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Lack of proper mortgage paper trail could leave big banks reeling again
Some analysts doubt whether the consequences will be dire.
"Does it call into question all securities? I think that's flying way, way too far," said Laurie Goodman, a securities analyst at Amherst Mortgage Insight. Goodman said there should be an easy way to go back and transfer documents correctly, which she says some firms are already doing.
Yet officials at the ratings agency Moody's say they are watching the courts very closely.
If they rule that the securitization process muddied the ownership of the loans, "then basically the whole thing winds down," said Debash Chatterjee, senior vice president at Moody's.
Adam Levitin, an associate professor of law at Georgetown University, who briefed Citigroup's clients on a conference call this week, said in an interview that it's hard to predict the scope of the problem.
"If you read through court decisions, there's a pretty consistent picture that there are all kinds of problems in the chain of title," Levitin said. "It's not clear how it's going to be resolved. There's a question mark hanging over the whole housing system."
Big lenders have said the issues could be solved in a month or so, but Levitin questioned that, saying that any resolution could take at least a year. In the worst-case scenario, this becomes a "systemic problem" and the mortgage market grinds to a halt.
"The liability here for the major banks is potentially enormous, and can lead to systemic risk," wrote Rep. Alan Grayson (D-Fla.) in a letter last week to Treasury Secretary Timothy F. Geithner, Federal Reserve Chairman Ben S. Bernanke and other senior regulators.
A number of investors, who are already suing trusts for losses related to mortgage securities, are seeking to expand their lawsuits or file new ones focused on whether the trusts actually owned the loans, according to lawyers involved in the discussions. Lawyers said the investors could try to force the banks to buy back the assets if contracts were violated.
"If we can't come up with a system for investors to enforce their contract rights here, then there shouldn't be a securitization market," said Bill Frey, chief executive of the hedge fund Greenwich Financial Services. "It's just as simple as that.
"Ultimately, the resolution of this is in the hands of the investors, and they have to have the political and economic will to stand up," he added.
That might already be happening. The Association of Mortgage Investors is pressuring trustees to investigate the transfer of loans in the securitization process. The trade organization has said big lenders should be liable for losses due to their negligence.
A key case before the supreme court of Massachusetts should shed more light on whether the trusts have valid ownership of the loans. A lower-court judge ruled that Wells Fargo and U.S. Bank did not have the right to foreclose on two properties because of errors in the securitization process, a decision the banks dispute.
A search of court records by an attorney for homeowners in Florida turned up nearly 80 cases in which a trust initiated foreclosure proceedings before it registered its ownership of the mortgage with county offices. Citibank, for instance, started foreclosure proceedings on a home in May 2008 but recorded the trust's ownership of the mortgage in March 2009.
Ann Rutledge, chief strategist of the structured finance advisory firm R&R Consulting, said not much more could go wrong in the mortgage-backed securities market.
"It's certainly not an indication that [the market] doesn't work," she said. "It's one more indication that it hasn't worked."