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That’s the question that millions of Americans struggling to pay their mortgages should be asking now with the foreclosure freeze. The question for forex traders is: how will this mortgage mess move currencies? Here’s a review of the crisis, still a low profile crisis, the  devastating  implications and scenarios for the dollar.

Bank of America has stopped foreclosure procedures in the US, and so did a few additional banks. They were forced to do so after it was discovered that many foreclosures are illegal – a result of a few things. In some cases, the mortgage note was turned into a Mortgage Backed Security, but the chain of signatures necessary for this process wasn’t complete. If the note was sold over and over again, without proper signatures, the house owner owes no money anymore.

As home owners began asking these legal questions, some documents were fixed – they were faked in order for the process to continue. And now, too many cases were discovered, forcing BoA, JP Morgan Chase and others to freeze all foreclosure process. You can read a lot more about it in Gonzalo Lira’s post.

Banks Can’t Handle Foreclosures Anymore

The official version is that the banks need to check their paperwork, and many suspect that there’s mass wrong-doing here. There could be another reason – due to the weak housing market, the banks don’t want to waste resources to foreclose houses now – they won’t be able to sell them, so they’d rather wait.

After seizing a house, the bank needs to maintain it, physically and legally, until it’s sold. If the house can’t be sold, it’s cheaper not to proceed with foreclosures.

This is no better. In any case, without foreclosures, the banks lose their leverage on home owners that don’t pay.

Big Mess, Still Behind the Scenes

Although the foreclosure freeze, robo-signing and fears of fraud are already in the mainstream news for quite some time, the terrible implications of such a crisis are still dealt with only in smaller media outlets.

Again: If they can’t take your house, why continue paying for it? The number of “walk-aways” could leap rapidly. If it turns into a general feeling of a de-facto moratorium, the snowball will turn into an avalanche. It doesn’t matter if there’a a real moratorium or not – the financial system is endangered.

Foreclosure Freeze and Forex

Higher Volatility: An  eruption of such a crisis  means lots of action in currencies. It probably not be a one day event, but rather an ongoing crisis that will consist of reports on the amount of walk away, speeches that will address the crisis, leaks of plans to solve the problem and possible surprises. Every piece of news will add to the markets’ volatility.

Short Term: This scenario of another major collapse of the housing sector and the financial system is bad news for the the US – bad news for the dollar. If the government or the Federal Reserve make a fresh plan to buy toxic assets such as Mortgage Based Securities, this will devalue the dollar just as additional quantitative easing hurts the dollar. A nationalization of the troubled banks will also hurt the dollar.

Long Term: Another collapse in the housing sector means a deeper financial crisis and a definite double dip recession for the whole world. Roubini’s now pessimistic outlooks will be looked back as optimistic. In this case, where the whole world is going down, the US dollar will gain – it’s still the reserve currency, and a “safe haven” currency. This may sound absurd, but that’s how the markets reacted in previous crises. Also the Japanese yen will gain on such a crisis.

What do you think? Will this crisis turn into a big mess? Will it be defused?

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