Foreclosure Fraud: what is really happening?

Some 3 years ago when the subprime crisis first manifest as problems with banks, here in Asia, no one gave a damn, Today, 3 years later, when the foreclosure drama is unfolding, here in Asia, no one gives a damn. Unfortunately, the “small local problem” 3 years ago turned into a Global Recession. Will the “Foreclosure Gate” be just as serious as the subprime crisis?

Photo by Jeff Turner

In a few words, with the great financial innovations, when you go to buy a house in Florida, you borrow money from a bank or mortgage originator. But these institutions may in turn sell your mortgage to an investment bank, and it may end up that in reality, you are borrowing money from an investor in China, for example, through a chain of intermediaries.

Back in 2007, the subprime crisis emerged as home prices started to plunge, and the worries about the ability for homeowners to repay the mortgages and the drop in the value of the collateral made the mortgage-backed securities drop in value as well. Investment bank might provided guarantee for these instruments in order to obtain top-rating from credit rating agencies, so if these mortgage-based securities turned sour, these investment banks would have to write-off the value. And oddly, because accounting rules somehow permitted these stuff to be hidden off-balance sheet, investors of these banks seemed to know nothing about all these stuff. When people start realising this mess, these investment banks were broke.

Now, this picture is coming back to bit us again. This time, the problem is concerned with some lousy paperwork. When a homeowner bought a house in the secondary market, they basically have to sign a note to promise to repay the lender. Then this mortgage note would have to be sent to the next party in this chain of intermediaries, and should ended up in the hand of a trustee for that mortgage-backed securities.

Although this is a mandatory part in this chain of transactions, this was not always done properly. As a result, this note might be lost, might not exist, or it exists, but no one knows where it is. Without this note, there is actually no way to ascertain the true owner of this mortgage. Or in other words, no one knows who actually borrow the money to own that house.

Now, the problem is, when these homeowners fail to pay their mortgage payments, the trustee will want to foreclose the homes. But if they do not have the note in their hands, they can only foreclose, with the help of servicers, by having the servicer to provide an affidavit, that is to swear that they know that you own the mortgage. They sign these documents, but actually they do know nothing about who really owns the mortgage, and they sign 10,000 affidavits a month, which is basically impossible to be done at that speed.

Now the major banks have stopped foreclosing, pending more work to review the papers. As foreclosed homes accounted for as much as 31% of total home sales transactions, now the halt in foreclosure and clearing up some previous foreclosure mess have essentially take the whole housing market to a standstill. Worse, because of all these lousy paper works, there will be whole range of ramifications surrounding it. For instance, there might be a tax issue for the investors of mortgage-backed securities. And if these foreclosed homes are sold, because of these lousy paper works, the new homeowners may not be able to obtain insurance for their mortgages because the previous mortgages were not released with proper paper works.

This problem might probably be a local problem involving some legal technicalities. However, the problem can get very serious to a point where there might be lawsuits against these investment banks, or the title insurer will refuse to insure new mortgages. In that case, this would be a very bad news for the already weak housing market. The financial system might be under pressure again if it proves that banks are responsible for this mess and have to settle billions of dollars with mortgage investors.

(For more complete review, read this, this and this)

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About Zarathustra

Zarathustra: Founder and Managing Editor of Also sprach Analyst. Once an analyst, now an investor and entrepreneur. Based in Hong Kong, but Londoner at heart.