What Foreclosuregate Means for Investors

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This article is part of our Rising Star Portfolios series. You can read about the Dada Portfolio here.

With tales of mortgage securitization "improprieties" and foreclosure fraud on the rise, investors may be wondering which companies will be affected. Here are three areas the Dada Portfolio is watching.

1. Originators
To the extent that originators didn't convey mortgage notes to trusts, those trusts may lack legal standing to foreclose. In short, the mortgage-backed securities investors thought they were buying may not have actually been mortgage-backed. Investors may not be happy if it turns out that they were lied to, that their collateral doesn't have clear title, or that their trusts didn't actually qualify for tax-exempt status because of misrepresentations made by originators and/or trustees.

The problem appears to have been widespread: Banking executives told a Florida court that it was standard industry practice to destroy the documents necessary for foreclosure. A Countrywide employee recently testified that it was customary for Countrywide to retain the note rather than pass it on to the trusts (Bank of America has disputed its employee's testimony.) The robosigning scandal may have been driven by a need to cover up the missing notes.

All of this would be a violation of many pooling and servicing agreements that govern those trusts. PIMCO, Blackrock, Legg Mason's (NYSE: LM  ) Western Asset Management, and taxpayers (via the New York Fed and Freddie Mac) have been making signs that they will try to force Countrywide to repurchase mortgages. Bank of America (NYSE: BAC  ) , JPMorgan (NYSE: JPM  ) , Wells Fargo (NYSE: WFC  ) , and Citigroup (NYSE: C  ) may be in hot water to the extent that mortgage originators didn't convey notes to trusts. Industrywide exposure estimates range from the tens to hundreds of billions. Trustees such as Bank of New York Mellon (NYSE: BK  ) and Deutsche Bank may also have exposure.

2. Foreclosure mills
Lender Processing Services
, a major player in foreclosure "processing," faces several challenges, including a suit charging illegal fee sharing. A former subsidiary, DOCX, was apparently caught providing a document fabrication service. (It even had a pricing sheet!) While DOCX has since been shut down, a Reuters investigation recently suggested that problems were not limited to subsidiaries.

3. Monoline insurers
During the housing boom, Wall Street sold terrible-quality mortgages as great investments. When those investments blew up, both investors and insurers MBIA (NYSE: MBI  ) and Ambac took a big hit. MBIA fell more than 80%, while Ambac filed for bankruptcy last month. Yesterday, MBIA sued Morgan Stanley, arguing that it failed to disclose that the mortgages it underwrote weren't up to snuff. Unlike most homeowners facing foreclosure, MBIA has lawyers. If this type of suit proves successful, it could be a windfall for insurers.

The Dada Portfolio is a part of the Rising Stars series of real money portfolios. It is co-managed by Sean Sun and Ilan Moscovitz. Join us on our discussion board or follow us on Twitter @TMFDada.

Ilan Moscovitz has no interest in any of the companies mentioned. The Fool owns shares of Bank of America, JPMorgan, and Legg Mason. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

Read/Post Comments (6) | Recommend This Article (8)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 10, 2010, at 11:29 AM, Barbaralawgrace wrote:

    Request for Congressional Foreclosure Panel to Examine Foreclosure Lawyers

    "Although increasing numbers of courts are continuing to reject improper and fraudulent foreclosures, the Congressional Foreclosure Panel examination of mortgage services and foreclosure practices did not include foreclosure lawyers.

    Lawyers are officers of the court; knowledge of applicable laws and civil procedure is not required from mortgage lenders, nor loan servicers. In states that require judicial foreclosures, lawyers are the ones who file lawsuits to seize and sell property; and lawyers are responsible for filing and recording foreclosure property deeds.

    An investigation could prove helpful to sorting out whether improper and illegal foreclosure proceedings are linked to any self-dealing conduct disadvantaging lenders, investors, homeowners, and city governments.

    Inadequate or questionable foreclosure can lead to useless property deeds that impede real estate sales. Increasing numbers of title insurance companies are refusing to cover foreclosed properties; and certain mortgage default claims, are being denied because of defective foreclosure proceedings.


  • Report this Comment On December 10, 2010, at 11:36 AM, TMFDiogenes wrote:

    oh, cool. signed.


  • Report this Comment On December 10, 2010, at 12:38 PM, pete163 wrote:

    What bull s__t is this! Everyone knows that the banks are not going to be made to buy the mortgages back. What are they going to do with then, sell them and to WHO I ask. Stop plucking at your dingle Barry's. Do you want another melt down of the banks! Let Fannie and Ferdie do the dumping of the houses and move on with building the banks back up.

  • Report this Comment On December 10, 2010, at 1:33 PM, TMFDiogenes wrote:

    i don't think it's spelled dingle Barry's.

    it's both a policy and legal issue. i think it's preferable for banks to take the losses via putbacks and modifications rather than taxpayers and the economy via foreclosures. it may be a moot issue, though, since it's a matter of state law, and all 50 ag's are investigating, so even if someone prefers socializing the losses when tbtf banks break the law, they might have to be held accountable for their mistakes anyways.

  • Report this Comment On December 11, 2010, at 10:13 PM, rtichy wrote:

    You left out 1 aspect that still has potential--

    straight out fraud by the mortgage brokers; like a cocaine dealer cutting the product with something worthless like talcum, we haven't yet heard of someone passing completely fake mortgages up to the trusts for inclusion in the MBSes. There's really no reason not to expect this to come out at this point, since the whole industry has shown itself to have no credibility or trustworthiness.

  • Report this Comment On December 12, 2010, at 4:55 PM, TMFDiogenes wrote:


    Yeah, I wouldn't be surprised if failure to convey they notes is in part a coverup for other fraudulent activity.

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