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The Fed on Mortgage Servicing

posted by Adam Levitin

I had the privilege today of hearing Federal Reserve Board Governor Sarah Bloom Raskin deliver the keynote address to the Section on Financial Institutions at the American Association of Law Schools Annual Meeting.  Governor Bloom Raskin's topic: mortgage servicing, which is not something the Fed has previously addressed.  I strongly commend her speech to you. It's rare to see a bank regulator invoke Shakespeare to great effect, as she does, but it's much more important for some of the other things she says:

This wave of foreclosures is one of the factors hindering a rapid recovery in the economy. Traditionally, the housing sector, buoyed by low interest rates and pent-up demand, has played an important role in propelling economic recoveries. The increase in housing sales and construction often is accompanied by purchases of complementary goods, like furniture and appliances, which magnify the effect of the housing recovery.

However, six years after house prices first began to fall, the pace of the economic recovery remains slow. Nationally, house prices have fallen by nearly one-third since their peak in the first quarter of 2006, and total homeowners' equity in the United States has shrunk by more than one-half--a loss of more than $7 trillion. The drop in house prices has had far-reaching effects on families, neighborhoods, small businesses, and the economy, in part because so many American families--more than 65 percent--own their homes. The fall in house prices has caused families to cut back on their spending and has prevented them from using their home equity to fund education expenses or start small businesses. The decline in house prices has also impeded families from benefiting from the historically low level of interest rates, as perhaps only half of homeowners who could profitably refinance have the equity and creditworthiness needed to qualify for traditional refinancing.

This is a really important set of points. They shouldn't sound new to Credit Slips readers, but it's really important to have a Fed Governor saying them.  

This is the Fed saying that foreclosures are having a macroeconomic impact. One point that we haven't previously emphasized, but which is obviously of critical importance to the Fed, is that the foreclosure crisis is impeding the Fed's ability to restart the economy because it interferes with monetary transmission. The Fed's basic tool for heating up the economy is to lower interest rates. Consumers with negative equity or damaged credit can't take advantage of lower rates. So if the Fed wants to do its job using its traditional tools, it has to do something about the housing sector. And no matter how the Fed staff's recent report to Congress reads, the truth is there's no way to dance around the big problem of the $700B in negative equity. (The NY Fed recently made some noise in this direction.) We can nibble around the edges, but we just aren't taking the housing sector or the economic recovery seriously unless we address negative equity in a strong and convincing fashion. That will take tools that are not in the Fed's traditional kit, and the servicing fraud investigation is by far the best leverage for pushing through changes in housing. 

[btw, I commend Yves Smith's analysis of the Fed staff's report, as well as her commentary on the NY Fed speech. To summarize, it recites conventional thinking circa 2009--which is major progress for the Fed, sadly--and reads like a report cobbled together by economists who have no connection with the realities of the housing market. (Not that this is a new critique of either economists or the Fed. Say what you will about lawyers, but they tend to pay attention to institutional arrangements and practical issues. But this is a symptom of a larger problem of government policy-making in many areas moving from lawyers to economists.)  In particular, blathering on about bulk sales of REO to be turned into rentals shows a real disconnect with the market.  There's been only one firm that's been buying REO to turn into rental on any scale, Carrington (yes, that same Carrington that Rich Cordray, then Ohio AG, sued in 2008 and which has been screwing MBS investors to boot), and you'd better believe that they're cherrypicking, not doing bulk buys.  There's just no market demand for purchasing hundreds of dispersed single-family detached residences for rental because of the uncertainties or unworkabilities of the economics.]  

Governor Bloom Raskin also emphasizes that the foreclosures reviews are only step one.  There will also be monetary penalties.  Take note of the sentence I underlined below, that the penalties must be large enough to incentivize good behavior (and disincentivize bad behavior).  

The enforcement actions against these 14 institutions and the associated corrective action plans are only a start in a comprehensive enforcement response to the foreclosure crisis. Monetary penalties for the deficient practices in mortgage loan servicing and foreclosure processing also must be imposed against the 14 institutions. The Federal Reserve and other federal regulators must impose penalties for deficiencies that resulted in unsafe and unsound practices or violations of federal law, just as state banking commissioners and state attorneys general impose penalties for violations of state law. The Federal Reserve believes monetary sanctions in these cases are appropriate and plans to announce monetary penalties. One purpose of monetary penalties, when they are appropriately sized, is to incentivize mortgage servicers to incorporate strong programs to comply with laws when they build their business models. This is an operational purpose, but as mentioned earlier, monetary penalties also remind regulated institutions that non-compliance has real consequences; the law is not a scarecrow where the birds of prey can seek refuge and perch to plan their next attack.

If the Fed takes this seriously, then the penalties must (1) include disgorgement of all illegal servicing profits--something the CFPB calculated at around $24 billion, (2) include a penalty on top of that so that non-compliance with the law is not just revenue neutral, but revenue negative.  In other words, this is a clear is the benchmark by which the Fed and OCC must be judged.  If the penalty is a few hundred million, it's laughable.  And even a billion or two isn't in the ballpark. Consider the wrongdoing described by Governor Bloom Raskin:

a wide range of troubling issues, such as claims of missing or forged promissory notes; claims that mortgage servicers have foreclosed on the houses of active-duty U.S. soldiers who are legally eligible to have foreclosures halted; sworn affidavits containing false "facts" that homeowners were in arrears for amounts not yet due; claims of falsifications of documents required to transfer ownership of the mortgage; allegations of false affidavits claiming homeowners owe fees for services never rendered; and claims of false affidavits overstating how much homeowners are behind on their payments.

I was also glad to see Governor Bloom Raskin take note of the need for transparency in the federal review. 

It is also worth noting the obvious, which is that Congress enacted some of the laws that are allegedly being violated--they are public laws. Their efficacy must be evaluated and re-evaluated by the public. This means that enforcement of laws must occur in a manner that permits an appropriate public evaluation. There is currently a lively debate about the appropriateness and value of transparency regarding the regulatory remediation required by the enforcement actions entered into with the 14 mortgage servicers. The fact that this public debate is occurring is entirely appropriate, and underscores the importance that Americans place on enforcement in the mortgage servicing context.

The cease and desist orders against the 14 large mortgage servicers are publicly available; they have been fully disclosed. The corrective actions that the mortgage servicers are undertaking pursuant to the enforcement actions in an appropriate format also need to be shared with the public. Not only is the public directly and significantly affected by how the acts of mortgage servicers have contributed to the state of the economy, but cities, neighborhoods, and communities have a direct and significant interest in the role that mortgage servicers play in the value of a homeowner's investment.

To this I would add that it's not enough for us to know what corrective actions are being taken.  We also need to know exactly what the "independent" review finds for each servicer.  This cannot be done with the secrecy that typically accompanies bank regulation.  Sunlight is a necessary disinfectant here. 

The Fed has not yet released the engagement letters for the "independent" reviewers of its regulated entities. I am hopeful that they will be more transparent than the OCC's when released--it's inexcusable that the conflicts of interest sections and indemnification sections in the OCC letters were redacted so they can't be evaluated.

Indeed, as I've been thinking more about the independent reviews, I'm particularly troubled:  many of the entities doing the reviews are staffed by former bank regulators.  The servicing violations aren't something new. They've been going on for some time. But bank regulators never caught them. The bank regulators were asleep at the switch and only got in the game after the banks themselves voluntarily stopped some foreclosures and major scandal broke. So now we have some of the former cops who dropped the ball reviewing the banks on that very issue. Another turn of the revolving door. I'm shocked, shocked.  

While I get that "Requiring an independent review of certain banking operations is not a new enforcement tool," I don't understand why the bank regulators don't just do the work themselves and make the banks pay for it. That would make me feel far better about the conflicts.  

Let me end on an upbeat note.  I was particularly heartened to hear this line:  

Too many of the practices in the mortgage servicing industry have been developed and defended solely on the basis of "standard industry practice," but many practices were not only standard, but shoddy. This has proven true, I might add, on the underwriting and secondary-market sides of the business, and we are seeing courts reject many of those practices.

This is phrased rather obliquely, but I took it as a subtle endorsement of Ibanez, Levaya and other lower court rulings.  Perhaps I'm overreading, but I don't think so.  (Indeed, I think there was a lot in this speech that doesn't meet the eye in terms of references to inside-baseball things.)  Which brings me to a final point.  Something that is often not transparent to the outside world is that there are a range of opinions on regulatory issues, including mortgage servicing, within federal agencies. Servicing problems are not a new issue to Governor Bloom Raskin.  It is something she addressed aggressively as Maryland Commissioner for Financial Institutions, and she gets it. And while Governor Bloom Raskin was technically speaking for herself, that's not how Fed Governors operate; the Fed is really careful about messaging. When Governors give speeches, they are quite careful in what they say, as they are really speaking for the Fed.

The Fed has been far from perfect in terms of bank regulatory policy and consumer protection in the past. But what a difference we have here between the Fed and the OCC. I can't imagine the Comptroller making this speech. Let's hope that Governor Bloom Raskin's voice is one that is heeded more broadly in the federal agencies. 

Comments

Do we really trust that the regulators who were grossly negligent in their oversight the first time around will do their jobs this time?

I do not buy it for one second.

grossly negligent is the operative term. Now, Mr. Levitin, I do not need to read any more on how unfair, out of touch, negligent, etc. the regulators and lenders were. Nor do I need to hear another complicit Fed governor reference the term "lax underwriting" . I think lendign that literally destroys the banking system sendign rates to zero is a good deal more serious than just lenders being "lax." try gross systemic negligence. Instead, I would like to see you help bring legal action (in the courts) since lawmakers, bankers, and our fine executive branch are busy defending themselves and deflecting attention by creating "voluntary" programs that do not work nor adress the problem. Ms Coakley seems to understand what went on and is willing to bring it to court. why dont you help. I am not a lawyer or expert but know there were many victims and clearly injustice. What abot FTC section 5, how about gross systemic negligence, or massive appraisal fraud (lenders advertise USPAP compliant appraisal but fail to reveal "undue stimulus" in the form of "lax underwriting")will any of these work and, if not, why not?

I guess she was appointed because of her focus on this kind of issue but I don't think she speaks for the Fed as a whole as it is presently constituted.

I also don't think investigation / prosection of mortgage servicing fraud is favorable or terribly relevant to the economics of housing. First, enforcing law is a good thing in and of itself so does not need further jutification in terms of a strained short-term economic argument. Second, fixing mortgage servicing has only a speculative or attenuated connection to negative equity and, wadr, negative equity is not a problem for very many homeowners; debt service struggles are more of a problem. Last, fixing mortgage servicing makes it more expensive and that most likely will make mortgage lending more expensive, which isn't going to have a positive sectoral or macroeconomic effect as the parargraph that begins "This is the Fed saying" seems to suggest. Again, broken things should be fixed, wrongdoers should be punished, but those principles obtain regardless of s/t macro- economic arguments.

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