Global sharemarkets were cheered by a rebound in US home sales last month, but top US officials are grimly aware of the damage that the impending foreclosure debacle is about to unleash, both on the country’s housing market, and on its banking system.

Sheila Bair, who heads of the Federal Deposit Insurance Corp that guarantees bank deposits and who has consistently provided a realistic assessment of the problems facing US banks, warned that problems with foreclosures could undermine the housing market.

“I fear that the litigation generated by this issue could ultimately be very damaging to our housing markets, by prolonging those foreclosures that are necessary and justified,” she told a housing conference overnight. Her comments came as Bank of America conceded for the first time that it has uncovered some mistakes in foreclosure files, as it prepares to resubmit documents in more than 100,000 foreclosure cases.

The bank said it discovered errors in 10 to 25 of the first several hundred foreclosure cases it examined. These errors included improper paperwork, lack of signatures and missing files. In some cases, information about the property and payment history didn’t match. However, the bank emphasised that it hadn’t uncovered any evidence of wrongful foreclosures.

Even so, claims of innocence from the bankers are unlikely to prevent the foreclosure crisis from cascading.

Already, attorneys general in all 50 US states have launched an investigation into whether lenders rushed through foreclosures, using ‘robo-signers’ to approve large numbers of foreclosure documents without reading them closely.

At the same time, the fact that investors who bought mortgage-backed securities are preparing legal action to force banks to repurchase hundreds of billions of dollars of loans at face value, is raising fears that the balance sheets of the big US banks could be ravaged by massive write-downs.

Even worse, there are fears that the US banking system could be slugged with even greater losses if the foreclosure crisis, along with the legal action surrounding mortgage-backed securities, causes the backlog of distressed properties to swell, putting further pressure on housing prices.

A further 10% decline in US house prices could push the market to a major tipping point, as it would mean that more than half of all US borrowers were underwater on their home loans.

Top US officials are extremely aware of the fragility of this crucial market. Ben Bernanke, head of the US Federal Reserve, told the same housing conference that “more than 20% of borrowers owe more than their home is worth, and an additional 33% have equity cushions of 10% or less, putting them at risk should house prices decline much further”.

Bernanke said that Fed officials, along with other bank regulators, were examining the policies and procedures of US banks “seeking to determine whether systematic weaknesses are leading to improper foreclosures”. He added that the results of this preliminary review were expected next month.

But he appeared deeply pessimistic about the outlook for the US housing market, pointing out that “with housing markets still weak, high levels of mortgage distress may well persist for some time to come”.

*This article originally appeared on Business Spectator

Peter Fray

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