Which word to choose? Chaos. Debacle. Scandal. Perhaps even, crisis. Just when you thought the US housing market, epicentre of the earthquake that collapsed the world's financial system two years ago, had stopped causing us all problems, it is time to pay attention again. Because after the Subprime Mortgage Mess, now we have the American Foreclosure Fiasco.
Around 7 million Americans are now either not paying their mortgages at all, or are seriously behind in their monthly payments – about one in seven of all residential mortgage borrowers – but that is not the surprising issue. This remains largely in line with the predictions that were made at the onset of the credit crisis, when it became clear lenders had been foisting unsuitable loans on indigent borrowers for years.
The surprising issue is this: the lenders and their agents have messed up the paperwork in truly heroic fashion. What ought to be a simple process – taking back the home used as collateral for a loan that is no longer being paid – has in fact turned into a legal quagmire, as each day brings forth revelations of fraud, cutting corners and shoddy treatment of homeowners. The ultimate outcome of the furore is difficult to predict.
Today, attorneys general from some 40 states will band together to launch a formal investigation of the mortgage servicing industry, which processes foreclosures. Bank of America, one of the top four lenders in the US, has halted all repossessions while it tries to work through the mess, and numerous other players have also stopped the foreclosure process in some or all of the country's 50 states. The White House yesterday rejected the idea of imposing a national moratorium on foreclosures – partly because the mortgage market is regulated at the state, rather than federal level, partly because the unintended consequences are scary – but that hasn't stopped a slew of other politicians demanding such a halt. Once again, public anger is stirred against the banks.
First, a very quick summary of the very slow road here – with four dates.
On 31 October, 2007, an Ohio judge called Christopher Boyko refused to rubber-stamp the foreclosure of 14 homes by Deutsche Bank. The bank had not been able to prove to the judge's satisfaction that it was the owner of the "mortgage note", the core loan agreement, and therefore had the legal right to repossess.
Perhaps it was inevitable, given the complexities of modern mortgage finance. The loans on the 14 properties had been flipped many times, as part of the securitisation process that slices and dices loans into mortgage-backed securities and other derivatives, while the task of looking after the mortgage and dealing with the borrower had been outsourced. The paper trail did not properly identify Deutsche Bank as the original mortgage holder, or as an assignee, trustee or successor-interest. So, no, said Judge Boyko, you can't foreclose.
The decision didn't go unnoticed by the advocacy groups looking to help those threatened with foreclosure, or by attorneys that saw foreclosure prevention as a lucrative new area of business.
"This is the biggest asset in your life. It's just a piece of paper to them, and one they likely either lose or destroy," Angie Moreschi wrote on 19 June, 2008. Ms Moreschi is editor of Consumer Warning Network Web, a campaign group which swung into action to promote this new weapon for struggling borrowers. The "show me the note" movement was born, and more and more people began to resist the foreclosure of their homes, not just in the 23 states where repossessions must be rubber-stamped by the courts, but all across the US.
"It's important to hold lenders accountable for their carelessness," Ms Moreschi wrote. "This process is not intended to help you get your house for free. The primary goal is to delay the foreclosure and put pressure on the lender to negotiate."
The next important date is 10 December, 2009. That is when Christopher Immel, an attorney with the Florida firm Ice Legal, took a deposition from Jeffrey Stephan from GMAC, a car finance firm that had branched disastrously into subprime mortgages. It was the day that Mr Stephan told Ice that he personally signed off on 10,000 foreclosures every month. The only logical conclusion was that GMAC was sending out foreclosure notices without having fully checked the paperwork – a practice that has become known as robo-signing, and which we now know was common across the banks.
Which leads us to the fourth and most important date, 17 September, 2010, when GMAC dramatically told its employees to stop work on foreclosures in the 23 states where court approval is needed. Other major banks were forced to follow suit, and the subject has become a political hot button issue ahead of the mid-term elections. Bit by bit, the foreclosure process is grinding to a halt. And because 1.2 million homes were expected to have been repossessed this year, up from 1 million last year and just 100,000 before the housing market bust in 2005, everyone from bank bosses to economists are trying to assess the consequences. These will manifest themselves in four areas.
First, on banks' results. JP Morgan Chase alone has about $19.5bn in residential mortgages in the foreclosure process, about 7.5 per cent of its total, according to SNL, a financial data company, and the bank services another $54.5bn of loans in foreclosure for other companies. Many of the delinquent loans will have been written down already, but if banks are forced to renegotiate mortgages, and cut the size of the outstanding amount, instead of foreclosing, the write-downs could grow. Analysts will begin to demand guidance on possible outcomes when the banks' reporting season kicks off next week.
Second, there will be consequences for other players in the financial system. The underlying mortgages are assets inside mortgage-backed securities and, often, inside further derivatives such as collateralised debt obligations (CDOs), whose investors get paid according to cashflows from the loans, or take losses depending on the reduced price of a foreclosure sale. It has been so hard to renegotiate the loans of those 7 million struggling borrowers because so many different investors have an interest in what happens.
Third, there is the effect on the fragile US housing market. "We are already in a position where there is excess supply of houses and not enough demand," said one senior Wall Street economist, who wanted to speak anonymously because it is too early to come up with firm numbers for the effect of the crisis. "The longer it takes to foreclose, the less pressure there will be on the market in terms of sales. We will be dragging it out and may not change the ultimate price correction that needs to come."
Fourthly, finally, there are the legal consequences for an industry which has been caught with its administrative trousers on the floor. As those 40 attorneys general are expected to say today, "mortgage-servicing firms face real exposure now".