How Bad Paperwork Might Cause Another Financial Meltdown

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Here's the problem: banks haven't been keeping good records. First, we discovered that foreclosures weren't being properly processed and practiced. Then it became clear that these shoddy foreclosures might be tied to an even bigger problem: "For more than a decade," explains The Washington Post, "big lenders sold millions of mortgages around the globe at lightning speed without properly transferring the physical documents that prove who legally owned the loans." In other words, it's very tricky to legally establish who owns a number of mortgages--banks just weren't processing the paperwork as mortgages were sold to various investors and other banks. In theory, this sloppiness could allow investors to force lenders to buy back their securities, wreaking havoc on financial markets. The foreclosure process, meanwhile, has ground to a halt. Economics bloggers have gone into overdrive trying to explain this mess. Here's what they've come up with.

  • 'Good Scenario ... Bad Scenario'  It's possible "agencies like Fannie and Freddie can simply take of this on their own," writes The Washington Post's Ezra Klein. But if "investors are able to push the rotten mortgages back onto the banks that sold them, we could be looking at another insolvency crisis." Translation? Another 2008-style collapse. Even if this happens, though, he points out that "there's an opportunity here" to change policy and help homeowners.

That the banks were this lazy and shoddy and potentially fraudulent when the consequences would be on them is a good reminder of how many homeowners were sold mortgages that they not only didn't understand, but that were simply misrepresented to them.
  • And 'Doomsday Scenario'  If things are as bad as they might be, ventures The Atlantic's Dan Indiviglio, "it's hard to see how the government could fix it simply without tramping over contract law. Instead, more aggressive approached would be required," like offering the banks tons of  money "so they could afford to repurchase" the mortgage bonds they thought they'd bought originally. There are some other ways of doing this, but "in all scenarios," cautions Indiviglio, "taxpayers would ultimately suffer."
  • This Is Ridiculous--Let's Jail These Guys  "If your home was broken into by a firm to change the locks illegally, that is breaking and entering, and conspiracy," declares finance blogger Barry Ritholtz.  "If the wrong bank filed a foreclosure action, if the wrong house was foreclosed upon, its time to go criminal prosecution route."
  • Another Problem With Mortgage Securities  Reuters's Felix Salmon, meanwhile, has been looking into a different aspect of the way these mortgage bonds were bought and sold: banks buying loans "they knew were bad" because they could get them cheaply, then not "pass[ing] that discount on to investors," who were sold the loans as if they were quality material. Comments Salmon:
That's a lie of omission, and if I was one of the investors in one of these pools, I'd be inclined to sue for my money back. Prosecutors, too, are reportedly looking at these deals, and I can’t imagine they’ll like what they find. ... This whole scandal has nothing to do with the foreclosure mess, but it certainly complicates matters. It’s going to be a very long time, I think, before the banking system is going to be free and clear of the nightmare it created during the boom.

This article is from the archive of our partner The Wire.