NEW YORK (
) -- Banks may want to reconsider their outsourcing practices.
The country's biggest lenders are holding the bag for trillions in bad mortgage debt that was originated by outside brokers then packaged and sold off by third- party asset managers. In both instances, banks are being held accountable for the actions of their "partners" to the tune of billions in possible liability.
Now the final step in the mortgage death spiral -- foreclosures -- could end up costing banks even more grief as a result of outside contractors.
The most current legal mess is the practice of "robosigning," in which employees blindly signed thousands of foreclosure documents under oath without having verified any information.
Consumer advocates and foreclosed-upon homeowners provided dozens of foreclosure and court documents to
. The documents indicate that misrepresentations and apparent forgeries occurred in states across the country, from Colorado to Georgia. At times, an individual presented himself as a representative of several companies. In other cases, nearly identical - though illegible - signatures appear for different attorneys at an array of law firms.
The names of several top banks appear in the paperwork, though they often farmed out the foreclosure proceedings to small default servicers that operate locally in the states.
"We started instructing people to pull their documents from the clerk of the court," says Anne Batte, who runs a foreclosure-assistance group in Georgia called Operation Restoration. "And the more we instructed, the more we saw. Nearly every document I have seen has been improperly signed."
"Nearly every document I have seen has been improperly signed,"
-- Anne Batte, Operation Restoration.
Richard Cordray, Ohio's attorney general, filed suit against GMAC on Wednesday, seeking up to $25,000 for every violation of proper documentation practices. Cordray is also seeking restitution for affected consumers; the financial impact of that request is still "vague," he says, until the discovery process gets under way.
"It was the first case in which one individual - and we suspect it was much broader than that - acknowledged in a deposition signing tens of thousands of affidavits where he claimed to have personal knowledge - and he's saying this under oath in a court - but in fact he didn't know the first thing about the information in the affidavit," Cordray said in an interview with
on Thursday. "It is an outright fraud."
Attorneys general in more than two dozen states are now investigating or prosecuting foreclosure proceedings at major lenders like
Bank of America
PNC Financial Services
. BofA, JPMorgan and another major mortgage servicer,
, also known as
, have agreed to halt foreclosures as they work to get their arms around the problem.
Cordray called his attack on GMAC "a very significant lawsuit with significant consequences." His office has asked other banks to halt foreclosure proceedings in Ohio, saying there are indications that Bank of America and JPMorgan Chase employees acted similarly. He has also requested information from the two other leading mortgage servicers, Wells Fargo and
His efforts are being mirrored by attorneys general coast to coast because so many of their constituents have fallen behind on mortgage payments. Since the beginning of last year, more than 180,000 homes have received foreclosure filings in Ohio alone, according to RealtyTrac. More than 8 million homes have received filings across the country during that time, with one in every 381 U.S. households receiving a notice in August.
As a result, big banks find themselves in a sticky situation. Their reliance on small, outside mortgage contractors to do their dirty work without direct oversight could have significant financial consequences.
In addition to foreclosure fraud allegations, the industry is facing demands to repurchase mortgage debt that was sold to
, and in some cases, private investors. Those parties claim loan documents were handled improperly at origination as well, creating breaches in representations and warranties of purchasing contracts.
Josh Shein, who is now CEO of mortgage lender Great Oak Lending, spent nine years as a broker. During the boom days, he says, big lending institutions were risk-hungry, begging for NINJA - short for no income, no job and no assets - loans.
"As a mortgage broker back in the day, we did our job the way we were supposed to do it - we were responsible, we were ethical," says Shein. "But, in my eyes, it was up to us to be responsible and ethical on our own. The banks we were selling the loans to gave us a lot of leeway. Countrywide and the large subprime guys - Taylor, Bean and Whitaker, which went out of business - they would let you essentially deliver what you want to them."
Banks are also dealing with delinquent debt that's stuck directly on the balance sheet.
On Wednesday, Wells Fargo announced an agreement with attorneys general in eight states. The bank will take aggressive steps to modify loans for borrowers that are part of its most troubled "Pick-A-Pay" mortgage portfolio. The loans weren't originated by Wells - they came along with the Wachovia merger in 2008 - and the $50 billion in Pick-A-Pay debt represents just a fraction of Wells Fargo's enormous mortgage portfolio.
Still, the price tag of the agreement stands at nearly $800 million, more than half of which will come from outright principal forgiveness.
"When we acquired Wachovia, keep in mind, the Pick-A-Pay portfolio was about $117 billion," says Franklin Codel, CFO of Wells' home-loan division. "And they were all sitting on our balance sheet - they are not sitting in securities owned by other people, they were here."
Nonetheless, it's hard to gauge how big of an impact the foreclosure-litigation mess will have on individual banks. Estimates are lacking for many significant issues: How many documents have serious errors? Will attorneys general really go so far as to cripple the industry financially? How many piggyback lawsuits will follow from borrowers or mortgage-backed securities investors? What will be the response of title insurers, which are standing behind tens of thousands of potentially erroneous home-loan documents?
And what will banks do to respond?
James Keneally, a partner in the white-collar criminal practice group at Kelley Drye & Warren, says it's logical to assume that a vast number of foreclosure documents were "robosigned," given the huge volume of foreclosure filings over the past few years.
"If you're signing thousands of things a month, that's all you'd spend your time doing," says Keneally, who works with major financial firms. "That's basically your job."
Steven Alexander, president of Atlanta-based Private Mortgage Services, says the entire mortgage business has become "a production line."
"The big banks have become overwhelmed by volume, which needs to be put through a system - albeit a flawed system," says Alexander, who brokers mortgages for Private Bank of Buckhead. "They're hiring consultants who will legally try to push out as much paperwork as they can."
Keneally believes that banks will have to implement technology that allows them to verify documents with speed and accuracy. He thinks there will be announcements by year-end of major overhauls to the foreclosure process - particularly because banks want to get rid of foreclosed inventory now sitting on their balance sheets.
"If I were the CFO, I'd be banging my fists on the table, demanding all hands on deck," says Keneally. "It's something I would expect the banks to jump on. It doesn't just make legal sense, it doesn't just make reputational sense, it doesn't just make moral sense - it makes business sense."
For its part, Wells isn't planning to implement a moratorium like some of its competitors; a spokeswoman says "Our affidavit procedures and daily auditing demonstrate that our foreclosure affidavits are accurate."
Dan Frahm, a spokesman for Bank of America's mortgage division says an initial assessment "shows the factual loan information underlying our foreclosures is accurate." A JPMorgan spokesman says that in some instances, employees signed affidavits without having personally reviewed the material. The bank has begun to "systematically re-examine" all its documents for current foreclosure proceedings, but believes that "the accuracy of the factual loan information contained in the affidavits was not affected by whether or not the signer had personal knowledge of the precise details."
Big banks have also started cutting back on their outside contracting, with Bank of America saying it will originate all new mortgage loans in-house and JPMorgan and Citi also curtailing their dealings with brokers. But there seems to be little chance of holding the little guys - often, the actual "robosigners" - responsible. Cordray says contracting a third party "certainly does not absolve" banks of central responsibility.
Says Shein, the former mortgage broker: "They're left holding the bag at the end of the day...Everyone likes to target the guy with the deepest pockets."
-- Written by Lauren Tara LaCapra in New York
>To contact the writer of this article, click here:
Lauren Tara LaCapra
>To submit a news tip, send an email to:
Disclosure: TheStreet's editorial policy prohibits staff editors, reporters and analysts from holding positions in any individual stocks.