The “Alphabet Problem” For Dummies

Because I am a nerdy restructuring and bankruptcy attorney, I am on a fair number of email listervs with colleagues. One recurring item in our discussions is what legendary bankruptcy attorney Max Gardner calls the “Alphabet Problem.” If you click on that link, you get a wonderful, in-depth explanation of the Alphabet Problem that Max wrote. If you are like me, though, and have a short attention span, you need a simpler explanation if you want to understand the Alphabet Problem.

Fortunately, I explain the Alphabet Problem to many of my bankruptcy clients because I want them to understand the approach that I will take to the real estate in their case. Although some of my clients are attorneys, most of them are not. So I try to put Max’s explanation into something that most folks can understand. As with any simplification, some of the nuance will be lost in the translation. But with luck you will understand the basics.

At some point a couple decades or so ago, banks started selling the right to receive the payment from your mortgage and turning that right to payment into mortgage-backed securities. Along the way, the banks established a basic protocol for these transactions. To make this easier to understand, Max gave each of the cast of characters a nickname consisting of a letter. So the originating bank, the one whose name you see on the loan documents, is called A. A sells the right to payment to an entity called the sponsor, whom we call B. B in turn transfers the right to an entity called the depositor, C. C then sells the right to a trust, D, who ultimately holds the right to payment on behalf of the holders of the security. In theory the trust, D, holds all of the loan documents related to your loan and the evidence of each true sale from A to B, B to C, and C to D.

Everyone understands that: A to B, B to C, C to D. Simple, right?

In the most straightforward bankruptcy case, D, the trust, ends up being the entity trying to enforce your mortgage. To do so lawfully, D needs to show an unbroken chain of true sales of original note from A to B, B to C, and C to D along with corresponding assignments of the mortgage, true sale agreements, transfer and delivery receipts, true sale opinions, etc.

In theory, this should not be hard. I remember as a law clerk at the bankruptcy court (this was maybe fifteen years ago) reviewing the documents that lenders provided. The documents contained endorsements of notes and recorded assignments from A to B, B to C, etc. But that was before the days of securitization.

These days, you almost never see a proof of claim that attaches all of the necessary documents. Why is that?

There are a couple of obvious reasons Either: (i) the documents don’t exist; or (ii) the attorneys for the creditor do not want to take the time to find out if the documents exist.

A typical Pooling and Servicing Agreement (aka the PSA), one of the main documents that controls the securitization of mortgages, does not require the parties (i.e., A, B, C, and D) to execute proper endorsement of the notes and recorded assignments of the mortgages. In fact, a typical PSA requires the parties to endorse the notes to no one; the endorsement should say “Pay to the order of _____, without recourse” and there will be no name in the blank. With no contractual requirement to document the transfers properly, and arguably a contractual requirement to do so improperly, the parties selling these rights had little incentive to execute proper endorsements and assignments.

So how does the typical D manage to enforce its rights in a bankruptcy case in light of the Alphabet Problem? There are at least two ways:

First, it happens often that no one challenges D’s loan documents. Bankruptcy lawyers and trustees vary in their approach to this issue. At one end of the spectrum are Boot Campers like me who tend to probe the bank’s documents at length. At the other end are people who barely look at the documents.

Second, and I want to say this as delicately as I can, banks have been known to create documents after the fact to give the impression that they documented the transaction properly. Again, this is the type of thing that Boot Campers have been working to expose.

As an easy example, one of the most typical versions of the fraudulent documents is an “A to D” transfer. When we see an A to D transfer, we know that it is bogus. For reasons that are beyond the scope of this post, the securitization process is designed to include at least two true sales. If we see an A to D transfer, we know that the lender by-passed the protocols imposed by the securitization process. We know that A didn’t sell to D, A sold to B. So when we see an endorsement from the originating bank to the trust, we know that document is a fake.

So why does this matter? There are a few points worth making here.

First, on a big-picture level, if you ever wonder why the mess that the banks created is so hard to fix, consider what I have discussed here. The securitization process made it difficult for the banks to enforce the mortgages they wrote. Rather than having a neighborhood bank holding your mortgage note in its records down the street, some securitization trust might hold the right to some payment from your mortgage while some other entity holds the right to foreclose on your home. It is not an easy task to match all those up to turn your mortgage into a useful asset for a bank.

Second, and by the same token, if you happen to be eligible for a home loan modification under a program like HAMP and cannot seem to get your mortgage lender to process the modification, you might consider the complexities described here. If one entity held both your note and mortgage, that entity could determine whether you are eligible for a modification and make the economic decision of whether to grant the modification. As it is, there are too many different parties with different incentives to want to manage your mortgage situation.

Third, there is a substantial tactical benefit in a bankruptcy case to finding the weakness in a secured creditor’s claim. No mortgage lender wants to be turned into an unsecured creditor. If there are defects in the mortgage lender’s documentation, and there almost always are, finding those weaknesses gives us leverage. Whether the ultimate goal for the client is a mortgage modification or otherwise, being able to put a bank on its back foot carries a substantial advantage. I use this both to get better results for my clients and also to take clients whom otherwise I would not be able to represent. Sadly, using this type of “leverage” is the best way to force a bank into sustainable mortgage modification.

Readers of A Clean Slate come from all walks of life, but a couple specific types might be particularly interested in the Alphabet Problem.

If you are an attorney and want to learn more about mortgage securitization works and the problems that it causes, you might want to get some training from Max Gardner. In addition to his regular Bankruptcy Boot Camps which I reviewed here, Max has a special weekend seminar in September on mortgage securitization and servicing. 

If you are a consumer having difficulty with your mortgage lender and maybe facing foreclosure, you could do worse than finding an attorney who is versed in the Alphabet Problem. If you are in North Jersey, Central Jersey, or nearby parts of New York, feel free to contact me. Otherwise, the Bankruptcy Boot Camp alumni list would be a good place to start.

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