10/27/2010 06:23 pm ET | Updated May 25, 2011

Foreclosure Documentation Scandal Speaks Volumes About the Mechanics of the Mortgage Mess

Current mortgage rates are at an all-time low, but if you are wondering why this hasn't provided the desired support for the housing market, look no further than the foreclosure documentation scandal that has recently rocked some prominent banks.

Recent revelations about faulty foreclosure documentation provide a window into the reality of how banks operate -- and the view isn't pretty.

The foreclosure documentation scandal -- what it says about banks

Bank officials are supposed to personally verify the information on foreclosure documents before signing off on them. It turns out, though, that when faced with an overwhelming volume of foreclosures, some bank officials signed off on the documents automatically, without reviewing them -- a practice that has become known as "robo-signing."

Does this mean that the epidemic of foreclosures over the past couple years need not have occurred -- that it was just a banking error? Unfortunately, no. The likely outcome is that the vast majority of foreclosures that were robo-signed would have gone through anyway had they been properly reviewed.

What this does confirm is two things about the way some banks responded to the flood of foreclosures:

  • Besides the financial losses of loan defaults, the mortgage crisis saddled banks with a paralyzing bureaucratic burden. At a time when banks were cutting back on mortgage staff, mortgage departments were trying to process an avalanche of paperwork. Some cut corners as a result.
  • Banks were tone-deaf about how to handle the crisis. If they couldn't keep up with the pace of foreclosures anyway, banks could have gotten some public relations benefit at no cost to themselves by extending a grace period to troubled home owners. This would have helped mortgage departments catch up on foreclosure paperwork, and might even have allowed some home owners to turn things around.

Muting the impact of current mortgage rates

What happened instead has muted the potential benefit of current mortgage rates. Houses have been precipitously dumped on the market via foreclosures, and overwhelmed mortgage departments have been slow to write new loans. To the extent this has prolonged the housing slump, banks may be victims of their own bureaucracy.