Foreclosure Mess – Update

Given this morning’s disappointing report of existing home sales it is worth recalling that one factor weighing down heavily on real estate is the ongoing foreclosure mess. By this I mean the growing chaos within the foreclosure process, and the steady and increasing stream of revelations that indicate that the banks have a slew of documentation problems. Lest we forget: foreclosure is a process that hinges on proper documentation. Getting a clear view of property rights and thus title is a vital component of a healthy real estate market. We all tend to overlook this simple fact because we have assumed for decades that the American system is a well oiled machine with title clear and thus borrowers and lenders rights well established. Finally we should also recall that real estate is an extraordinarily well established body of law at the state level.

So, with that said, what is going on?

Well, there is an interesting ongoing foreclosure case in New Jersey that threatens to destabilize everything. The basic facts do not concern us. What we need to focus on is that during the court hearing a representative of Bank of America stated, under oath, that it was customary for Countrywide, that bete noir of the bubble and now part of BoA, to retain documents pertaining to securitized loans. They were retained for ease of reference and out of fear they would be lost.

This is an extraordinary admission. It contradicts what BoA had said previously and completely calls into question the validity of any securitized loans BoA contributes assets to.

Why?

Because the law is simple: for a trust associated with a securitized loan to be securitized the trustee has to take possession of all the relevant paperwork. To the extent that Countrywide kept documents relating to mortgages it sent forward for inclusion in such a trust, then those loans are not properly securitized. If this is held to be the case, and after the court testimony it would be hard to roll this one back, then it is equally clear that there are a few, possibly very many, securitized loans sitting on third party balance sheets that are not correctly securitized. They are unsecured loans no different from a credit card. Since this would undermine their valuation anyone holding such an asset would be looking at a substantial loss. They would almost certainly sue to reclaim that loss. That means they would end up suing BoA, as it now is the owner of all that Countrywide paper. The potential damage to BoA is huge, and I doubt that its current stock price reflects this properly.

So why has the stock price not sunk?

I can suggest a number of issues.

One is that the market doesn’t believe the court testimony has a generalized impact and that it may be only a localized problem. In which case the loss is restricted to this one case – BoA would not be able to complete the foreclosure on the home of the litigant in question.

Another, far more dangerous reason for market indifference, is the belief that the government will stop the damage from spreading. This is, I fear more likely. Our government, under both Bush and Obama, has been supine in the face of bank incompetence and misconduct. At every turn the government has seen fit to “save the system” rather than enforce economic punishment for anti-social behavior. The banks are well aware of this and so indulge in all sorts of corner cutting in their activities. They are under no pressure to behave well or even obey well established law. They have the ultimate get out of jail card: government complicity.

Unfortunately for all concerned this game of complicit behavior could run afoul of state law, where armies of real estate lawyers are challenging the veracity of Wall Street’s slick legal teams who botched the securitization process. The consequence of this confrontation is a sudden and massive slowdown in the foreclosure process. This, in turn, is stopping the healing of real estate values – until the backlog of foreclosures are dealt with it is very difficult to place a good valuation on property. More to the point: the bank’s apparent disregard for paperwork is starting to gum up the entire real estate transaction process. Title searches, new mortgages, liens,and other aspects of the conveyance of property are all now suspect. It will take a while for confidence to return and for long established processes to be trusted again.

Yes, the banks really were that stupid.