RENEE MONTAGNE, host:
We will be getting new numbers on the U.S. housing market this week. The ongoing wave of foreclosures has kept housing in the doldrums and now there's a new chapter unfolding in this crisis. This month, the state Supreme Court in Massachusetts issued a ruling in a foreclosure case that sent banks' stocks down sharply. NPR's Chris Arnold reports from Boston.
CHRIS ARNOLD: To understand what's been going on in the world of mortgages, I've climbed into my car here and I'm pulling out the title to my car. And if you've ever bought or sold a used car, you know that on the back of this piece of paper there's a place that you sign when you sell the car. Here is says: the assignment of certificate of title by owner. And it turns out this is very similar to what happens with mortgages.
Mr. KEVIN COSTELLO (Attorney): That's exactly right. And this is - to use the car analogy - this is like the car gets sold once; it then gets sold 10 more times except that piece of paper never gets signed again.
ARNOLD: Kevin Costello is an attorney in Boston who represents homeowners. He says in recent years, more mortgages were packaged into securities on Wall Street. They were often sold to different parties again and again and in some cases the systems broke down for keeping the required legal paper trail. And so banks that are trying to foreclose sometimes can't prove to a judge that they actually have the legal right to do that.
Mr. COSTELLO: In order for that foreclosure to be appropriate, you have to show that the originator assigned the interest to entity A, who then assigned the interest to entity B, all the way down to whoever it is that's showing up to foreclose on your house.
ARNOLD: If it turns out that there are legal questions surrounding the mortgages for millions of homes facing foreclosure, that could mean pretty big trouble for the banks.
That's what sent bank stocks down after this recent so-called Ibanez decision by the state Supreme Court in Massachusetts. The banks were basically arguing they should be able to foreclose anyway. But, Costello explains, the judge not only disagreed, he disagreed pretty strongly.
Mr. COSTELLO: The term that he uses is utter carelessness with which the banks documented the titles to their assets.
Mr. GARY KLEIN (Attorney): The importance to me of Ibanez is that the court is saying that banks are not above the law.
ARNOLD: That's Gary Klein. He heads up the legal team that Costello's on. They're seeking a class action status on a related lawsuit on behalf of homeowners.
Wells Fargo, one of the banks involved in the Ibanez case, released a statement. It said, quote, "Wells Fargo believes that the court's ruling does not prevent foreclosures on loans in securitizations. The court simply set forth a standard legal process that mortgage servicers must follow in Massachusetts."
And in Massachusetts and other states, in many cases, the banks may be able to sort out their paperwork problems given time. It's also unclear though how many mortgages are even faulty. Gary Klein:
Mr. KLEIN: I think that's something that we don't know yet. I think there's reason to believe that this problem affects a lot of foreclosures, but not every foreclosure.
ARNOLD: Some analysts think this faulty paperwork could also open up the banks to litigation from investors who lost money on securities that are backed by home loans that went bad.
Randall Wray is an economics professor at the University of Missouri, Kansas City.
Professor RANDALL WRAY (Economics, University of Missouri, Kansas City): It means that what we have been calling mortgage-backed securities aren't. They're not backed by mortgages.
ARNOLD: Wray says if the paperwork wasn't done right, investors could argue that they were sold faulty securities and demand their money back from the banks.
Wray's fellow professor in Kansas City, William Black, agrees. He's a lawyer, a criminologist and a former federal bank regulator. He says it used to be that banks were punctilious about mortgage paperwork.
Professor WILLIAM BLACK (Law and Economics, University of Missouri, Kansas City): You had to get everything right. You had to have copies of all the documents. That was the very mark of a banker. And now it's, you know, the equivalent of "Girls Gone Wild." It's just that it's now banks gone wild.
ARNOLD: So, what happens next for the major banks? Marty Regalia is chief economist with the U.S. Chamber of Commerce.
Mr. MARTY REGALIA (Chief Economist, U.S. Chamber of Commerce): Could it be terrible? Yes. Do we think it's at that stage? Not based on what we've seen yet. More than likely we're going to see something in the middle. It won't be as good as we hoped. It won't be as bad as we fear.
ARNOLD: Some other economists, too, predict that these legal problems will probably slow down foreclosures, but not derail the whole banking system.
Gary Klein is hoping that all this will give homeowners some more leverage, and push banks to work out alternatives to foreclosures to keep more people in their homes.
Chris Arnold, NPR News, Boston.