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The U.S. and other Western democracies have grown wealthy over the past three centuries for a simple reason: Their citizens have been able to establish clear title to land, buildings, and other property. So argues Hernando de Soto, the Peruvian economist, in his influential 2000 book The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else. While people in developed nations can borrow against their property and use the money to start businesses and accumulate wealth, he wrote, squatters in countries like Peru have no such option. Property rights beget prosperity.
That's why the burgeoning foreclosure mess in the U.S. strikes at the nation's economic heart. Confusion is so rife that Bank of America (BAC), the biggest mortgage lender, suspended foreclosures in all 50 states to determine whether faulty documents were used to confiscate homes. Americans took their title-recording system for granted, abused it during the housing boom, and let it deteriorate. "Somehow in the last 10 or 15 years, everything that was good record-keeping isn't telling the truth anymore," says de Soto, reached by phone while traveling in Copenhagen. "My feeling is this: Your recession is going to last. And it's going to last, and it's going to last, because essentially the trust has broken down."
De Soto may be an alarmist, but he has correctly identified why the foreclosure mess is not a simple clerical problem. It's part of a broader breakdown in the financial world—the one that nearly caused a depression in 2008 when banks and other financial players couldn't tell whose balance sheets were stuffed with toxic subprime mortgage debt and whose weren't. Unable to trust one another, the big institutions pulled back from every asset except Treasury debt. At the height of the crisis, even stalwarts like AT&T couldn't borrow in the commercial paper market for durations of more than a day—meaning they were only 24 hours removed from default.
That crisis is past, but its causes aren't. Uncertainty still reigns. Its current manifestation is faintly ridiculous: Lenders can't say for sure who holds a mortgage—which means that sales can't go through. Buyers won't put down good money for a property if they aren't sure they'll get clear title to it, nor will lenders extend loans. Buyers of hundreds of billions of dollars' worth of mortgage-backed securities may have grounds to sue. That could "rock the market," says Joshua H. Rosner, managing director of Graham Fisher & Co., a research firm.
All this at a time when every imaginable bit of information—from your bank statement to your Facebook photos—seems to be stored in the cloud, ready for instant retrieval. Google "who owns my mortgage?" and you get a quarter of a million results in a quarter of a second. What the cloud can't tell you is what you really want to know, which is who actually does own your mortgage—that is, who has the power to throw you out on the street if you stop paying. The only way to verify that is to leave the cloud and dive into a recording system that predates the founding of the U.S.
Titles and mortgages on real property are officially recorded in county clerks' offices, a slow-moving, old-fashioned, deliberate world of ink, paper, and filing cabinets. The process has been perfected over a millennium, going back to the Domesday Book, the survey of English property completed in 1086 for William the Conqueror. This paper-based system, though admirably accurate and permanent, wasn't equipped for the era of rapid-fire refinancing and securitization. When over 8 million new and used homes are sold per year, as at the height of the boom, and most loans are packaged into securities, you need a lot of clerks.
The mortgage industry responded to the scale and speed of the modern housing market by creating an electronic overlay called Mortgage Electronic Registration Systems (MERS) in 1997. MERS, however, lacks the thoroughness and—more important—the legal standing of the old system. Some judges have rejected foreclosures based on MERS when the party claiming to hold the mortgage couldn't produce the note to prove to the court's satisfaction that it was in fact the creditor. The courts want to see paper.
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