Might happen in a few rare cases, but I'm dubious. I don't want to minimize the scope of this problem: it's clear that overwhelmed servicers decided the fastest way to move through their vast backlog of foreclosures was to muster a sort of heroic insouciance about the legal niceties surrounding the paperwork. Courts (and banks) are right to say that the process needs to slow down until that's straightened out.
But so far, we haven't seen many cases of people being foreclosed upon when they were not in default. If a bank tries to foreclose using bad paperwork, and you have in fact been paying the mortgage, then what you do is show up in court with record of the payments. If you can't do that--if there is a mortage on the house that you haven't been paying--the judge is unlikely to hand you your house as a freebie. Judges have other remedies to penalize servicers that misbehave which are a lot less drastic. You can probably stall the foreclosure until they get their paperwork in order, and well you should. But you're not going to get a free house out of it.
What this mess is most likely to do, as far as I can tell, is slow down even more the process of clearing out the backlog of bad housing loans. We may get a legislative moratorium--though it's not clear to me if this will accomplish much more than simply having judges scrutinize the paperwork more closely--and making it clear that sanctions await any firms who don't take care. These sorts of problems do arise periodically as changes in financial markets--like the massive boom in securitization--outstrip the legal and insitutional framework surrounding real estate transactions. The relatively new innovation of second mortgages became a huge headache in the 1930s, and it took the law and the courts a while to catch up. But the gaps in our regulatory framework did not result in mass mortgage forgiveness; it is rare that one party emerges a clear winner.
The worst case scenario is not that all mortgages are cancelled and banks start going bust; it's more like what Adam Levitin outlined for the Wall Street Journal:
"In the worst case, the issues become a "systemic problem" that grinds the mortgage market to a halt and title insurers refuse to insure mortgages involving existing homes. In other words, housing Armageddon. "It would be devastating for the resale market if this robo-signer issue spiraled out of control," Mr. Watson says."
Folks hoping that now the banks finally get what's coming to them should be mindful of the fact that if we decide there's no clear title on houses with existing mortgages, that probably means you can't sell your home, either.
But I doubt it will ever get that far; either courts will find a way to wrap this up, or legislators will, by creating some alternate process by which titles can be established and claims reconciled. It will be messy, time consuming, and expensive, and it will delay still further the day when we can all be confident that the housing market has bottomed. The US legal system is slow to deal with emerging crises, and the solutions it crafts generally satisfy no one. But for all that, they usually work tolerably well.
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