by Amy Lillard
(8/18/2012) As the housing market slowly shows signs of recovery, we’re still analyzing all the reasons for the market collapse. We know of many scandals and improper practices that contributed to the problems. Lending practices associated with subprime mortgages helped. Home values erroneously skyrocketed with out-of-whack appraisal practices. We know of a hundred and one other reasons as well.
But one of the biggest problems to come to light concerns wrongdoing long after the bubble burst. The so-called “robo-signing” scandal contributed to housing market decline, but has also exacerbated the problems facing borrowers and the economy at large. And it will have far-reaching consequences for foreclosed homeowners and the general market long past market recovery.
In simple terms, the robo-signing scandal refers to a practice in the foreclosure document processing centers at banks and lenders. Theoretically, qualified bank officials were in charge of reviewing the files on pending foreclosures to ensure that the last resort was in fact necessary for these borrowers. However, in 2010 investigations revealed that in a shamefully high number of banks and lenders one person, often a low-paid clerk that misrepresented their title and qualifications, was in charge of reviewing and signing as many as 10,000 foreclosure documents per month. Not only did that give each staffer only a couple minutes to review and sign each file, it bypassed the requirement of signing in front of notaries to ensure thoroughness.
This meant a painfully high number of borrowers facing foreclosure probably did not get a mandated full review of their case. They may have lost their home without proper cause, and certainly without proper legal procedures.
Since then state attorney generals and the federal government have investigated, and details have emerged that this fraudulent practice actually extends back to the late 1990s . And it continued long past the initial bubble burst in 2008. In addition, investigation has shown that this practice was not limited to foreclosure documents. It affects many other key mortgage documents.
Taken as a whole, the robo-signing scandal means homeowners may have been improperly foreclosed, or may have a hard time proving their ownership. It’s a devastating consequence that could have repercussions for years to come.
Why did this happen? As with many of the problems that drove the housing market into trouble, increased demand and increased greed were drivers. The practice began in the late ‘90s as demand for homes jumped and banks and lenders struggled to keep up. It extended to foreclosure documents recently, as the demand has shifted to this area.
But robo-signing also comes from the evolution of the banking “shadow” industry. Analysts have increasingly documented this shadow system in recent years. It all stems from a desire and need for large institutional investors (pension funds, mutual funds, hedge funds, etc) to place millions somewhere between bigger investments. They want a place that is secure, provides a little interest, and is liquid. The result has been a “special purpose vehicle” (SPV) - investors place their money here, and receive mortgage-backed securities in return, which acts as insurance. If the SPV fails to return investments, the investors foreclose on the securities.
This shadow banking system is the real deal, as large as the traditional and regulated banking system. It is also the source of funding for the traditional banking system, allowing for lending and crediting. So in many ways it is necessary. But here’s a major problem - the key element of mortgage-backed securities are in fact mortgages. They are the home loans borrowers take out, and which they pledge their home as collateral to pay back. Investors with mortgage-backed securities become essentially owners of the mortgage note and holders of the mortgage.
And one of the most essential documents in this process, the mortgage note which can give investors the right to take action against delinquent borrowers and foreclose on properties, are often involved in the robo-signing fraud. Investors used an army of robosigners to prove their ownership and ability to foreclose, but many of the documents are downright forgeries.
The scandal is truly staggering. Federal and state attention to the matter resulted in widespread outcry from the agencies and from borrowers. While no legal action was taken, a massive settlement was reached earlier this year between the government and five key lenders. The lenders will be forced to pay $20 billion for financial relief for borrowers, $10 billion of which will be used to reduce the principal for delinquent or underwater borrowers. An additional $3 billion will go towards refinancing loans for underwater borrowers. And a maximum of $7 billion will go towards other relief like short sales, anti-blight programs, and principal forgiveness for unemployed borrowers.
What happens now? While the settlement will punish several lenders that were involved in the scandal, and will help some borrowers climb out of bad situations, there will still be massive fallout.
One key problem that will result from robo-signing is actually an increase in foreclosures. When the scandal initially came to light in 2010, lenders put the brakes on foreclosures, scared of making costly mistakes and/or showing their culpability in robo-signing. That resulted in a 34% drop in foreclosure filings in 2011. But now that the settlement is reached, lenders will move forward with new and backlogged foreclosures. Ideally, they will be legal, following the letter of the law without any trace of robo-signing or other fraud. But there is a chance it could continue - the Associated Press reported as recently as July that officials in four states said mortgage documents with suspect signatures had been filed in recent months. Claims such as these may result in increasing problems, and increasing government scrutiny.
But perhaps the bigger problem on an individual and national scale is the unclear ownership resulting from robo-signing. For individuals looking to sell right now, they may find that somewhere in the chain of ownership invalid robo-signed documents may exist. It could delay sales or make it difficult to transfer ownership. For folks looking to purchase a foreclosed property, or even a normal property that has changed owners in the past, there may be many new steps and/or delays in the process. And of course, individuals who have experienced a foreclosure will at the very least wonder if things could have been different.
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