On September 29, the Washington Post had an article (by Ariana Eunjung Cha) about the brewing foreclosure mess which talked about “allegations of forged documents and signatures and other similar problems”. Apart from one solitary reference to forged paperwork, the issue was never fleshed out. It wasn’t clear at all what kind of forgeries were alleged, and how widespread the problems may be. What was clear was that it wasn’t shady, fly-by-night mortgage lenders who were alleged to have engaged in foreclosure forgery; it was the likes of J.P. Morgan Chase.

One week later, on October 6, the Washington Post had another article (by Brady Dennis and Ariana Eunjung Cha) about the systemic problems resulting from the mortgage industry’s hubris in deciding that hundreds of thousands of mortgages could be sent whizzing through the global financial system at high velocity, merrily changing hands, without following the pesky local laws that record and establish legal ownership of the mortgage loans as they change hands. The lack of a clear title to mortgage loans in default now not only threatens to disrupt foreclosures all over the country, but may also have severe repercussions for the state of the housing market, with all kinds of collateral damage to innocent bystanders.

This second article also raised the possibility that, in addition to homeowners filing lawsuits to contest foreclosures, banks could also “face lawsuits from … investors who bought stakes in the mortgage securities – an expensive and potentially crippling proposition”.

Fast forward another week, and lo and behold, there was another article in the Washington Post on October 13 (by Ariana Eunjung Cha and Jia Lynn Yang, this time).

One, this article sheds a little light on the forgery allegations, tying them to the mortgage-loan-title mess:

However, local laws in most states dictate that each time a mortgage changes hands, the transaction needs to be recorded in courts or county offices. But the speed with which the loans were being generated during the housing boom and then pooled together and passed around Wall Street meant that big financial firms took shortcuts, consumer lawyers said.

Often the proper paperwork got lost or was passed along without being filled out, lawyers say. Some documents have been found retroactively signed or even forged.

So documents were forged because banks realized, at least by the time it came to foreclosure, that they lacked clear title to the loans? (And what better way to address the problem than by indulging in a little harmless forgery?)

Two, the article reports that large institutional mortgage investors are indeed trying “to force banks to compensate them or even invalidate the mortgage trades themselves.”

For more than a decade, big lenders sold millions of mortgages around the globe at lightning speed without properly transferring the physical documents that prove who legally owned the loans.

Now, some of the pension systems, hedge funds and other investors that took big losses on the loans are seeking to use this flaw to force banks to compensate them or even invalidate the mortgage trades themselves.

Their collective actions, if successful, could blow a hole through the balance sheets of big banks and raise fundamental questions about the financial system, financial analysts and a lawmaker said.

If judges rule in favor of such lawsuits, “it could be 2008 all over again,” said Josh Rosner, managing director at Graham Fisher & Co., referring to the Wall Street meltdown that occurred after Lehman Brothers collapsed.

I’m not sure it makes a lot of sense for mortgage investors to go down this street, whether by formally filing a lawsuit or by using the threat of a lawsuit to negotiate some form of compensation. Investor A would probably do well to remember that, in most cases, after buying a mortgage from Bank X, it then sold the mortgage to Investor B. Whatever lack-of-legal-title claim Investor A has against Bank X, Investor B would have the exact same claim against Investor A. The only investor who can hope to extract some compensation without having to pay it out, in turn, would be the poor sod at the end of the chain, investor P or Q or R, the proverbial greater fool who was left holding the mortgage when everything came tumbling down like the pack of cards it was.

But none of these investors made just a single transaction in these toxic mortgages. For every mortgage that a given investor ended up holding at the end, there would be many dozens of mortgages which passed through their hands, leaving them now open to a claim against them.

If these institutional investors seriously pursue such claims, all that will happen is that they will beget a long chain of domino claims. If Investor R goes after Q, then Q will be forced to go after P, who will be forced to go after O, and so on down the line. Lawyers will make out like bandits, no doubt, but everyone else is just going to lose.