Charting the Foreclosure Crisis's Far-Reaching Consequences

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Bank owned foreclosure homeEven as the consequences of the ongoing foreclosure crisis slowly unfold -- and the ultimate impact is yet unknown -- it's not too early to tote up a list of 10 potentially important developments that have already happened. (For more background, see my recent DailyFinance article "The Foreclosure Crisis: Eroding Trust -- and Ending the Recovery?")

1) Title companies are pulling back from issuing title insurance on homes that were sold in foreclosure or that were previously foreclosed. Not being able to obtain title insurance is the kiss of death for real estate transactions, as Mark Hanson, an independent housing analyst in Menlo Park, Calif., recently observed. "Title companies would be crazy to ensure title on anything remotely associated with a foreclosed property because we don't know how this is going to resolve itself."

2) This uncertainty will make it more difficult to sell or even refinance homes that were purchased while in the foreclosure pipeline. This will have an outsize impact on the market for foreclosed or distressed properties, which now make up a significant percentage of all home sales. Investors who have been snapping up distressed homes accounted for over 20% of all home sales in August, according to National Association of Realtors.

3) Buyers who are purchasing foreclosed homes now face legal challenges to their ownership and potentially even "clawback" of the property if the previous owner claims he/she was defrauded by a flawed/defective foreclosure process.

A Southern California family has already launched a potentially precedent-setting case by reoccupying their former home that they had lost to foreclosure, thwarting its sale by the lender to an investor. The family claims the foreclosure documents were fatally flawed and that their eviction was wrongful.

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4) The foundation of the banks' legal claim to trade mortgages like securities includes a registry called MERS (Mortgage Electronic Registry System). In what may be legally questionable slight-of-hand, MERS doesn't actually own title to the properties behind the mortgages on its registry.

If a court rejects the MERS claim of ownership in a foreclosure, that could mean the owner of a mortgage has no claim to the house as collateral. That conclusion could potentially reduce the value of mortgage's servicing fees to near zero.

Why does this matter? Banks count those servicing rights -- the rights to collect the interest and principal payments made on the mortgage -- as an asset. If servicing rights are in doubt, that would vaporize a key asset and revenue stream for many banks.

5)All 50 states and the District of Columbia are joining forces to investigate the legal issues raised by the foreclosure crisis. Ohio Attorney General Richard Cordray has already filed a lawsuit against one mortgage servicer, with potential damages in the billions of dollars.

If damages are collected from any servicer, then claims against others may have the benefit of precedent. The costs of battling multiple lawsuits could conceivably bankrupt banks with low reserves against losses.

6) Millions of underwater homeowners may realize they can stop paying their mortgages with no near-term consequence because the foreclosure system is frozen. While the legality and ethics of such a move can be debated, the fact remains that the incentives for underwater homeowners to stop making mortgage payments are high -- and the disincentives have now been significantly lowered.

Stories of "salt of the Earth" homeowners refusing to comply with their lenders' demands are now appearing in the blogosphere.

7) Evictions based on foreclosures can be challenged, halted, delayed or even canceled. The entire pipeline of foreclosure -- a lengthy process -- has been effectively plugged.

8) In most states, the necessary paperwork must be physically transferred when mortgage ownership is transferred from one party to another. Clearly, that has not been done in the robo-signing cases. Indeed, the entire MERS registry was intended to bypass this cumbersome and often arcane process. If the procedures were not followed, then it will take a monumentally labor-intensive cleanup to track down every owner of securitized mortgages and rebuild the properly executed chain of transferred mortgages.

These costs could weigh heavily on banks' cash flows and profits.

9) If millions of defaulted mortgages pile up awaiting some future resolution of the many issues at stake, the potential for a truly massive "shadow inventory" of unsold homes increases. That raises the unsettling possibility that a severe imbalance between a modest demand for houses from qualified buyers and an overwhelming supply of available homes will further depress prices.

10) The ultimate resolution of the crisis is unknown and unpredictable. Phrases such as "housing Armageddon" are now appearing in the mainstream financial media as commentators and legal authorities hazard guesses about how the crisis may play out. The key feature of the issue may well be that nobody knows.
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