The mortgage-foreclosure crisis spilled into the financial markets on Thursday, driving down bank stocks and weighing on mortgage bonds as investors took a grim view of the potential costs. 
 
 View Full Image Getty Images A bank owned sign hangs in front of a foreclosed home in Miami, Florida. Bank repossessions rose to their highest level in September, exceeding 100,000 in a month for the first time. 
 
 Shares of U.S. banks fell, while the broader stock market was essentially flat. Bank of America Corp., potentially among the most affected, dropped more than 5%. Bank bonds also fell, and the cost of buying protection against a possible debt default by banks climbed. 
 
 "The level of uncertainty in the economy is at extraordinarily high levels to begin with," said Jack Scott, chief investment officer at BlackHawk Capital Management, a Charlotte, N.C., money manager that owns mortgage securities. "The foreclosure problem adds another layer of acute uncertainty." 
 
 So far, the foreclosure crisis hasn't affected consumer mortgage rates, which remain near record lows. They are closely linked to rates on U.S. Treasurys, which have tumbled in recent months. 
 
 The crisis has been escalating for several weeks, as banks suspend foreclosures across the country, citing flaws they have uncovered, including faulty or missing documentation. Tales of mismanagement within the foreclosure process—including so-called robo-signers, who were paid to rubber stamp documents without properly reviewing them—are emerging daily. 
 
 Until recently, investors hadn't fled financial stocks. If the issues raised about foreclosure practices in recent days are easily resolved technical glitches, with most foreclosures resuming after brief delays, then the impact on most investors would be small. 
 
 "The [mortgage] market seems to be functioning relatively well, but that could change depending on how we see this play out," said BlackRock Inc. portfolio manager John Vibert. 
 
 But some fear that it may be difficult to do any foreclosures for a while. The risk is that foreclosure flaws are so widespread, or the political furor so heated, that the entire process grinds to a halt, as Citigroup analyst Joshua Levin said in a conference call this week. 
 
 In some cases, that would choke off much of the cash flow used to pay mortgage bondholders. 
 
 Another concern is that banks could be forced to modify billions of dollars in loans, including reducing principal, which could leave bondholders as big losers. 
 
 "All this does is increase uncertainty and make me question my estimates of returns" on mortgage bonds, said Mr. Scott of BlackHawk, which bought mortgages that aren't guaranteed by government agencies near the bottom in early 2009. BlackHawk started trimming its mortgage holdings this summer after a run-up. 
 
 PM Report: Foreclosure Mess - How Bad Will It Get? 9:48 Nick Timiraos discusses the unfolding foreclosure-crisis, including how bad it's likely to get, how much it's likely to cost banks and the risk that it could paralyze the housing market. Plus, a health-care ruling and seniors flip for college teams. 
 
 News Hub: Bank Stocks Hit on Foreclosure Worries 2:41 Mike Reid looks at how news of the escalating foreclosure mess impacted bank stocks today as well why the market fell then rebounded in late trading. 
 
 Bank of America CEO Comments on Moratorium 1:16 Bank of America CEO Brian Moynihan comments on when the foreclosure moratorium might be lifted and what impact it could have on the housing market, MarketWatch's Val Brickates Kennedy reports from Boston. 
 
 Banks, meanwhile, could be hit with investor lawsuits, and foreclosure delays could bring short-term losses. Some investors are pushing for banks to take back nonperforming mortgages in cases of faulty documentation. 
 
 Such worries helped push down shares of Bank of America on Thursday, in their biggest one-day drop since mid-July. Wells Fargo, with its own large mortgage portfolio, fell more than 4%, as did Citigroup Inc. J.P. Morgan Chase & Co. dropped 2.8%. 
 
 The annual cost of buying five-year credit-default swap protection on $10 million of Bank of America debt rose from $155,000 on Monday to $193,000 on Thursday, with the bulk of the rise coming in the past two days, according to data provider Markit. The cost of protecting similar debt from Wells Fargo rose to $129,000 from $95,000 on Monday. 
 
 "If nothing else, this is creating uncertainty for the banks," Nomura Securities bank analyst David Havens wrote in an email. "Our take is that it could be quite negative for the banks, and the markets are waking up to this very quickly." 
 
 The latest foreclosure headache is just one in a string for owners of mortgage securities not backed by government agencies. This $1.3 trillion market has yet to fully recover from its implosion starting in 2007. 
 
 Estimates of the size of the foreclosure problem are still forming. Some $154 billion in mortgages could be affected by foreclosure delays, according to an estimate this week by Laurie Goodman, senior managing director at mortgage-bond trader Amherst Securities Group LP in New York. 
 
 Morgan Stanley trading-desk analyst Greg Gore estimated in a conference call on Tuesday that as much as $134 billion of mortgage bonds held by the nation's four biggest banks could ultimately be affected by foreclosure delays. 
 
 For now, many bond investors doubt the damage will be extensive. But wild cards remain. For starters, attorneys general in all 50 states are investigating foreclosures. 
 
 Some investors still feel burned by a 2008 settlement between attorneys general and Bank of America, after the bank bought Countrywide Financial. The bank agreed to modify mortgages, and investors say they are bearing the costs unfairly. They fear foreclosure investigations could result in mortgage modifications that once again hurt investors. 
 
 In an Oct. 7 ruling, a New York state justice dismissed a lawsuit by investors who argued they shouldn't bear any of the cost of the $8.4 billion settlement. 
 
 Mortgage-bond investors will get more information at the end of the month, when they get fresh data on cash flows from the bonds they own. But that data may only partially reflect the impact of recent foreclosure delays. 
 
 —Ruth Simon contributed to this article. 
 
 Write to Mark Gongloff at mark.gongloff@wsj.com ||||| “I don’t see how it can be cleared up in a short period of time,” said Richard X. Bove, an analyst with Rochdale Securities. “The moratorium won’t last that long but the problem will last at least four or five years, maybe a decade.” In the short term, he said, “it could easily cost $1.5 billion per quarter.” 
 
 Meanwhile, the foreclosure machinery in many states has ground to a halt. Major institutions like Bank of America, JPMorgan and GMAC Mortgage have halted foreclosures in many states, and have not said when they would resume. As a result, foreclosed homes will remain on the bank’s books while racking up thousands of dollars a month in extra costs. 
 
 Until Thursday, Wall Street regarded the foreclosure issue as a risk to the banks’ reputations, rather than their bottom lines. Indeed, some analysts insisted it was unlikely that wide-scale abuses would be found. 
 
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 “It’s inexcusable that the banks didn’t staff up to meet the surge in foreclosures,” said Christopher Kotowski, an analyst with Oppenheimer. “On the other hand, we need to look at whether they are filing foreclosures on a massive basis against people who are not delinquent. So far, I haven’t seen any evidence that they are.” 
 
 Inside the investment houses, several traders said nerves were frazzled further by worries that banks could face much bigger mortgage related losses, not from foreclosures, but because of questions about how the money was lent in the first place. If it turns out that mortgages were bundled together and sold improperly, more holders could sue the banks and force them to buy back tens of billions in mortgage-backed securities. 
 
 An alarming report on Bank of America, compiled by Branch Hill Capital, a San Francisco hedge fund, circulated widely on Wall Street on Thursday. Branch Hill suggested that the bank, the nation’s largest, could be facing more than $70 billion in losses from mortgage securities that it may have to repurchase from Fannie Mae and Freddie Mac, as well as private investors. 
 
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 “We think this is a very important issue, and the liability will be substantial,” said Manal Mehta, a partner at Branch Hill. “There has been pervasive bad behavior throughout the system.” The fund is betting that Bank of America shares could decline because of the potential liability. 
 
 Bank of America declined to comment Thursday. But the company’s chief executive, Brian T. Moynihan, said last month at an investor conference that adequate reserves had been taken to protect against any losses that could materialize if it was forced to repurchase mortgage securities. “This will be manageable over time, but it has cost us a lot of money so I’m not making light of it,” he said. “We’ll continue to manage it.” 
 
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 On Wednesday, JPMorgan said it had added $1 billion to its reserves to cover faulty home loans that it was obligated to repurchase from Fannie Mae, Freddie Mac and private insurers. It has set aside a total of $3 billion for potential repurchases. 
 
 Even if the larger losses envisioned by Mr. Mehta do not materialize, the foreclosure issue remains a worry. In a report, Paul Miller, an analyst with FBR Capital Markets, forecast that the controversy would cost the banking industry $6 billion to $10 billion. He estimated that each month’s delay cost the banks $1,000 per home loan, so if there was a three-month delay on the roughly two million homes currently in foreclosure, that translated into a $6 billion hit. 
 
 In addition to the losses directly caused by the delay, Mr. Miller foresees additional charges totaling $3 billion to $4 billion to cover lawsuits stemming from faulty foreclosure procedures. 
 
 For now, bank executives are not making any predictions how long the foreclosure halt will last. 
 
 “If you’re talking about three or four weeks it will be a blip in the housing market,” said Jamie Dimon, chief executive of JPMorgan Chase, in a conference call on Wednesday. “If it went on for a long period of time, it will have a lot of consequences, most of which will be adverse on everybody.”
– Investors sent bank stocks plunging yesterday, as they finally started to worry about the mortgage robo-signing scandal. Up until now, investors have mostly assumed the crisis would blow over. But on Wednesday, 50 states announced investigations into mortgage servicing practices, and yesterday a San Francisco hedge fund circulated a report predicting that the crisis would wind up costing Bank of America a whopping $70 billion, the New York Times reports. As a result, Bank of America fell 5.2%, its biggest drop since mid-July, Wells Fargo fell 4% and JP Morgan fell 2.8%, despite a relatively flat stock market, according to the Wall Street Journal. “I don’t see how it can be cleared up in a short period of time,” said one analyst. “The moratorium won’t last that long, but the problem will last four or five years, maybe a decade.”