Could Foreclosure Fiasco Harm the Recovery? You Can Bet the House on It.

Halloween is still 10 days off, but the housing market has been rocked by horror stories for weeks: tales of mortgage servicers who rubber-stamped documents approving foreclosure without reading them, robo-signers who handled 10,000 cases a month, affidavits that were signed and backdated with no notary present, homeowners who had been evicted from their homes and are now breaking back in, electronic mortgage registration systems that didn’t keep track of who owned the mortgage notes, law firms that acted as foreclosure mills, and judges who have threatened to charge loan servicers with fraud after presenting improper documents. It all culminated in Bank of America, JP Morgan Chase, and Ally Financial suspending foreclosures while they determined whether they should be take place at all.

The housing market is in a real mess, and it’s no wonder that attorneys general across the country are investigating the mortgage servicing business. Some numbers help tell the story: One out of every 371 homes received a foreclosure notice last month. The real estate data company Realty Trac reports that 100,000 foreclosures took place nationwide in all of 2005, but that number was topped in just a single month this year. Realty Trac estimates that lenders will foreclose on a record 1.2 million homes in 2010. And one out of every seven of Bank of America’s 14 million mortgage borrowers is having trouble making payments or has already stopped making them.

home foreclosuresThese nightmarish tales raise a serious question: Does the foreclosure fiasco threaten the economic recovery?

Well, yes, it does.

Although the reactionary calls for a nationwide moratorium on foreclosures appear to have subsided, the crisis is far from over. And the longer it continues and the more banks and mortgage service companies reveal about their sloppy practices, the more likely it is that this fiasco will harm an already stagnant recovery.

That view is shared by a growing number of economists. Nobel Prize winner and New York Times columnist Paul Krugman says that the problem is “much worse than you think.” Writing in the Financial Times, Tracy Alloway worries that the banks’ failure to keep track of their mortgages could prompt potential purchasers of foreclosed homes to demand to see the mortgage note before they close the deals (this is the so-called “show me the note” scenario); when the bank is unable to do so — either because the note was not properly assigned when the mortgage was securitized or because the bank cannot find it — the housing market may well come to a standstill.

Whereas bankers might prefer to get this whole mess out of the way — and push the pig through the python, to use a favorite expression of theirs — the fact is that this mess will not go away so easily. This is true even though the big mortgage servicers, having decided that their robo-signers did not do anything wrong, have restarted the foreclosure process they abruptly halted two weeks ago.

There are myriad reasons why this whole mess is nowhere near ending and why it may still severely damage the economy.

First, some background. During the expansion of the housing bubble, banks and other mortgage lenders provided millions of loans to borrowers who could not afford them. Of course, so-called no-doc loans, liar loans and pick-a-pay mortgages, written for low-credit borrowers, made a modicum of sense when housing prices were zooming upward. These loans allowed people to partake of the American dream, and few of the players really worried that the borrower would one day be unable to make the payments.

Who could fault them? After all, Angelo R. Mozilo, the chairman of Countrywide Financial (whose $1.4 trillion portfolio made it the nation’s largest mortgage lender), told CNBC in 2005 that housing prices can only go up. As late as mid-2007, Mozilo insisted that Countrywide’s future is “going to be great.”

He was wrong, of course. Within months of making that prediction, Countrywide was in ashes and the housing market was headed toward ruin. Time magazine now calls Mozilo one of the 25 culprits of the financial crisis, and last Friday, Mozilo agreed to pay a $67 million fine as part of a settlement of civil fraud charges with the Securities and Exchange Commission.

So the foreclosure crisis arose from the housing bubble and its aftermath (and was not triggered by an improper foreclosure on a $75,000 home or from seven other foreclosures, as the Wall Street Journal laments). The bubble, which began in early 2000, burst in the summer of 2006, and home prices in every city on the Case-Shiller index fell, some by 50 and 60 percent over two years.

As we all know, though the price decline appears to have bottomed out in April 2009, home prices have not recovered. For example, the typical home in Las Vegas now sells for half of what it did in 2006, and more than 20 percent of homes in Nevada, California, and Florida are underwater, meaning that the mortgage is bigger than the value of the house. By some estimates, homeowners had lost $7 trillion in equity by the end of last year. Some experts believe that it will take another four to five years for the market to fully recover.

And so foreclosures have come en masse, with the shoddy paperwork gumming up the works in ways few would have predicted. Complicating matters is the mistaken belief that title insurance can alleviate the uncertainties surrounding the purchase of a foreclosed home, as it gives the buyer protection against a faulty transfer. But there’s no guarantee that title insurance companies will provide insurance on these doubtful properties. Republic Title, for example, has said that it will no longer insure homes foreclosed by Ally Financial or JP Morgan Chase.

Moreover, there’s no guarantee that the companies that do continue to offer title insurance would be able to pay all claims should the situation worsen. This scenario calls to mind the demise of insurance giant American International Group in 2008. AIG collapsed when it could no longer cover the insurance payments (known as credit default swaps) written on half a trillion dollars’ worth of toxic mortgage-backed securities. Just months before reporting a nearly $6 billion loss on these products, the head of AIG’s Financial Products group, Joseph Cassano, had said that he could not envision a scenario where AIG would lose even a single dollar on these deals. He was wrong, too.

This leads us to the pivotal aspect of the crisis: Just as eBay thrives as a virtual marketplace only when the buyer is satisfied that the seller will deliver the goods, the housing market can only survive when the buyer has confidence that the seller has the right to sell the property. That will happen when mortgage lenders do their jobs scrupulously — and not by simply declaring that all is well again (pushing the pig through the python). This means redoing affidavits properly, tracking down mortgage notes to certify who the lender is, cleaning up other paperwork to establish clear title to properties.

The banks would also be better off — we all would be — if they arranged repayment terms to head off foreclosures, and this is where the economic growth we so badly need would help borrowers make those payments, especially given that one out of every five unemployed workers is also an underwater homeowner. But even with foreclosure as a last resort, the process must be beyond reproach. Homes that sit empty and in bad repair result in “negative spillover,” adversely impacting other homes in the area. Prompt and proper action re-establishes confidence in the markets.

As long as the banks and mortgage servicers continue to insist that their foreclosure process is fine and that simply clearing up the affidavits will solve the problem, the mortgage mess will continue. And the longer the mess remains, the longer the delay in creating the robust growth essential to reversing the unemployment trend.

By: Joann M. Weiner /


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