October 14th, 2010

One thing to watch in this foreclosure scandal...

...is how the share prices of the major lenders (like Bank of America [BAC] and J.P. Morgan Chase [JPM]) behave. (You can't look at Ally Financial because it's privately held by a consortium with a majority of its shares held by the Treasury; i.e., it's a government-controlled bank.)

Right now they're holding up reasonably well--neither has fallen off a cliff--which means that either that market participants believe the foreclosure documentation scandal is just a temporary glitch (as the banks claim), or that the fix is in, and the banks won't be held to account this time either (as a lot of observers think).

In the meantime, if you have bought a foreclosed property, or if you are in foreclosure or likely to be, I strongly recommend you find yourself a sharp real estate lawyer.

Oh, and while we're on the whole lost paper trail problem...

...the mortgage-backed securities--whose market collapse started this whole crisis--are facing another bit of a problem.

From The enormous mortgage-bond scandal:
You thought the foreclosure mess was bad? You’re right about that. But it gets so much worse once you start adding in a whole bunch of parallel messes in the world of mortgage bonds. For instance, as Tracy Alloway says, mortgage-bond documentation generally says that if more than a minuscule proportion of notes in a mortgage pool weren’t properly transferred, then the trustee for the bondholders can force the investment bank who put the deal together to repurchase the mortgages. And it’s looking very much as though none of the notes were properly transferred.
This Citibank note (pdf), via FT Alphaville goes into a bit more detail:
Most mortgage trusts were set up as REMICs (Real Estate Mortgage Investment Conduits) which are special purpose vehicles used to pool mortgages. Under the IRS code, REMIC confers a special tax status in which the cash flows to the trust are not taxed. Investors in the trust pay taxes. The tax exempt nature is important. If the trusts were in fact to be taxed, the taxes would distort the yields required by investors.

To qualify as a REMIC under the IRS code and enjoy the beneficial tax treatment, the trust (1) must be passive and (2) cannot acquire any new assets 90 days following the trust’s creation.

If … mortgage documents were never correctly passed through to the trust when it was established, then the trust may not actually own the underlying mortgages it purports to own. Although it is possible that this issue could be remedied by some legal maneuvering, doing so could violate the REMIC status since the trust would be acquiring assets long after the aforementioned 90 day period has expired. Such a violation in turn could trigger a sizeable tax burden for investors. Our speaker indicated that there are a handful of open questions on this front and that this is a legal gray area.
This may be a bigger problem for the banks than some pesky homeowners as bondholders tend to have lots of highly paid lawyers to press their cases.