Fraud at the Core of Foreclosures Puts Entire System at Risk Until Resolved

Jim Wilson/The New York Times

Updated: Oct. 21, 2010

When the housing boom began to cool in 2006, that set in motion a chain of events that was a disaster for millions of homeowners whose property has been seized by lenders. The plummeting property values that both followed from and accelerated foreclosures helped create the billion-dollar losses for lenders that brought the financial system to the brink of collapse in the fall of 2008. The recession that followed led to even greater homeowner delinquencies. And in the fall of 2010, what had become a foreclosure boom threatened to become a gigantic legal mess for banks, as evidence emerged of sloppy recordkeeping, cut corners and possible fraud.

Revelations that mortgage servicers failed to accurately document the seizure and sale of tens of thousands of homes have caused a public uproar and prompted lenders like Bank of America, JPMorgan Chase and GMAC Mortgage to temporarily halt foreclosures in many states. In October, all 50 state attorneys general announced that they would investigate foreclosure practices. The nation’s largest electronic mortgage tracking system, MERS, has been criticized for losing documents and other sloppy practices and JPMorgan Chase announced that it no longer used the service.

Mortgage documents of all sorts were treated in an almost lackadaisical way during the dizzying mortgage lending spree from 2005 through 2007, according to court documents, analysts and interviews. Now those missing and possibly fraudulent documents are at the center of a potentially seismic legal clash that pits big lenders against homeowners and their advocates concerned that the lenders’ rush to foreclose flouts private property rights.

In short, the legal disagreement amounts to whether banks can rely on flawed documentation to repossess homes.

Hundreds of thousands of households could be effected. In the first quarter of 2010, there were 930,000 foreclosure filings — an increase of 7 percent from the previous quarter and 16 percent from the first three months of 2009, according to recent data from RealtyTrac, an online marketer of foreclosed properties. Some six million borrowers were more than 60 days delinquent. About 11.5 percent of borrowers were in default, up from 5.7 percent from two years earlier.

The root of today’s problems goes back to the boom years, when home prices were soaring and banks pursued profit while paying less attention to the business of mortgage servicing, or collecting and processing monthly payments from homeowners.

Banks spent billions of dollars in the good times to build vast mortgage machines that made new loans, bundled them into securities and sold those investments worldwide. Lowly servicing became an afterthought. When borrowers began to default in droves, banks found themselves in a never-ending game of catch-up, unable to devote enough manpower to modify, or ease the terms of, loans to millions of customers on the verge of losing their homes. Now banks are ill-equipped to dealwith the foreclosure process.

The revelations about the sloppy paperwork emboldened homeowners and law enforcement officials in many states to challenge notarizations — including those by so-called robo-signers,’ employees who approved hundreds of documents in a day — and to question whether lenders rightfully hold the notes underlying foreclosed properties. Evictions were expected to slow sharply — good news for many homeowners. But at the same time, the freezes further disrupted an already shaky housing market.

As banks’ foreclosure practices have come under the microscope, problems with notarizations on mortgage assignments have emerged. These documents transfer the ownership of the underlying note from one institution to another and are required for foreclosures to proceed. In some cases, the notarizations predated the preparation of the legal documents, suggesting that signatures were not reviewed by a notary. Other notarizations took place in offices far away from where the documents were signed, indicating that the notaries might not have witnessed the signings as the law required.

The swelling outcry over fast-and-loose foreclosures thrust the Obama administration back into the uncomfortable position of sheltering the banking industry from the demands of an angry public. While Mr. Obama did block a law passed by Congress that was seen as unintentionally making it easier to speed up foreclosures, his aides spoke out against calls from many Democrats for a national freeze on evictions, fearing that a moratorium could hurt still-shaky banks.

Overall, there have been three distinct waves in foreclosures. The initial spike involved speculators who gave up property because of plunging real estate prices, and the secondary shock centered on borrowers whose introductory interest rates expired and were reset higher. The third wave represents standard mortgages, known as prime, written to people who had decent credit ratings, but who have lost their jobs in the economic downturn and are facing the loss of homes they had considered safe.

Those sliding into foreclosure today are more likely to be modest borrowers whose loans fit their income than the consumers of exotically lenient mortgages that formerly typified the crisis. Economy.com said in 2009 that it expected that 60 percent of the mortgage defaults that year would be set off primarily by unemployment, up from 29 percent in 2008.

The slowdown in evictions may give such borrowers time to accumulate some capital or more leverage in settlement talks with their lender. Some analysts said that could conceivably help the housing market get back on its feet, by ending the undermining effect of a steady stream of foreclose houses going up for sale. Others, however, worried that blocking sales in an already weak market would drive prices down even further, continuing a spiral that has been deeply destructive to banks and communities.

Interviews with bank employees, executives and federal regulators suggest that this mess was years in the making and came as little surprise to industry insiders and government officials.

Almost overnight, what had been a factorylike business that relied on workers with high school educations to process monthly payments needed to come up with a custom-made operation that could solve the problems of individual homeowners.

To make matters worse, the banks had few financial incentives to invest in their servicing operations, several former executives said. A mortgage generates an annual fee equal to only about 0.25 percent of the loan’s total value, or about $500 a year on a typical $200,000 mortgage. That revenue evaporates once a loan becomes delinquent, while the cost of a foreclosure can easily reach $2,500 and devour the meager profits generated from handling healthy loans.

And even when banks did begin hiring to deal with the avalanche of defaults, they often turned to workers with minimal qualifications or work experience, employees a former JPMorgan executive characterized as the “Burger King kids,” walk-in hires who often barely knew what a mortgage was.

At Citigroup and GMAC, dotting the i’s and crossing the t’s on home foreclosures was outsourced to frazzled workers who sometimes tossed the paperwork into the garbage. And at Litton Loan Servicing, an arm of Goldman Sachs, employees processed foreclosure documents so quickly that they barely had time to see what they were signing.

On October 1, 2010, Bank of America announced it was freezing all foreclosures while it reviewed its procedures. On Oct. 18th, it said it had found no problems and was resuming the proceedings in the 27 states in which courts are involved in foreclosures. GMAC also resumed foreclosures after a short break.

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