Specialist mortgage-banking firms, like Countrywide (now part of Bank of America), along with more than 8,000 lenders affiliated with banks, thrifts or credit unions have been the dominant force in home mortgages.
While companies are free to lend through branch offices, websites or call centers, their main way of reaching customers has been via independent mortgage-brokerage firms, generally tiny local outfits. Mortgage brokers find customers, advise them on which types of loans are available and collect fees for handling the initial processing. There were more than 50,000 mortgage-brokerage firms and they are involved in 60% of all home loans, says Tom LaMalfa, managing director of Wholesale Access, a mortgage research firm in Columbia, MD. Behind these home loans, Wall Street banks extended billions of dollars of short-term credit, called warehouse lines, that allowed lenders to fund mortgage loans.
But by outsourcing much of its direct contact with consumers, lenders also lost control over the screening of borrowers and the presenting of loan choices. Some lenders and industry consultants say subprime lenders' dependence on brokers partly explains the industrywide surge in mortgage fraud. Fraud appears to be one reason for the rash of defaults. For example, subprime loans made in 2006 totaled about $605 billion, or about 20% of the total mortgage market, up from $120 billion, or 5% in 2001, according to Inside Mortgage Finance, an industry newsletter. Wall Street was deeply entrenched in the entire mortgage market, buying these subprime home mortgages, consolidating them with loans to more creditworthy borrowers and then offering these 'safe' investment packages to the marketplace.
Fast-forward to today's defective title crisis...
These procedural mistakes in the handling of mortgage documents have clouded titles establishing ownership of the homes, a problem that could plague both buyers and sellers for years. "This is going to become a hydra," says Peter J. Henning, a professor at Wayne State University Law School in Detroit. "You've got so many potential avenues of liability. You don't even know the parameters of this yet."
Homeowners in class actions and individual lawsuits across the U.S. claim lenders and servicers have used falsified documents to foreclose on homes, sometimes when the banks didn't hold titles to the properties. Attorneys general in at least seven states are investigating foreclosure practices, and the number of these probes may grow. "You're going to see a tremendous amount of activity with all the AGs in the U.S.," says Ohio Attorney General Richard Cordray, who has sued Ally over foreclosures. "We have a high degree of skepticism that the corners that were cut are truly legal."
People who bought homes in foreclosure face their own worries, as paperwork errors raise questions about the validity of the titles needed to prove ownership. "Defective documentation has created millions of blighted titles that will plague the nation for the next decade," says Richard Kessler, an attorney in Sarasota, Fla., who conducted a study that found errors in about three-fourths of court filings related to home repossessions.
A defective title means the person who paid for and moved into a house may not be the legal owner. "This is the most important issue of the whole mortgage mess," says Glenn Russell, a Fall River (Mass.) real estate attorney who won a case last year that reversed a foreclosure because of faulty paperwork. "Families are being thrown out of their homes by people who may not have the right to do that."
Ownership questions may not arise until a home is under contract and the potential purchaser applies for title insurance or even decades later as one deed researcher catches errors overlooked by another.
Sources: Bloomberg BusinessWeek, October 11, 2010 and The Wall Street Journal, March 12, 2007