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Investor Money Goes Down the Rabbit Hole with Foreclosure Freezes

In last two weeks, three of the nation's largest mortgage loan servicers called an emergency halt to foreclosures because employees in their servicing shops were submitting foreclosures to the courts without reading the foreclosure documents, and without properly notarized signatures attesting that the documents have been read.

The number of affected loans is staggering: as many as 1 million, according to some estimates. The moratoria are in the 23 states that have laws requiring a person read the documents and attest to such in front of a notary.

Last week, Connecticut's attorney general, Richard Blumenthal, took this a step farther, asking a court to halt of all foreclosure activity in the state. Governors and attorneys general in several states have followed suit calling for foreclosure freezes, while members of Congress press for investigations.

One practical effect of this will be bringing the real estate market to a halt, right when it was beginning to show its first sign of life since the onset of the credit crisis. This is bad news for everyone who participates in the market- buyers, sellers, loan originators and especially investors- and for the U.S. economy. It's good news for only one group: plaintiff's lawyers.

At issue is a rush servicers put on getting foreclosures processed. Shortcuts were taken, including the use of so-called "robo-signers" In some cases, homeowners and their lawyers found evidence of critical errors and outright fraud. But in the vast majority of these cases, these are mere technicalities.

The servicer's job is to collect on loans, and to sell properties when borrowers don't pay. As millions of Americans have defaulted on their mortgages over the past two years, servicers have had to re-invent themselves overnight to deal with the mountain of defaults, modifications and foreclosures. They've gone from being big processing shops that collected money from borrowers and posted their payments, to being huge collections companies.

Given the pressures faced by servicers, I'm not surprised people took shortcuts. I don't condone it, and most servicers don't either, but it's not a shock given the insane volume of papers that had to be processed.

The question is whether some servicers' failure to follow procedures by the book should result in a halt to foreclosures across the board. Whether the right person read the documents or merely skimmed them, and whether their signature was legitimately notarized or not, in most cases, the facts don't change. The borrower was able to buy a home because an investor made money available for a loan, the borrower stopped making payments on the loan, and the investor has the right, and the need, to liquidate the property to try to recoup the money.

Someone at the servicing shop didn't read every page? Someone didn't notarize the signature? That shouldn't mean someone gets to stay in a house they aren't paying for. It doesn't mean investor money is play money that the courts can stuff down a rabbit hole while they find someone to read a set of loan docs.

Who's going to pay the real penalty? The answer is all of us. If delinquent loans can't be foreclosed, the real estate market will come to a standstill. That makes it harder for Americans to buy homes, and to sell them, because investors will not risk lending money that could be tied up indefinitely while actors ranging from state attorneys general to the Department of Justice to the Financial Fraud Enforcement Task Force to the SEC launch investigations to find out what happened, which we already know.

Will this keep some people struggling with financial hardship in their homes longer? Most definitely. But it's like injecting molasses into the lifeblood of the economy. It represents a transfer of resources from investors to defaulted borrowers, instead of putting those resources to work enabling viable borrowers to conduct real estate transactions that would fuel the economic recovery that we need.