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Wall Street Whispers: A Foreclosure Reality Check

While 'robosigning' has caused a huge headache for mortgage servicers, the real issue is the sheer volume of foreclosed homes.



) - As banks, borrowers and the government struggle to shift the housing crisis into recovery-mode, "robosigners" have become a sideshow for the issue at hand: Foreclosures.

A lot of people have stopped paying their mortgages. That may be because they're out of work, they've taken on more debt with more expensive terms than they can afford or because their homes have lost so much value that monthly payments fall into an abyss of negative equity.

"A lot of the consumers, for whatever reason, made bad housing choices - whether it was homeownership for everyone, whether they got bad loans or they were victims of the downturn in the economy and employment," says Steven Alexander, a mortgage broker at Private Mortgage Services in Atlanta. "But a lot of people just have said, 'The market dropped and my house isn't worth what it used to be worth and I'm just not going to pay the mortgage anymore.'"

Whatever the reason, about 4.5% of single-family home loans were still going sour last quarter, according to data from

Fannie Mae



Freddie Mac


. That figure is down from previous periods, but given heightened stress in the housing market since June 30, there's a good chance the number has since climbed higher.

Foreclosure filings increased by 4% on a sequential basis in both July and August, according to RealtyTrac. Banks had been trying to move quickly through the process of getting rid of toxic mortgage debt - seizing property, pushing paperwork through the court system, selling homes on the cheap at foreclosure auctions. But it's not quite that simple anymore.

The assembly-line manner in which big banks were processing foreclosures has effectively bitten them in the behind. Executives, employees and third-party contractors were "robosigning" thousands of court documents each month, under oath, without having verified information. Documents reviewed by


contain the same scribbled signature signed for several different people, while others show the same person claiming to be a representative of no less than five companies.

"That's why so many states have extensive requirements for home foreclosures," says James R. Gomes, director of the Mosakowski Institute for Public Enterprise at Clark University. "We don't want foreclosures to be the financial equivalent of predator drones, we want a real person who knows the situation of the particular loan to be the one making the decision to foreclose."

In the sloppiest cases, homeowners who were current on mortgages allege that banks have attempted to seize their homes improperly. In one case,

a blogger claims

Bank of America's

(BAC) - Get Report

Countrywide division tried to auction off his home - even though he says Countrywide didn't own the loan anymore and the defendant the bank was pursuing was a completely different person. In another case,

a contractor hired by JPMorgan apparently busted into the home of a mortgage-paying woman who responded by calling 9-1-1.

Even if those shocking stories aren't the norm, enough of them have bubbled up to prompt lawsuits, negative media attention and government action.

Lawmakers have called for a nationwide foreclosure moratorium and attorneys general in 40 states are reportedly banding together to seek monetary compensation for paperwork errors. The U.S. Treasury Department's banking regulatory division is also investigating the foreclosure practices of top mortgage servicers.

The industry has responded like a deer in the headlights.

Bank of America

(BAC) - Get Report

, the nation's largest mortgage servicer, has heeded calls to halt foreclosure proceedings across all 50 states. Others, like JPMorgan,


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PNC Financial Services

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are reviewing their practices. (

Wells Fargo

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, the second-biggest mortgage servicer, has stuck to its guns and continued with its foreclosure plans despite evidence of similar "robosigning" practices.)

Some banks have asked courts not to make decisions on pending foreclosures while they review documents. They plan to "cure" errors - in mortgage industry parlance - before judgments are made. Essentially, they will review thousands of affidavits, line by line, to verify information and swap robosignatures into real, live autographs.

There's no doubt that lying under oath is wrong and that "robosigning" is a bad business practice. But for most people with skin in the housing game - including bank-stock investors - the new headwinds for processing foreclosures is bad news only marginally to the broader issue of foreclosure volume.

"Lenders never envisioned having this many bad loans at the same time," says Gomes, "which makes everyone's favored solution -- a workout -- less feasible."

Indeed, at an event last month, JPMorgan CEO Jamie Dimon indicated that efforts to modify mortgages for the most troubled borrowers was superficial, if not naive.

"We have been writing off foreclosures that are delayed because of HAMP," said Dimon, referring to the Obama administration's home-loan modification program.

While modification efforts initially eased some of the pressure, Dimon predicted that improvements wouldn't last. A slideshow provided by JPMorgan at the time predicted that foreclosed inventory would "remain at elevated levels" through early next year, and "trend down gradually" through 2013.

Dimon said the volume was "certainly manageable the way we are selling things today," but that was Sept. 14, before "foreclosuregate" shot off. Richard Bove, a bank-stock analyst with Rochdale Securities, notes that there are millions of vacant homes in the country, with hundreds of billions of dollars' worth of debt now being contested. He predicts that 2 million homes will "get thrown on the market" when the current moratoria end, hurting interested buyers and existing borrowers the most.

Unsurprisingly, sources inside of big banks say the chorus of voices shouting against "robosigning" are making a big issue out of a relatively minor technicality. They also say that court battles won't provide the outcome that delinquent borrowers want - in the industry's view, a free lunch - it will only delay the inevitable.

Richard Gottlieb, who heads the financial services group at the law firm Dykema, has defended big banks like IndyMac and


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in court. He acknowledges that "robosigning" isn't the best way to do business, but given the volume of foreclosures - with 8 million homes receiving notices over the past two years - he's more inclined to be sympathetic with the lenders who weren't getting paid.

"The facts of the defaults, the merits of the foreclosures, that stuff is nearly 100% accurate in every filing in every jurisdiction by every bank," says Gottlieb. "People want to make a crisis out of a process that is arguably flawed - only because there are so many filings and no really efficient way to process foreclosures without doing so in a manner that, with the benefit of a little bit of hindsight, may have been imperfect."

Gottlieb also notes that, at the end of the day, the lawsuits and monetary judgments may not even help troubled borrowers at the center of the issue - and almost certainly won't let them stay in homes without paying their mortgages.

For instance, Ohio Attorney General Richard Cordray has sued GMAC, also known as Ally Financial, seeking $25,000 per incident of flawed paperwork. His office is also seeking restitution for consumers, but Cordray said in an interview last week that the terms of that are "more vague until we can refine that over the terms of the discovery of the lawsuits."

For his part, Gottlieb says troubled borrowers and their representatives in government need "a reality check."

"What were your damages?" he asks. "The amounts that were in the affidavits were correct. So how were you harmed? You weren't harmed. You were in default."

-- Written by Lauren Tara LaCapra in New York


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Lauren Tara LaCapra


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