Those Contrite Mortgage Servicers Have Plenty to Be Sorry for

Auction of foreclosed bank owned propertyExecutives from the mortgage servicing industry go before the Senate today, and they'll try to save face by apologizing for their industry's role in the foreclosure mess. One theme sure to be touched on is how the foreclosure documentation problems -- robo-signing and all -- are just 'technical' errors. Another theme will be how as servicers, the banks are caught between the homeowners and the investors, and that it's investors who are forcing the foreclosures.

But don't believe the hype: The document problems are substantive, and the servicers, not investors, are the ones with a powerful incentive to foreclose instead of modify.

According to The New York Times, Barbara Desoer, the head of Bank of America Home Loans, will announce new initiatives, including the revolutionary idea that each borrower should be assigned a single case manager, so borrowers don't get passed from employee to employee. That such a basic concept is a new initiative speaks volumes about why the millions of borrowers that Bank of America (BAC) is foreclosing on have been unable to get modifications or otherwise work things out with BofA. Similarly the Times says the head of Chase Home Loans (JPM), David Lowman, is expected to take "an apologetic stance."

Who Gets the Money?

Of course, no apology can fix the problems created by the banks' foreclosure processes. For example, hundreds, perhaps thousands, of Massachusetts foreclosures must be redone because the banks filed incomplete papers, resulting in clouded titles, reported The Boston Globe.

A different problem results when banks, presumably deliberately, are foreclosing in their own names instead of the entity that really owns the loan. Naked Capitalism reported that BofA, at least in Kentucky, has apparently taken to foreclosing in its own name instead of in the name of the securitization trust that officially owns the loan.

After such a foreclosure, who gets the proceeds? Are the security holders sure they'll get paid properly? And it's not just BofA. I've already reported on Wells Fargo (WFC) trying foreclose on a home in its own name that was really owned by Freddie Mac. I've seen papers it filed in a different case where Wells Fargo tried to foreclose in its own name, but the loan was owned by Fannie Mae.

Finally, a report from the Congressional Oversight Panel cautions that it's just too early to know what the ramifications of the foreclosure documentation problem are, but that the consequences could be "severe" enough to warrant stress testing the banks.

Servicers Profit in Two Ways

The investors-make-us-foreclose line is as specious as the one about the documentation problems. For starters, given that investors generally lose less money when a defaulted loan is modified than foreclosed, there's little reason for investors to push foreclosure over modifications. On the other hand, the economics of servicing make foreclosure infinitely more attractive to a servicer than any meaningful loan modification. As the inspector general for the TARP program (TARP includes the government's loan-modification efforts) explained in his October report to Congress, servicers make money in two ways.

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First, they get a fee that's a percentage of the mortgage's principal balance, so any modification that reduces the principal -- exactly what underwater homeowners need -- also reduces servicer income. That's why most of the modifications that servicers do finalize aren't in the government program -- because the government doesn't let them roll as many fees into principal, and it pushes to reduce the principal balance. Under their "proprietary" programs, the servicers can preserve or even increase this fee income.

Second, when servicers foreclose, they get to deduct all the accumulated fees, such as late fees, broker price-opinion fees and inspection fees, from the foreclosure's proceeds before sending the balance of the foreclosure sale money to investors. Those fees can really add up, since during trial modifications the homeowner can still be charged late fees for not paying the amounts they aren't supposed to be paying under the modification, which the TARP October report explains on page 72.

Keeping People in Their Homes

Given the financial incentives for servicers and their extraordinary inability to do basic customer service (given the "new initiative" of having one person be responsible for each loan), it's not surprising that modifications have been such a failure so far. Iowa Attorney General Tom Miller, who's also scheduled to testify, will reportedly say the state AGs are focusing more on fixing the modification process than the documentation problems. That's good news as long as the documentation problems are taken on after modifications are fixed.

Keeping people in their homes is the best possible outcome for most communities, as foreclosure can have severely damaging consequences for surrounding properties. Besides, court systems have been taking steps to defend themselves from the bad documents, for example by requiring special affirmations. So, with luck the bad document problem will be ending anyway.

One problem unlikely to come up today is just how bad the servicers are beyond their foreclosure problems. Federal Reserve Governor Sarah Bloom Raskin says she has seen servicers use "a Pandora's Box of predatory tactics that included:
the padding of fees, such as late fees, broker-price opinions, inspection fees, attorney's fees, and other fees;

the strategic misapplication of payments so that the homeowner's payments for principal and interest due on the loan were improperly applied to the servicer's fees, sometimes improperly causing the loan to be considered to be in default; and

the inappropriate assessment of force-placed insurance, with premiums of two to four times the cost of standard homeowners' insurance, which in turn caused servicers to collect these premiums before applying the payments to principal and interest, precipitating foreclosure.
So if you to tune into the political theater of today's hearing, keep in mind just how broad and deep the servicing industry's problems are, and how far we have to go to get real accountability for its tactics.

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