Thursday, September 30, 2010

Foreclosure Mess: the Mortgage Monster Rears Its Head Again

Like a ghoul in a low budget horror flick, the mortgage morass never dies. Just when you think it's dead, its eyes snap open. Then it smiles a fang-filled grimace and gets up to lurch again in search of victims. The latest resurrection of the beast is the foreclosure mess.

Recent news reports indicate that financial firms servicing mortgages have many times foreclosed on defaulting homeowners without really knowing if they had the legal right to foreclose. Mortgage records in some cases seem to have been evanescent. But, no matter, as key employees whose job it was to review mortgage files and determine that foreclosure was warranted apparently paid scant attention to the contents of the files anyway. One such employee reportedly signed off on thousands of foreclosures a month, perhaps spending only a minute or two per file. Let's guess that his nickname is Robopen.

Other news stories in recent months have reported courts balking at foreclosures when banks couldn't prove they owned the mortgages that were supposedly in default or that they truly had authority to proceed with the foreclosure. There have been allegations of document forgeries and other irregularities. Foreclosures by two major financial institutions--Ally Financial (formerly GMAC) and J.P. Morgan Chase--are grinding to a halt. Today's Washington Post reported that other banks may follow in applying the brakes to their foreclosures. Some state attorneys general are starting to investigate and members of Congress are making noise about compensation for homeowners improperly ejected from their homes.

This is seriously bad shhhhh . . . stuff. The news reports probably reveal only the tip of the iceberg. It's impossible right now to identify all the potential ramifications of this sewage spill. But what we can see already is really stinky.

Systemic risk. With the recently enacted Dodd-Frank legislation, systemic risk is all the rage. So why don't we start with it. There are trillions of dollars of mortgages still held by America's major financial institutions. If the recordkeeping of mortgage servicers is really bad, and numerous mortgages cannot be connected to a legal owner (i.e., a lender or investor who truly has title to the mortgage), a lot of bank writedowns may be necessary. If a bank can't prove it holds the mortgage it thought it held, it will likely have to write off the entire debt. And it will have to stop taking payments from the homeowner, since it can't legally take money it's not entitled to get. We aren't just talking about defaulting and defaulted mortgages. We're talking about all mortgages. A bank that can't document its legal right to a mortgage will have to write it down because you can't count as an asset something you don't own. And the bank can't take payments from a homeowner who doesn't legally owe it any money. The recordkeeping problem here could mean many billions of losses. Federal regulators concerned about bank capital levels just got another massive migraine.

A heroic effort to straighten out the recordkeeping problems might eventually link up a lot of orphaned mortgages with their true owners. But that will probably take months and years. By all indications, each mortgage's file will have to be manually reviewed and straightened out--and not by Robopen or his clones. Such labor intensive work, which likely will require lots of lawyer time, will blow up bank legal budgets nationwide. And, given the inadequacy of the records, lawsuits will sprout like mold in damp drywall. All the while, massive amounts of bank capital will be tied down in mortgages, because the banks won't be able to sell what they can't prove they own. And they may have to reimburse mortgage investors to whom they sold mortgages they didn't own in the first place. Future lending--for new home purchases or to support economic recovery--may recede from today's sputter to a trickle.

Investors, lawyer up and stop buying mortgages. Investors who hold mortgage-backed securities just found themselves living in a world of septic content. They may, or may not, own any mortgage interests. If banks can't be sure who owns which mortgages, they can't be sure what they sold to mortgage investors. The 2007-08 mortgage crisis was bad enough. But today's clouds over title to mortgages means the pricing of numerous mortgage-backed investments may have become hazy indeed.

Fannie Mae and Freddie Mac have been backing new mortgages, so investors in newly issued debt may be at less risk. But if the recordkeeping problems include recent mortgages, the U.S taxpayer (that would be you, dear reader) just got screwed. Oh well, chalk it up to life in a world of too-big-to-fail financial institutions.

Homeowners, to the ramparts. If you're struggling to pay the mortgage, and the mortgage servicing bank or firm is getting ugly, fight back. Fight back hard, because you don't want to be shoved out of your home by someone to whom you don't legally owe any money. Demand to see documentation proving their ownership of your mortgage. Hire a lawyer if you don't understand legal documents. If you're getting the runaround, call your Representative and Senators in Congress, and your state's attorney general. If you truly have defaulted, there may well have to be a settling of accounts eventually. But don't get bullied out of your home by someone who has no legal right to foreclose.

Buyers beware. If you're looking to buy a house, don't buy at a foreclosure auction, and don't touch any property that is a bank sale after a foreclosure. Also, if the property is now owned by ordinary individuals, think about avoiding it if it was foreclosed on in the past. There's no way to tell when the recordkeeping mess might have begun; if you want to be truly careful, don't buy anything that has ever been foreclosed on. You can usually tell if there's been a foreclosure by looking at the history of ownership of the home (often available online in county or city records). If a bank, other corporation, or corporate trustee, is listed as an owner, there's a good chance the property was foreclosed on. If you buy a property with a foreclosure in its history, the mortgage mess may mean that the previous owner who was forced out may actually still own the house and might be able to reclaim it from you. You would probably be able to recover money under your title insurance policy (be sure you have one of these, even if your lender also has one). But you'd be out of the house.

There are legal rules that would probably bar prior homeowners from trying to reclaim the house after a number of years, but you'd have to hire a lawyer in the state where the house is situated to find out how many years that would be. This isn't the short time period homeowners have after foreclosure to recover the home, but a longer period that homeowners would have to recover after being forced out due to the foreclosing lender's fraud. The law may not be entirely clear on this issue, which is why you might want to avoid homes that have ever been foreclosed on.

Sellers beware. Sellers may think that with foreclosures grinding to a halt, the flood of bank sales onto the market will abate and prices will rise. They shouldn't smile too quickly. The foreclosure mess will eventually be resolved and the defaulted properties put on the market. That overhang will keep buyers on the cautious side. Mortgage loans may become harder than ever to get, as mortgage investors from Fannie and Freddie to institutional investors everywhere step back from buying more problems until the current problems are fixed. Title insurance premiums could rise sharply. Higher costs mean fewer buyers. Closings could become more difficult, as title insurers verify two or three times over that the correct mortgagor and home equity lender, if there is one, are being paid off. The home(s) down the street whose foreclosures were just suspended may not be well-maintained, as neither a defaulting homeowner nor a bank that may or may not hold the mortgage have much incentive to keep the place up. Your neighborhood could go to weeds if no one is responsible for ownership. A vibrant real estate market can't exist without good recordkeeping.

Taxpayers. Need we say it? After the bailouts of 2008 and 2009, we all know who gets nailed in the end. Senior government officials will solemnly intone well-rehearsed proclamations about protecting the viability of the financial system, etc., etc., so on, and so forth. Then they'll foist the dog doo on you. Bank bonuses might again temporarily fluctuate, but rest assured that the wealthy and powerful won't truly bear the burdens.

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