How much of a problem is foreclosure fraud? It’s enough of a problem that several of the largest banks in the country have suspended foreclosures, enough of a problem that a large title insurance company is refusing to insure foreclosure sales by some of these banks. It’s serious enough that there is a realistic chance that some bank officers and executives could serve jail terms. It is bad enough that one real estate blogger says it would be a mistake for anyone to buy any house this year or next, until this is all sorted out. When someone on the inside is essentially calling for a moratorium on real estate transactions, it’s a good guess that the whole system has broken down.
I have to pause to explain the significance of title insurance in the foreclosure process — to connect the dots. A bank doesn’t foreclose on a house just so that it can take possession of the house. There is no gain to the bank unless it can then sell the house. For a bank to sell a house, there has to be a buyer, and most buyers will need financing — they’ll need a mortgage of their own. A mortgage can’t be issued without title insurance, however. The title insurance protects the bank that issues the new mortgage from prior mistakes in acquiring the real estate — mistakes such as the ones that occur in foreclosure fraud. Without title insurance, there is no new mortgage, and the property can’t be sold. If the property can’t be sold, there is nothing for the bank to gain by foreclosing.
So if the title insurance may not be available, a bank is almost forced to suspend its foreclosures, as several banks have announced in the last week. In a practical sense, the bank won’t be able to sell the foreclosed house. In theory, it could sell the house, but only to a cash customer — and the people who are financially strong enough to pay cash for a house tend also to be savvy enough to say, “I know this is a hurt property you’re selling, one that ordinary people aren’t able to bid on. I want it for a 30 percent discount.”
A bank that chose to continue its foreclosure express when the title insurance isn’t there can plan on taking huge losses on the process in addition to the risk of extraordinary legal expenses. It risks losing liquidity because of foreclosures, when the whole purpose of foreclosing, from the bank’s point of view is to gain liquidity. If done on a large enough scale, this course of action could put a bank of any size into insolvency.
The banks that sound cheerful and nonchalant in announcing a moratorium on foreclosures are not so sanguine after they go back inside and close the doors. Quite likely, they’re screaming for a fresh look at the accounting numbers that tell them whether they’re going to come out of this solvent or insolvent.
Some observers point out that the title insurance companies aren’t taking such a huge risk in insuring fraudulent foreclosures, because they can ultimately collect any losses from the foreclosing bank. This is mostly true. However, this works only for foreclosure errors that are discovered well before the bank in question fails. No company with the word “insurance” in its name wants to stake its future existence on the continued operation of any one bank, no matter how likely that seems now. Furthermore, a title insurance company faces potential administrative and legal costs of $30,000 or more in recovering from an erroneous foreclosure. That’s a huge sum of money when you look at how much money a title insurance company makes. It’s not a big deal if the rate of foreclosure errors is about 1 in 10,000. But if it is closer to 1 in 1,000, then a title insurance company could lose so much money it could require a financial rescue of its own.
So how high is the rate of foreclosure errors? I have previously guessed that it could be around 1 percent, or 1 in 100. That’s based on my knowledge of the accuracy of bank transaction processing. I don’t have any direct experience with foreclosures, but I have seen banks make mistakes in transactions of comparable complexity. For example, when banks issue loans, they occasionally fail to identify the borrower correctly. When banks waive service fees, they occasionally assign the waiver to the wrong account. When customers close accounts, the banks may mistakenly reopen the accounts the next day. And so on. Extrapolating what I’ve seen, I believe the rate of foreclosure errors would have to be significant.
There is anecdotal evidence to support this. David Dayen at Firedoglake shows a video from Rep. Alan Grayson that’s meant to emphasize how gross the errors can be.
He talks about a man who was foreclosed on when he didn’t have a mortgage and paid cash for the home; a home that had two foreclosure suits against it because both servicers claimed ownership of the title; a couple foreclosed on over a contested $75 late fee; and a story that sounded a lot like the ones from my HAMP series, only in the end the servicer used forged documents to claim ownership of the title.
Based on Grayson’s analysis, as many of 60 percent of foreclosures likely contain some degree of error — and Grayson has looked at this issue more closely than almost anyone else in Washington. Many of these foreclosures, obviously, would stand up with further revision. But anyone who imagines that the rate of erroneous foreclosures is insignificant, a small fraction of a percent, is whistling in the dark.
People dismiss the thought of foreclosure error in part because they imagine that the mortgage business is a nicely automated system, the kind that the banking system is known for, but the reality is otherwise. Mortgage financing is a system built on fax machines, spreadsheets, scribbled Post-It notes, e-mail, and phone calls. It’s easy for mistakes to occur, and when people are in a hurry, mistakes are guaranteed.
I don’t believe the ultimate rate of foreclosure error could be as high as 3 percent — but if it is, that would be enough to wipe out even the largest commercial banks and force the shutdown of Fannie Mae, not in the far distant future, but perhaps next year. So when you see a major bank trying to put a good face on the announcement that it has to take a second look at its foreclosure process — that’s a bank that knows its future is in doubt.