Investor fears grow over foreclosure mess

A foreclosed home is seen in Bullhead City, Arizona, November 4, 2009.

WASHINGTON/NEW YORK (Reuters) - A growing crisis over shoddy foreclosure documents deepened on Thursday as investors dumped stock in some of the biggest U.S. banks on fears their profits could be hit.

At risk is not just the health of the banks but also the fragile housing market and the broader economy, which is still struggling to emerge from the worst recession since the 1930s, analysts warn.

All 50 U.S. states have started a joint investigation of the mortgage industry, focusing on allegations that for years banks have not reviewed documents properly or have submitted false statements to evict delinquent borrowers.

The investigation, one of the biggest legal probes of the mortgage industry in decades, has alarmed investors who fear cleaning up the foreclosure paperwork mess could take months, even years.

The fiasco threatens to eat into bank profits by delaying sales of bank-owned properties, drawing fines from regulators, and spawning lawsuits from both homeowners and investors in mortgage-backed securities.

The KBW Banks index dropped 2.6 percent on Thursday while the broad Standard & Poor's 500 index fell just 0.4 percent.

Bank of America, the largest U.S. mortgage servicer, has temporarily halted evictions nationwide. JPMorgan Chase and others have halted some foreclosures pending reviews, while some have left foreclosure policies in place.

The moratoriums, combined with buyer wariness, could suppress home sales. Nearly one-third of all homes sold in September were in the foreclosure process, according to real estate data company RealtyTrac.

"Banks could be dealing with this on a loan-by-loan basis for years," warned Jefferson Harralson, a bank analyst at Keefe, Bruyette & Woods in Atlanta.

Mindful of the dangers, federal regulators have pressed banks to quickly complete internal reviews and not slow down foreclosures where the paperwork is in order.

JPMorgan Chief Executive Jamie Dimon said a prolonged investigation by the state attorneys general could slow down the housing recovery. "But we're hoping it won't kill it," he told Reuters on the sidelines of a Business Council meeting in Chicago.

But Bank of America CEO Brian Moynihan played down the impact of the foreclosure document inquiry, calling the housing market "stable" and saying unemployment levels would have a bigger impact.

JPMorgan shares closed down 2.8 percent, Bank of America ended down 5.2 percent, Citigroup fell 4.5 percent and Wells Fargo lost 4.2 percent. The banks are the top four mortgage servicers in the United States.

Officials from Citigroup, BofA and Wells Fargo are likely to face questions on the foreclosure issue when they host conference calls on their quarterly earnings next week.

CALLS FOR MORATORIUM

Despite the White House rebuffing calls by some senior Democratic lawmakers and others for a nationwide moratorium on foreclosures, the issue has mushroomed in the runup to the November 2 congressional elections.

The number of homes taken over by banks topped 100,000 in a month for the first time in September but foreclosures are likely to slow as lenders review their paperwork, RealtyTrac said.

The disclosures that lenders may have engaged in illegal practices to evict delinquent homeowners has reignited simmering public anger with banks, whose excessive risk-taking is blamed for helping cause the financial crisis that plunged the country into the 2007-2009 recession.

The Obama administration says it backs the attorneys general investigation but at the same time it has signaled it is wary of doing anything that could derail any recovery in the housing market, usually a driver of economic rebounds.

Republicans are expected to make big gains in the November elections on the back of growing disapproval over how President Barack Obama and his Democrats are handling the economy.

"MASSIVE, MASSIVE PROBLEM"

Despite the White House's reluctance to get involved, political pressure is mounting on the top mortgage servicers, which took money from the government's $700 billion Troubled Asset Relief Program to ride out the financial crisis.

Ted Kaufman, head of the panel that oversees TARP, told Reuters Insider the watchdog is likely to probe the foreclosure paperwork issue, along with the special investigator for TARP and the Government Accountability Office.

"This is a massive, massive problem," Kaufman said, calling it "a real concern to the economy."

FBR Capital Markets said the U.S. banking industry faces foreclosure-related losses of $6 billion to $10 billion but is ready to "comfortably" absorb them. Still, the analysts said, mortgage servicers may be in trouble as they have never faced such extensive investigations.

"The real cost to the industry is going to be the drag on the foreclosure process, which could delay any recovery in the housing market," FBR said. "While we had previously believed that this was an election issue, we now think that this could materialize into a longer-term concern."

At issue is the use of "robo-signers" -- people who sign hundreds of affidavits a day -- by banks and companies that collect monthly mortgage payments. It is alleged they did not have time to review the foreclosure documents they signed.

James Barth, an economist at the Milken Institute, said the issue was legal blip that was unlikely to lead to the entire foreclosure process being called into question.

"It's apparently in many cases more of a legal technicality than a matter in which you will find someone who borrowed money doesn't really owe the money," he told Reuters.

(Additional reporting by James B. Kelleher in Chicago, Abhinav Sharma in Bangalore, Julie Haviv and Elinor Comlay in New York, Karey Wutkowski, Dave Clarke and Corbett B. Daly in Washington, and Joe Rauch in Charlotte, N.C.; Writing by John O'Callaghan and Ross Colvin; Editing by Tim Dobbyn)