As the fallout from the foreclosure crisis continues, investors who bought mortgage-backed securities are pushing the big banks for a resolution of the 50-state probe of the lenders’ foreclosure and loan modification practices. According to a recent report by Bloomberg, these investors are beginning to realize that continued massive foreclosures aren’t going to increase the value of their investments.

Florida Attorney General Bill McCollum is currently investigating a number of large mortgage lenders whose foreclosure practices are questionable. His office has held talks with Bank of America, JPMorgan Chase and Litton Loan Servicing, which is owned by Goldman Sachs. McCollum’s office has also met with Ally Bank, which owns GMAC’s mortgage unit, and PNC Financial Services Group. His office has also said they plan to meet with Wells Fargo.

All 50 states and several federal agencies are pursuing investigations of what has become known as “foreclosure-gate,” where banks and mortgage loan services appear to have used legally defective documents as evidence in hundreds of thousands of foreclosure cases.

That probe has now expanded to other mortgage practices, and the state attorneys general have suggested that any resolution to the crisis will need to include a number of reforms to the loan modification process and compensation for homeowners who have been victims of wrongful foreclosures.

Pressure From Investor Groups May Help or Hinder Negotiation With Banks

One of the reforms the attorneys general appear to want is for the foreclosure process to be halted completely when a homeowner is trying to negotiate a loan modification. The resolution of the 50-state probe will also likely require a massive effort to get sustainable loan modifications for as many homeowners as possible.

Some owners of mortgage-backed securities fear that they will lose money during a large-scale loan modification effort. However, Iowa Attorney General Tom Miller says that a number of investors have told him they are not opposed.

One obstacle is conflicts among investors with divergent interests. When the mortgages were securitized, many mortgages were put into pools. The contracts setting up those pools, along with some loan servicing agreements, may dictate who has the right to approve or deny loan modifications, says Miller.

There are also some federal rules that stand in the way of improving the loan modification process at Fannie Mae, Freddie Mac and Ginnie Mae, which are government sponsored. Miller says that the attorneys general are working with federal agencies to break down those road blocks.

The stakes are high for both banks and investors — if they can’t resolve the foreclosure crisis through negotiation with the attorneys general, each bank could be sued by every jurisdiction in which it operates — with national banks facing some 50 lawsuits each.

“Ongoing discussions with lenders and servicers include reforming the loan modification process and greater foreclosure relief for homeowners,” says Connecticut attorney general Richard Blumenthal.

“We will explore all options, including possible legal action, if discussions fail to produce a settlement assuring the rule of law, property rights and fair treatment,” he said.

Source: Bloomberg, “Foreclosure Probe Talks Expanded to Include Investors Urging Resolution,” Margaret Cronin Fisk and David McLaughlin, November 24, 2010