Everyone knew that the foreclosure fraud crisis was going to spawn a festival of lawsuits, and now it looks like it is already beginning. The New York Federal Reserve Bank is part of a consortium of eight large institutional investment firms that has launched an effort to force Bank of America to repurchase $47 billion worth of mortgages packaged into bonds by its Countrywide Financial unit. It turns out that most mortgage bond contracts explicitly require the repurchase of loans when the quality of the loans falls short of promises made by the sellers. As most of us know by now, many of these mortgages that were packaged together into “AAA rated” securities were actually a bunch of junk. But this is just the beginning. There are going to be hordes of lawsuits stemming from this crisis and it is going to take years and years for this thing to work through the legal system. All of the big players in the U.S. mortgage industry are going to be paralyzed for an extended period of time by this crisis, and that means that buying a home and achieving the American Dream is going to become a lot harder for millions of Americans. Not only that, if mortgage lending institutions end up being forced to take back gigantic mountains of bad mortgages it could end up sinking a whole lot of them. The implications for the U.S. financial system would be staggering.

And it turns out that the effort by the consortium of eight large institutional investment firms to get Bank of America to take back $47 billion in mortgages is not the only action already being taken. An even larger mortgage repurchase initiative involving investors holding a total of more than $500 billion in mortgage debt is being coordinated by Dallas lawyer Talcott Franklin.

The sad reality is that all of this is going to create one of the biggest legal messes in U.S. history and lawyers from coast to coast are salivating.

For example, Peter Ticktin of the Ticktin Law Group in Deerfield Beach, Florida represents approximately 3,000 homeowners and he says that he plans to meet with a number of other prominent attorneys this week to discuss launching a nationwide class action lawsuit against the big mortgage lenders.

Mortgage companies are going to go broke just trying to defend against all the lawsuits that are coming. It is going to be a complete and total mess.

But beyond the problems with bad mortgages, there are now many legal authorities that are even questioning whether it was ever legal to package mortgages together, securitize them, and sell them at lightning speed around the globe.

A recent article in The New York Times is asking this question….

“Was the great securitization machine that made hundreds of billions of dollars in mortgage loans based on a legal foundation of sand?”

It turns out that there are some legitimate questions as to whether or not it was ever proper for the big mortgage lenders to set up and utilize MERS (Mortgage Electronic Registration Systems) to securitize and market mortgages.

The article in the New York Times went on to describe what a “worst case scenario” might look like if courts around the country start finding fundamental legal flaws with MERS….

The worst outcome would be a conclusion that errors by financial institutions had decoupled the payment promises made by borrowers from the mortgages they signed. In that case, the mortgages would be invalid. Homes could be sold without paying off lenders. There also could be heavy tax consequences for lenders, both in terms of federal income taxes and in payment of back fees for mortgage registrations to local governments across the country.

On top of everything else, the Feds are considering going after the major mortgage lenders. On Tuesday, the Obama administration warned lending institutions that it would go after them for any mortgage practices that violated federal law.

Needless to say, things are very tense at the big U.S. mortgage lenders right now, and many investors are wondering if they should start looking for the exit doors.

In fact, there are some analysts that are speculating that this could even set off another big financial crisis like we saw in 2008.

On Tuesday, U.S. stocks had their worst day in two months.

So will things get even worse for the stock market?

Let’s certainly hope not, but we had all better buckle up our seat belts because there are some bumpy times ahead for the U.S. financial system.