Subprime Servicing Getting Worse?

Wall Street is watching closely to see what, if any, “ripple effect” the problems in the subprime market will have on other credit markets. It is also watching to see what effect the market meltdown will have on subprime servicing. Financial troubles, staff layoffs and potentially higher servicing costs on defaulting loans have led to concerns that servicing quality may decline.

SUBPRIME SERVICING QUALITY MAY DECLINE!! This is really bad news for homeowners in bankruptcy where mortgage loan servicing is already abysmal. Of course, according to servicers and their attorneys it’s not really their fault. It’s those darn pesky computers that keep giving them incorrect information.

Apparently, part of the problem is that the Mortgage Servicing Package (MSP)—“banking industry’s most widely used servicing system”—and other loan servicing programs can’t accurately credit the debtor’s and trustee’s post-petition payments. As a result, a “bankruptcy specialist” at the loan servicer must make manual adjustments to the account. Manual adjustments? According to MSP’s proprietor, Fidelity National Information Systems, its system can create additional cross-selling opportunities, place mass or individual letter requests, automate loss mitigation, utilize suspense management functionality (more on this in another post), and integrate with taxing authorities, insurance providers, credit report bureaus, and MERS. But, according the court in In re Nosek, 2007 WL 682581 (Bankr. D. Mass. Mar. 6, 2007), it can’t properly bill a chapter 13 debtor, provide an accurate account statement, or correctly apply payments from the chapter 13 trustee.

The problem, of course, is that servicers and their software providers have no real incentive to write a bankruptcy software module to properly account for payments made by debtors and chapter 13 trustees. After all, debtors in bankruptcy rarely have the resources to do battle with sophisticated national financial institutions and their attorneys. Maybe Judge Rosenthal’s award of $500,000 in punitive damages in Nosek will scare servicers straight. Or maybe sanctions against servicers’ bankruptcy counsel will prompt some response. See, e.g., In re Allen, 2007 WL 115182 (Bankr. S.D. Tex. Jan. 9, 2007)(finding sanctions were warranted against Countrywide’s counsel, Barrett Burke Wilson Castle Daffin & Frapier, LLP, based on, among other things, false allegations in “computer generated pleadings”). Then again, maybe not. As Judge Steen noted in Allen, "after two warnings and a $65,000 monetary sanction the Court is at a loss to determine the appropriate sanction in this case. If the prior warnings and sanction have not worked, what would?" (We'll find out Thursday, March 22, at the hearing on sanctions.)

Until there is a computer fix for this problem, we'll just have to keep doing things the old-fashioned way. But wait, with all the staff layoffs in the subprime industry who is going to make all the manual adjustments necessary to properly apply payments for homeowners already in chapter 13? And, what about all the homeowners headed to chapter 13 because of unaffordable subprime loans? Mortgage servicing in bankruptcy was bad before, the collapse of the subprime market will only make it worse.