The Unanticipated Consequences of MERS

By William K. Black

(cross-posted with

One of the defining motifs of theoclassical economics textbooks is the provision of examples of the unintended consequences of government action. Those consequences are invariably negative. The narrative is the government intended to achieve some goal, e.g., help the poor, and ended up harming the poor. Four counter narratives virtually never appear in these tracts. Theoclassical economists rarely mention: 1. Any governmental program that succeeds in its aims 2. Any governmental program that has unanticipated, positive consequences 3. Any private action that has negative unanticipated consequences 4. Any private action that has negative, intended consequences
A fifth counter narrative sometimes appears in theoclassical accounts – governmental actions that are intended to be harmful by the private parties that corruptly convince public sector actors to aid the private parties at the expense of the public interest. The fifth example reflects poorly on both the public and private sector actors and suggests that the private sector is a source of corruption of the public sector – which fits poorly with theoclassical dogma.
This column focuses on MERS as an example of the first and third types of counter narrative. It will be the first in a series of columns about MERS. A conservative, but not theoclassical economist, Hernando de Soto, is famous for his work on private property. I highly recommend his book: The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. De Soto’s primary point is that private ownership of real property allows even poorer people to mobilize their limited wealth by pledging the real estate as security for loans. The individuals can use those loans as a source of capital to become entrepreneurs. De Soto uses the United States as an exemplar of his thesis, explaining that the colonies that become the U.S. began a system of public recordation of land titles and a system of surveying land. The developing U.S. made these systems a major priority. De Soto argues that these public sector programs were spectacularly successful and helped produce America’s economic success by encouraging entrepreneurial activity.

These two successful government programs (public recordation of land titles and transfers and public land surveys) achieved their intended goals. They made it far easier to pledge real property, which made real property more valuable. Public recordation greatly reduced the risk of fraudulent pledges. Reducing the risk of fraudulent pledges makes lenders more willing to lend and reduces the interest rates on secured lending. Reduced interest rates mean a lower “hurdle” rate for investment, which means that more productive investments will occur and economic growth will increase.

Public recordation in the U.S. became even more effective in spurring growth and efficiency with the development of Article 9 of the Uniform Commercial Code (UCC). Article 9 set out to make it far easier for lenders to access public records of liens by dramatically increasing the degree of uniformity in how and where such records would be kept. Article 9 was not only a governmental program that achieved its aim – it was the brainchild of an academic (Yale Law School’s Professor Grant Gilmore). Article 9 further reduced the risk of fraudulent pledges and greatly increased efficiency. Business, particularly lenders, strongly supported its adoption.

MERS (Mortgage Electronic Registration Systems) sought to privatize key aspects of the public title system. The primary purpose was to avoid recordation fees when interests in real property were assigned or transferred. MERS’ founders read like a who’s who of the entities who caused the recent financial crisis, so some scholars view its creation as an example of a private sector action intended to harm the public. This column assumes that MERS’ harms were, originally, unintended. It focuses on the insanity – from the standpoint of honest lenders and investors – of MERS’ devastation of a public system of recordation that had served business, particularly lenders and investors, brilliantly.

MERS’ problems are legion, but they are also inherent in its structure. This column addresses only one aspect of its “agency” problem. MERS is set up in a bizarre fashion designed to minimize costs. It has only a trivial number of real employees. It has no ability to check its members’ initial or continuing quality or integrity. MERS appoints its members’ personnel as MERS officers and exercises no meaningful oversight over their actions.

As I have explained in prior articles, MERS’ members have endemic, severe problems with mortgage documentation. They originated, purchased, or agreed to service loans and collateralized debt obligations (CDOs) without the underlying mortgage note. Fraud begets fraud. The exceptional incidence of underlying mortgage origination fraud led to widespread failure to prepare and maintain proper documentation – and that was before the mortgage originators failed. When the mortgage originators failed, as they did by the hundreds, mortgage documents were frequently thrown away. Mortgage documentation became particularly defective because originators could sell mortgages without the purchaser even checking whether the seller was delivering the original note.

The secondary market in nonprime mortgages operated under the financial version of “don’t ask; don’t tell.” The incidence of fraud and defective documentation in nonprime loans was so large that the purchaser faced an inescapable dilemma. If it did competent underwriting it would detect widespread fraud and missing notes and document that it knew that the nonprime loan portfolio it was purchasing (and then reselling them as the collateral for CDOs) was fraudulent. Documenting that one is selling CDOs one knows to be backed by fraudulent loans that often lacked the underlying note is an excellent strategy for going to prison and being sued by every CDO purchaser. The alternative was not to do any meaningful underwriting when purchasing nonprime loans. The no meaningful underwriting alternative, however, maximized the already perverse incentives to originate and sell fraudulent loans lacking essential documentation.

MERS’ members, therefore, had overwhelming incentives to engage in foreclosure fraud. The loans they were seeking to foreclose on often lacked essential documentation and were induced by defrauding the borrower. They had no legal right to foreclose, but that result was unacceptable to the senior officers controlling the loan servicers. They insisted on results, and did not monitor compliance with the law. The result was tens of thousands of felonies – monthly – by some of the largest financial institutions in the world. Filing false affidavits became business as usual. No one senior in the Justice Department or administration appears to be seriously upset about this. These felonies were committed by, or at the direction of, MERS “officers” – and MERS does not appear to be seriously upset about fraudulently foreclosing on the homes of tens of thousands of Americans. I study fraud by elites, and even I am stunned by the frequency and nature of the frauds and felonies and the lack of prosecutions and the overall blasé attitude by CEOs to the fraud and felonies.

4 responses to “The Unanticipated Consequences of MERS

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  2. Why are you surprised? Didn't you read Bonfire o the Vanities? The financial sector is our new criminal class. Clinton may have cut crime in the streets, but it just moved to the board rooms where it is even more costly to society.

  3. Hi Bill – I first learned of your work watching BookTV in 2005. I bought and read "The Best Way to Rob a Bank Is to Own One." In spite of being so alerted, it really wasn't possible for me to meaningfully see what was going on.I've followed your continuing work and congratulate you and the others at the University of Missouri, Kansas City for your contributions, but the public doesn't yet understand how the system works against their best interests.In reading this post, the phrase "fraud by elites" stood out. There is an inherent dissonance to me, here in the classless U.S. The "elite" are the most talented. They have earned their way to the top. We admire apparent success and want that for ourselves and families. Fraud in not a talent, it is an abuse that is enabled by inherent trust. It is also a crime, but one where the victim is blamed. Is there any similar situation in our society where trust and general respect has enabled abuse to remain hidden and where victims are silent? Where there the victims feel shame and are blamed for their losses. For decades the Catholic Church denied claims of sexual abuse by priests. Abusers were moved to other areas, no admissions of guilt or rehab, and then more were victimized. It just couldn't be admitted that holy men, trusted priests, could be sexual predators. Yet, it was true.Americans worship at the Church of the Here and Now, where a financial priesthood has taken the "Vow of wealth" and sermonize about it. Debt will make you rich; that's how the rich get rich. Losses, that's just business. Heaven is promised, but you are warned in the prospectus that the stairway has risks and falls aren't covered.After the fall, this world we have is different than what we thought we were building. The American landscape of McManions looked like wealth, but really it was the manifestation of a mortgaged future. Although in theoretical balance, assets equalling liabilities, those values were inflated. Appreciation can't erase debt. We feel abused. We trusted and predators took advanatage of our innocence. We feel shame. Nouriel Roubini talked about how people incurring losses were: "gambling for redemption." Losses unrecognized and paid, were followed by riskier and riskier bets.So, who are we after? Perhaps: abusers of fiancial trust, false priesthood of high growth, predatory gamers of the financial regulation, … words fail to capture criminal theft of the future.

  4. Well, I've been off running for school board for the last few months, and don't get to visit very much any more… but did anyone else notice that the first comment above is an advertisement for a ponzi scheme?