With everyone focusing on QE2, I thought it would be helpful to see where we stand with the foreclosure problems.
On October 27th there was a congressional hearing on foreclosure mitigation programs (e.g., HAMP). Katherine Porter gave an in depth analysis of some of the problems facing the foreclosure process (I recommend reading it if you want the gory details. Here is a quick summary of the major issues.
Robo-signers – Mortgage services had employees signing affidavits attesting to facts they didn’t verify (this is fraud on the court, a criminal offence). Banks have characterized this as a technical problem (i.e., nothing to see here). When this came to light the services put a temporary stop to foreclosures in judicial states. Within two weeks foreclosures were started again and Bank of America (the biggest servicer) said they would be amending 102K affidavits in current motions (really???, in two weeks they were able to verify the fact in 102K files?). Amending fraudulent documents, does not eliminate the original crime.
Misapplication of payments – When you make a late mortgage payment you incur a late payment fee. Servicers sometimes purposely hold onto a check past the due date to make it late. If in the following month you send a check for your mortgage payment on time, but don’t include the late payment fee, the servicer is required to apply the money first to your mortgage payment, so that you would still just owe the late payment fee (plus interest). However, servicers instead took their late payment fee out first which meant that the mortgage payment was incomplete and triggered an additional late payment fee. Once this train got going, the servicer would add other made up fees to the account. If someone wasn’t paying close attention after six months they could have racked up so many fees that they can’t catch up and can’t afford to the legal bills to fight the inappropriate fees.
Origination Fraud – Refinancing shops would promise anything on the phone to get someone to refinance. They would then send a stack of paperwork with the first handful of pages looking like what was promised, but then the real documents would be below. Many people would glance at the first couple of pages and then just sign the rest without looking. The processor would then just discard the top pages and submit the loan. Numerous people with good 30 year fixed mortgages were tricked into sub prime mortgages using these techniques.
Improper Loan Transfer – A private extra-legal framework that bypassed existing property transfer/lien laws was created by the mortgage and securitization industry (MERS). From a legal standpoint it is not clear whether these transfers were valid. While congress could ride roughshod over this problem, there are good reasons why you don’t want to abandon the centuries practice of making real property transfers public. If you can’t find out who has title to a property and who owns the liens to it, you can quickly get into a situation with multiple parties claiming liens on the same property or claiming liens on property that never had a lien in the first place.
Fraudulent Securitization – Imagine we have 1000 mortgages and we are going to put them in pools of 100. When securitizing mortgages, all the mortgages in a pool were supposed to conform to the trust’s requirements. Instead of examining every mortgage in a pool for compliance with the trust requirements, only a sample would be examined (e.g., 10). If a mortgage failed it would be put back with the rest of the mortgages so that it could be included in another securitization pool. Since there was only sampling going on, most of these mortgages that were thrown back ended up in other pools. The net result is that easily over a third of the mortgages in a pool might not meet the underwriting requirements of the trust. This is why PIMCO and others are suing to force the buy back of these securities.
Unfortunately, many of these problems are very technical in nature and are therefore hard to stay in the public mind. The cynic in me says that those in power will find a way to make the problems go away without anyone going to jail. But with unemployment staying high, there is a small chance that enough anger will be maintained to affect real change.
Personally, I would recommend staying away from investing in mortgage funds for the forseable future. The tail risks are just too large.