Foreclosure Fraud: Megabanks At Risk As Analyst Identifies New Problems With Mortgages
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Pension funds and other investors who have suffered losses on mortgage-backed securities could have a "strong legal basis" to call into question the very securitized mortgages they purchased stakes in, increasing the pressure facing large Wall Street firms that packaged these securities during the housing boom, a prominent mortgage bond analyst said Thursday.
Wall Street firms have packaged and sold trillions of dollars in mortgage-linked securities this decade. But in their rush to push paper through various levels, from the firm giving homeowners a mortgage ultimately to the investor, shortcuts were likely taken due to the large volume at play. More than $4.4 trillion in mortgages not guaranteed by the federal government were bundled into securities and sold to investors from 2003 through 2007, according to Inside Mortgage Finance, a leading trade publication and data provider.
Recent revelations by servicers that their employees and contractors were careless in their handling of basic paperwork now threaten to unravel an untold number of securities and mortgages. The issue prompted Bank of America and Ally Financial to halt their home foreclosures across the country; JPMorgan Chase is reviewing 115,000 foreclosure cases across 41 states. Other servicers stopped foreclosure proceedings in states where foreclosures must go through the courts.
The problem is, no one yet knows how many mortgages have been affected by the slipshod handling of paperwork. Some analysts say hundreds of billions of dollars in mortgage-linked securities could be affected. Others say this could be resolved with just a few weeks of reviews and after-the-fact fixes.
Noted bond analyst Joshua Rosner sent his clients a memo Tuesday floating a theory of how big the impact could be. Though the managing director at Graham Fisher & Co. said he believes the paperwork problems regarding foreclosed properties will ultimately be resolved, he wrote that "We have a larger and more significant concern, which, if proved out, could call into question the validity of nearly all securitizations."
Investors would thus have the upper hand in their negotiations with big Wall Street securities issuers and mortgage servicers, and could force the firms to buy back more of the shoddy loans underlying their securities.
There are more than $1.3 trillion in outstanding mortgage-backed securities in which the mortgages are not backed by the federal government, Inside Mortgage Finance data show.
But that doesn't mean Rosner thinks securities issuers could be forced to buy all of that back. Nor can all of it likely be challenged.
Investors could exact a hefty settlement from the Wall Street firms that issued those securities, or they could simply settle their claims if no widespread problems were found, Rosner wrote. Ultimately, he said in an interview, it's the lack of certainty that complicates matters -- the paperwork problems could give investors the ammunition to force Wall Street firms to buy back defective mortgages. Or, it could be a small and easy-to-digest problem that Wall Street handles like they would a temporary hiccup.
In a Thursday note to clients, Rosner bemoaned how media outlets took his comments to clients and to Bloomberg News out of context.
"Several new-media have quoted an early story on our October 12th note which suggested we saw risks that origination flaws would allow investors to challenge securitizations on $1.3 trillion of mortgages. This is incorrect," he wrote. Rather, Rosner said, the current scandal "may give investors an opening to challenge the legality of deals, threatening to unnerve financial markets."
Those challenges, which would result from the revelations unearthed during the foreclosure process, could then be used to investigate the documentation practices that occurred when these mortgages were first given to borrowers. Inflated income levels, fake home appraisals and other lies inserted into mortgage documents -- something Wall Street and Washington have long suspected, but never truly investigated -- could then be used to force big banks to buy back the garbage they peddled in the first place to unwitting investors.
Another possibility is that trustees, who oversee the flow of documents from the originator of the mortgage to the vehicle that holds those documents for investors, may not have properly performed their role, either.
"It is our belief that, given the black box nature of the process and the former white-hot origination market, some trustees may not have properly transferred notes to the trusts," Rosner wrote Thursday. "If not properly transferred, the 'true sale' of mortgages to the trusts that issued mortgage-backed securities would be in question. If this proves to have occurred we believe the Trustee may have liability."
Just four firms dominate the trustee market for mortgage-backed securities in which the mortgages aren't guaranteed by Uncle Sam: Deutsche Bank, U.S. Bancorp, Bank of New York Mellon, and HSBC serve as trustees for 70.5 percent of all such issuance since 2005, according to Asset-Backed Alert, an industry newsletter and data provider. An additional four firms -- Wells Fargo, Bank of America, JPMorgan Chase, and Citigroup -- control 29.1 percent, Asset-Backed Alert data show.
All told, these eight firms have served as trustees for 99.6 percent of all private-label mortgage-backed securities issued since 2005.
Were the document errors now cropping up in a handful of cases "to be found to have resulted from [the] widespread failure of issuers and trusts" to properly handle and transfer documents, "there would ... appear to be a strong legal basis for the calling into question [of] securitizations," Rosner wrote.
In a common example detailing how an investor may have either sold his bonds at a loss or lost money because of the trustee's inability to foreclose on a home, all because of paperwork problems, "it is reasonable to believe that this investor would consider suit against the trustee to recoup losses," Rosner wrote.
Shares of all eight firms were down at the close of Thursday trading on the New York Stock Exchange. Bank of America and Citigroup led the way, slipping more than 5 and 4 percent, respectively.
READ Rosner's note:
Joshua Rosner On Foreclosure Fraud
Shahien Nasiripour is the business reporter for the Huffington Post. You can send him an e-mail; bookmark his page; subscribe to his RSS feed; follow him on Twitter; friend him on Facebook; become a fan; and/or get e-mail alerts when he reports the latest news. He can be reached at 646-274-2455.
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First Posted: 10/14/10 09:27 PM ET Updated: 05/25/11 07:00 PM ET