Where is the foreclosure mess leading?

By Felix Salmon
October 7, 2010
Yves Smith and 4closureFraud have doing an astonishingly good job of keeping on top of all of the legal matters surrounding mortgage foreclosure.

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Yves Smith and 4closureFraud have doing an astonishingly good job of keeping on top of all of the legal matters surrounding mortgage foreclosure. There are lots of them — do you know what phony allonges are? — and they are all very complicated, and they vary from state to state and from bank to bank, with the result that it’s really hard to sum it all up in a simple overview. But it’s impossible to read those sites and not conclude that we’re at the early stages of an absolutely monster legal mess.

Any one of Smith’s posts is astonishing enough — try here for a good starter, although you could do worse than to start here or here if you’re in Florida — but put them all together, and it becomes clear that the mother of all legal messes has already emerged from the foreclosure crisis, and threatens not only a large chunk of the financial system but also venerable civic institutions, like the courts, which have thus far emerged from the crisis largely unscathed.

While there’s some evidence that Congress is willing to find a bank-friendly way out of this mess, I don’t think that’s going to fly, not when state AGs are already filing lawsuits against the likes of GMAC.

Argentina’s sovereign default has been called “the slowest trainwreck in history”, but this one might turn out to be slower, bigger, and much less fair. Millions of people have already lost their houses to lenders who didn’t have the proper paperwork, and it’s unlikely they will ever get any redress. For people who haven’t yet been foreclosed upon, however, it could now be a very long time before they lose their house.

The big-picture consequences here are by their nature unpredictable, as no one has a clue how this might all play out. But I can think of a few themes:

  1. Bond investors, who have seen the value of their mortgage-backed debt rise impressively over the past 18 months, could find themselves unable to find any kind of bid at all. The paper will still be cashflowing, but those cashflows will be surrounded by enormous uncertainty, and no one’s going to want to buy them except at extremely deep discounts until the mess is cleared up.
  2. Mortgage servicers will go from being assets to being liabilities, and banks which own mortgage servicers could find themselves on the hook for substantial losses.
  3. The time from default to foreclosure will become indefinite, and as a result there will be a significant uptick in strategic defaults, especially in states with judicial foreclosures.
  4. The “shadow inventory” of houses which aren’t on the market but will eventually be sold once the bank gets around to foreclosing will grow substantially from its already-enormous level.

All of this is going to be very costly and very unpleasant for all concerned; the only winners I see here are the lawyers. Add in possible securities-fraud charges against investment banks which underwrote a lot of these bonds, and the end result is a level of legal chaos I can barely imagine, in both the civil and criminal courts. And I see no easy way out at all.


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It looks like it has been touched on before, but there was a New Jersey Bankruptcy Court judge in 2006 that noticed irregularities in affidavits generated by mortgage servicers, and undertook an investigation of their practices and wrote a report on their business practices in a published opinion. In re Rivera, 342 B.R. 435 (Bankr. D.N.J. 2006). Or Case No. 01-42625-MS for PACER users.

As to this issue, the mortgage servicers are clearly in violation of rules requiring notarized and personally signed affidavits for certain court motions, but in a world of computerized communication and multinational companies, it is questionable whether this isn’t a symptom of a legal profession has a certain amount of modernization to do. The idea that a central headquarters can’t process a servicer’s foreclosure work, and that each company must have a locally located representative to attest to attest to the facts of each foreclosure is an odd administrative hurdle to impose.

On the other hand, I’m waiting to hear the counterargument that the CRA somehow compelled mortgage servicers to maintain sloppy records, and this is a failure of government intervention rather than free markets.

Posted by doug374 | Report as abusive

Congress cannot help their friends this time.
The outcry would be more than anything we have seen before.

Defending these lawsuits is going to bankrupt some banks. I’ll root for that to happen and for justice to be served.


Posted by MarkWolfinger | Report as abusive

“…much less fair. Millions of people have already lost their houses to lenders who didn’t have the proper paperwork…”

This is the kind of thing I think we should be very careful about. The issue of “fairness” does not really turn on whether the lender’s paperwork is perfectly in order; it turns on whether the loan is in default and the lender has the right to foreclose. Usually, when the outcome of a judicial process is reversed because a signature is missing from a document, we call that “a technicality.”

In particular, if a loan is in default, we can identify with certainty the one person who should _not_ have possession of the house–and that is the borrower. “Fairness” can’t allow borrowers to default on loans but retain the properties securing them.

Posted by ckbryant | Report as abusive

“Bond investors, who have seen the value of their mortgage-backed debt rise impressively over the past 18 months,”

Uh, that’s the price of the MB(S)-backed debt. And how much of that was the decisions to hold the really bad paper “to maturity” is left as an exercise.

Posted by klhoughton | Report as abusive

What I find grimly amusing in all this, is the utter incompetence, and its sheer scale.

So, we’ve all be intimidated by the financial industry and its legions of wannabe rich physicists.

Now we see that under that crust of mad scientists, this crew is more incompetent than any other group of American professionals I have ever dealt with.

Somehow I am not surprised.

Perhaps the kid gloves approach of the Obama administration has encouraged these defects to persist.

Posted by nyet | Report as abusive

“Wannabe rich physicists”… I love that. I’m guessing it’s also the fault of the computer programmers when the bank charges you a $39 debit card overdraft fee on your $4 latte. Probably also the fault of the carpenter when your house built in the floodplain ends up under water.

“Better to remain silent and be thought a fool than to speak out and remove all doubt.”

Posted by FosterBoondog | Report as abusive

So where has the MSM been on issues like this? The WSJ has done a couple of small stories but as far as I can tell, nearly all of the digging, thinking, and publishing is being done by a network of bloggers and their contacts. Where have the NYT and Post been? Where has CNN been?

And the newspapers etc. wonder why they are in trouble and are being replaced by the Comedy Channel and people working out of their kitchen.

Posted by ErnieD | Report as abusive

@FosterBoondog, I’m sorry, I’m failing to grasp what your examples have to do with what nyet posted. Can you explain? Are they in reference to the financial industry comment or the Obama comment?

Posted by spectre855 | Report as abusive

The mortgage is itself a legal abomination. They give you a loan equal to the then value of the house to use to buy the house. Then, when unemployment, cancer, accident or other dire straights constrain payment of principal plus profit on the loan amount, they keep all the money you have paid thus far, whatever that amount is, however allocated to profit or principal, and are contractually entitled to take away your house and dispose of it any which way they like, including letting it sit and rot, or selling it later at a profit over the original loan/price.

All this is contractually “legal” and about as moral as sticking a gun to the homeowners head and saying “hand over your money and move out of your house,” and that for what was a fully collateralized and essentially riskless loan ab initio.

It amazes me to hear these essential legal safeguards dismissed as “technicalities.” The whole mortgage contract is an amoral “technicality” devised by banks for banks, predicated on the basic human need for shelter. A legal abomination.

The idea of congress passing this “stampede the foreclosers” bill shows just how far banking owns congress.

Posted by forthetimebeing | Report as abusive

To share some good news: Operation Home Relief just launched today to help protect military families from losing their homes to foreclosure. It’s really sad how many of our military are fighting overseas and don’t even know if they will still have a home to return to. For every person who “likes” the Facebook cause, $1 will be donated to USA Cares. I hope you’ll all show your support! http://on.fb.me/ctuP3f

Posted by jMac1 | Report as abusive

@spectre855 – I thought the phrase I quoted made it clear.

Claiming that the mortgage mess (and the failure to properly document loan title chains) is somehow the fault of evil “physicist” wizardry is simply delusional. I can see blaming the rating agencies. I can see blaming heads-I-win-tails-you-lose compensation schemes at the big banks. I can see blaming mortgage brokers who told their clients to lie about their income. I can see blaming the MBS securitizers who didn’t care what was going into their sausage machine as long as they could sell what was coming out. But I really can’t see pinning this on a bunch of grunt programmers (which is what 98% of the ex-physicists are).

Finding an easy scapegoat is always a mistake: you blame the wrong person and you let the culpable parties off the hook. The current frenzy of undocumented-immigrant-bashing is another version of the same mistake with respect to employment. It’s an old tactic, usually promoted by that actual people responsible for the misery.

Posted by FosterBoondog | Report as abusive

My wife and I will be first time home buyers in about 2 years, and plan to live there long term (20+ years). This will probably work in our favor, right? Lots of cheap houses.

Posted by drewbie | Report as abusive

I can’t really accept any of that. In particular, banks are not allowed to dispose of foreclosed properties “any which way they like”–they can’t, for instance, sell them to the cousins and nephews of board members for a dollar each, and then sue the borrower for the “deficiency.” In fact, the procedures for sale of foreclosed properties are well-defined and fairly rigid, and designed to establish a fair-market value. It may take a bank a long time to actually _complete_ the foreclosure, but that is another matter, and it is not the bank that is letting the property rot in the meantime; it is the borrower.

And as for “keeping the money you have paid thus far,” well, what _should_ happen to it? The principal payments reduce the debt outstanding, so the bank is “keeping” that money in the sense that the borrower doesn’t owe it any longer, and the interest payments were the contractually-agreed-to price of obtaining the money up front. Outside of Deuteronomy, these are pretty well accepted ways of doing business.

What bothers me about so much of the argument I read about foreclosures these days is that it is so willing to deprive the borrower of moral agency. Moral agents can enter into contractual agreements, and it is a pretty fundamental notion in law and ethics that agreements should be largely honored.

You may find mortgages abhorrent–even responsible, fixed-rate mortgages with a reasonable down payment and everything else. If so, I would encourage you not to take out a mortgage. I do not find the idea of a secured loan per se to be abhorrent.

Posted by ckbryant | Report as abusive

Response to “forthetimebeing” above. Sorry about that.

Posted by ckbryant | Report as abusive

and i can’t see how we can avoid blaming the previous administrations deregulation scheme. had they not wanted to be so customer friendly to those they regulated maybe this mess wouldn’t have happened as the number of loans would never have ballooned so large. and we could blame business who cut corners and got them selves in to this mess. and we could blame the TBTF crowd who got bailed out last time, but seemly isn’t going to this time. and we can blame the states as they manage the foreclosure process.

Posted by willid3 | Report as abusive

In the past three years, potential home buyers have already found that buying repossessed properties is a long, difficult and often costly process.
This fact has driven prices or repossessed homes lower, and consequently, helped driving all home prices lower.

With the additional unexpected complications and uncertainty, repossessed properties are going to lose value more rapidly, and drive the housing market further down, and the banking industry with it.

The problem is that this time neither the Fed nor the Treasury will be able to save the banks, who’ve been surviving on borrowed time, so far.

Posted by yr2009 | Report as abusive

Don’t forget that the banks never lent any money in the first place – which makes it all fraudulent – whether proper signatures are in place or not.

No one at the bank walked to the vault and removed $100,000 and gave it to someone to buy a house. They simply wrote a number on a piece of paper, backed by absolutely nothing, and said “Now you owe me $100,000 plus interest”.

No value was exchanged. The borrowers brought value by bringing the house into the equation, but the bankers brought nothing…..

All the kings horses and all the kings men are not putting this one back together. The criminals used the system for there gain until they broke it – and now they want it all to come back together in more or less the same way.

Now that we know the american dream is just that, a dream, and that if you work hard and do good, you ultimately get screwed by criminals calling themselves legislators and bankers, who’s gonna fall for it again?

Now that everyone lost big money in the stock market through criminality, does it make sense to go back and invest in it again?

We were fooled because we were gullible and naive. We assumed the gov’t and banks had at least a bit of our best interest at heart. Now that we know they simply lie, cheat, steal and deceive – who but the most deep asleep people would come back for round two?

Posted by thedave | Report as abusive

Sorry but how is it unfair to the borrower? To be in foreclosure you need to be relatively seriously delinquent on your mortgage. It is exactly to avoid this kind of nonsense that banks tend to bend over backwards to avoid foreclosing. So in no way, shape or form is the home-”owner” in this case a victim.

I am amazed you seem to be claiming that it is somehow moral and just that someone should be allowed to stay cost-free in a home and how this cannot be offensive to the 99+% of homeowners who ARE paying their bills.

As for the impact on MBSes? The only thing they have to fear is a Peston Mk 2 manufactured panic by incompetent churnalists. Again to reiterate – most mortgages are not delinquent, most delinquent mortgages are not in these states and where there is fraud the MBS can put back to the originator.

Posted by Danny_Black | Report as abusive

Fraud, which is being committed by the lenders/servicers in connection with bogus foreclosure documents, is an intentional tort (i.e., legal wrong). Intentional torts are not amenable to defenses, like the contributory negligence of the borrower (read: “personal responsibility”). The onus of the fraud, and its consequences, are placed on the fraudster.

Similarly, there is another legal concept known as “in pari delicto,” which, loosely translated, means of equal fault. Even in situations where this concept is invoked, the Supreme Court has said that the burden, once again, is placed on the party to the transaction at issue with the greater responsibility/duty. In that case, it was someone who provided illegal inside information to a “tippee” who tried to profit from the information and then sued when the information turned out to be false. Here, that would, once again, be the lenders/servicers.

The real issue in all this, and what gets lost in the outrage over fraudulent documents being used to accomplish the dispossession of homeowners, and the single-minded focus of most mainstream media stories about this whole debacle, is that the underlying problem isn’t the tainted foreclosure procedure; it’s the tainted transaction(s) that led up to the foreclosure. Saying that rectifying the foreclosure procedures will correct the problem is like saying putting a fresh band-aid on a gangrenous limb will heal it.

Much has been written about the effect of the “sliced and diced” mortgages (i.e., pooling and service agreements governing the securitization of mortgages), so I won’t repeat that here (see the links to Yves Smith and 4closurefraud, above). The point is, even if the foreclosure procedure is remedied, the flaws in the underlying transactions will still exist, and the parties who are claiming the right to foreclose still won’t have that right (a fact the title insurance companies have finally realized, and is why they’re refusing to write policies on these foreclosed properties), and that isn’t something a band-aid will remedy.

Posted by Martskers | Report as abusive

Felix, maybe this would be a good time for you to write a piece on Ally/GMAC — why does the government still own it, and why is there no exit plan? The only explanation I can think of for why this company is being kept alive is that the Obama administration does not want to realize any TARP losses before the election.

Posted by RogerNegotiator | Report as abusive

I can see the market value of foreclosed houses going the way of the used car.

Posted by rogueecon | Report as abusive

Martskers, the people are not being “dispossed” because of fraud. They are being dispossed because they agree to pay a loan and haven’t. That is the simple truth. Maybe some of them couldn’t pay but apparently enough of them could afford lawyers.

The only possible victims I can see here are the people who bought a foreclosed home, maybe not knowing it was such, and now have to live with the fact they may lose their homes due to populist scare-mongering.

Posted by Danny_Black | Report as abusive