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The Foreclosure Mess: Now State AGs Are Piling On

State legal officials aren't content simply to treat the symptoms of the housing crash -- they want to attack the disease. Nearly 50 attorneys general around the country are banding together to investigate loan servicers suspected of illegal foreclosure. Critically, they also hope to pressure financial firms to offer mortgage relief to struggling homeowners.

The probe will initially focus on identifying which financial institutions filed improper foreclosure documents, but could expand to look at other problems. Said Iowa AG Tom Miller, who's leading the investigation, in a statement today:

This group has the backing of nearly every state in the nation to get to the bottom of this foreclosure mess, and we plan to work together as thoroughly and expeditiously as possible. Since this issue affects peoples' homes and has clear economic implications, this probe and its outcome need to be fair both to homeowners and also to lenders.
The coalition's immediate objectives:
  • Putting an immediate stop to improper mortgage foreclosure practices
  • Reviewing past and present practices by mortgage servicers subject to the inquiry
  • Evaluating potential remedies for past practices and to deter future improper practices
  • Establishing a mechanism for more effective independent monitoring of future mortgage foreclosure practices
This is an important -- and positive -- turn in this affair. A major reason foreclosures have soared since 2007 is that lenders have resisted reducing loan principals. Unwilling to swallow the loss from such writedowns, they prefer to reduce a loan's interest rate or extend its life. But that does little to address the core problem driving foreclosures -- the growing number of borrowers who owe more on their mortgages than their homes are worth. Roughly 1 in 6 U.S. homeowners, or 12 million households, are "underwater."

Some states have previously sought to force banks to modify mortgages, with occasional success. A threatened lawsuit by Massachusetts AG Martha Coakley induced Bank of America (BAC) in March to cut loan balances for eligible borrowers by up to 30 percent. As initially rolled out, however, that program had severe limitations. It covered only two kinds of loans, pay-option and hybrid ARMs, and it tried to restore equity to homeowners over five years, which doesn't help people in the short term.

The joint state foreclosure probe could prove far more effective. Mortgage servicers have been caught red-handed submitting fraudulent foreclosure documents in court, giving the states far greater legal leverage:

"The behavior already on the record involves thousands of false statements to judges," said Peter Swire, an Ohio State University law professor who recently left the White House economic policy staff. "That's a weak hand for the banks."
The level of fraud also may go well beyond what financial institutions have blithely dismissed as procedural deficiencies in their documentation. Georgetown University law professor Adam Levitin recently told CNBC's Diana Glick that the back-dated affidavits and other faulty paperwork raise questions about banks' ownership not only of foreclosed properties, but of healthy mortgages. That could lead to this nightmare scenario for banks, he said:
The mortgage is still owed, but there's going to be a problem figuring out who actually holds the mortgage... You have a trust that has been getting payments from borrowers for years that it has no right to receive. So you might see borrowers suing the trusts saying give me my money back, you're stealing my money.
The White House is lending support, if somewhat grudgingly, to the state investigation. Politically, of course, it has little choice. Although Obama administration officials have dismissed the need for a national foreclosure moratorium, it would be suicide only weeks from the midterm elections to impede state law enforcement officials from taking steps to defend homeowners.

Since neither the U.S. Justice Department nor financial regulators appear to be on the case, that leaves the states. Mortgage servicers claim they have found no evidence of improper foreclosures. That's false, since we already know that these firms broke the law by filing legal documents without reviewing them. Even if that were true, however, how do we know for sure there have been no other abuses? As financial industry wonk Mike Konczal writes:

Is there any reason to believe that the servicer and foreclosure mill fraud is over? That securitizations actually have the proper legal documentation necessary? That borrowers and lenders are actually getting a chance to come to mutually beneficial situations? Is there any reason to believe they aren't lying?

Because servicers aren't currently regulated. They have a patchwork of state regulators and the OCC may regulate their parent company if it is a bank or thrift, but there's no government agent to provide any accountability here.

Correct. If we're to get to the bottom of this, it won't be because financial firms are investigating themselves.


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