Securitization – Separation of Note from Mortgage
In brief, most of the sub-prime loans were pooled and used as an investment backed security. The lender would pool the asset, i.e. principle and interest with other loans and sell fractional ownership as one would sell stock in a company. Although the security was allegedly backed by the mortgage (Mortgage Backed Security) in reality the mortgage did not follow the original note but was held by MERS instead who at all times was not a beneficiary to the original note.
The failure to transfer the mortgage along with the note when pooled and sold as a security opens a whole myriad of security violations under the Securities Act of 1933 and the Securities Exchange Act of 1934 most notably violation of Rule 10(b) and 10(b)(5). This however is a story for another day.
The problem for the lender but a potential windfall for those who can exploit this separation of the note and the mortgage is that although the underlying obligation to pay the lender still exists, it is no longer secured by the real property originally encumbered by the mortgage.