When the housing boom began to cool in 2006, a chain of events was set in motion that was a disaster for millions of homeowners whose property has been seized by lenders, and for the lenders themselves. Millions of Americans have received foreclosure notices and tens of billions in real-estate assets have been written off as losses by banks.
What followed was a vicious circle. Foreclosures helped accelerate the fall of property values, helping to spur more foreclosures. The losses they created brought the financial system to the brink of collapse in the fall of 2008. The steep recession that followed led to even greater homeowner delinquencies, as homeowners who lost their jobs often lost their homes. The program designed by the Obama administration to prevent foreclosures has helped only a small percentage of those it was designed for, particularly the unemployed.
In June 2011, evidence emerged of the first break homeowners have caught since the crisis began: a sharp slowdown in the rate of foreclosure filings and of repossessions.
The large number of cases nationally — about two million, plus another two million waiting in the wings — have overwhelmed many lenders and the courts. But the slowdown also stems from the evidence that emerged in the fall of 2010 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 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 2010, 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 early 2011, the attorneys general and the newly created Consumer Financial Protection Bureau began pressing for a settlement that would involve banks paying penalties of up to $20 billion, and for steps drastically alter the foreclosure process and give the government sweeping authority over how mortgage servicers deal with millions of Americans in danger of losing their homes.
The banks have resisted the proposed settlement, and the attorneys general group began to fracture in 2011, with some in Republican states dropping out, and others, including the attorneys general of New York and Delaware, launching new investigations into how banks handled the bundling of mortgages into the securities that led to billions in losses.
In January 2012, Obama administration officials said they were close to a deal that could be worth about $25 billion, depending on how many states sign up, with up to $17 billion of that used to reduce principal for homeowners facing foreclosure. Another portion would be set aside for homeowners who have been the victim of improper foreclosure practices, with about 750,000 families receiving about $1,800 each.
In addition to disagreements over the total amount, negotiations have been held up over the question of how much latitude authorities would have in pursuing investigations into mortgage abuses before the housing bubble burst in 2007. The banks are pushing for a broad release from future claims, but several attorneys general, including prominent figures like Eric Schneiderman of New York and Martha Coakley of Massachusetts, have demanded a tougher line on the banks, saying that the settlement could prevent them from investigating broader claims.
The courts have also become more aggressive about challenging foreclosures. In January 2011, Massachusetts’s top court voided the seizure of two homes by Wells Fargo & Company and US Bancorp after the banks failed to show that they held the mortgages at the time of the foreclosures, and courts in several states are considering similar cases.
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.
The Three Waves
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.
A Mess Years in the Making
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.