UPDATE at end.

Wow. Stopforeclosurefraud finds testimony from New Jersey bankruptcy court case indicating that Countrywide was not passing along notes as part of the securitization process:

The new allonge was signed by Sharon Mason, Vice President of Countrywide Home Loans, Inc., in the Bankruptcy Risk Litigation Management Department. Linda DeMartini, a supervisor and operational team leader for the Litigation Management Department for BAC Home Loans Servicing L.P. (“BAC Servicing”V testified that the new allonge was prepared in anticipation of this litigation, and that it was signed several weeks before the trial by Sharon Mason. As to the location of the note, Ms. DeMartini testified that to her knowledge, the original note never left the possession of Countrywide, and that the original note appears to have been transferred to Countrywide’s foreclosure unit, as evidenced by internal FedEx tracking numbers. She also confirmed that the new allonge had not been attached or otherwise affIXed to the note. She testified further that it was customary for Countrywide to maintain possession of the original note and related loan documents.

Both Yves Smith and David Dayen have write-ups of this news that you should read.

Why is this a big deal? It might be helpful to go back to the diagram we used for Part 1 of the Foreclosure Fraud for Dummies series that explained the chain of securitization. Let’s update it for the Countrywide situation. As you can see, at each point conveying and transferring the note plays a crucial part of creating these mortgage-backed securities (please click through for larger, easier to read, image):

(Thanks to Tom Adams for a discussion about this chart.)

These are not technicalities – these obligations come from secured credit and trust law, two of fields where strict requirements are essential. We don’t want confusion over conflicting claims to property, and we don’t want tax-free trusts being set up without the homework being done. The channels for the securitization are tax free under a special type of law (“REMIC”), and in exchange for that the trusts have to be setup correctly from the get go.

These laws are based out of New York trust law, not congressional law. As Professor Adam Levitin noted in his testimony, between the New York trust law and the Pooling and Service Agreements there are very specific requirements to passing these notes down the chain. They are required to protect investors from both malfeasance, to avoid fraudulent transfer concerns, and to create “bankruptcy remoteness” of that asset from the originator/sponsor.

And it appears that during the worst excesses of the mortgage bubble the very basic rules of property transfer and record-keeping were ignored. The trust and its servicers have no standing to foreclose.

Key point: Tim Geithner and Treasury did not announce this breakthrough in what we know. The Federal Reserve did not announce this breakthrough in what we know. Even at this late stage, the actions of the trust, servicers and depositors are opaque to regulators and investors.

The only reason we know about this is from a New Jersey bankruptcy court. And it’s only because of the people in the field, deposing robosigners, piecing together the records and fighting to get information about what is actually broken in the biggest piece of our stalled economy, that we know any of this. Advances like this will disappear if Congress doesn’t allocate the $35 million dollars it is supposed to for legal aid groups, and you can now understand why lawmakers are hoping this request dies quietly. And it also shows why Attorneys General will need to step up to the plate and take over this fight, while the public needs to hold federal regulators accountable for their lack of effort here.

UPDATE:

At nakedcapitalism, Tom Adams goes and pulls the securitization documents for the Countrywide case involved above, and finds that there aren’t any special exemptions. They stated they moved these notes when they did not:

On Sunday, the New York Times reported on a recent case known as Kemp vs. Countrywide. In it, the judge in his decision states that for the mortgage loan in question in the case, a Countrywide employee testified that the mortgage note had never been delivered to the trustee, as required under the securitization documents. In addition, the Countrywide employee testified that it was the company’s practice not to deliver the notes. These facts were so extraordinary that I felt compelled to track down the underlying legal documents to the securitization to see what was going on….In the Kemp case, it appears that not only did Countrywide fail to properly convey the mortgage loan, it didn’t even bother to deliver it. Based on my review, Countrywide failed to comply with the terms of the agreement for the delivery of the mortgage notes….I tracked down the pooling and servicing agreement in the Kemp case from CWABS 2006-8 to make sure it did not have any unique exceptions to delivery. It did not…The trustee, pursuant to Section 2.02(a) of the PSA states that it has possession of the mortgage note (identified as section 2.01(g)(i)) and the assignment of mortgage (identified as section 2.01(g)(iii)…. According to the language above, the trustee specifically issues a preliminary certification that it has all of the notes on the closing date….In March, 2007 Countrywide filed the form below from Bank of New York, as trustee, that the trustee’s sections of Reg AB were in compliance, including the pool assets and documents were safeguarded as required by the PSA…. Countrywide’s law firm has denied that the bank failed to convey notes as a matter of policy. However, it seems odd that an employee would make such a claim without some basis for that belief. We are in the early stages of finding out how widespread the failure to convey notes really was, and the Countrywide employee statement suggests these concerns could be well founded.