This Motley Fool series examines things that just aren't right in the world of finance and investing. Here's what's got us riled up this week. If something's bugging you, too, go ahead and unload in the comments section below.

Today's subject
Foreclosure fraud is heating up. While bankruptcy judges have chastised Wall Street's lacksidaisical approach to recordkeeping and fabrication of court documents at least as far back as 1999, the foreclosure wave sweeping America has provided a new venue for lawbreaking.

Wall Street has characterized the fraud epidemic as a mere paperwork issue. Various journalists have echoed and expounded the party line, laying the blame thick on "deadbeat " homeowners.

Here's The Wall Street Journal editorial team:

Talk about a financial scandal. A consumer borrows money to buy a house, doesn't make the mortgage payments, and then loses the house in foreclosure -- only to learn that the wrong guy at the bank signed the foreclosure paperwork. Can you imagine ...? Welcome to Washington's financial crisis of the week ...

We're not aware of a single case so far of a substantive error. Out of tens of thousands of potentially affected borrowers, we're still waiting for the first victim claiming that he was current on his mortgage when the bank seized the home.

Umm ...

  • Bank of America (NYSE: BAC) foreclosed on a Fort Lauderdale home that didn't even have a mortgage .
  • A terrified Orlando woman for whom foreclosure proceedings had not begun dialed 911 when JPMorgan (NYSE: JPM) contractors attempted to break into her home.
  • On Wednesday The New York times reported that Deutsche Bank tried to foreclose on a Michigan house that was paid for in cash, a Kentucky couple was foreclosed on by a trust that did not exist, and a Colorado woman is facing foreclosure after her bank told her to skip a payment as compensation after it mistakenly changed her locks.
  • My favorite: Wells Fargo (NYSE: WFC) hired a law firm to foreclose on a condo owned by ... Wells Fargo. The bank then hired a separate legal team to defend itself. As business reporter Al Lewis is quoted, "You can't expect a bank that is dumb enough to sue itself to know why it is suing itself."
  • And the list goes on. Wells Fargo alone has found documentation "lapses" in 55,000 current cases, and there's no reason to think they are special among mortgage servicers.

Why you should be indignant
As Cleveland Federal District Court Judge Christopher Boyko wrote in 2007:

Plaintiff's "Judge, you just don't understand how things work" argument reveals a condescending mind-set and quasi-monopolistic system where financial institutions have traditionally controlled, and still control, the foreclosure process.

It's galling when Wall Street institutions that were bailed out by the public in 2008 still feel they can rip off consumers and investors because they're above the law.

So here's the fraud: In order to foreclose on a house, you need to have the note, the IOU that identifies which homeowner owes money to whom.

But during the housing securitization bonanza, as mortgages were issued, sliced and diced, and traded left-and-right, sketchy mortgage originators appear to have cut corners by failing to supply notes to mortgage-backed security trusts. According to the CEO of a major subprime lender, "We never transferred the paper. No one in the industry transferred the paper."

Many of these contracts were also destroyed -- banking executives told a Florida court in 2009 that it was standard practice to shred them.

Now that Wall Street is without the notes, it may be unclear in many cases who owes money to whom. As law professor Catherine Porter testified yesterday before the Congressional Oversight Panel:

If the trust does not have the loan, homeowners may have been making payments to the wrong party. If the trust does not have the note or mortgage, it may not have standing to foreclose.

Now, Wall Street could agree to negotiate with more homeowners to restructure their loans in an affordable manner, as is common in the corporate world. Or we could create a process that would allow mortgage debt relief to be included in personal bankruptcy proceedings, as Blackrock's (NYSE: BLK) Vice Chairman recently argued we should. Such moves would help to clean up consumer debt and move the housing and economic recoveries forward.

They might even be welcomed by investors like PIMCO, Blackrock, Legg Mason's (NYSE: LM) Western Asset Management, Annaly Capital (NYSE: NLY)-managed Chimera (NYSE: CIM ), taxpayers (via the New York Fed and Freddie Mac), the investors who actually own the mortgages, since foreclosure can be a costly process for them too. (That group, minus Chimera, recently notified Countrywide they were displeased with how it was servicing their investments in mortgage-backed securities.)

But Wall Street, which collects late payment fees and additional fees during foreclosure, has instead resorted to hiring companies to "recover" the documents and paying notaries to "robo-sign" themselves hundreds of times daily. They're even charging investors for the robo-signing tab.

What now?
Honestly, no one knows the full scale of the fraud. But it could be big -- all 50 state attorneys general are investigating. I'll be writing more on the potential fallout this crisis could have on Wall Street and the $2.8 trillion residential mortgage-backed securities market.

This doesn't appear to be a mere "paperwork issue" – we seem to be dealing with bullying and lawbreaking.

The Journal editorial team, whose "About Us" page congratulates itself on "stand[ing] for free trade and sound money; against confiscatory taxation and the ukases of kings and other collectivists; and for individual autonomy against dictators [and] bullies," seems to feel that government is inherently evil, whereas corporate violations of individual rights isn't a major concern.

But sometimes we need laws, regulators, and courts to enforce contracts and protect individuals from corporate bullying. Illegally seizing property or seizing the wrong property, failing to live up to contractual obligations to investors, and lying in court is, yes, illegal -- even when Wall Street does it.

As the facts come out, they are painting a picture of institutional stupidity and greed by Wall Street. Again. This is something that should come as no surprise to Fools. When Wall Street breaks the law and journalists won't let the facts interrupt their prejudged narratives about "deadbeats," it's not surprising -- but it's certainly shameful.

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