Foreclosure mess prompts call for stress tests

NEW YORK (CNNMoney.com) -- A Congressional watchdog group said Tuesday that U.S. banks should undergo stress tests to determine whether or not they have enough money to absorb losses that could stem from investigations into their foreclosure processes.

The Congressional Oversight Panel, created by Congress in 2008 to review the Treasury Department's response to the financial crisis, issued a 125-page report detailing recent allegations that banks and loan servicers filed thousands of inaccurate documents in foreclosure cases across the country.

While the report acknowledged that the scope and the consequences of controversy remain unknown, the panel warned that the financial system could be at risk if the allegations of "robo-signing" are proven to be true.

"If documentation problems prove to be pervasive and, more importantly, throw into doubt the ownership of not only foreclosed properties but also pooled mortgages, the consequences could be severe," the report said.

The worry is that banks will be forced to buy back mortgages that had been bundled and sold in the $7.6 trillion market for Residential Mortgage Backed Securities, or RMBS. That could result in severe losses for the banks and destabilize the still-fragile financial system, according to the report.

Bank of America has already come under fire from some big institutional investors, including the Pacific Investment Management Company and the Federal Reserve Bank of New York, which have accused the bank of mishandling $47 billion in home loans.

In addition, attorneys general from all 50 states have launched investigations into banks' foreclosure practices.

Still, the report noted that concerns about robo-signing could be overblown, and the panel's chairman told reporters Monday that he doesn't yet know the full impact of the problem.

"It could turn out to be nothing, or it could turn out to be a big deal," said Senator Ted Kaufman, D-Del. "We're not at the stage yet were we have all the info we need to determine how bad it's going to be," he added.

To assess banks' vulnerability, the panel called on regulators to subject banks to stress tests to gauge whether their financial health is sound enough to withstand losses that could result from the controversy under a worst-case scenario.

The Federal Reserve and the Treasury Department conducted stress tests on banks in 2009 amid the financial crisis. But those tests offer "limited reassurance that major banks could survive further shocks in the months and years to come," the report said.

The panel also took issue with statements from the Treasury Department suggesting that the robo-signing problem does not currently pose a threat to the financial system, saying such assertions "appear premature."

In response, a Treasury official said in a statement that the agency is working closely with 11 other federal regulators to investigate the issue, but "they have not found evidence to date of a systemic threat to the broader financial system."

"We strongly believe that the reported behavior within the mortgage servicer industry is simply unacceptable, and servicers who have failed to follow the law must be held accountable," said Treasury spokesman Mark Paustenbach.

The report also raised concerns that the controversy could undermine the Treasury's main foreclosure prevention program, the Home Affordable Modification Program, or HAMP. Panel members are concerned that 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.

However, the Treasury noted that HAMP is intended to help eligible homeowners before they enter the foreclosure process.