Where the foreclosure process mess may be headed - #1 of no doubt many

AOK - This is rapidly revealing itself to be another major "intricacies of the financial system interconnectedness" issue - the end impacts are less dramatic than no doubt many would wish (no Virginia your mortgage debt did not just go away) but the rippling impacts on investment funds owning now-unsecured MBA paper originated by now-bankrupt entities will drag on and out and create a huge bloody mess for expensive lawyers to sort out. And there really doesn't at this time seem to be any quick fix, not even from the government, at least not for non-conforming (e.g. non-GSE) pools. I'll try to restrain my enthusiasm and only blog up notable plot turns in this opera-quality saga ... 

Where is the foreclosure mess leading?

By Felix Salmon on Oct 7, 2010 10:41 EDT

Yves Smith and 4closureFraud have doing an astonishingly good job of keeping on top of all of the legal matters surrounding mortgage foreclosure. There are lots of them — do you know what phony allonges are? — and they are all very complicated, and they vary from state to state and from bank to bank, with the result that it’s really hard to sum it all up in a simple overview. But it’s impossible to read those sites and not conclude that we’re at the early stages of an absolutely monster legal mess.
Any one of Smith’s posts is astonishing enough — try here for a good starter, although you could do worse than to start here or here if you’re in Florida — but put them all together, and it becomes clear that the mother of all legal messes has already emerged from the foreclosure crisis, and threatens not only a large chunk of the financial system but also venerable civic institutions, like the courts, which have thus far emerged from the crisis largely unscathed.
While there’s some evidence that Congress is willing to find a bank-friendly way out of this mess, I don’t think that’s going to fly, not when state AGs are already filing lawsuits against the likes of GMAC.
Argentina’s sovereign default has been called “the slowest train wreck in history”, but this one might turn out to be slower, bigger, and much less fair. Millions of people have already lost their houses to lenders who didn’t have the proper paperwork, and it’s unlikely they will ever get any redress. For people who haven’t yet been foreclosed upon, however, it could now be a very long time before they lose their house.
The big-picture consequences here are by their nature unpredictable, as no one has a clue how this might all play out. But I can think of a few themes:

1. Bond investors, who have seen the value of their mortgage-backed debt rise impressively over the past 18 months, could find themselves unable to find any kind of bid at all. The paper will still be cash flowing, but those cash flows will be surrounded by enormous uncertainty, and no one’s going to want to buy them except at extremely deep discounts until the mess is cleared up.
2. Mortgage servicers will go from being assets to being liabilities, and banks which own mortgage servicers could find themselves on the hook for substantial losses.
3. The time from default to foreclosure will become indefinite, and as a result there will be a significant uptick in strategic defaults, especially in states with judicial foreclosures.
4. The “shadow inventory” of houses which aren’t on the market but will eventually be sold once the bank gets around to foreclosing will grow substantially from its already-enormous level.

All of this is going to be very costly and very unpleasant for all concerned; the only winners I see here are the lawyers. Add in possible securities-fraud charges against investment banks which underwrote a lot of these bonds, and the end result is a level of legal chaos I can barely imagine, in both the civil and criminal courts. And I see no easy way out at all."