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Mortgage security zombies are still crawling through the US financial system

Zombie mortgage scandals resulting from bad loans and bad lending practices in the US just keep rising from the dead. The mortgage backed securities (MBS) that fueled the US housing bubble are still trying to shake out all the bad loans they were constructed from—which has led to scandals over how banks built MBS and how they mismanaged foreclosures. In the latest scandal, the businesses that service home loans (collecting payments, sending out late notices and initiating foreclosures) appear to have falsified information for investors in mortgage backed securities.

The first wave of scandal had to do with the act of constructing MBS that were built during the housing market’s go-go days. At that time, demand for mortgage loans outstripped supply, which resulted in home loans of dubious quality being packaged and marketed as low-risk securities. When housing prices began to drop and all those loans ran into trouble, the market for MBS froze up, and 2008 happened. The defining mortgage market scandal here is Abacus. In 2010, the SEC alleged that Goldman Sachs constructed and marketed a mortgage-based investment vehicle it expected to fail.

The second wave came in the aftermath of the crisis, when all eyes were on struggling home owners who couldn’t make their mortgage payments and underwater borrowers, whose mortgage loans were now worth more than their homes. Homeowners seeking to work out these lending problems had to navigate a confusing tangle of banks, mortgage servicers who manage the loans for them, investors and government officials. In the midst of all this, a new scandal emerged: It turned out that many banks weren’t doing due diligence on home loans they decided to foreclose. Instead, they were “robo-signing” key documents without sufficient review. The court system deemed the practice fraud, and US prosecutors wrung a $9.3 billion settlement from 13 major banks.

Now we find out that, in addition to home owners, MBS investors are also allegedly getting screwed by bad document management.  Today, Reuters reported that foreclosure investigator Lisa Epstein (who helped uncover the robo-signing scandal) found mortgage servicers sending false information about home loans they manage to the trustees of MBS. The mortgage servicers failed to report when a foreclosed home had been sold, which allowed them to continue to charge fees to investors while disguising the need to write down the value of the security. Some of these MBS could still be harboring billions in unrecognized losses. For example:

Bank of America filed a document at a local county office on July 22, 2011 showing that the $162,400 loan on a cream-colored duplex in Greenacres, Florida, owned by a drywall hanger named Roman Pino, had been satisfied and “canceled.” But investors in Pino’s loan and more than 6,700 other similar mortgages that are bundled together in a subprime mortgage bond still have not been informed that the loan no longer exists, according to the last investor report in May.

It’s one more reminder that the toxic assets of the last crisis still haven’t been cleaned up yet. Expect lawsuits.

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