The Rule of Flaw: Ibanez and the Too-Big-to-Succeed Problem
posted by Jonathan Lipson
The Massachusetts Supreme Judicial Court’s recent ruling in U.S. Bank v. Ibanez is the latest and loudest salvo in what may be the most engaging and gruesome legal aspect of the credit crisis yet: The day of reckoning for the staggering sloppiness that infected virtually every step of the mortgage-securitization process.
Ibanez held that, according to well-established Massachusetts precedent, a mortgagee cannot foreclose unless — surprise, surprise — it actually isthe mortgagee, or a legitimate assignee thereof. In Ibanez, lenders or servicers had foreclosed mortgages prior to completing (or commencing) the process of taking assignment of the note and mortgage on which they foreclosed. When they later sought to clear title, Massachusetts courts balked. “Utter carelessness,” Justice Cordy scolded the plaintiffs.
This is potentially a huge problem for mortgage servicers (among others), given the long and convoluted chains of title through which mortgages may have passed in order to create mortgage-backed securities (MBS). Not surprisingly, many observers are apoplectic, warning that this will lead to the end of the financial markets as we know them.
How did this happen?
There are probably several answers, but I think one is that the elite financial services sector (EFSS) that created the MBS is (or believes itself to be) a unique institutional force, unchallengeable by the ordinary legal or political mechanisms that keep institutions in check. It is immune from the rules and norms that apply to the rest of us. But we know that spoilt children often lack discipline, so persistent failures of scrutiny have led inevitably to failures of competence. The drip, drip, drip of deregulation left us with firms that are not only too big to fail: they’re also too big to succeed.
What will happen next?
We can expect that the EFSS will respond to Ibanez as it always has after suffering any set-back: It will run to Congress for help. With a newly purchased Republican majority in the House, it will likely get it.
The important questions for those concerned about the power of the EFSS should therefore be:
1. What power does Congress have to remedy these mistakes—especially in a world where, Republicans would tell us, we are bound to a Constitution whose “original” understanding would probably not tolerate federal intrusion into state power over real property conveyancing? and
2. What will we get in exchange for fixing yet another mess created by the EFSS?
Others have already begun to address the former question, and the latter will play out in the media if (when) Congress takes up the question in the future. I think many (not all) would agree that we should not permit portfolios of MBS to collapse further, or void (technically flawed) foreclosure sales to bona fide purchasers. But simply sweeping aside state foreclosure law (as Congress nearly did last term) is probably not the answer, either.
In the meantime, what no one seems to have noticed is the larger point here: We have, for many years, made “the rule of law” a core objective at home and abroad. What this means generally — and whether it is sound policy — are debates above my pay grade. Yet, whatever else it may mean, it would appear that from bailout to whiteout, when it comes to the EFSS, it is the rule of flaw — not the rule of law — that counts.