You’ve probably seen the headlines about major banks suspending foreclosure proceedings to reclaim houses from borrowers who have defaulted on their mortgages. This has the potential to be hugely disruptive—a milestone development comparable to the failure of Lehman Brothers in 2008, after which all hell broke loose.
Let me emphasize the word “potential.” The core of the problem is that there are serious problems in proving who actually has clear, lawful title to specific houses.
This situation arose because of the last two decades’ common practice of “securitization”—the bundling of large numbers of mortgages into a new interest-paying, tradable security. These securities are then sold and resold, often several times. This has lead to widespread confusion. I read of one case in which no fewer than four different firms claimed to own a particular title, and thus the right to foreclose, on the same property.
Because many judges have blocked foreclosure proceedings on the grounds of unclear title, Bank of America, GMAC, and other financial giants have declared a moratorium on foreclosures until the legal picture becomes less muddied.
Some commentators insist that the problem is nothing more than a few technical glitches that can be easily corrected. Others assert that there has been massive fraud, perjury (attesting to facts without having ascertained those alleged facts), and forgery (creating documents after the fact to produce a fictitious paper trail). Apparently, the states Attorneys General feel there might be fire among all the smoke, because all 50 of them have initiated investigations, and many of them appear as though they are about to go on the prosecutorial warpath.
If, in fact, the problem is not easily rectified and the various allegations of malfeasance are sustained, here is what is at stake:
We are looking at a breakdown of the housing market. Would-be buyers can’t obtain title insurance or loans to buy property without clear title. The country’s entire real-estate market could freeze up, further torpedoing home prices and throwing a monkey wrench into the plans of millions of people who want or need to relocate.
The financial industry could break down. Currently, 4.5 percent of existing mortgages are in some stage of foreclosure. If banks can neither collect mortgage payments nor replace that lost income by selling the related properties, losses could be massive, perhaps catastrophic. Then the bailout issue would be back on the front burner.
If courts rule that “robo-signing”—lenders mechanically signing off on thousands of foreclosures without taking the time to review the facts of each individual case as required by law—constitutes fraud, then the resulting tsunami of fines and lawsuits could cripple or wipe out many lenders. Here again, a breakdown of the financial sector.
If either the housing market freezes up and/or the financial industry cracks up, then the process of economic recovery itself will break down.
If lenders can no longer foreclose on properties, how many millions of other mortgage-holders will decide to stop making their monthly payments? Anecdotal evidence indicates that there are already hundreds of thousands of “strategic defaulters.” These are people who can afford their monthly payments, but have chosen to stop making payments, figuring that, at the very least, they can get away with living rent-free for a year or two before getting evicted. These numbers are bound to soar. The whole “strategic default” epidemic represents a breakdown of respect for law and also for the moral code (of honoring contracts) that constitutes the very heart of a viable economy.
The issue of clear legal titles to property is indispensable to a thriving capitalist economy, as the Peruvian economist Hernando de Soto explained in his best-seller The Mystery of Capital. We either restore the clarity and inviolability of titles to property, or our capitalist system breaks down.
At the center of the foreclosure controversy is an entity named Mortgage Electronic Registration Systems. MERS was hatched by Fannie Mae, Freddie Mac, and other giant players in the mortgage business to speed up the mortgage-backed securitization process and bypass various local property laws. If, in fact, MERS trampled on state and local laws, this represents a breakdown of constitutional federalism and a direct assault on the rule of law.
If all of the breakdowns listed above continue unabated, then we are peering over the precipice at a potential breakdown of social, civil, and political order, too. That’s the nightmare scenario. Let’s get back on track before it’s too late.