Worries over fast-tracked foreclosures send bank stocks plummeting

Oct. 14 (Bloomberg) -- Rick Sharga, senior vice president for marketing at RealtyTrac Inc., talks with Bloomberg's Mark Crumpton about U.S. home foreclosures in September. Lenders took over 102,134 properties last month, RealtyTrac said in a report today, a record number that probably will decline in coming months as major banks halt repossessions and review their foreclosure practices. (Source: Bloomberg)
By David S. Hilzenrath
Washington Post Staff Writer
Thursday, October 14, 2010; 8:13 PM

Stocks of major banks declined sharply Thursday amid concern that widespread corner-cutting in the foreclosure process could saddle the financial system with a costly and paralyzing mess.

The sell-off was one of the most vivid indications yet that, just as banks were recovering from the financial crisis of recent years, foreclosure problems could take a new toll. Indeed, J.P. Morgan Chase said Wednesday it had set aside $1.3 billion of new reserves for litigation, "including those for mortgage-related matters."

Share prices declined Thursday by 2.8 percent for J.P. Morgan, 4.2 percent for Wells Fargo, 4.5 percent for Citigroup and 5.2 percent for Bank of America. In contrast, the Dow Jones industrial average was down by 0.01 percent, and the Standard & Poor's 500-stock index, a broader market gauge, was down by 0.36 percent.

Several major lending institutions have frozen foreclosures in response to evidence that employees in what were essentially foreclosure mills signed the paperwork to seize homes without checking whether the evictions were justified.

Meanwhile, a similar but potentially broader concern has cast an additional cloud over the system. Some analysts are concerned that securities based on huge pools of mortgages might be defective.

Mortgages are routinely pooled and packaged into securities that are traded around the world like stocks and bonds. The securities are widely held by investors, including mortgage finance giants Fannie Mae and Freddie Mac, which are wards of the government. Court documents show that in many cases the paperwork transferring legal ownership of those loans to the pools was lost, ignored or even forged.

It is not yet clear what the consequences will be if large quantities of mortgage-backed securities turn out to be flawed - or how the problem could be solved.

"If the basic principles of property law have been violated here . . . it may be extremely difficult to fix," said a source involved in government oversight of financial institutions who spoke on the condition of anonymity because of the uncertainties involved. "There is a chain of questions that no one seems to know the answer to."

Banks and other players in the mortgage industry could face substantial penalties from state law enforcement officials and potentially extensive litigation from homeowners over the disputed foreclosures, as well as from investors who bought the mortgage securities.

Analysts are divided over what the final cost will be to big financial firms. Some predict the cost could run into the tens of billions of dollars. A few say the foreclosure debacle could evolve into a major crisis for the entire financial system.

In a note to investment clients Thursday, Paul J. Miller, an analyst at FBR Capital Markets, estimated that lenders could see a hit of $6 billion to $10 billion, a large sum but one the industry "could comfortably absorb."

Much depends on how courts approach the issue. Companies that service mortgages "may be in uncharted waters as they have never been challenged by the judicial system as extensively as they are now," analysts at FBR wrote.

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