On Friday two Governors of the Federal Reserve spoke out about disincentives
in the servicing industry and their impact in the foreclosure crisis. While Governor Daniel K. Tarullo referenced the issue as an aside in a Friday address on
banking reform, newly minted Governor Sarah Bloom Raskin in a separate speech took
the industry head on.
Raskin, who was appointed as a
Governor on October 4, told attendees at the National Consumer Law Center's
Consumer Rights Litigation Conference in Boston that the foreclosure picture is
grim and will probably remain so, with over four million more foreclosures expected
by the end of 2012. Now public attention
has focused on alleged robo-signing of mortgage documents. "This development is troubling on its
own," she said, "but
it also shines a harsh spotlight on other longstanding procedural flaws in
mortgage servicing."
While many may view these flaws
as trivial, technical, or inconsequential, Raskin said she sees them as part of
a deeper systemic problem. In her previous
position as the former Mary Commissioner of Financial Regulation, she witnessed infractions
such as padding of fees, strategic misapplication of mortgage payments to
servicers' fees, and inappropriate assessment of force-placed insurance with
excessively high premiums. Some
infractions threw homeowners into default and foreclosure.
Mortgage servicing in its
present form is a relatively recent Raskin said, an outgrowth of widespread
securitization. This changed the old
model from one where the entity that originated the loan also serviced it to
one where the bulk of servicers are subsidiaries or affiliates of depository
institutions or independent companies with a primary or exclusive focus on loan
services. This shift from "an originate-to-hold
model to an originate-to-distribute model is one that has never been tested in
a housing crisis like the one today.
The consolidation of
servicing has led to significant economies of scale in routine matters. The servicers
earn money through servicing fees, other fees and float interest while maximizing
profits by keeping costs down, streamlining processes, and buying servicing
rights for pools that will require little work. But the model was not designed
for the time-consuming, detailed loss mitigation on the scale needed today nor
was the payment structure. The structural incentives that influence servicer
actions, especially when they are servicing loans for a third party, now run
counter to the interests of homeowners and investors.
A foreclosure almost always
costs the investor money, but may bring the servicer additional fees while proactive
measures to avoid foreclosure and minimize investor losses cost the servicer. Loss
mitigation requires individualized case work for which costs may not be reimbursed,
and even temporary forbearance usually requires the servicer to advance
payments to the investor. "Even in
the case of a servicer who has every best intention of doing the right
thing," the bottom-line incentives are largely misaligned with everyone
else involved in the transaction, and most certainly the homeowners themselves."
Raskin said the end results
for homeowners are still unknown but the standard business model for the
industry "would seem to put a thumb on the scale in favor of
foreclosure." Today's needs require
sufficient numbers of personnel with adequate training, tools, and judgment to
deal with problems loans on a level that does not permit economies of scale. Servicers have been pledging for several
years to increase their servicing capacity, she said, and many have, but there
is plenty of evidence to suggest their workforces often lack the ability to
deal with the immensity of the crisis.
Recent events point to a
lack of strong internal procedures. More seriously recurring issues go beyond
misaligned incentives to simple bad business practices like improperly
allocating mortgage payments, obtaining unwarranted fees from unfair collection
practices; lost paperwork, and sloppy recordkeeping. The impact of poor
business practices can linger on even after the foreclosure sale. Servicers
have forced homeowners or tenants to vacate before they are legally required to
do so and servicers decide whether to repair foreclosed properly based on how
recoverable their advances will be. Raskin
said this influences neighborhood stabilization efforts at a time of persistent
decline in home values and markets already weakened by a glut of vacant and
abandoned properties.
Servicers' concerns about
the Treasury's Home Affordable Modification Program (HAMP) are well-known,
Raskin said, but not enough is known about how servicers are complying with HAMP
requirements or how well they are doing modifications outside of HAMP where the
bulk of them actually occur.
The problems grabbing
headlines recently she said are neither new nor amenable to quick fixes. Chronic problems continue to plague the
industry and, because consumers cannot choose to hire or fire their servicers
(other than by paying off the loan), the industry lacks the market discipline
imposed in other industries. The very
structure of the loan servicing industry inevitably leads to misaligned
incentives and a propensity to defer costly investments, thus a more
significant re-thinking of the basic business model must be undertaken to avoid
repeating prior mistakes.
Raskin pointed to some
attempts to address the problems. Although
foreclosure practices are a state domain, the Federal Reserve has been
expanding its expertise, first, in a review of non-bank subsidiaries in
conjunction with other state and federal regulators, and a current review of
loan modification practices by certain servicers. The Fed and other federal agencies
initiated an in-depth review of practices at the largest mortgage servicers which
focuses on foreclosure practices generally, and the breakdowns behind inaccurate
affidavits and other questionable legal documents being used in the foreclosure
process. The Fed has also gathered information from outside sources to help detect
possible systematic problems at specific servicers or within the industry at
large.
Certain firms have been
directed to assess their policies and procedures for determining whether to
foreclose and to examine their processes to determine if they comply with
relevant federal and state laws, not just in theory but in practice. Banking examiners will be on-site to review
individual loan files, evaluate controls over the selection and management of
third-party service providers, and test the assertions that the institutions
make in their self-assessments. As federal examiners typically are not experts
in state laws they need to coordinate with their state counterparts. The Federal Reserve requires that the federal banks
they supervise have adequate compliance risk management programs and that they are
being followed.
Given the potential
ramifications, it's fair to say that every relevant arm of the federal government
is taking the underlying dynamics of the mortgage foreclosure crisis very
seriously Raskin said. She hopes that
the multi-state work engaged in by the 50 state attorneys general will prove to
be a vehicle for resolving the underlying problems. To the extent that legal
settlements are structured in such a way as to generate a broader underlying
reform of servicing processes, it will be more likely that we can assure
consumers that they will not encounter other mortgage harms moving forward.
Raskin concluded, "Until
a better business model is developed that eliminates the business incentives
that can potentially harm consumers, there will be a need for close regulatory
scrutiny of these issues and for appropriate enforcement action that addresses
them."