made on time, as well as for unnecessary appraisals and force-placed
hazard <a href="http://topics.nytimes.com/your-money/insurance/index.html?inline=nyt-classifier" title="More articles about insurance." class="meta-classifier">insurance</a>, he said. </p>
<p>
Mr. Lavalle refused to pay. The bank refused to bend. The balance rose
as the bank tacked on lawyers’ fees and the loan was deemed delinquent.
The fight continued after his mortgage was allegedly sold to EMC, a Bear
Stearns unit. </p>
<p>
Unlike most people, Mr. Lavalle had the time and money to fight. He
persuaded his family to help him pay for a lawsuit against EMC and Bear
Stearns. Seven years and a small fortune later, they lost the house in
Dallas. Back then, judges weren’t as interested in mortgage practices as
some are now, he said. </p>
<p>
The experience lit a fire. Mr. Lavalle set out to learn everything he
could about the mortgage industry. In a five-hour interview in Naples,
Fla., last month, he described his travels nationwide. He dove into
mortgage arcana, land records and court filings. By 1996, he had
identified what appeared to be forged signatures on foreclosure
documents, foreshadowing troubles to come. He took his findings to big
players in the industry: Banc One, Bear Stearns, Countrywide Financial,
Freddie Mac, JPMorgan, Washington Mutual and others. A few responded but
later said his claims were not valid, he said. </p>
<p>
Now he splits his time between Orlando and Boca Raton, advising lawyers
as an expert witness. “From my own personal experience and 20 years of
research and investigation, nothing — and I mean nothing — that a bank,
lender, loan servicer or their lawyer says or puts on paper can be
trusted and accepted as true,” Mr. Lavalle said. </p>
<p>
FANNIE MAE, now in government hands, has acknowledged how abusive
foreclosure practices can hurt its own business. “The failure of our
servicers or a law firm to apply prudent and effective process controls
and to comply with legal and other requirements in the foreclosure
process poses operational, reputational and legal risks for us,” it said
in a 2010 filing with the Securities and Exchange Commission. </p>
<p>
Five years earlier, Fannie seemed to have taken a different view. That
was when Mr. Lavalle pointed out legal lapses by some of its
representatives. Among them was the law offices of David J. Stern, in
Plantation, Fla., which was handling an astonishing 75,000 foreclosure
cases a year — more than 200 a day. In 2005, Mr. Lavalle warned Fannie
Mae that some judges had ruled that the Stern firm was submitting “sham
pleadings.” Nonetheless, Fannie continued to do business with the firm
until it closed its doors last year, after evidence emerged of rampant
forgeries and fraudulent filings. </p>
<p>
O.C.J. Case No. 5595 found that Stern wasn’t the only firm working for
Fannie that seemed to be cutting corners. It also found that lawyers
operating in seven other states — Connecticut, Georgia, New York,
Illinois, Louisiana, Kentucky and Ohio — had made false filings in
connection with work for Fannie Mae or the <a href="http://topics.nytimes.com/top/news/business/companies/mortgage_electronic_registration_systems_inc/index.html?inline=nyt-org" title="More articles about Mortgage Electronic Registration Systems Inc." class="meta-org">Mortgage Electronic Registration System</a>, or MERS, a private mortgage registry Fannie helped establish in 1995. </p>
<p>
“While Fannie Mae officials do not have a single opinion, some officials
believe foreclosure counsel are sacrificing accuracy for speed,” the
report said. </p>
<p>
The lawyers at Baker & Hostetler did not agree with everything Mr.
Lavalle said. Mark A. Cymrot, a partner who led the investigation,
discounted Mr. Lavalle’s fear that Fannie could lose billions if large
numbers of foreclosures had to be unwound as a result of misconduct by
its lawyers and servicers. </p>
<p>
Even so, the report didn’t conclude that Mr. Lavalle was wrong on the
legal issues. It simply said that few people would have the financial
resources to challenge foreclosures. In other words, few people would be
like Mr. Lavalle. </p>
<p>
“Courts are unlikely to unwind foreclosures unless borrowers can
demonstrate that the foreclosure would not have gone forward with the
correct pleadings, which is a difficult burden for most borrowers to
meet,” the report said. “Nevertheless, the issues Mr. Lavalle raises
should be addressed promptly in order to mitigate the risk of exposure
to lawsuits and some degree of liability.” Mr. Cymrot declined to
comment for this article. </p>
<p>
O.C.J. 5595 also questioned Mr. Lavalle’s contention that improprieties
by loan servicers were pervasive. But based on interviews with 30 Fannie
employees, the report conceded that the company had no mechanism to
ensure that servicers were charging borrowers appropriate fees. </p>
<p>
Other oversight at Fannie was similarly lacking, the Baker &
Hostetler lawyers found. For instance, when Fannie identified fraud by a
lender or servicer, it didn’t notify the homeowner. Nor did it police
activities of lawyers or servicers it hired. As a result, the report
said, Fannie might not be insulated from liability for their misconduct.
</p>
<p>
Lewis D. Lowenfels, a securities law expert, said he was perplexed that
Fannie’s board appeared to have done nothing to correct these practices.
“If it had been brought to the board’s attention that specific acts of
illegality were being committed, it should have directed that
relationships with the transgressors be terminated forthwith and Fannie
Mae’s regulator be advised accordingly,” he said. </p>
<p>
Daniel H. Mudd, Fannie’s chief executive at the time, declined to
comment through his lawyer. Mr. Mudd was recently sued by the S.E.C.,
accused of failing to disclose Fannie’s participation in the subprime
mortgage market. </p>
<p>
PERHAPS no development has done more to obscure the forces behind the
foreclosure epidemic than the rise of the MERS, the private registry
that has all but replaced public land ownership records. Created by
Fannie, Freddie and big banks, MERS claims to hold title to roughly half
the nation’s home mortgages. Judges and lawmakers have questioned
MERS’s legal authority to initiate foreclosures, and some judges have
thrown out foreclosures brought in its name. On Friday, New York’s
attorney general sued MERS, contending that its system led to fraudulent
foreclosure filings. MERS refuted the claims and said it would fight.
</p>
<p>
Mr. Lavalle warned Fannie years ago that MERS couldn’t legally foreclose
because it didn’t actually own notes underlying properties. </p>
<p>
The report agreed. MERS’s approach of letting loan servicers foreclose
in its own name, not in that of institutions owning the notes, “is not
accepted legal practice in all states,” the report said. Moreover,
“MERS’s counsel conceded false allegations are routinely made, and the
practice should be ‘modified.’ ” </p>
<p>
It continued: “To our knowledge, MERS has not addressed the issue of its
counsels’ repeated false statements to the courts.” </p>
<p>
Janis L. Smith, a spokeswoman for MERS, said it had not seen the Baker
& Hostetler report and declined comment on its references to the
false statements made on its behalf to the courts. She said that MERS’s
business model is legal in all states and that as a nominee, it has the
right to foreclose. MERS stopped allowing its members to foreclose in
its name in all states in 2011. </p>
<p>
Robert D. Drain, a federal bankruptcy judge in the Southern District of
New York, said in court last month that the failure of the mortgage
industry to deal with pervasive problems involving inaccurate
documentation and improper court filings amounted to “the greatest
failure of lawyering in the last 50 years.” </p>
<p>
In an interview last week, Judge Drain said several practices have
contributed to the foreclosure mess. One is that Fannie and the rest of
the industry failed to ensure that MERS was operating legally in all
states. Another is that the industry failed to perform due diligence on
documentation. </p>
<p>
MERS no longer participates in foreclosures. But a lot of damage has already been done, Mr. Lavalle said. </p>
<p>
“Hundreds of thousands of foreclosures in Florida and across America
were knowingly conducted unlawfully, for which there are still severe
liabilities and implications to come for many years,” he said. </p>
<p>
THERE was a time when Americans had mortgage-burning parties: When they
paid off a promisory note, they celebrated by burning the release of the
lien. </p>
<p>
But they kept the canceled promissory note — and there was a reason for
that. Promissory notes, like dollar bills, are negotiable currency.
Whoever holds them can essentially claim them. </p>
<p>
According to O.C.J. Case No. 5595, Fannie held roughly two million
mortgage notes in its offices in Herndon, Va., in 2005 — a fraction of
the 15 million loans it actually owned or guaranteed. Who had the rest?
Various third parties. </p>
<p>
At that time, Fannie typically destroyed 40 percent of the notes once
the mortgages were paid off. It returned the rest to the respective
lenders, only without marking the notes as canceled. </p>
<p>
Mr. Lavalle and the internal report raised concerns that Fannie wasn’t
taking enough care in handling these documents. The company lacked a
centralized system for reporting lost notes, for instance. Nor did
custodians or loan servicers that held notes on its behalf report
missing notes to homeowners. </p>
<p>
The potential for mayhem, the report said, was serious. Anyone who gains
control of a note can, in theory, try to force the borrower to pay it,
even if it has already been paid. In such a case, “the borrower would
have the expensive and unenviable task of trying to collect from the
custodian that was negligent in losing the note, from the servicer that
accepted payments, or from others responsible for the predicament,” the
report stated. Mr. Lavalle suggested that Fannie return the paid notes
to borrowers after stamping them “canceled.” Impractical, the 2006
report said. </p>
<p>
This leaves open the possibility that someone might try to force
homeowners to pay the same mortgage twice. Or that loans could be
improperly pledged as collateral by some other institution, even though
the loans have been paid, Mr. Lavalle said. Indeed, there have been
instances in the foreclosure crisis when two different institutions laid
claim to the same mortgage note. </p>
<p>
In its statement last week, Fannie said it quickly addressed questions
of lost note affidavits and issued guidance to servicers that no
judicial foreclosures be conducted in MERS’s name. It also said it
instructed Florida foreclosure lawyers “to use specific language to
assure no confusion over the identity of the ‘owner’ and the ’holder’ of
the note.” </p>
<p>
The 2006 report said Mr. Lavalle at times came across as over the top,
that he was, in its words, “partial to extreme analogies that undermine
his credibility.” Knowing what we know now, he looks more like one of
the financial Cassandras of our time — a man whose prescient warnings
went unheeded. </p>
<p>
Now, he hopes dubious mortgage practices will be eradicated. </p>
<p>
“Any attorney general, lawyer, bank director, judge, regulator or member
of Congress who does not open their eyes to the abuse, ask pertinent
questions and allow proper investigation and discovery,” he said, “is
only assisting in the concealment of what may be the fraud of our
lifetime.” </p>
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<br clear="all"><br>-- <br>Art Deco (Wayne A. Fox)<br><a href="mailto:art.deco.studios@gmail.com" target="_blank">art.deco.studios@gmail.com</a><br>