One of the year's most chilling reads comes from an unexpected source: the Congressional Oversight Panel. In language both dry and dramatic, the report makes it clear that the mortgage mess is metastasizing and that it could again bring the American financial system to its knees.

The under-the-radar report didn't garner headlines, but it's must-reading for policymakers and taxpayers. Debate should be starting now over how to head off a second bailout, or how to improve upon the first one if necessary.

Bad loans made to borrowers who couldn't pay are only a part of the mortgage problem, according to the Nov. 16 congressional report. The financial industry's failure to abide by basic legal requirements in transferring mortgage loans -- a process often rushed as loans were bundled to sell to investors during the housing bubble's heyday -- also has cancerous dangers.

Without proper documentation, it's difficult to establish ownership of the various pieces of bundled mortgages that have been bought and sold. That has far-reaching consequences, none of them good. "Clear and uncontested property rights are the foundation of the housing market. If these rights fall into question, that foundation may collapse,'' the report's authors conclude.

Such a breakdown might mean that lenders foreclosing on delinquent borrowers don't have the paperwork to prove ownership -- recent "robo-signing" scandals involved foreclosures without proper records. Multiple banks with faulty records might try to foreclose on the same house. Those trying to buy or sell a foreclosed home may also find themselves in limbo. An already destabilized housing market could go into total free fall, something that should concern those who are able to make their house payments.

Shoddy recordkeeping may also mean that banks still own millions of mortgages they thought they had sold, resulting in billions of dollars of losses. As if all this weren't frightening enough, the report notes another risk. Investors who bought the bundled loans often were given assurances about their quality. Banks that misrepresented the loans might have to buy loans back. Just one investor-led action could force the Bank of America to buy back up to $47 billion of troubled loans.

While the report avoids fear-mongering by offering best- and worst-case scenarios, it's clear that panel members were rattled by what they uncovered. It's still unknown how widespread the noncompliant-recordkeeping problem is, but the report understandably concludes that the American financial system is in "a precarious place.''

A nation that thought it had handled the mortgage meltdown already now needs to face a grim reality. It's possible under worst-case scenarios that some big banks will need another cash infusion. It's much more likely they'll need legislation to legitimize controversial, privately run documentation practices that electronically bypassed traditional transfer recording offices.

This time, any type of bailout -- whether it's straight cash or a new bill the industry wants -- absolutely must be tied to industry changes that keep families who can pay in their houses while legally unsnarling the foreclosures of those who cannot. The industry is floundering on its own at this. Straightening out and expediting this bogged-down process will help reduce the glut of foreclosed properties dragging down everyone's home values.

Two nationally respected Minnesota mortgage crisis experts -- Prentiss Cox and Claire Hill of the University of Minnesota Law School -- have proposed intelligent solutions (described in a commentary today on the facing page). In exchange for measures the industry needs to establish loan ownership, lenders would be required in some cases to modify mortgages. Other key components: transparent and standardized loan modification formulas, as well as temporary specialized courts to administer loan modifications and handle titles. The plan laudably allows banks to recoup some money if a home with a modified loan appreciates in value and then is sold. That may make banks more willing to reduce the loan amount. It also means homeowners with modified mortgages may wind up paying some of their original loan back -- the fair thing to do.

The mortgage meltdown is complex, but it's not an unsolvable mess. Lawmakers have experience dealing with this industry and this issue. They have thoughtful experts like Hill and Cox ready to help. Mortgage Meltdown 2.0 doesn't have to be. The nation's leaders just need to lead.