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What began as a ripple of concern about a few isolated foreclosure actions is threatening to reach tsunami proportions, possibly delaying or reversing thousands of foreclosures nationwide and adding further insult to the housing market’s already substantial injuries.

Two major mortgage lenders-- Ally Financial (formerly GMAC) and J.P. Morgan Chase-- have temporarily suspended some foreclosure actions in 23 states that require judicial review of foreclosure petitions, citing concerns about “technical” flaws in their documentation for the loans. After announcing a similar, limited foreclosure suspension, Bank of American announced a moratorium on all foreclosure proceedings nationwide. Additionally:

  • The attorneys general in four states -- Connecticut, California, Illinois and Ohio -- have asked Ally to freeze all foreclosures in order to prevent what Connecticut Attorney General Richard Blumenthal termed “a foreclosure steamroller based on defective documents.” Attorneys general in 40 states are reportedly ready to announce a joint investigation into foreclosure practices at the nation’s largest banks and mortgage companies.
  • Going a step further, Ohio has filed a civil lawsuit accusing against GMAC and its parent (Ally Financial) of fraud in the handling of hundreds of home foreclosures in the state.
  • Massachusetts Attorney General Martha Coakley has asked Bank of America and “other major creditors” to halt foreclosures on Massachusetts homeowners “until they can demonstrate that they have complied with Massachusetts laws.”
  • The Texas Attorney General has asked 23 servicers there to voluntarily suspend foreclosures and halt the sale of properties on which they have foreclosed, pending a review of their foreclosure procedures.
  • Fannie Mae and Freddie Mac have directed their servicers to review their foreclosure procedures; the Office of the Comptroller of the Currency has issued a similar request to seven of the large national banks the OCC regulates.
  • A group of homeowners in Kentucky have filed a civil racketeering class action suit, accusing Ally Financial and Citigroup of conspiring with the Mortgage Electronic Registration System – a paperless mortgage processing system – to foreclose falsely on homes to which the lenders do not hold legal title. Although this action hasn’t gotten much press, yet, it has the potential to seriously rattle windows industry-wide, as an estimated 60 percent of all outstanding mortgages - and 97 percent of the loans originated between 2005 and 2008 – were processed through MERS, according to industry estimates. Similar class actions have been filed on behalf of homeowners in Florida and New York, according to recent press reports.
  • Rep. Barney Frank (D-MA), Rep. Alan Grayson (D-FL) and Rep. Corrine Brown (D-FL) have questioned Fannie Mae’s use of “foreclosure mills” – law firms specializing in expediting foreclosure actions “without regard to process, substance, or legal propriety.”
  • Responding to increasing Congressional pressure, U.S. Attorney General Eric Holder told reporters recently that his office is investigating allegations that some lenders and servicers have improperly evicted owners from their homes. Sen. Jeff Merkley (D-OR) has asked the Treasury Department and the Department of Housing and Urban Development to launch their own investigations of the foreclosure problems. Separately, Rep. Gabrielle Giffords (D-AZ) has called for a three-month nationwide foreclosure moratorium to “help make sure homeowners facing foreclosure will be treated fairly.”
  • Mortgage industry executives, including those in the institutions that have temporarily suspended foreclosures, insist that the problems are rare and technical. Industry critics and plaintiffs’ attorneys say the problems are widespread, serious and may, in some cases, constitute fraud. Fitch Ratings is sufficiently concerned about the issue that it is reportedly considering lowering the ratings on the mortgage divisions of the nation’s largest financial institutions.

As demands for foreclosure moratoria spread, and as more courts take foreclosure challenges seriously, industry analysts are warning that the resulting delays will further impede the housing market’s recovery.

“This is going to become a hydra," Peter Henning, a professor at Wayne State University Law School in Detroit told Business Week. "You've got so many potential avenues of liability. You don't even know the parameters of this yet."

Underscoring that concern, Republic National Title announced recently that it will not insure titles on properties foreclosed on by Ally or GMAC, and will not insure properties purchased post-foreclosure from Chase. Similar actions by other title companies could virtually freeze foreclosure sales – which represented nearly 25 percent of total sales in the second quarter, according to Realty Trac.

As more borrowers challenge foreclosure actions – including completed foreclosures – owners who purchased foreclosed properties may find their ownership claims challenged as well, some industry analysts have suggested. Trying to calm those fears, the American Land Title Association (ALTA) issued a statement recently asserting, “It is unlikely a court will take property from an innocent current homeowner and return it to a previous owner who failed to make payments on the loan subject to foreclosure.”

Industry executives agree. The documentation ‘dust-up’, they say, may delay some foreclosures, but it won’t ultimately affect their outcome – which may be true. But the controversy about loan documentation – which looks a lot more like a firestorm than a ‘dust-up’ - is injecting another large dose of uncertainty into the housing market, which is about the last thing this already very uncertain housing market needs.

Census Changes

Analysts who have been speculating that the impact of the current recession may be more severe and more long-lasting than past downturns can find supporting evidence in the 2009 census data. Among other trends, the latest report notes:

  • Fewer people are moving.
  • More are delaying marriage, pushing the proportion of women 18 or older who are married below 50 percent for the first time in more than 100 years.
  • Fewer households have more than one car.
  • More people are working from home.
  • More are pursuing higher education. The income gap between rich and poor remains at an historic high, with individuals earning $100,000 or more claiming almost 50 percent of all income generated in the U.S. compared with a 3.4 percent share for those with incomes below the poverty line. The resulting ratio -- 14.5-to-1 – was up from 13.6 in 2008, and nearly double the 1968 ratio of 7.69, giving the U.S. the highest rich-poor disparity ratio among all Western industrialized nations.

“Income inequality is rising,” Timothy Smeeding, a professor at the University of Wisconsin-Madison, told USA Today. “And if we took into account tax data,” he added, it would be even [greater]. More than other countries, we have a very unequal income distribution, where compensation goes to the top in a winner-takes-all economy.”

Lessons Learned --Or Not

Analysts searching for a silver lining in financial statistics that remain more grim than uplifting have focused on the decline in credit card debt outstanding as evidence that consumers have learned their lessons and are living less on credit and more within their income limits.

These statistics look encouraging. The Federal Reserve reports that household liabilities – a category that includes mortgages, credit card accounts and non-revolving loans – declined by $200 billion between the second quarter of 2009 and the same quarter this year. Credit card accounts alone declined from $915 billion to $83222.2 billion, according to the Fed report.

But some economists think loan balances are declining not because borrowers are voluntarily reducing their debt loads but because banks are charging off unpaid balances and denying credit to borrowers who have defaulted in the past.

“Non-defaulting borrows are reducing their overall credit exposures, but not at an especially rapid pace, given stagnant incomes and wealth,” Cristian deRitis, director of credit analytics at Moody’s Analytics, told the New York Times. The preliminary results of an incomplete analysis of credit card debt suggest that charge-offs are responsible for most of the overall decline in credit card debt, deRitis said.

Analysts at CardHub.com have reached the same conclusion. They found that credit card debt declined by $12 billion between the first and second quarters of this year, but banks charged off nearly $22 billion in credit card debt during the same period. The nearly $10 billion difference reflects new credit card debt incurred, Odysseas Papadimitriou, chief executive and founder of the company, told the New York Times, suggesting, he said, that consumers may not have learned much of a lesson after all.

No Change

The recession may have altered many financial patterns (see related item), but it has left at least one long-standing trend intact: Minorities continue to have a harder time obtaining mortgage loans than whites. Loan denial rates for African Americans and Latinos were “notably higher” than for white applicants in 2009. Minorities were also more likely to obtain “high-cost” mortgages and FHA-insured or VA-guaranteed loans, and more likely to lose their homes to foreclosures.

Those trends, reflected in the 2009 Home Mortgage Disclosure Act (HMDA) statistics compiled by the Federal Financial Institutions Examination Council (FFIEC) have been stubbornly consistent since federal regulators began collecting detailed data on home mortgage origination and refinance activity as part of an effort to identify discriminatory lending patterns.

The Center for Responsible Lending (CRL), a consumer advocacy group, said the “highly disturbing” trends reflected in the statistics constitute “a national tragedy.” While a “superficial” analysis views the subprime crisis as evidence that minorities had too much access to mortgage credit, in fact, the CRL contends, the problem was a mortgage system that pushed minorities improperly into unaffordable loans. “If there had been high access to sustainable mortgages,” the CRL says, “the subprime market would have behaved quite differently.”

The release of the new HMDA statistics coincides with Federal Reserve hearings on proposals to revamp the annual report, as mandated by the financial reform legislation enacted earlier this year. Among other changes, the legislation calls for adding the ages and credit scores of borrowers to the information lenders are required to collect and report. Industry executives have opposed those changes, arguing that the additional information could compromise consumer privacy. “I don’t know that we should know that [much] about our neighbors,” Greg Ohlendorf, president and CEO of First Community Bank and Trust, testified at the Fed hearing. “That’s a hug concern,” he added. “It’s like handing your loan application to your neighbor.”

Community advocates argue that the expanded data will improve efforts to identify abusive lending practices and discriminatory patterns. “There are substantial concerns about the re-emergence of redlining as borrowers in communities of color devastated by the foreclosure crisis experience difficulty accessing mortgage credit,” Geoff Smith, senior vice president of the Woodstock Institute, a Chicago-based advocacy group, said at the Fed hearing.

Separately, a report sponsored by the Mortgage bankers Association warns that the statistical models used to identify lending discrimination and credit risk are flawed and “have likely contributed to recent problems in [the] mortgage markets.”

These models lack “robust theoretical support,” and reliance on them produces “false findings of discrimination” and erroneous assessment of credit risks, Anthony Yezer, a professor at George Washington University, contends in his research paper, “A Review of Statistical Problems in the measurement of Mortgage Market and Credit Risk.”

“Though the problems with these simplistic modes of analysis are well known to the academic world,” Yezer contends, they “continue to be overlooked....If these limitations are not recognized and naive reliance on them continues,” he warns, “current problems are likely to recur in the future. Alternatively, there are major gains to be made if economic analysis of mortgage market discrimination and mortgage credit risk can be improved.”

Second Looks

Responding to complaints that the lax lending policies that contributed to the financial melt-down have given way to overly restrictive policies that are strangling the recovery, some lenders are now taking a “second look” at loan applications they have initially rejected.

A recent Wall Street Journal article described these reviews, applied primarily (although not exclusively) to small business loans, as “a throwback to traditional, roll-up-the-sleeves loan underwriting,” considering a knowledge of the borrower and the borrower’s relationships with the lender instead of relying entirely on statistical underwriting formulas.

“I don’t think of it as being looser. I think of it as making good judgments,” Stephen Steinour, chairman and chief executive of Huntington Bancshares, Inc. told the Journal, in describing his institutions’ review program. Huntington has increased its approval rate for small business loans by 4.7 percent since implementing the program earlier this year.

While critics suggest that second look programs are designed more to burnish the banking industry’s severely tarnished image than to boost lending totals, some analysts see evidence of more tangible impacts. They note, among other indicators, the Federal Reserve’s most recent senior loan officers’ survey, which reported an easing in loan standards for small businesses for the first time since 2006.