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Dirty Remics

Dirty Remics

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Published by Foreclosure Fraud
4closureFraud.org
4closureFraud.org

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Categories:Types, Research
Published by: Foreclosure Fraud on Feb 03, 2013
Copyright:Attribution Non-commercial

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05/02/2013

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Electronic copy available at: http://ssrn.com/abstract=2209863
Brooklyn Law School Legal StudiesResearch Papers Accepted Paper Series
Research Paper No. 322 January 2013
Dirt Lawyers, Dirty REMICs
Bradley T. BordenDavid J. Reiss
This paper can be downloaded without charge from theSocial Science Research Network Electronic Paper Collection:http://ssrn.com/abstract=2209863
 
Electronic copy available at: http://ssrn.com/abstract=2209863
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Bradley T. Borden & David J. Reiss
*
The day-to-day practice of real estate law does not touch on the intricacies of thesecuritization of mortgages, let alone the tax laws that apply to mortgage-backed securities. Andthat is okay. What is not okay is that securitization professionals did not account for the day-to-day practices of dirt lawyers as they relate to the transfer and assignment of mortgage notes andmortgages when structuring mortgage-backed securities. The consequences of this may turn outto be severe for investors, underwriters, and securitization professionals.But of equal gravity is the responsibility that this imposes on dirt lawyers, as members of society with specialized knowledge, to help shape policy. As the business cycle turns and themortgage markets rise from the depths of the Bust, dirt lawyers should be sure to make theirviews known about the role that law should play in the business of real estate finance. Inparticular, they should make clear how formalistic legal rules protect the parties to a real estatefinance transaction and that these rules should be treated with appropriate deference. Thatformalism can protect the borrower from paying the debt more than once or to the wrong party.It can also protect the owner of the note from disputes over whether the underlying debt shouldbe paid.Take, for example, the negotiability of mortgage notes, which is governed by theUniform Commercial Code (UCC). Notes can be sold by the thousands in run of the millsecondary market transactions. Negotiable notes are much better for lenders than non-negotiableones, so lenders are incentivized to properly negotiate them. Trusts are bulk purchasers of negotiable instruments
which put the “security” in
mortgage-backed securities (MBS). Thesetrusts are best protected if they are holders in due course of the negotiable instruments and are
 
Electronic copy available at: http://ssrn.com/abstract=2209863
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1/31/2013 DRAFT Borden & Reiss
thusly incentivized to ensure that the note was properly negotiated. The rules of negotiability arequite clear, designed as they were for a broad swath of the commercial world. Negotiation of a
typical mortgage note requires delivery and the payee’s signature or 
endorsement.Notwithstanding these incentives and clear rules, a mountain of recently revealed evidenceindicates that many notes in secondary market transactions were not properly negotiated.One of the consequences of the sale of a negotiable note not done in accordance with therequirements of the holder in due course doctrine is that the purchaser of the note may not be freeof the personal defenses that the note maker (borrower) would have had against the originallender. (The personal defenses include lack of consideration; non-performance; actual paymentof the debt; and fraud in the inducement. UCC § 3-302.) Another consequence of the sale of anote that is not done properly is that the beneficial owner (as opposed to the legal owner) maynot be able to collect on the debt if the borrower is in default. And a third
 – 
and until recentlyhidden -- consequence of an improper sale of a note to a secondary market participant is that thepurchaser may fail to comply with requirements necessary to obtain favorable tax treatment as aReal Estate Mortgage Investment Conduit, a REMIC.Modern Residential Real Estate FinanceBefore 1986, complex mortgage-backed securities had various tax-related inefficiencies.First amongst them, these securities were taxable at the entity level and so investors faced doubletaxation. Wall Street firms successfully lobbied Congress to do away with double taxation in1986. This legislation created the Real Estate Mortgage Investment Conduit (REMIC), whichwas not taxed at the entity level. This one change automatically boosted its yields over otherforms of mortgage-backed securities that would otherwise be taxed. Unsurprisingly, REMICs

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