Another Fed Governor Calls Servicer System "Misaligned"

by devteam November 15th, 2010 | Share

On Friday two Governors of the Federal Reserve spoke out about disincentivesrnin 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 onrnbanking reform, newly minted Governor Sarah Bloom Raskin in a separate speech tookrnthe industry head on.</p

Raskin, who was appointed as arnGovernor on October 4, told attendees at the National Consumer Law Center'srnConsumer Rights Litigation Conference in Boston that the foreclosure picture isrngrim and will probably remain so, with over four million more foreclosures expectedrnby the end of 2012.  Now public attentionrnhas focused on alleged robo-signing of mortgage documents.  “This development is troubling on itsrnown,” she said, “butrnit also shines a harsh spotlight on other longstanding procedural flaws inrnmortgage servicing.”</p

While many may view these flawsrnas trivial, technical, or inconsequential, Raskin said she sees them as part ofrna deeper systemic problem.  In her previousrnposition as the former Mary Commissioner of Financial Regulation, she witnessed infractionsrnsuch as padding of fees, strategic misapplication of mortgage payments tornservicers' fees, and inappropriate assessment of force-placed insurance withrnexcessively high premiums.  Somerninfractions threw homeowners into default and foreclosure. </p

Mortgage servicing in itsrnpresent form is a relatively recent Raskin said, an outgrowth of widespreadrnsecuritization.  This changed the oldrnmodel from one where the entity that originated the loan also serviced it tornone where the bulk of servicers are subsidiaries or affiliates of depositoryrninstitutions or independent companies with a primary or exclusive focus on loanrnservices.  This shift from “an originate-to-holdrnmodel to an originate-to-distribute model is one that has never been tested inrna housing crisis like the one today.  </p

The consolidation ofrnservicing has led to significant economies of scale in routine matters. The servicersrnearn money through servicing fees, other fees and float interest while maximizingrnprofits by keeping costs down, streamlining processes, and buying servicingrnrights for pools that will require little work. But the model was not designedrnfor the time-consuming, detailed loss mitigation on the scale needed today norrnwas the payment structure. The structural incentives that influence servicerrnactions, especially when they are servicing loans for a third party, now runrncounter to the interests of homeowners and investors. </p

A foreclosure almost alwaysrncosts the investor money, but may bring the servicer additional fees while proactivernmeasures to avoid foreclosure and minimize investor losses cost the servicer. Lossrnmitigation requires individualized case work for which costs may not be reimbursed,rnand even temporary forbearance usually requires the servicer to advancernpayments to the investor.  “Even inrnthe case of a servicer who has every best intention of doing the rightrnthing,” the bottom-line incentives are largely misaligned with everyonernelse involved in the transaction, and most certainly the homeowners themselves.”rn</p

Raskin said the end resultsrnfor homeowners are still unknown but the standard business model for thernindustry “would seem to put a thumb on the scale in favor ofrnforeclosure.”  Today's needs requirernsufficient numbers of personnel with adequate training, tools, and judgment torndeal with problems loans on a level that does not permit economies of scale.  Servicers have been pledging for severalrnyears to increase their servicing capacity, she said, and many have, but therernis plenty of evidence to suggest their workforces often lack the ability torndeal with the immensity of the crisis. </p

Recent events point to arnlack of strong internal procedures. More seriously recurring issues go beyondrnmisaligned incentives to simple bad business practices like improperlyrnallocating mortgage payments, obtaining unwarranted fees from unfair collectionrnpractices; lost paperwork, and sloppy recordkeeping. The impact of poorrnbusiness practices can linger on even after the foreclosure sale. Servicersrnhave forced homeowners or tenants to vacate before they are legally required torndo so and servicers decide whether to repair foreclosed properly based on howrnrecoverable their advances will be.  Raskinrnsaid this influences neighborhood stabilization efforts at a time of persistentrndecline in home values and markets already weakened by a glut of vacant andrnabandoned properties. </p

Servicers' concerns aboutrnthe Treasury's Home Affordable Modification Program (HAMP) are well-known,rnRaskin said, but not enough is known about how servicers are complying with HAMPrnrequirements or how well they are doing modifications outside of HAMP where thernbulk of them actually occur. </p

The problems grabbingrnheadlines recently she said are neither new nor amenable to quick fixes.  Chronic problems continue to plague thernindustry and, because consumers cannot choose to hire or fire their servicersrn(other than by paying off the loan), the industry lacks the market disciplinernimposed in other industries.  The veryrnstructure of the loan servicing industry inevitably leads to misalignedrnincentives and a propensity to defer costly investments, thus a morernsignificant re-thinking of the basic business model must be undertaken to avoidrnrepeating prior mistakes. </p

Raskin pointed to somernattempts to address the problems.  Althoughrnforeclosure practices are a state domain, the Federal Reserve has beenrnexpanding its expertise, first, in a review of non-bank subsidiaries inrnconjunction with other state and federal regulators, and a current review ofrnloan modification practices by certain servicers. The Fed and other federal agenciesrninitiated an in-depth review of practices at the largest mortgage servicers whichrnfocuses on foreclosure practices generally, and the breakdowns behind inaccuraternaffidavits and other questionable legal documents being used in the foreclosurernprocess. The Fed has also gathered information from outside sources to help detectrnpossible systematic problems at specific servicers or within the industry atrnlarge. </p

Certain firms have beenrndirected to assess their policies and procedures for determining whether tornforeclose and to examine their processes to determine if they comply withrnrelevant federal and state laws, not just in theory but in practice.   Banking examiners will be on-site to reviewrnindividual loan files, evaluate controls over the selection and management ofrnthird-party service providers, and test the assertions that the institutionsrnmake in their self-assessments. As federal examiners typically are not expertsrnin state laws they need to coordinate with their state counterparts.  The Federal Reserve requires that the federal banksrnthey supervise have adequate compliance risk management programs and that they arernbeing followed. </p

Given the potentialrnramifications, it's fair to say that every relevant arm of the federal governmentrnis taking the underlying dynamics of the mortgage foreclosure crisis veryrnseriously Raskin said.  She hopes thatrnthe multi-state work engaged in by the 50 state attorneys general will prove tornbe a vehicle for resolving the underlying problems. To the extent that legalrnsettlements are structured in such a way as to generate a broader underlyingrnreform of servicing processes, it will be more likely that we can assurernconsumers that they will not encounter other mortgage harms moving forward. </p

Raskin concluded, “Untilrna better business model is developed that eliminates the business incentivesrnthat can potentially harm consumers, there will be a need for close regulatoryrnscrutiny of these issues and for appropriate enforcement action that addressesrnthem.” </prn

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About the Author


Steven A Feinberg (@CPAsteve) of Appletree Business Services LLC, is a PASBA member accountant located in Londonderry, New Hampshire.

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