The Banking Sector, which must participate in any stock market rally for the rally to be real and lasting, has failed several times this year to break out along with other sectors. And it just failed again this month. Perhaps investors are thinking about something that’s been on our minds this week: and that is the effect of the exploding foreclosure “chain of title” problem on banks.
What is the Chain of Title?
Before the existence of mortgage-backed securities, most mortgages were held by local banks, the good old savings and loan. Title on the note was easy to prove. But when mortgage securitization happened, mortgage loans were bundled into Real-Estate Mortgage Investment Conduits (REMICs), handled by the Mortgage Electronic Registration System (MERS), which became the repository for the digitized mortgage notes, and which ended up slicing and dicing them into mortgage-backed securities. And these were then sold off to investors, according to their risk characteristics.
So what’s the problem? Everything was fine and dandy as home prices continued to rise.
But as home prices fell, and foreclosures rose, some sharp homeowners began asking the question, “does the bank who is foreclosing on me actually own the note? Do they really have the legal right to foreclose?”
Good question, because what these homeowners’ lawyers found was that in many cases the “chain of title” was broken. What does this mean? The actual IOU of a mortgage loan is the note. A note can be sold or transferred an unlimited number of times, but the physical document has to be physically signed over to the next holder. All of the signatures are what’s called the “chain of title.” If these signatures are skipped, then the chain of title is broken, and legally, the note is no longer valid. And so, legally, the homeowner no longer owes the loan.
A Higher Mortgage Delinquency Rate
Now, we’re not naive enough to believe that the government, bought and sold by the banks, is going to allow people to simply walk on the loans. Complete chaos would ensue. But, the confusion over the nation’s foreclosure process, and the temporary halting of all foreclosures by big banks such as Bank of America, will have a consequence.
Homeowners on the edge, who have already missed a payment, or have struggled to make their mortgage payments, will look at this mess and think, “Hmmm…it’s safe to miss a few payments while this is going on. I’ll worry about them later.” Since virtually no one can get any kind of loan these days, it’s a way for a homeowner in trouble to get a loan for a few months.
And don’t discount the ability of the media to ask the question, day in and day out, “Will homeowners be able to walk away from their mortgages?” They’ll trot out legal experts on both sides, leaving homeowners not only confused, but leaving a great many actually believing they can walk. It’s easy to believe when you are desperate, trying to put food on the table.
Our prediction is that the next few months will see the already staggering number of delinquent mortgages rise even further, and at a more rapid rate than expected.
Eventually, as go the Banks…
A higher mortgage delinquency rate means a less revenue for the banks. And this comes at a time when the banks will be spending untold sums trying to reestablish the chain of title on the notes, which will be a legal nightmare. This will put the underperforming banking stocks further underwater. And with no leadership from the banking sector, along with the failed recovery, the entire stock market will suffer.
No, don’t believe the subprime crisis is over. We’re just in the second act.