Shares of the biggest banks tumbled Friday after a Massachussetts court ruled units of Wells Fargo (WFC) and U.S. Bancorp (USB) improperly foreclosed on two houses in a closely watched 2007 case.

The court ruled the banks failed to show they held the mortgages at the time of the foreclosures. The case has been viewed as an important test of a key strategy being employed by lawyers fighting the big banks in foreclosure cases: the argument that banks that can’t show they hold a mortgage note cannot by law take the house that secures the mortgage.

The Ibanez ruling comes at the end of what had been an upbeat week for the banks. On Monday, Bank of America (BAC) announced a settlement of mortgage-repurchase claims filed by the two big government-sponsored mortgage investors, Fannie Mae and Freddie Mac.

The bank said it would spend almost $3 billion to settle demands by the mortgage firms that it buy back loans that ran afoul of underwriting guidelines or otherwise failed to meet contractual standards. The deal was widely criticized as the latest giveaway by an administration intent on propping up the biggest banks, all of which have returned to profitability but remain painfully vulnerable to another housing downturn.

At Wells, for instance, some 60% of the bank’s loans are “tied to real estate in some way,” Guggenheim Partners analyst Marty Mosby wrote in a note to clients Friday. He rates the stock buy, contending that the market has failed to appreciate the stabilization of real estate markets.

But decisions like the one Friday threaten to complicate that dynamic, by adding to the already bulging pipeline of foreclosed houses sitting vacant in neighborhoods and rotting away on the banks’ books.

Accordingly, buyers were backing away from the bank stocks Friday, as Wells and JPMorgan Chase (JPM) each fell 3% and BofA dropped 2%.