Wall Street Whispers: Foreclosure Freeze Gives Banks Breathing Room

NEW YORK (TheStreet) -- The foreclosure moratorium, part deux, is generating a lot of negative attention that may not be fully deserved.

Several major banks have said they will halt foreclosure proceedings due to a raft of litigation from homeowners and investors and pressure from regulators. What started off being characterized as minor paperwork errors late last year has turned into something of a legal nightmare.

But in the worst-case scenario, big banks will have delayed the inevitable for the housing market, while facing additional costs for reckless and sloppy procedures. In the best-case scenario, the halt in foreclosure proceedings may give the housing market enough time to begin healing again.

So far, Bank of America (BAC), JPMorgan Chase (JPM) and GMAC Mortgage have said they will stop foreclosing on homes until they can get their arms around the problem. Wells Fargo (WFC) has said it will not halt foreclosures, though an executive admitted to signing off on documents without having fully reviewed them. Regulators have reportedly advised other big banks, like Citigroup (C), U.S. Bancorp (USB), PNC Financial Services (PNC) and HSBC (HBC), to review their paperwork and foreclosure-processing procedures as well.

Problems with the way big banks handle mortgage documents became evident last year, when Fannie Mae (FNMA.OB) and Freddie Mac (FMCC.OB) started demanding they repurchase billions of dollars worth of loans due to faux pas in documentation. At the time, few were alleging outright fraud. Last month, a top official from the Federal Housing Finance Agency implied that regulators may take legal action if banks don't step up buybacks of mortgage debt with faulty documents.

Now even more interested parties have stepped into the foreclosure fray. Borrowers contesting the propriety of foreclosure proceedings have started to sue, as have investors with competing claims to ownership of foreclosed-upon homes. In some cases, bank employees processing foreclosures were simply sloppy - they didn't verify basic borrower information or read all the details of what they were signing. In others, documents seem to contain forged signatures or forged notarizations.

"The industry has tried to move things along as quickly and as low-cost as possible," says Gagan Sharma, president and CEO of BSI Financial, which services distressed mortgage debt. "This is a result of that process - something slips through the cracks."

Homeowners and investors have some skin in the game - one party doesn't want to lose its home, while the other doesn't want to preclude any possibility of future note payments. But mortgage servicers stop having an economic incentive as soon as the mortgage stops performing because they stop receiving servicing fees.