Wrongful Foreclosure Scandal, Shoddy Loan Practices Could Create Legal Mess for Big Banks

Banks are facing a potential legal storm over the way they handled loan origination and mortgage servicing. According to various media reports, the recent revelations regarding wrongful foreclosures could precipitate a wave of lawsuits by embattled homeowners, as well as investors in mortgage-backed securities who have been burned by the shoddy way banks originated and serviced home loans.

Earlier this month, GMAC Mortgage, JP Morgan Chase, Bank of America and PNC Bank suspended various aspects of the foreclosure process after discovering irregularities in the preparation of court documents. Just this past week, Wells Fargo admitted to finding mistakes in thousands of foreclosure documents, but did not move to suspend home seizures.

The banks’ actions came after it was learned that some mortgage servicers employed people who could sign foreclosure affidavits so quickly they popularized a new term for them: “robo-signer.” In depositions taken by lawyers for embattled homeowners, some robo-signers said they or their team had signed 10,000 or more foreclosure affidavits a month. Those affidavits say the preparer personally reviewed the files, but in their depositions, the workers acknowledge they had no time to actually do that. In some cases, the affidavits weren’t properly notarized.

While some banks have chosen to restart foreclosures, asserting that their reviews found no major errors, the mess is far from cleaned up. Earlier this week, Bank of America admitted that identified errors in 10 to 25 of the first several hundred foreclosure cases it has reviewed. The bank is working on resubmitting documents in 102,000 cases. The errors found so far were discovered in 1 percent of the first foreclosure files that Bank of America intends to resubmit to the courts in 23 states where foreclosures require a court order.

The banks’ disclosures have prompted multiple investigations, including one by attorneys general in all 50 states. Those investigations could uncover criminal misconduct or large-scale errors that force foreclosures to be put on hold for an extended period of time. That will encourage thousands of people whose homes have been seized or are facing foreclosure to mount legal action against the banks.

But such lawsuits aren’t the only banks’ only legal worry. Large investors in mortgage backed securities could also join the fray, filing lawsuits to try to force banks to buy back securities that they say were the result of the lenders’ shoddy loan origination practices. According to a report in The Christian Science Monitor, Bank of America is already under pressure from institutional investors such as BlackRock and Pacific Investment Management Co., known as Pimco, to buy back troubled loans because of improper servicing. The case could end up in court, and Bank of America could owe billions of dollars if the investors win.

According to a Reuters report, momentum is building among investors to pursue those types of actions. On Wednesday, for example, securities lawyers met with more than 50 large mortgage bond investors to try to persuade them to fight banks.

There are concerns in some quarters that banks will try to pass along the costs of cleaning up the wrongful foreclosure mess to bondholders. To prevent that, investors could sue banks and mortgage-servicing firms for problems such as robo-signing or questionable affidavits used in foreclosure proceedings.