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Opinion

At Yahoo: Foreclosure-Gate

My latest at Yahoo: Foreclosure-Gate.

Gripping the US financial system, like so many things recently, is something that seems to have come out of nowhere – Foreclosure-Gate. This is a broad term, now referring to different means of fraud in the process of foreclosure, the act of evicting people and repossessing their houses after they failed to pay back their mortgages.

The “fraud” became mainstream when Jeffrey Stephan, employee at GMAC Mortgage, admitted to approving a large number of such repossessions without reviewing the underlying documents in detail, which he was required to do. He couldn’t possibly have – he was supposedly hand-signing 10,000 documents a month, which now has earned a name: robo-signing.

The scandal has erupted because the lack of review means that homeowners may have gotten a raw deal. Joseph Tauke lists a number of issues in the process at The Daily Caller. Banks have foreclosed on people who were making payments consistently, or didn’t give them appropriate notice that they were going to foreclose, or didn’t have enough documents to prove they owned the mortgage in the first place. Competing with the Organizing Committee at the Commonwealth Games, Bank of Americaeven foreclosed on Jason Grodensky, who, it turned out, had no mortgage at all.

But that’s not all. Loans were originated and then sold to multiple parties, many times pooled with other loans as a part of mortgage-based securities and then further as derivatives, and derivatives of derivatives. The ownership paperwork should have been transferred correspondingly, but in their hurry to generate volume, parts of this process have been left out, documents lost and signatures missing. The correct option at this point would be to actually get the paperwork done – but that is expensive; instead, certain institutions and law firms decided to simply forge the documents instead. One lie led to others, and now it’s not just missing documentation; the fraud spreads to unserved summons, fake signatures and false affidavits.

Recognising the problem, many states have launched inquiries into foreclosure fraud, and many banks have voluntarily stopped foreclosures until they have sorted out the documentation. This, some commenters cry, will tip the scales in favour of the homeowners; they will be able to stay in their homes for a while longer and if judges rule some documents were fraudulently attested, that there is a chance the foreclosures will not be allowed. Meaning, a free-house for the homeowner. That would be a disaster, but honestly, it’s very unlikely.

Now, foreclosures happen because the homeowner doesn’t pay the mortgage back for at least three months. The homeowner is getting evicted because he hasn’t paid back what he owes, and those that lent him the money must get his house in lieu. It is one thing to feel outraged at someone being evicted despite following the law (or having no mortage!) and completely another to see someone demanding a house free despite not paying back the mortgage, on the basis that the paperwork is incomplete. In other words, the “free-house” is just not going to happen.

What will happen, though, is a delay in the foreclosure process, because of this scandal. As judges take more time to run through a process that would otherwise take less than a minute, homeowners may find it attractive to hire lawyers and stall the process so they can stay rent-free for a little while longer. The loser is the industry itself: with so many foreclosures under a cloud of suspicion, banks will be unwilling to lend to houses, title insurers will refuse business, the costs of the process will eat into bank capital, and distressed homes will stay in the “shadows” keeping home prices at higher levels initially due to lack of supply. Later, when the process is ironed out, the supply will take prices right the other way.

The scale of the problem is incredible. Just the top three banks have an exposure of $234 billion (SNL Financial) to foreclosures, and this is likely to go up further. For each further delay and increase in costs, the lenders lose further money and the financial system, battered from a crisis that never seems to end, finds itself losing more and more.

Mike Konczal has a must-read three-part article on foreclosure fraud (OneTwoThree), which talks about how technical the problem has become, and how it can easily devolve into a new crisis.

One one side are the banks saying the real problem is that homeowners defaulted on their mortgages, and are simply using this as an excuse to be “squatters” – living off their properties without paying. On the other is a political issue – that the banks were responsible and must get their act together, and now. Despite all the conjecture, it’s unclear how the story will end, even if we all know that the banking system is sacrosanct and must be protected at all (US Taxpayer) costs. With the public distaste for the financial indust
ry, and the situation getting political another bailout will not be easily digested; in fact, the answer to “Too Big To Fail” could just be “Maybe not”.

Why is this even relevant to India? The recent rally in the stock markets that has taken the Sensex above 20,000 and the Nifty above 6,000 have its roots in foreign fund inflows. More than 35,000 crores of foreign money have been pushed into the market since September 1, taking the broad indices up 15%; if there is a serious problem abroad we could see money flow the other way quite as easily.

The US is set to have another round of “quantitative easing”, or QE2, in November. As another stimulus, it is slated to be another massive printing of money from the Federal Reserve, leading to asset price bubbles everywhere, including in your neighbourhoods in Delhi and Mumbai. Yet, even this is unconfirmed – and it might not happen, or foreclosure-gate might turn out to be even bigger than it sounds today. In either case, we’ll see money flying out of our markets: while it may seem that India is de-coupled from the American economy, the answer might still be “Maybe not”.