With Fannie Mae and Freddie Mac now requiring that all mortgage servicers review how they handle foreclosures, more questions are being raised about the impact that potentially invalid affidavits will have on the foreclosure process, on servicers and the industry overall.

Three of the largest servicers — Ally Financial's GMAC Mortgage, JPMorgan Chase and Bank of America Corp. — have delayed some foreclosures in 23 states in the past two weeks because of documentation problems. Those companies say no wrongful foreclosures have been identified — yet. It is widely believed other servicers will take similar steps.

American Banker asked analysts, industry representatives, academics and other sources about the wider impact of the controversy.

Why have GMAC, JPMorgan Chase and Bank of America delayed foreclosures?

The servicers halted foreclosures after some of their employees said in depositions that they had signed off on thousands of foreclosure documents a month without verifying or reviewing the information, or did so based on reviews by third parties. Servicing executives say the practice of using "robo-signers" has been widespread for years and is common practice for many legal documents from notices of default to lost-note affidavits that foreclosure attorneys submit in court when they cannot prove they have the underlying promissory note showing ownership of the property.

How will this affect other servicers?

Flawed documents are expected to delay foreclosures and result in longer timelines for the disposing of seized property, said Linda Stesney, a Moody's analyst, who has spoken with many servicers. Because real estate is so local, it will depend on how courts react and what servicers are doing to mitigate these issues.

Servicing and legal costs will skyrocket. More foreclosures will be delayed, adding to investor losses. Further scrutiny by Fannie and Freddie, attorneys general, and federal agencies will add to the uncertainty. Combined with class actions, large bank servicers face the possibility of a significant reduction of earnings.

"If servicers took a short-hand approach that falls below the level of legally appropriate conduct, then they have a grade-A problem," said Joseph Lynyak, a partner at the law firm Venable.
The legal repercussions likely will be determined on a state-by-state basis with some foreclosure proceedings restarted. Attorneys general also may allege a pattern of misrepresentations. "It's not totally clear what the remedies are, and then it becomes a complicated enforcement issue," Lynyak said.

Even if there aren't any inaccuracies in the court documents, homeowners could claim that because servicers did not follow proper legal procedure, the case against them is invalid.
"By putting these affidavits into the record, they are attesting to the fact and they haven't seen any documents," said John Rao, an attorney at the National Consumer Law Center. "That's fraud on the court."

Such arguments have been made in foreclosure cases before, but legal experts believe they will become more rampant now that so much attention has been given to this issue.

William Black, an associate economics and law professor at the University of Missouri-Kansas City School of Law, said filing a false affidavit is a felony and courts will determine whether fraud was used to illegally foreclose and take away people's homes.

What is the worst-case scenario?

Servicer ratings are now under review for possible downgrade by Moody's Investor Services and Fitch Ratings. A downgrade could prompt Fannie and Freddie to pull servicing rights and transfer them to special servicers. Pulling servicing rights is rare and could cause significant capacity constraints.

Meanwhile, investors are banding together and exploring whether to trigger servicer defaults based on breaches of the contractual and fiduciary obligation by servicers to manage the foreclosure process and protect the interests of mortgage-backed securities investors. Doing so would shift liability to MBS trustees, said Bill Frey, the chief executive of the hedge fund Greenwich Financial Services, that represents investors holding $600 billion in nonagency securities.

"The servicers are contractually obligated to enforce these contracts," said Frey.
He said it could take up to 10 years to sort through the mismanaged paperwork from the securitization process and track down any missing documents. "Investors have a non-earning and depreciating asset, and they want to get it resolved in some manner and the servicers in charge of resolving it, don't want to get it resolved, so there is an unsolvable conflict of interest. If the servicer is not adhering to the contract, the investors can hold the trustee liable."

Servicers also are concerned about the potential for federal lawsuits. On Tuesday, House Speaker Nancy Pelosi and other California Democrats sent a letter to the Department of Justice, the Federal Reserve and the Comptroller of the Currency urging a federal investigation into the matter. Sens. Robert Menendez and Al Franken have called on the Government Accountability Office to investigate.

How could this have possibly been going on?

After news reports revealed GMAC's problem on Sept. 20, a spokeswoman described it as a "procedural defect." Other servicers have said the issue is merely "technical" because the accuracy of the loan information did not change based on the affidavits.

The consolidation and transfer of servicing rights in the past few years has meant "documentation is not readily available," Lynyak said. Moreover, pooling and servicing agreements negotiated long before the housing crisis typically pay servicers an average of 40 basis points per loan — too little to cover the costs of foreclosure, he said.

Black blames what had been up to now lax oversight in states such as Florida. "What prompted this, in part, is the obscenity that is Florida, and the attempt to pervert the judiciary," Black said. "No prosecutors were stepping in and going after senior officers at the major lenders or the foreclosure mills."

"This is only the 'echo' epidemic of the far-deeper underlying fraud of millions of liar's loans," Black said.

Prosecutors could charge servicers with perpetrating a "fraud on the court," and hold them in contempt, which is punishable by fines, he said.

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