Foreclosure machinery creaks back to life

Ever since the robo-signing scandal erupted in October 2010, large U.S. banks have slowly come to realize that their practices are under ever-increasing scrutiny. A “Duh!” observation for most people, but not, apparently, for bankers.

Belatedly, the bankers took a closer look at their internal procedures for handling defaulted mortgages. It did not take long for them to discover that something significant was amiss. By mid-2011, most of the major money center banks had put the brakes on their normal foreclosure machinery: “What was all this sturm und drang over some bums who don’t pay their bills? Perhaps we better look into it.”

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(The Washington Post/Source: RealtyTrac)

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Their internal review of how mortgages in default were handled revealed a surprising amount of chicanery. Indeed, most of what was going on had elements of something wrong. The banks might have been better served had they asked the question: “Are we doing anything legally?”

As it turned out, not very much.

Large banks had long used outside law firms and third-party service processors to pursue recoveries from debtors. What made this cycle so different was the sheer volume: A massive increase in foreclosures combined with a big upsurge in outside vendors to process them. The combination ran roughshod over centuries of property laws, to say nothing of well-established banking procedures and legal practices.

Using third parties did not protect the banks from liability. As it turns out, subcontracting fraud does not insulate your organization from the illegal behavior of your hires. This created a problem for the banks.

Eventually, some smart executive figured out exactly how rampant the illegal robo-signings had become and halted the runaway foreclosure process. Even though it was temporary, it gave the banks some time to try to clean up their acts. While there was hope of a settlement (as opposed to prosecution), the banks stopped processing defaulted home loans. This voluntary foreclosure abatement continued even as negotiations plodded on with the U.S. attorney general. Thus, with the foreclosure pipeline shut down for well over a year, home prices stabilized and distressed sales fell as a percentage of total home sales.

Ultimately, the attorneys general settlement amounted to a mere slap on the wrist for the banks in light of the institutionalized fraud that occurred.

With all that legal unpleasantness behind them, the voluntary foreclosure abatements quietly ended. This year, the banks began to once again review unpaid home loans. It takes a while for the creaky, wheezy, inadequate machinery of processing defaulted mortgages to rumble back to life. So it has — and we should expect to see signs of increasing foreclosures and distressed sales any day now.

The first data point supporting this was April’s existing-home sales. That gave us an early clue about what was to come. During the abatement period, distressed home sales, including foreclosures and short sales, had fallen substantially. They were down to 28 percent of existing-home sales for April – significantly less than the 37 percent a year earlier.