Growing concerns over the handling of U.S. home foreclosures hit bank shares hard Thursday, with analysts warning of harm to the fragile housing market and broader economy if the issue escalates.
The attorneys general of all 50 states have started a concerted investigation of the mortgage industry, focusing on allegations that some banks did not review documents properly or submitted false statements to evict delinquent borrowers.
"This is a potential cost to factor into long-term profitability," said Jefferson Harralson, a bank analyst at Keefe, Bruyette & Woods in Atlanta. "Banks could be dealing with this on a loan-by-loan basis for years."
The KBW Banks index was down 3.7 percent in early afternoon trade, while the broader stock market was down less that 1 percent, as analysts joined JPMorgan Chase Chief Executive Jamie Dimon in highlighting the dangers of a prolonged probe.
"We would hope that we would be in a position to move briskly here to avoid further damage and further pressure on the housing market and ultimately further pressure on the economy," Dimon said during an earnings conference call on Wednesday.
JPMorgan shares were down 3.2 percent, Bank of America was 5.5 percent lower, Citigroup was off 5.4 percent and Wells Fargo fell 5 percent.
With less than three weeks to congressional elections, public anger is running hot over the foreclosure fiasco in the $11 trillion U.S. residential mortgage market.
Republicans are expected to make big gains in the Nov. 2 election on the back of growing disapproval over how President Barack Obama and his Democrats are handling the economy as it emerges slowly from the worst recession since the 1930s.
"MASSIVE, MASSIVE PROBLEM"
Political pressure is mounting on the top mortgage servicers, which all took bailout money from the government's $700 billion Troubled Asset Relief Program to ride out the 2007-2009 financial crisis that began with a collapse in the housing market.
Ted Kaufman, head of the panel that oversees TARP, told Reuters Insider that 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," they wrote in a client note. "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.
Iowa's attorney general, Tom Miller, told Reuters the states were seeking redress for affected homeowners and financial penalties "where appropriate." The attorneys general might also press lenders to change procedures and modify mortgages for people struggling to make payments, he said.
The White House supports the investigation by the states but has rejected calls by some senior Democratic lawmakers and others for a temporary nationwide moratorium on foreclosures, saying it would do more harm than good.
Miller said the states were "very conscious of the broader housing market issues and the broader economy issues."
Adam Levitin, a law professor at Georgetown University, has predicted the paperwork issue could mushroom into a "systemic problem" that seizes up the mortgage market as title insurers refuse to deal with mortgages for existing homes.
Levitin, whose argument was laid out in a Citigroup note this week, said the Obama administration may be forced to step in to broker a payment from lenders and servicers.
RATES FALL, FORECLOSURES RISE
Bank of America, the largest U.S. mortgage servicer, has temporarily halted evictions nationwide. JPMorgan and others have halted some foreclosures pending reviews, while some have left foreclosure policies in place.
Banks repossessed nearly 3 million homes between January 2007 and August 2010, real estate data company RealtyTrac Inc. says. One of every four homes sold in the second quarter was a foreclosed property and banks are expected to take over a record 1.2 million homes this year.
While record-low mortgage rates offer some hope for the housing market, the effect on demand for loans to buy homes has been minimal as high unemployment and the health of the economy weigh on consumer confidence.
On the Internet, the comment sections of blogs and news media sites are filled with politically charged arguments over who is responsible for the mortgage and foreclosure mess.
Some say irresponsible people deserve what they get for taking on mortgages they could not afford, while others appeal for understanding after losing their jobs in the recession or having a costly medical problem in the family.
Talk of greedy bankers and complicit politicians is rife.
"The taxpayers have pumped billions of dollars into these banks, they in turn can conduct business properly!" said one of the many comments on the New York Times website.
"These bank presidents, CEOs and board members need to be incarcerated or hanged," one person said on the Fox News site.
"It's election season folks," another wrote on Fox News. "Thousands of unqualified loans were made to people that should have never been approved and now politicians are bringing out the rescue blanket with the lawyers to follow close behind."
© 2014 Thomson/Reuters. All rights reserved.