The foreclosure crisis was burbling along as house prices dropped, but now increasing evidence of fraud in the paper chain between borrowers and the people who bought their loans is suddenly grinding the process to a halt. A massive lawsuit by Ohio Attorney General Richard Cordray against a major mortgage service dropped earlier this week, Bank of America is halting foreclosures around the country, and President Obama even declined to sign a bill streaming-lining interstate mortgage transfers because the bill might make it easier for banks to evict homeowners.
To understand the technical problems that led us to this point, I highly recommend Mike Konzcal's post on the issue and this 2007 post from the late Tanta for more background. It's clear that massive legal uncertainty has been introduced into the housing markets, and the outcome could be that homeowners in default actually see some lenience; if these allegations are true, the people who have been evicting homeowners may well have had no legal right to do so.
That could also end up costing the banks more money, since it will mean that their mortgage-dependent assets drop in value; however, that could also be an incentive for banks and the government to adopt policies, like judicial modification of mortgage loans in bankruptcy, allowing defaulting homeowners to lease their homes at market rates or allowing principle write-downs, that progressives have long encouraged. There's been some (premature) talk of TARP 2 to help shore up the banks, but it's not clear to me that such an extreme policy will be needed or is even feasible. These developments could be the first test of the new Financial Stability Oversight Council and the broader Dodd-Frank bill -- look for more on those topics here next week.
That said, there's little that the federal government can do proactively about this specific problem, but it's worth pointing out that the newly created Consumer Financial Protection Bureau has brought independent mortgage originators, originally unregulated, under federal supervision, and has the authority to enact further reforms of the home-loan servicing sector if Congress doesn't take action on its own.
What about the politics? Majority Leader Harry Reid is already jumping on board, demanding a foreclosure moratorium across the country. This issue could be the October surprise Democrats hoped for, since it gives them a chance to demonstrate where they stand in the long-running Main Street versus Wall Street debate: on the side of people who have been doing their best to pay their bills and stay in their homes, and against unscrupulous mortgage factories who couldn't even be bothered to do their legal homework as they rushed for profits. From President Obama on down, Democrats should make this their topic of conversation for the next few weeks.
-- Tim Fernholz
