I think it's understandable that a lot of the reaction to the foreclosure mess has focused on the theater--law firms hiring incompetents! robo-signing!--rather than the actual impact. The thing is ludicrous, though it was also probably predictible that something alone these lines would be uncovered. (Not that I did predict it, mind you; I just mean that in hindsight, it seems inevitable) The mass outsourcing of loan service to specialist firms is relatively recent, and those firms have never gone through a large wave of foreclosures, which means that what they're specialized for is simply collecting checks and mailing them onward. Meanwhile, the sheer volume of loans that was pouring through the securitization system seems to have overwhelmed the private companies, the state registry systems, and the regulators; a lot of paperwork has been lost.
So it's not exactly an unexpected shock to find that a bunch of companies decided that the easiest way to handle these little gaps in the paperwork was to, um, commit notary fraud. I'm not condoning it, mind you; these firms will richly deserve whatever sanctions are ultimately imposed. But I can't say it has caused me to leap out of my chair in surprise and horror and shout "Say it ain't so, Joe!"
I find it odd, however, that so many people seem to be implicitly treating this as something horrible that the servicers have done primarily to those being foreclosed on. Yet no one's arguing that the outcome would have been different if the paperwork had been in order. It might have taken longer, which would allow people extra time in their homes--but that's what's happening now. There's some implication that unfair fees are being tacked on for people in foreclosure, which demands redress--I smell class action. But overall, the implications seem much more disturbing for people who aren't in foreclosure.
Take the investors in these mortgage bonds. Most of these securities have clauses that allow investors to force the banks to take back loans in the case of fraud. When did the fraud start? You can expect to see that extensively legislated--and I doubt that many of the originators have the capital to withstand a mass wave of such loan repatriations, especially since you can expect that they'll only be forced to take the bad ones. This is going to be an expensive mess for the courts to sort out, could lead to another wave of bank failures, and doesn't have any obvious legislative fix.
Or how about people who are in trouble, but not in foreclosure? I heard someone on the radio saying that this all could have been avoided if banks had modified loans with generous principal reductions, like they ought to have. I find this remark puzzling. If a loan servicer doesn't have sufficiently clear authority to foreclose, then presumably they also don't have any authority to modify the loan. In fact, shouldn't banks be stopping their modifications, too, until clear lines of ownership are established?
Already, it's apparently impossible to sell a foreclosure--and people who have bought foreclosed homes are starting to sweat, wondering if they're going to get embroiled in a lawsuit. But what about short sales? Again, if a company doesn't have the authority to foreclose, it doesn't have the authority to authorize you to sell it for less than the value of the mortgage. Things seem cleaner with ordinary sales, but what if some other company comes out of the woodwork to claim that the note wasn't properly registered, and you paid the wrong guy? Does the lien go back on the house? Who owes the money?
This is why people are worried that the title-insurance system will break down. We finally closed on our house last Friday, and though it was a straight sale, I have been comforted all week with the knowledge that if something goes desperately wrong with the old mortgage, at least the title insurance will make us whole. But if I were a title insurer, that would make me kind of reluctant to write new policies.
Even for people like me, this raises questions: if there's a 0.5% chance of some thorny clouded title problem, then perhaps we shouldn't do any renovations just yet. I don't think the odds are quite that high. But given the cost of renovations, they don't have to be very high to make me think twice.
All this uncertainty is ultimately going to be terrible for both the housing market, and the broader economy. We'd better work hard at crafting legislative and judicial remedies--more about which later.
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is a columnist at Bloomberg View
and a former senior editor at The Atlantic.
Her new book is The Up Side of Down