Foreclosure Scandal Poses Severe Economic Threat, Report Says

foreclosure signFallout from the ongoing "robo-signing" foreclosure scandal may cost major banks billions, shake the foundations of the fragile housing market and threaten the stability of the U.S. economy, warns a new report from a congressional watchdog.

The Congressional Oversight Panel's November report, "Examining the Consequences of Mortgage Irregularities for Financial Stability and Foreclosure Mitigation," spells out best- and worst-case scenarios, though the picture is grim if the latter plays out."It is possible ... that 'robo-signing' may have concealed much deeper problems in the mortgage market that could potentially threaten financial stability and undermine the
government's efforts to mitigate the foreclosure crisis," the report warns. The Treasury Department and bank regulators need to take immediate steps to prepare for potential risks, it says.

The scandal first erupted when employees of financial institutions including GMAC Mortgage, Bank of America and others admitted rubber-stamping thousands of foreclosure affidavits without bothering to confirm their accuracy. News reports of massive robo-signing quickly led to investigations by all 50 states and federal authorities, as Consumer Ally has reported.

In the best-case scenario -- supported by the financial industry, the report notes -- concerns about foreclosure documentation irregularities will prove overblown. Because only a handful of employees failed to follow correct procedures, the facts underlying the affidavits will remain accurate and foreclosures can proceed as soon the paperwork is properly updated.

The worst-case scenario, however, supported by academics and advocates for homeowners, maintains that "robo-signing" covered up the fact that loan servicers carried out foreclosures they couldn't legally support.

"In essence, banks may be unable to prove that they own the mortgage loans they claim to own," the panel notes. "The risk stems from the possibility that the rapid growth of mortgage securitization outpaced the ability of the legal and financial system to track mortgage loan ownership."

Traditionally, the report explains, homeowners borrowed money from a single bank and paid the same bank back over the life of the loan. Now, however, a mortgage loan may be bought and sold dozens of times between various banks natiowide. Meanwhile, the financial industry bundles the rights of thousands of home loans into mortgage-backed securities, creating a complex, electronic process now facing legal challenges. The validity of 33 million mortgage loans could be at stake.

And if documentation problems do prove to be widespread and throw into doubt the ownership of both foreclosed properties and pooled mortgages, "the consequences could be severe," the report cautions.

"Clear and uncontested property rights are the foundation of the housing market. If these rights fall into question, that foundation could collapse," the panel says. "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."

And if a major Wall Street bank discovers that, because of sloppy paperwork, it owns millions of defaulted mortgages it thought sold years ago, it could face billions of dollars in losses.

The report also rebukes the Treasury Department's claims that, based on current evidence, mortgage-related problems pose no threat to the financial system, noting that, "in light of the extensive uncertainties in the market today, Treasury's assertions appear premature."

Besides calling on the department to explain its upbeat assessment, the oversight panel urges bank regulators to conduct new stress tests on Wall Street banks.

"The American financial system is in a precarious place," the panel report warns. "The housing market and the broader economy remain troubled and thus vulnerable to future shocks. In short, even as the government's response to the financial crisis is drawing to a close, severe threats remain that have the potential to damage financial stability."
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