Federal Deposit Insurance Corporation Chairperson Sheila Bair told an audience in Washington on Tuesday that the current "robo-signing" situation underscores how wrong things went in the financial crisis and that there is still a lot of work to do.
Robo-signing refers to recent reports that servicers are relying on shoddy documentation and skirting legal procedures in some states, foreclosing on properties without sufficient authority or even reading the relevant documents. These reports have led three large money center banks to temporarily halt foreclosures and the sale of owned real estate as the attorneys generals of the majority of states have called for a nationwide moratorium.
Bair told the Urban Land Institute that the robo-signing issue also points to the poorly aligned incentives that have existed in the mortgage servicing business. Pricing of mortgage securitization deals have resulted in inadequate funding and staffing of servicers, making it difficult for them to address problems. In addition, the frequent practice of requiring servicers to advance principal and interest payments to the securitization trusts for nonperforming loans while they quickly reimbursing them for their foreclosure costs has had the effect of accelerating foreclosures while discouraging modifications. Foreclosure is a costly, unpleasant, and emotional process, she said. It hurts communities and families alike and should be a last resort; loan modifications should be considered whenever possible. "Foreclosure should only come after careful thought, thorough analysis, and good documentation."
In response to these systemic problems, Bair said that the FDIC has recently adopted a new rule on securitizations which requires that the issue of servicer incentives be addressed in order to obtain safe-harbor status. New agreements must provide servicers with the authority to act to mitigate losses in a timely manner and modify loans in order to address reasonably foreseeable defaults. "The agreements," she said, "must require the servicer to act for the benefit of all investors, not for any particular class of investors. The new rule also strictly limits the number of advances the servicer must make to three months unless there is a way to promptly repay the servicer short of foreclosing and selling the home.
FDIC's authority is limited to imposing this rule on banks, but Bair said that the Dodd-Frank financial reform law provides an opportunity to improve incentives across the market. "Dodd-Frank requires regulations governing the risk retained by a securitizer. Those regulations may reduce the standard 5 percent risk-retention where the loan poses a reduced risk of default."
While an initial review indicates that FDIC supervised non-member state banks did not engage in robo-signing and have limited exposure to the current situation, Bair said her agency continues to closely monitor the problem and is working with other regulators through its backup examination capacity where the FDIC is not the primary federal regulator. FDIC is also requesting certifications from loss share participants in failed bank transactions that their foreclosure activity complies with all legal requirements.
Bair said that servicing plays an important role in mitigating the incidence of default and that new regulations should addressed the need for servicer reform. "We want the securitization market to come back," she said, "but in a sustainable manner. Its return should be characterized by strong disclosure requirements, high-quality loans, accurate documentation, better oversight of servicers, and incentives to assure that servicers act to maximize value for all investors.
Bair also spoke to the audience about challenges in commercial real estate where, she said, average prices are down by 30 to 40 percent from peak levels of 2007 and rents continue to drop. Credit availability has been limited as lenders have tightened standards, the commercial mortgage-backed securities market has virtually disappeared, and the credit standing of many borrowers has declined. She said that FDIC holds about half of the $4.5 trillion in CRE loans currently outstanding so her agency has been focusing on this market for a long time.
Federal regulatory agencies issued guidance last fall on how banks should confront the choices they have to make when some loans with significantly reduced collateral values come up for renewal. This, she said was an important step to reduce uncertainty as to how restructuring efforts would be viewed and reported for regulatory purposes. Some have criticized these loan workouts as a policy of "extend and pretend," she said, but "the restructuring of commercial real estate loans around today's cash flows and today's low interest rates may be preferable to the alternative of foreclosure and the forced sale of a distressed property. And going forward, as is the case with residential mortgage lending, we need better risk management and stronger lending standards for bank and nonbank originators to help prevent a recurrence of problems in commercial real estate finance."
Bair said that she believes that, for now, continued federal involvement in mortgage lending is needed to keep credit flowing on reasonable terms to the housing market as the economy and the financial system recover. But going forward, there needs to be a broader debate about the future role of government in mortgage finance and the housing sector.
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