Of course it's still way too early to tell just how systemically important the back office failings of the mortgage servicers will turn out to be. But NY Fed President Dudley referenced the importance of robust back office operations underpinning a functioning mortgage securities markets in his speech this morning. And that is important.
Indeed, the financial markets were wrecked by a back office meltdown the living of memory man, indeed in the memory (just barely) of non-retirement age living man--and woman, for that matter, though back then the women weren't the, ah, players they've since become. Actually, the back office meltdown just finished the job. It came after a market boom followed by a meltdown had stressed the whole system, against the backdrop of prolonged and unsatisfying military entanglements on the Asian landmass and a rickety economy.
Maybe that all sounds familiar. And in the last three years we've had a debate about whether we were headed for a reprise of the 1930s or the 1970s. What I'm talking about here happened early in the 1970s, and was really the final inning of a game started in the 1960s.
The 1960s were the Go-Go years. You had mutual funds instead of program trading and conglomerates rather than hedge funds, but you had the same psychology of boom. Which was followed by bust. And throughout it all, elevated levels of transactional activities.
All of which settled on paper. And all that paper swamped the back offices. Now these were the back offices of the member firms of New York Stock Exchange firms. Those firms were partnerships and the partners were frequently more interested in playing golf at Winged Foot, racing sailboats on Long Island City or drinking at the Brook Club.
By the time anybody started paying any attention, the systems had broken down. As in, knee deep in trade slips, lost stock certificates, daily ledgers weeks behind in recording transactions, blown settlements, broken trades, etc. A number of firms failed.
Unlike the current situation, all of these failures were internal, pretty much confined to Manhattan, maybe bleeding over to Jersey City. An effort today is being made to portray the problem as one of antiquated state property laws and filing requirements. As far as I can tell, those antiquated state systems and procedures work just fine, and 'time-tested' might be a more polite adjective.
The problem is a systemic back office failure to comply with state legal requirements, leaving the beneficial owners of the notes in a position where they are unable to efficiently and quickly assert their rights under state law. At worst, they lose the benefit of their security interest and become general creditors in a bankruptcy. At best, at considerable expense to the trusts, servicers and perhaps even the deal sponsors, the remedial work necessary to comply with well-established state law requirements.
But it's difficult to challenge the notion that, if a litigant wants to assert rights in a state court under the laws of that state, it should be compelled to comply with the procedural requirements of that forum. And it that litigant is a federally regulated financial institution, it's about time that federal regulators look into the situation. If those institutions have by their own strategic decisions, operating procedures, and resource allocation, put themselves in a position where they can't obtain state legal remedies, then there need to be some changes--in the financial institutions, not in the state laws.
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