Widespread problems in how U.S. lenders documented foreclosures could spark a wave of legal challenges resulting in massive losses to banks and serious new troubles for the housing market, a federal watchdog warned on Tuesday.

The Congressional Oversight Panel, the overseer of the government's Wall Street bailout, in its latest report laid out a range of possible outcomes for the foreclosure paperwork mess that emerged in September.

In the best-case scenario, the watchdog said, concerns about the paperwork mess are "overblown" and banks would be able to proceed with foreclosures as soon as invalid court documents were replaced with proper paperwork.

But in the worst-case scenario, it warned that banks could face billions of dollars in losses.
Banks are accused of having used "robo-signers" to sign hundreds of foreclosure documents a day without proper review, a fiasco that reignited public anger with banks that received billions of dollars in taxpayer aid during the financial crisis.

Bank of America (NYSE:BAC) Ally Financial and JPMorgan (NYSE:JPM) were among banks that temporarily suspended foreclosures pending internal reviews of their practices, but have since begun to resume sales of foreclosed properties.

In the worst-case scenario, the panel said banks may be unable to prove that they own the mortgage loans they claim to own, legal challenges could call into question the validity of 33 million mortgage loans — many of which were then securitized and sold to investors — and banks could face billions of dollars in unexpected losses.

"If such problems were to arise on a large scale, the housing market could experience even greater disruptions than have already occurred, resulting in significant harm to major financial institutions," the 125-page report said. "At present, the reach of these irregularities is unknown."

The panel, created to oversee the $700 billion bank rescue approved by Congress in 2008, also said banks could end up losing $52 billion from so-called mortgage put-backs, or loans that were sold to other investors but would have to be bought back due to problems that have turned up.

Those losses would be borne predominantly by Citigroup (NYSE:C), JPMorgan Chase, Bank of America and Wells Fargo (NYSE:WFC), the panel said.

Lawmaker Showdown

Banks have been eager to downplay the impact of the foreclosure paperwork mess, saying evictions through foreclosure have been "materially accurate." The banks face lawmaker scrutiny later on Tuesday in hearings by the Senate Banking Committee, and then another hearing on Thursday before the House of Representatives Financial Services Committee.

A top Bank of America executive acknowledged problems in the bank's foreclosure practices in testimony prepared for the Senate hearing and said Bank of America is working to replace previously filed affidavits in as many as 102,000 pending foreclosure cases.

"Thus far, we have confirmed the basis for our foreclosure decisions has been accurate. At the same time, however, we have not found a perfect process," said BofA home loans chief Barbara Desoer in the prepared testimony.

David Lowman, chief executive for home lending at JPMorgan Chase, also laid out missteps in foreclosure paperwork and said the bank is cleaning up errors.

Both officials said their banks work closely with struggling borrowers to modify loans rather than foreclose, but lawmakers are expected to press banks on why more loan modifications have not gone forward.

Bank regulators who are probing banks' foreclosure procedures have also pushed for more modifications.

The Congressional Oversight Panel hit on loan modifications in its report, saying documentation problems could undermine Treasury's main foreclosure prevention effort, the Home Affordable Modification Program.

"Some servicers dealing with Treasury may have no legal right to initiate foreclosures, which may call into question their ability to grant modifications or to demand payments from homeowners," the report said.

The panel said Treasury should undertake an investigation into whether paperwork errors could undermine HAMP, and report back to Congress and the public.