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Watchdog Warns of 'Potential Crisis' From Foreclosure Fraud

Federal report outlines worst-case scenario for $6.4 trillion market.

ByABC News
November 15, 2010, 4:33 PM

Nov. 16, 2010— -- Foreclosure fraud problems could cause the U.S. housing market to collapse, push the "precarious" financial system into disarray and shatter the economy's fragile recovery, a government watchdog warned in a new report due out today.

"Even as the government's response to the financial crisis is drawing to a close, severe threats remain that have the potential to damage financial stability," the Congressional Oversight Panel concluded in the first federal report on the foreclosure fraud problems.

"If documentation problems prove to be pervasive and, more importantly, throw into doubt the ownership of not only foreclosed properties but also pooled mortgages, the consequences could be severe. Clear and uncontested property rights are the foundation of the housing market. If these rights fall into question, that foundation could collapse."

While the Treasury Department has said that evidence to date shows that mortgage-related problems pose no threat to the financial system, the watchdog cautions that such a view is "premature."

While under a best-case scenario, the problems could prove "overblown" -- the work of only "a handful of employees" at mortgage servicers who failed to follow proper procedure -- the panel said there is a "considerably grimmer" outcome.

Under a worst-case scenario, the servicers will not be able to prove that they own the mortgage loans they claim to own. Under such a scenario, the banks, the government and homeowners would all end up hurting, only two years after the 2008 meltdown.

The banks, for instance, could face "significant harm" if the validity of 33 million loans is called into question. If an investor in a mortgage-backed security were to force a bank to repurchase a loan because the firm had misrepresented the quality of that loan, the problems could be severe. One such investor action, the panel said, could force Bank of America to repurchase and absorb partial losses on up to $47 billion in bad loans.