The lawsuit was filed on behalf of three surviving spouses of reverse-mortgage borrowers, who allege that HUD “abandoned long-established federal rules and violated protections for surviving spouses, with the result that the three individuals are now facing imminent foreclosure and eviction from their homes,” according to an AARP press statement. The elderly plaintiffs, from Indiana, New York and Maryland, are being represented by the AARP Foundation Litigation and the D.C.-based law firm Mehri & Skalet, PLLC.

At the center of the case is the principle of a reverse mortgage – a loan that allows homeowners over 62 to convert their home equity into cash, rather than making monthly mortgage payments. In the reverse mortgage, the loan only becomes due and payable if the homeowner dies, moves or decides to sell the home. The plaintiffs’ lawyers are claiming HUD had a policy in place that protected spouses but in 2008 the department changed its interpretation of that policy and began enforcing a rule that spouses who wanted to retain their homes were required to repay the full balance, even if the balance was more than what the home was worth.

From AARP:

The case will have broad national implications, because the outcome will determine whether spouses will be able to stay in homes that are now “underwater” as a result of the housing downturn, a possibility that reverse mortgage borrowers have always paid insurance premiums to protect against.

HUD rules in place since 1989 clearly state that a borrower or heirs would never owe more than the home was worth at the time of repayment. But at the end 2008, HUD abruptly changed the policy and said that an heir – including a surviving spouse who was not named on the mortgage – must pay the full mortgage balance to keep the home, even it if exceeds the value of the property. This does not just violate HUD rules; it violates existing contracts between reverse mortgage borrowers and lenders, and negates a key purpose for which borrowers had been paying insurance premiums.

… One protection is that no borrower or his heirs can be liable for more than the value of the property. The lawsuit notes that HUD’s Handbook, in effect since 1994, as well as other information published by HUD on its website and elsewhere, affirmed this policy. Then, in December, 2008, HUD abandoned that interpretation and stated for the first time that spouses or heirs who wanted to retain the home were required to repay the full balance, even if it exceeded the property’s current value. Strangely, HUD’s current rule is that a stranger can purchase the property for its current appraised value, but a surviving spouse cannot.

The three plaintiffs, all of modest means, were adversely affected by HUD’s illegal actions. Under HUD’s rules, they do not qualify as “homeowners” because they were not listed on the original reverse mortgage documents with their spouses. And they will suffer “substantial hardship” if forced to repay the original higher mortgage cost in order to retain their home, the lawsuit states.

About 23 percent of all mortgaged homes are underwater, according to housing data firm CoreLogic.

Ohio Attorney General Richard Cordray (ohioattorneygeneral.gov)

James Jones has spent the past five years trying to prevent foreclosures in Cleveland. Recently, his work as director of foreclosure prevention at the East Side Organizing Project, a community organizing group dedicated to improving neighborhood life in the city, has focused on targeting predatory lenders and trying to prevent banks from foreclosing on cash-strapped low-income borrowers.

[Economy1] “I’ve seen the foreclosure issue go from predatory loans, to subprime loans, to predatory loans, to an economic situation where folks have been laid off,” Jones explains. “And now we’re back to problems with paperwork.”

Ohio — and especially Cleveland — was hit earlier and worse by the foreclosure crisis than other states, due to widespread problems with predatory lending, an early economic downturn stemming from the loss of manufacturing jobs, and weak consumer-protection laws. Now, it is at the forefront of the foreclosure fraud crisis, with housing advocates and politicians calling for banks to halt evictions immediately and stop seizing homes.

The fraud scandal is complex. In September, a court case brought to light the existence of one Jeffrey Stephan, who worked for GMAC Mortgage, part of Ally Financial. Stephan attested that he signed as many as 10,000 foreclosure documents a month — one every minute or so. Soon, other revelations about banks using such “robosigners” to OK foreclosure documentation came to light.

The problem is, in 23 states, those robosigned documents went to a judge, who approved a final foreclosure, wherein the bank evicts a family and reclaims a house. Stephan and other signatories were meant to be carefully checking the information within and were giving the documents to the court as an affidavit, the equivalent of sworn testimony. The documents were not checked — meaning that the signers, and the banks they worked for, were defrauding the court. A judge ruled any such foreclosures to be illegitimate, sending a shudder through the housing markets. Banks started halting foreclosures in the 23 states that require judicial review. And the scandal has spiralled from there.

Officials in Ohio were among the first and the most aggressive in going after the banks making fraudulent foreclosures. On Sept. 30, Ohio’s secretary of state, Jennifer Brunner, told the state’s boards of elections not to use foreclosures to disqualify voters, under the premise that hundreds or even thousands of foreclosures in the state might be illegitimate. Then, last week, Richard Cordray, Ohio’s attorney general, filed a lawsuit against GMAC, seeking $25,000 for every violation of the state’s consumer-protection laws. It was the biggest and boldest legal action taken against mortgage companies since the crisis started unfolding.

“Some ugly revelations have recently come to light about how foreclosures are bring processed in this country,” Cordray said at a press conference on Wednesday. “It appears that, on a mass scale, many homeowners are being deprived of their property based on phony affidavits and without the due and proper processes of law. It is now becoming clear that fraud, deception and an utter disregard for accuracy are in part to blame for our national foreclosure disaster.”

In an interview with TWI, Cordray stressed that the problems were systemic and the violations serious. “What we’re talking about here is not just sloppy paperwork,” he said. “We’re talking about fraud in a court of law. The [foreclosure document signers] were lying under oath, to a judge. And there is evidence that this company has illegally ousted people from their private property, violating their property rights.”

Cordray did not just sue GMAC, but also wrote letters to other major banks, calling on them to investigate their foreclosure processes and to stop evicting families immediately. In intervening days, banks have stopped selling their previously repossessed properties, and have mostly halted the foreclosure and eviction process in Ohio.

The scandal came as no surprise to housing advocates in the state. “We had 90,000 foreclosure filings last year, and another 100,000 this year,” explains David Rothstein of the non-partisan think tank Policy Matters Ohio. “When we look at those statistics, and put our thinking caps on, you have to say, how were they processing all of these claims without bigger legal staffs and bank staffs? This wasn’t a surprise.”

He continues: “And there’s a tragic irony here. For five or ten years, the banks have said that the foreclosure crisis in this state is the borrowers’ fault. They bit off more than they could chew. It’s all their fault for buying expensive houses and then losing their jobs.

“But look at this! They’re taking people into foreclosure, without the right to do it! It is tragic. They were committing fraud, and were completely giving up their fiduciary responsibilities.”

Jones agrees. He explains that ESOP, which negotiates on behalf of borrowers undergoing eviction, demands to work with a qualified individual at a bank, and often manages to work out a solution other than foreclosure. But most Ohioans do not have an organization like ESOP on their side. “Foreclosure is not a quick process,” he says. “Most of the servicers — your Chases, your Wells Fargos — have these black holes. You send paperwork in, and it is months before you even find out where it went.

“They’re not set up to modify loans, or find other solutions. They’re not set up to do what needs to be done to help homeowners. A lot of things fall through the cracks. And that’s what the big problem is. They don’t have enough eyes, enough checks and double-checks. Not when they’re getting the volume they’re getting. So when you don’t have an advocate, look what happens.”

The question is now what the foreclosure fraud scandal might mean for homeowning Ohioans — and residents of every state across the country. Already, the foreclosure situation has rocked the housing market and hurt families in the state. In the first half of the year alone, there were 45,930 properties undergoing foreclosure, enough to impact one in every 100 households. Bank-repossessed homes are flooding the market in many areas. And, according to RealtyTrac, they sell for 43 percent less than the average house — the biggest discount of any state.

Housing advocates say that the stall in foreclosures will likely only prolong the pain for Ohio families, even if they are given temporary reprieve from foreclosure and now have assurance they will not be evicted without due process.

The best outcome, Rothstein says, would be for the government to finally step in to help homeowners with more effective programs than the Home Affordable Modification Program, the Treasury’s signature effort to keep families in their homes. (It has helped about one-tenth of the homeowners it said it would and is widely considered a failure.)

“The federal government made good attempts, but were really bank-focused,” Rothstein says. “They never had borrower-centered programs. But if banks are forced to reduce principals on mortgages and to make better loan terms, we might be in a better place.”

“Fine print obscures the cost of credit and makes it impossible for families to compare products. Too often, families come to understand the legalese only when they get bitten by it,” Warren said. ”Streamlined disclosure can level the playing field and give families better tools to make better choices. This is particularly true in the mortgage market, where borrowers receive stacks of incomprehensible paperwork when they’re looking for a loan.”

Under Warren, the CFPB will combine and clarify two overlapping laws — the Truth in Lending Act (TILA) of 1968 and the Real Estate Settlement Procedures Act (RESPA) of 1974 — so that loan applicants get just one document of easy-to-understand fine print from lenders. It’s a small-bore change in laws, but one that could have a huge impact on consumers — just what progressive activists wanted Warren in place to ensure and enforce.

Still, the likelihood is that the cost of bailing out the government-sponsored enterprises will be much lower. A number of sand-state housing markets — Arizona, Nevada, California and Florida — remain extremely fragile and might still be declining. But many other markets have stabilized. A 20 percent nationwide decline, while possible, particularly given the unemployment rate, still seems unlikely. Fannie and Freddie have thus far taken around $145 billion from the Treasury. The Congressional Budget Office predicts the final price tag to taxpayers for stabilizing the housing market and eating loan losses will be $389 billion.

Mortgage servicing will never be the same again. The unprecedented volume of delinquent loans over the past three years has triggered within the industry a sweeping re-examination and re-engineering of its delinquency and loss mitigation management practices. While the ultimate impact of this incredible period of financial stress, distended unemployment and evaporating equity has yet to be fully revealed, I believe the way the servicing industry has responded will significantly enhance its ability to react expediently and comprehensively to future downturns.

Of course, the mortgage business should never be the same again, since the notion that home prices on aggregate would never decline was exposed as myth. Companies that originate and purchase mortgages, like Freddie, should have plans for what to do when the housing market goes south. But again, a Freddie executive walks through the new modification efforts without mentioning right-to-rent or principal reduction — two programs that offer a clear path to keeping people in their homes and preventing a further slide in housing prices.

First, mortgage loan applications — measured by the MBA’s purchase index, which includes all mortgage applications for single-family homes — dropped 27 percent week-on-week, to 24 percent lower than a year ago. The news is not quite as terrible as it initially sounds. The precipitous drop is due to the sunset of the Obama administration’s homebuyer tax credits at the end of last month. If you were thinking of buying a house this spring, you would have probably rushed to do so before the tax credit expired; in terms of aggregate sales, it means that March and April have stolen from May and June.

“The data continue to suggest that the tax credit pulled sales into April at the expense of the remainder of the spring buying season. In fact, this drop occurred even as rates on 30-year fixed-rate mortgages continued to fall, and at 4.83 percent are at their lowest level since November 2009,” Michael Fratantoni, an MBA economist, said in a statement. “However, refinance borrowers did react to these lower rates, with refi applications up almost 15 percent, hitting their highest level in nine weeks.” The big question is aggregate housing demand — and all signs are that it is improving, even if it remains weak.

The second report shows that one in ten mortgage holders is now delinquent, meaning late on at least one payment. The first-quarter rate of 10.06 percent is up around 1 percent from a year ago. That is an all-time high. The percentage of loans in foreclosure was 4.63 percent in the first three months of the year, another record high. All in all, around 15 percent of homeowners are either in foreclosure or late on their payments. Before the financial crisis, most financial firms’ asset-backed security models did not factor in levels of delinquency higher than 5 percent. Now, with the foreclosure crisis peaking, we’re talking about numbers three times that predicted upper limit.

One other sour note in the MBA report: States that had relatively stable housing markets are seeing an upturn in delinquencies and foreclosures, implying that the “sand states” of California, Florida, Nevada and Arizona aren’t the only ones banks should worry about.

“The economy has begun to generate jobs and layoffs have declined, although new claims for unemployment insurance remained higher in the first quarter than we expected.  The percent of loans behind one payment had been declining as first-time claims for unemployment began falling in March 2009.  Those new claims stopped falling during the first quarter of this year, which likely halted the decline in the underlying 30-day delinquency rate.  If mortgage delinquencies are not yet clearly improving, it also appears they are not getting worse. However, a bad situation that is not getting worse is still bad.

“For several years, the four states of Florida, Arizona, Nevada, and California have dominated the national delinquency and foreclosure numbers.  Florida is still getting worse, but California is showing signs of improvement.  However, Washington, Maryland, Oregon, and Georgia showed the greatest overall increases in foreclosures started compared to last quarter,” Brinkmann said.

The economist backs this up by noting:

A reasonable estimate, based on bubble theory, is that housing inventory is about 3 or 4 percent above what it would have been without the bubble and without the temptation to overbuild. In order to make these excess homes worth buying, prices need to fall further; economists would generally estimate that an extra 1 percentage point of housing inventory requires a matching 1 percentage point decline in price to make those excess homes look like a good deal.

So if we believe we had 3 or 4 percent more homes than we really needed last year, based on market fundamentals, that means that housing prices would eventually be about 3 or 4 percent below what they were before the bubble, to make those extra houses worth purchasing.

Mulligan includes this chart to back the point up:

Mulligan adds that he plans to examine different aspects of this issue in further posts, so I cannot take on his whole argument yet. But I’d note that he discusses housing price fundamentals without mentioning Fannie Mae, Freddie Mac, mortgage rates, interest rates or the federal government’s extraordinary effort — literally, trillion-dollar effort — over the course of the past year to prevent foreclosures (therefore stemming supply) and to keep mortgage rates low (therefore stoking demand). The housing story is in no small part a credit and interest rate story — so I hope Mulligan turns to those topics soon.

MSNBC reports:

[Faisal Shahzad] defaulted on a $200,000 mortgage on his Connecticut home and the Shelton property is now in foreclosure, according to court records. The foreclosure records show Faisal Shahzad took out the mortgage in 2004, and that he co-owned the home with a woman named Huma Mian. Chase Home Finance LLC sued Shahzad, 30, in September to force the foreclosure. The case is pending in Milford Superior Court.

Around 7,000 homes in Connecticut were in the foreclosure process during the first three months of the year.

Indiviglio writes:

One big problem: the government-sponsored mortgage entities, which essentially everyone agrees paid a major role in the financial crisis. They have been the recipient of a still growing $200 billion bailout.

One [New York Times] source agrees: “Lawrence J. White, a finance professor at New York University, said it made no sense to overhaul financial regulation without addressing the future of federal housing policy. He said he was trying to find the strongest possible words to describe the omission of Fannie Mae and Freddie Mac from the legislation. ‘It’s outrageous,’ he finally said.”

This is also a Republican complaint. Fannie and Freddie played a huge role in helping to overheat the U.S. mortgage market. Until those agencies experience some fundamental change in policy and procedures, it’s hard to see how another housing disaster won’t occur again in the future. There’s no attempt at any reform for these companies in either of Congress’ financial regulation proposals.

But I’d push back hard on the notion that the bill “ignores” Fannie and Freddie, the government-sponsored enterprises now backing 90 percent of mortgages. The bill chooses not to handle them, for a number of reasons.

One, the financial regulatory reform bill focuses on re-regulating Wall Street, not changing Washington — on bolstering oversight and regulation of private businesses to ensure that they do not endanger the economy, rather than altering the government’s complicated relationship with housing finance.

A second and related point: The Fannie and Freddie bill might not be as big as financial regulatory reform. But it will be a big and complicated bill. Why roll all of the politicking over the trillion-dollar question of whether to shut Fannie and Freddie down — or whether the government should be in the business of subsidizing mortgages and backstopping the U.S. housing market at all — in with the question of, say, whether Goldman should keep more cash on hand? Why hold up the Dodd bill while Washington figures out how it wants to handle mortgage finance? Why let two potentially controversial bills hurt one another’s chances? Moreover, why group what might be an expensive housing bill in with the slightly deficit-reducing financial regulatory reform bill?

A third point: Washington was ready for the Dodd bill 18 months after the financial crisis. Consensus — whether good or not — had formed around the Dodd proposals. Washington is decidedly not ready for the housing bill — there are no proposals yet, and many on the Hill do not even know the parameters of what Congress might hope to accomplish. (Republicans should stop complaining about this. Their financial regulatory proposal hardly offered a disquisition on Fannie and Freddie. More like a sneeze.)

Finally, the Obama administration has buoyed the housing market this year, engaging in policies to keep fewer people underwater and to soften housing losses for banks. The Fannie and Freddie bill will likely change the housing market, for better or worse — the administration would not want to tackle how to do that now.

But this is the first private issuance of mortgage-backed securities in more than two years — and it has sparked a market frenzy. Redwood Trust’s Brett Nicholas proclaimed, “This transaction has broken the ice in the private mortgage securitization market, which has been essentially frozen since 2008.” Investor demand was high enough that Redwood Trust cut its yield. And citing a turnaround in the private mortgage securities market, Wells Fargo said it is rebuilding its housing finance team.

Gearing up for the market reawakening, Redwood hired Moody’s to rate the securities — expecting a AAA rating, meaning no more of a likelihood of default than the U.S. government. Moody’s delivered. But then, its chief rival in the credit ratings business, Standard & Poors, without having been hired to assess the Redwood mortgage-backed deal, decided it had something to say. On Wednesday, it released a note saying that it did not believe the Redwood residential mortgage-backed securities met its AAA standards. These “jumbo” loans were riskier, it said. Some of the loans have periods where the mortgage-holder only pays the interest rate, and some become adjustable-rate after five years. “If mortgage rates rise, property values remain flat, and the extension of credit is limited, we believe borrowers may face difficulties refinancing,” S&P said.

But the point of this post is not to question whether the Redwood deal is good or not, or whether the unfreezing of the private mortgage-backed securities market is good or not, or whether anyone should care about this deal or not. It is to point out the inanity of the credit ratings business. These Redwood securities have received more scrutiny than any other mortgage deal in recent memory. Investors and the press have poured over them with a fine-tooth comb. They have ginned up hundreds of inches of newspaper space, and hundreds of blog posts and a number of research reports. Presumably, the financial sophisticates buying up the Redwood securities pool have done extensive homework on everything from the risks of these precise Californian jumbo mortgages to the possibility of housing finance bills changing the marketplace down the line.

Nobody really needed the credit ratings agencies to analyze this deal, per se. But the credit ratings agencies did analyze it and… came up with different conclusions. It is as good an argument as any for ignoring the ratings and doing one’s own due diligence. And I wonder, since the financial regulatory reform bill does little to reform the way credit ratings work, whether that might become more common — for sophisticated investors to not care about (and therefore not demand) ratings on smaller and highly transparent financial instruments.