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Don't underestimate foreclosure crisis, watchdog warns

By Brady Dennis and Ariana Eunjung Cha
Washington Post Staff Writers
Tuesday, November 16, 2010; 12:18 PM

A congressional oversight panel warned on Tuesday that a widespread problem of flawed and fraudulent foreclosure paperwork could upend the housing market and undermine the nation's financial stability. The report comes just as the issue is drawing greater scrutiny this week in Washington.

The report, issued by the Congressional Oversight Panel, which monitors the government's bailout program, marks the first time a federal watchdog has weighed in on the nationwide foreclosure mess.

The panel echoed concerns raised by consumer advocates and financial analysts who have said that although the consequences of the foreclosure debacle remain unclear, the problems could throw into doubt the ownership not only of foreclosed properties but also the millions of ordinary mortgages that were pooled and traded by investors around the world.

On Tuesday afternoon, the Senate Banking Committee will hold a hearing on the matter. Lawmakers are considering several legislative responses to the findings.

The spotlight on the foreclosure process has anxious financial executives mobilizing on Capitol Hill. A financial lobbyist said senior executives have been meeting with lawmakers and their staffers, and industry groups are planning letter campaigns aimed at preventing aggressive new legislation.

"Everyone's very nervous about what's going to happen this week," said another industry official, who spoke on condition of anonymity because his firm has a stake in the outcome. "We have all hands on deck."

It's unclear what new measure could pass in a politically divided Congress, but some ideas under consideration could broadly reshape the mortgage industry.

Some lawmakers want to resurrect legislation that would give bankruptcy judges the power to order lenders to reduce the principal that homeowners owe. Others are pushing for some big banks to spin off their mortgage-servicing arms to avoid conflicts of interest. There's also discussion of replacing the industry's current system for tracking mortgages with one that would be subject to federal regulation.

"The risk is small that a bill gets through," the financial lobbyist said, but "we are taking it very seriously."

Potentially high costs

The problems came to light this fall as firms such as Ally Financial, Bank of America and J.P. Morgan Chase halted foreclosures because of revelations about shoddy mortgage documentation and other questionable practices.

The oversight panel raised concerns that lawsuits from investors who bought the mortgages could cost banks billions of dollars.

For such reasons, the watchdog report called the Treasury Department's assertions that the mortgage mess poses little systemic threat to the financial system premature.

"Clear and uncontested property rights are the foundation of the housing market. If these rights fall into question, that foundation could collapse," the report stated.

'Stress tests' proposed

The panel urged Treasury officials to deeply investigate the foreclosure problems, report their findings to the public and develop contingency plans for a worst-case scenario. The group also advised the Treasury and Federal Reserve to conduct new "stress tests" on Wall Street banks to gauge their ability to manage any fallout.

"This is an incredibly complex problem," Sen. Ted Kaufman (D-Del.), who heads the panel, told reporters. "Clearly, we've sent a message that this is something that's important. It's something they should be monitoring."

At the same time, he said, panel members sympathize with the conundrum facing policymakers as they deal with the issue: On one hand, grinding foreclosures to a halt unnecessarily could harm the economy and slow its recovery. On the other, he said, distressed borrowers are entitled to due process, especially when banks are trying to take their homes.

Administration officials say they are keeping a close watch on the issue.

"We strongly believe that the reported behavior within the mortgage servicer industry is simply unacceptable, and servicers who have failed to follow the law must be held accountable," said Treasury spokesman Mark Paustenbach. He added that the administration has led an interagency effort to "investigate misconduct, protect homeowners and mitigate any long-term effects on the housing market. The independent regulatory agencies, the Justice Department and [the Department of Housing and Urban Development] are examining servicers' behavior, and we will continue to monitor the situation closely."

The Tuesday Senate hearing will include testimony from banking executives, consumer advocates and Tom Miller, the Iowa attorney general leading a 50-state investigation into mortgage servicing and foreclosure practices. On Thursday, a separate hearing in the House will examine the practice of "robo-signing" - document processors who signed off on thousands of foreclosures each week without reviewing the files - and whether the industry properly transferred the ownership of mortgages while trading the loans.

The flurry of activity in Washington surrounding the foreclosure problem extends beyond watchdog reports and public hearings.

Behind the scenes, state officials investigating the matter are meeting with senior officials at the Treasury and White House on Tuesday.

The Financial Fraud Task Force at the Justice Department is also looking into the issue as other agencies try to understand the extent of the problems and gauge potential fallout. According to administration officials, nearly a dozen government regulators are coordinating foreclosure investigations, but they have not found evidence of a systemic threat to the U.S. economy.

dennisb@washpost.com chaa@washpost.com

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