BANKS COURT MORE FORECLOSURE WOE / THE WALL STREET JOURNAL ( HIGHLY RECOMMENDED READING )

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JANUARY 7, 2011, 3:26 P.M. ET.

Banks Court More Foreclosure Woe .


By DAVID REILLY

Make that strike two for banks.


Twice in recent weeks, state courts have dealt the banks a blow in disputes related to soured mortgages. That has rightly set investors on edge—bank stocks tumbled Friday on the latest decision—and provided a stark reminder that foreclosure and mortgage-repurchase problems are far from over.


The latest legal setback came when Massachusetts' highest court on Friday ruled that U.S. Bancorp and Wells Fargo improperly foreclosed on two properties because they couldn't prove they actually owned the mortgages. In December, the New York State Supreme Court said insurer MBIA could use statistical sampling of loans, rather than combing through thousands individually, in a suit against Bank of America's Countrywide over losses on mortgages it insured. If other courts do likewise, this could counter banks' strategy of fighting cases on a loan-by-loan basis.


The Massachusetts ruling is especially significant. Although it won't necessarily apply in other states, the decision suggests foreclosure-related problems aren't merely procedural, as banks have argued. Rather, documentation issues may call into question the actual ownership of billions of dollars of mortgages bundled into securities and sold to investors.


Banks have maintained that mortgage ownership was properly transferred to securitization trusts and that proper procedures were followed in splitting a mortgage, or legal right to foreclose, from a promissory note, or the borrower's IOU. The Massachusetts decision calls that into question.


Bank investors cheered earlier in the week when BofA reached a $2.8 billion deal with Fannie Mae and Freddie Mac over problem loans. But legal decisions like these may bolster mortgage-bond investors' chances of offloading toxic loans—and forcing banks to shoulder the losses.

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