A Mortgage Tornado Warning, Unheeded
YEARS before the housing bust — before all those home loans turned sour and millions of Americans faced foreclosure — a wealthy businessman in Florida set out to blow the whistle on the mortgage game.
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.
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, Fannie Mae.
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.
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, 147-page report corroborating many of his findings.
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.
"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."
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.
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 banks 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.
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.
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."
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."
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.
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.
But another report 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.
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.
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 insurance, he said.
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.
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.
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.
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.
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.
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.
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 Mortgage Electronic Registration System, or MERS, a private mortgage registry Fannie helped establish in 1995.
"While Fannie Mae officials do not have a single opinion, some officials believe foreclosure counsel are sacrificing accuracy for speed," the report said.
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.
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.
"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.
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.
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.
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.
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.
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.
Mr. Lavalle warned Fannie years ago that MERS couldn't legally foreclose because it didn't actually own notes underlying properties.
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.' "
It continued: "To our knowledge, MERS has not addressed the issue of its counsels' repeated false statements to the courts."
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.
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."
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.
MERS no longer participates in foreclosures. But a lot of damage has already been done, Mr. Lavalle said.
"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.
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.
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.
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.
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.
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.
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.
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.
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."
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.
Now, he hopes dubious mortgage practices will be eradicated.
"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."
