Scandal a Sign of Deeper Problems?

The robo-signing controversy could be a sign of deeper problems within the mortgage industry, specifically that banks may have lost track of the legal documents needed to prove ownership of mortgage loans.

That might not only undercut their ability to foreclose on delinquent mortgages, but even could even raise questions about their right to collect payments on performing mortgages as well, according to a report released today by the Congressional Oversight Panel.

In a worst-case scenario, those problems could threaten financial stability and undermine the government’s efforts to address the foreclosure crisis, the report said, as well as calling into question legal ownership of as many as 33 million mortgages.

“Clear and uncontested property rights are the foundation of the housing market,” the report states. “If these rights fall into question, that foundation could collapse.”

The robo-signing controversy has its roots in allegations that major lenders, including Bank of America, GMAC Mortgage and others, took shortcuts in documenting tens of thousands of foreclosure claims. In particular, it’s alleged that bank representatives routinely signed off affidavits certifying the accuracy of certain facts in foreclosure claims without even reading them first.

Ownership of mortgage loans could be questioned

In a best-case scenario, the report says, it will turn out that concerns over foreclosure documentation will prove to be overblown and the basic facts underlying the documents will prove to be accurate, so foreclosures may proceed once the paperwork is corrected.

In the worst case, according to the report, banks may have resorted to “robo-signing” not just to deal with a flood of thousands of foreclosures a month, but also to hide the fact that they could legally prove ownership of the loans.

The consequences could be severe, according to the report. Homeowners might not know if they’re sending their mortgage payments to the right company. Judges may not allow foreclosures even in cases where borrowers haven’t kept up on their payments. Several banks could try to foreclose on the same property.  Purchasers of foreclosed homes could find their ownership in doubt, unable to buy or sell and possibly face claims from former owners. And major banks could face billions in losses from defaulted mortgages they thought they had sold off but still legally own due to faulty paperwork.

”If such problems were to arise on a large scale, the housing market could experience even greater disruptions than have already occurred, resulting in significant harm to major financial institutions,” the report says.

Electronic trading blamed

The problem arises in the way mortgages are traded among banks and investors these days. Mortgages are routinely bought and sold, often dozens of times, and are commonly bundled into investment securities, which require multiple legal transactions. To keep up, banks have instituted electronic record-keeping to track when a mortgage is traded and to whom.

However, the legal system in most, if not all, states require that all mortgage transactions be recorded at the county level. By bypassing the county record system, the electronic process could throw into question not just the right of lenders to foreclose, but even the legal ownership of those loans, including who has the right to collect payments.

One possible benefit for homeowners in financial distress: straightening out the mess could make it more expensive for banks to pursue foreclosure, meaning they might become more willing to grant loan modifications and on more favorable terms to borrowers.