The second phase of the Senate Banking Committee's hearing on Problems in Mortgage Servicing from Modification to Foreclosure, held on December 1 featured two panels; one composed of federal regulators, the second by representatives of the two government sponsored enterprises (GSEs), the finance industry, and lawyers.

Phyllis Caldwell, Chief of the Department of the Treasury's Homeownership Preservation Office addressed the operations, accomplishments and safeguards of various federal anti-foreclosure programs, especially HAMP and said, because of the program's role as a loan modification facilitator it is has not been affected by the recent robo-signing and chain of title problems. However, she stressed that where servicers have failed to comply with the law, they should be held accountable.

While Treasury does not have the authority to regulate the foreclosure practices of financial institutions, it is working closely with agencies that do have such authority.  She outlined activities that the Financial Fraud Enforcement Task Force composed of 20 federal agencies, 94 U.S. Attorneys' offices and state and local participants; as well as the FHA, and Office of the Comptroller of the Currency are taking to investigate servicer behavior and foreclosure management.

The statement of Sheila C. Bair, Chairman, Federal Deposit Insurance Corporation called robo-signing just the latest symptom of persistent shortcomings in servicers' foreclosure prevention efforts.   While FDIC's reviews have revealed no evidence of robo-signing among FDIC insured state-chartered banks, the agency remains concerned about deficiencies among the larger servicers, most of which are FDIC insured.  She expressed hope that the new Financial Stability Oversight Council (FSOC) established under the Dodd Frank Act, will take the lead in addressing foreclosure documentation deficiencies and proposing a sensible and broad-based approach to reforming mortgage servicer processes. 

Bair addressed the issue of establishing rules for qualifying residential mortgages (QRMs) that would be exempted from the risk retention requirements of Dodd-Frank.  She urged that the definition include servicing requirements such as:

• Granting servicers the authority and compensation incentives to maximize the net present value of the mortgages for the benefit of all investors rather than the benefit of any particular class of investors;
• Establishing a pre-defined process to address any subordinate lien owned by the servicer or any affiliate of the servicers; and
• Requiring disclosure by the servicer of any ownership interest of the servicer or any affiliate of the servicer in other whole loans secured by the same real property that secures a loan included in the pool.

She also suggested that risk retention rules create financial incentives that promote effective loan servicing, ideally by requiring issuers to retain an interest in the mortgage pool that is directly proportional to the value of the pool as a whole, i.e. a "vertical slice" of a small, proportional share of every senior and subordinate tranche in the securitization; creating a combined financial interest that is not unduly tilted toward either senior or subordinate bondholders.

The Honorable Daniel K. Tarullo, Governor of the Federal Reserve System told the senators that Fannie Mae collected $1.6 billion in unpaid principal balances from loan originators through loan repurchase requests during the third quarter of 2010 and that the two GSEs together have another $13.3 billion in outstanding requests, $4.6 billion of which has been outstanding for more than 120 days.  At the end of the third quarter the four largest banks held $9.7 billion in repurchase reserves, most of which is intended for GSE putbacks.  He said that, while the full extent of put back exposure is hard to specify, it is the focus of supervisory oversight at some institutions and the Federal Reserve is asking institutions that originated large number of mortgages or sponsored significant MBS to assess and provide for these risks as part of their overall capital planning process.    

Other participants in Panel One of the second phase of hearings were John Walsh  Acting Comptroller of the Currency and Edward J. DeMarco Acting Director, Federal Housing Finance Agency, both of whom spoke about their agencies response to the robo-signing and loan documentation problems.

The first participants in Panel Two, Terry Edwards, Executive Vice President Credit Portfolio Management, Fannie Mae and Donald Bisenius Executive Vice President of Freddie Mac each testified about their company's role in the efforts to mitigate foreclosure and their response to the foreclosure problems among major servicers.  Each detailed the reviews they have conducted and the safeguards they have put in place to guarantee that foreclosures are conducted legally.

Kurt Eggert, Professor of Law, Chapman University School of Law told the committee that mortgage services appear to be plagued by conflicts of interest, "some they try to resolve, others they do not appear even to address."  Among the conflicts he outlined were:

• The risk of falling prey to "tranche warfare," where one tranche of investors can claim they are acting to benefit one class of investors to another's detriment, a situation made worse where servicers are also originators holding an interest in the securitization.

• The investor's main hope of repayment is from foreclosure and sale of the collateral and servicers add junk fees to the process and recoup them through foreclosure, thus taking money directly from investors.

• Investors must depend on servicers to recoup damages from securitizers under reps and warrants and servicers are subsidiaries of the entities that would provide the putbacks.

• Servicers that are subsidiaries of banks that also hold second liens are the property. A recent study showed that the four largest banks own 56.2 percent of the servicing industry and approximately 43 percent of the second loans outstanding.

Eggart said that regulators have tried to encourage servicers to make reasonable loan modifications, "begging them and bullying them and even paying them."  Even fining them, he said, has not worked.  "What is needed now is a thorough investigation of servicer behavior by someone with the power to demand to see their books, to review their processes and their fee structure, to see why they are failing to modify loans that could help investors, and to demand specific changes."  He also advocated that a consumer protection agency be allowed to write regulations and rein in servicer abuses and that servicers should be nationally licensed, regularly audited, and required to explain and document their fee system, their loan modifications and their foreclosure process."

The final panelist, Tom Deutsch, is executive director of the American Securitization Forum which represents parties engages in all aspects of mortgage securitization.  Deutsch addressed claims, largely those raised by Adam J. Levitin Associate Professor of Law, Georgetown University Law Center who had, in testimony during the first phase of the hearing, questioned the legal right of many trusts to foreclose on loans.  Deutsch said that his organizations research has verified that the loans meet the four key components of valid loan transfers including

• Meeting the requirements for a complete or unbroken chain of endorsement,
• Complying with New York trust law,
• Effectively achieving REMIC status, and
• That any mistakes do not affect the validity of transfer.