WASHINGTON – Oct. 22, 2010 – Mortgage documents were treated in an almost lackadaisical way during the mortgage lending spree and now those documents are at the center of a legal clash that pits big lenders against homeowners.

About a month after Washington Mutual Bank made a multimillion-dollar mortgage loan on a mountain home near Santa Barbara, California, a crucial piece of paperwork disappeared.

But bank officials were unperturbed. After conducting a “due and diligent search,” an assistant vice president simply drew up an affidavit stating that the paperwork – a promissory note committing the borrower to repay the mortgage – could not be found, according to court documents.

The handling of that lost note in 2006 was hardly unusual. Mortgage documents of all sorts were treated in an almost lackadaisical way during the dizzying mortgage lending spree from 2005 through 2007, according to court documents, analysts and interviews.

Now those missing and possibly fraudulent documents are at the center of a potentially seismic legal clash that pits big lenders against homeowners and their advocates who are concerned that the lenders’ rush to foreclose flouts private property rights.

That clash – expected to be played out in courtrooms across the United States and scrutinized by law enforcement officials investigating possible wrongdoing by big lenders – leaped to the forefront of the mortgage crisis this week as big lenders began lifting their freezes on foreclosures and insisted the worst was behind them.

U.S. government officials meeting in Washington on Wednesday indicated that a government review of the problems would not be complete until the end of the year.

In short, the legal disagreement amounts to whether banks can rely on flawed documentation to repossess homes.

While even critics of the big lenders acknowledge that the vast majority of foreclosures involve homeowners who have not paid their mortgages, they argue that the borrowers are entitled to due legal process.

Banks “have essentially sidestepped 400 years of property law in the United States,” said Rebel A. Cole, a professor of finance and real estate at DePaul University in Chicago. “There are so many questionable aspects to this thing it’s scary.”

The country’s mortgage lenders contend that any problems that might be identified are technical and will not change the fact that they have the right to foreclose en masse.

“We did a thorough review of the process, and we found the facts underlying the decision to foreclose have been accurate,” Barbara J. Desoer, president of Bank of America Home Loans, said this week. “We paused while we were doing that, and now we’re moving forward.”

Some analysts are not sure that banks can proceed so freely. Katherine M. Porter, a visiting law professor at Harvard University and an expert on consumer credit law, said that lenders were wrong to minimize problems with the legal documentation.

“The misbehavior is clear: They lied to the courts,” she said. “The fact that they are saying no one was harmed, they are missing the point. They did actual harm to the court system, to the rule of law. We don’t say, ‘You can perjure yourself on the stand because the jury will come to the right verdict anyway.’ That’s what they are saying.”

Robert Willens, a tax expert, said that documentation issues had created potentially severe tax problems for investors in mortgage securities and that there was “enough of a question here that the courts might well have to resolve the issue.”

As the legal system begins sorting through the competing claims, one thing is not in dispute: The pell-mell origination of mortgage loans during the real estate boom and the patchwork of financial machinery and documentation that supported it were created with speed and profits in mind, and with little attention to detail.

As lenders and Wall Street firms bundled thousands of mortgage loans into securities so they could be sold quickly, efficiently and lucratively to legions of investors, slipshod practices took hold among lenders and their representatives, former employees of these operations say.

Banks routinely failed to record each link in the chain of documents that demonstrate ownership of a note and a property, according to court documents, analysts and interviews. When problems arose, executives and managers at lenders and loan servicers sometimes patched such holes by issuing affidavits meant to prove control of a mortgage.

In Broward County, Florida, alone, more than 1,700 affidavits were filed in the last two years attesting to lost notes, according to Legalprise, a legal services company that tracks foreclosure data.

When many mortgage loans went bad in the last few years, lenders outsourced crucial tasks like verifying the amount a borrower owed or determining which institution had a right to foreclose.

Now investors who bought mortgage trusts – investment vehicles composed of mortgages – are wondering whether the loans inside them were recorded properly. If not, tax advantages of the trusts could be wiped out, leaving investors with significant tax bills.

For years, lenders bringing foreclosure cases commonly did not have to demonstrate proof of ownership of the note. Consumer advocates and consumer lawyers have complained about the practice, to little avail.

But a decision in October 2007 by Judge Christopher A. Boyko of U.S. District Court in northern Ohio to toss out 14 foreclosure cases put lenders on notice. Judge Boyko ruled that the entities trying to seize the properties had not proved that they actually owned the notes, and he blasted the banks for worrying “less about jurisdictional requirements and more about maximizing returns.”

He also said that lenders “seem to adopt the attitude that since they have been doing this for so long, unchallenged, this practice equates with legal compliance.” Now that their practices have been “put to the test, their weak legal arguments compel the court to stop them at the gate,” the judge ruled.

Copyright © 2010 International Herald Tribune.