What the Mortgage Mess Settlement Proposal Really Means

Now that I've had a chance to read the mortgage mess settlement proposal I realize what it really is: a repudiation of the servicing industries' standard business practices.

Thankfully, it includes a couple provisions I was concerned were absent. Servicers have to show their math when announcing if a modification is denied, so the consumer can challenge the calculation, and foreclosures will no longer start with incomplete or fraudulent documentation. Those steps buttress other good provisions: banning foreclosures while modifications are negotiated and tried, and making trial modifications permanent after three payments.

While I'm glad those provisions are in the document, the term sheet is nonetheless pathetic. Repudiating the servicing industry's business model mostly means telling servicers they can't break the law and must act with basic good faith, such as crediting payments as of the day they were received and charging only one late fee for a late payment. As a result, the agreement reads as an indictment -- not just of the servicing industry, but also of law enforcement, regulators and Congress.

A Minimum Demand, Not a "Wish List"

It's not surprising that a public company focused on generating profits for shareholders and obscene pay packages for its executives would, when faced with a money-losing business line like mortgage servicing, cut every corner and exploit every possible advantage to turn it profitable -- even to the point of routine illegality, bad faith and unfair dealing. Or rather, it's not surprising that it would try; what is surprising is that government would let it succeed.

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Government has to play that watchdog role because what power does a single consumer have against a corporate Goliath? Particularly when that consumer has been stigmatized, and usually unfairly, as a "deadbeat". The situation has been particularly bad because so few can afford attorneys -- and when they are involved, attorneys aren't consistently awarded attorneys fees for their fraud-exposing efforts. Balancing out the radically unequal, structurally unavoidable distribution of power between borrower and mortgage servicer should be the job of the triumvirate of law, regulation and law enforcement.

But that trio has so far failed, given the impunity with which the servicing industry has operated its illegal, abusive business model. That abuse also makes a powerful, well-funded Consumer Financial Protection Bureau a consumer's last, best hope. It's also why it's crucial people not buy into the idea that this term sheet is a "wish list" that gets negotiated away from, as I did when I read the first media reports. This term sheet must be seen as the opposite: a minimum demand.

Better Enforcement Needed

Indeed, the term sheet must be strengthened, primarily its enforcement and principal reduction sections. The term sheet mostly amounts to insisting servicers obey the law -- so unless real teeth are added, why would anyone expect them to obey the law this time? In fact, Tom Adams at the blog Naked Capitalism notes that the proposal is a rehash of a 2003 settlement between subprime servicer Fairbanks and the Federal Trade Commission that was supposed to guide the servicing industry. I guess the industry didn't get the memo.

I mean, the servicers haven't even been honest during these negotiations: A consumer bankruptcy attorney who discussed some issues at length with the AG's executive committee was asked for evidence of current servicer misconduct. The servicers had told the committee that no one misapplied payments, charged multiple late fees for a single late payment or did any of several other abusive practices anymore. They insisted all that had stopped two years ago. But since these practices are still common, the attorney had no problem producing the evidence. (And these seemingly pathological liars have law firms that boast of "a deep and invaluable reservoir of credibility with courts, prosecutors and regulatory agencies nationwide.")

Who knows what other lies the servicers are telling? To stop servicer abuses, terms like those in the agreement will have to be enforced, especially giving borrowers the right to sue to enforce the agreement.

Reduce Mortgage Principal to a Home's Market Value

As for principal reductions: well, as punishment for the sevicers' lawlessness and the banks' role in inflating the housing bubble to feed the securitization machine, every underwater mortgage should have its principal reduced to current market value, without tax consequences to the homeowner, full stop. Force the banks to make investors whole when necessary; force the banks to pay the homeowners' income tax bills on the forgiven principal. Paying executives' tax bills is a common practice, after all.

The full power of the government must be brought to bear on the miscreant companies this term sheet is targeting -- to force them to heel and submit to a stronger version. Hold the sword of those so-richly-deserved financial penalties so close to their corporate necks that they capitulate. And if they don't capitulate, prosecute. Coerce them like the feds coerce criminals all the time: cooperate or we'll throw the book at you.

Mortgage Servicers Lie

So what does the term sheet expose about the lawlessness and abusiveness of the servicing industry's business model, that justifies such harshness?

First, the industry routinely lies to borrowers and courts.

How do we know? The term sheet says the banks' word is no good: every foreclosure -- to the maximum extent possible in nonjudicial states -- must be backed up by sworn statements. What must the servicers swear to? The basics: how much is owed, who owns the loan and efforts to avoid foreclosure via modifications or other steps.

And just how profoundly have the servicers been lying? Servicer dishonesty is so extreme that it's not enough to demand affidavits. The term sheet says:

Seriously, the lying was so bad they're telling the servicers to obey the law and not commit perjury.

Indeed the whole of section I.A. is the affidavit equivalent of a first grade civics lesson: Nothing fancy, just basic framework and rules. The person signing the affidavit has to know the information is true; the affidavit has to be complete, with any documents relied on attached; the person has to actually sign the document with a pen and date it; and the person's job title and employer have to be accurate ( so Lender Processing Services employees can't pretend to be vice presidents of a bank). Finally, the servicer has to take back all the fraudulent documents its already filed and, if it ever files another one, it has to tell the borrower.

It's offensive the big banks need to be told this stuff.

The Borrower is Nobody's Customer

Second, the term sheet means the industry's totally incompetent at the basics of mortgage servicing. Consider section I.B., which contains such basics as:

"Servicer shall... ensure accuracy and timely updating of borrower's account information, including posting of payments and imposition of fees. Servicer shall also maintain adequate documentation, including maintenance of the original loan files."

They need to be told to do that?

Or consider this provision: 45 days before starting a foreclosure, the servicer has to give the borrower "an itemized, plain language account summary identifying payments made, period of delinquency, late fees, and advances assessed...for at least the previous 36 months, along with a statement of the total amount needed to reinstate or bring the account current." John, a foreclosed-on Arizonan I profiled last November, would have given a lot for such a statement. But he never could get the bank to tell him what it was doing with his payments. You'd think it would be as simple as calling up a screen and hitting print. But it's so revolutionary it has to be part of a settlement term sheet.

The fact that servicers have been incompetent at keeping good records and communicating with borrowers effectively reflects the industry's structure: The borrower is nobody's customer, so why worry about the quality of the service? Servicers are paid by the banks that hire them. And those banks don't seem to care about the quality of their servicers' work, as HSBC's refusal to be accountable for its servicers' fraudulent foreclosures shows. The borrower has no ability to force a change in servicer, no control over who is picked. The borrower's powerlessness is again a core reason the term sheet is an indictment of government, and why America needs a strong and well-funded Consumer Financial Protection Bureau.

Really, Servicers Must Obey the Law

The section called "Documentation of Note, Holder Status and Chain of Assignment" also speaks to servicers' abysmal record-keeping and dishonesty.

It requires a foreclosing servicer to do something they've routinely failed to do: produce a copy of the note with all the correct endorsements and explain why it has the right to foreclose. The servicer also has to identify the "location of the original note, mortgage, and any interim assignments and/or allonges". (Incidentally, "and/or allonges" is disturbing, since allonges are supposed to be affixed to the original note.)

Perhaps realizing servicers won't be able to do this for potentially millions of properties, the term sheet says if any of the key documents aren't available, "Servicer shall comply with applicable law in any attempt to establish ownership of the note and the right to enforcement." Again with the "you must follow the law." Recognizing that servicers might find it most convenient to suddenly find none of the documents available, the term sheet continues, "Servicer shall be prohibited from intentionally destroying or disposing of original notes or like documents."

Another "you must follow the law" provision is II.E, which says servicers shall comply with the "Servicemembers Civil Relief Act (SCRA) and any applicable state law offering protections to servicemembers."

Rejecting the Business Model

The third thing that pops out from these pages is how many standard industry practices have had to be specifically prohibited.

A biggie: "2.k.8. Servicer's employees shall not instruct, advise or recommend that borrowers go into default in order to qualify for [a modification]."

Another rich target is the abusive fee practices of services. The practices are so bad it takes three pages to fully elaborate what can't be done, to flesh out that "All default and foreclosure-related service fees, including third-party fees...shall be bona fide, reasonable in amount, and disclosed in detail to the borrower". Another provision goes to the lack of fair dealing: "Servicer shall not assess any default, foreclosure-related or bankruptcy-related fees while a completed loan modification application is under consideration or being performed as a trial modification."

The term sheet also addresses all the bad practices that result from the outsourcing of foreclosures. Indeed, Section 1.E.2 should be nicknamed the "Lender Processing Services section", since many of the provisions are aimed at it and its less successful competitors. Note to LPS shareholders -- it's an ominous sign when the term sheet points out that companies like LPS have to "comply with applicable rules and regulations (including prohibitions on fee splitting.)" It's also beyond pathetic, albeit necessary, that the term sheet has to instruct servicers to create "escalation procedures to allow attorneys... to communicate directly with Servicer."

Elsewhere, the term sheet makes a backhanded reference to LPS's infamous speed-based rating system of foreclosure attorneys. It warns that robo-signing is bad, so don't incentivize speed at the price of accuracy. Finally, servicers can't outsource responsibility: They have to review the documents their vendors and lawyers create and file.

Another slimy servicer practice is taken on: purchasing insurance on behalf of the homeowner, aka "force-placed insurance." The premiums for such insurance have sent current borrowers into default.

Check out these provisions: no buying insurance if the servicer "knows or has reason to know that the borrower has a policy in effect"; the servicer can't get more insurance -- at a higher premium, of course -- than the property is worth; and the servicer can't buy the insurance from its own subsidiary or affiliate or receive a kickback for referring a homeowner for a policy. The servicer has to tell the borrower it has bought insurance and how he can prove he has insurance already. Finally, the servicer has to refund the borrower any premiums it charged for unnecessary insurance.

Forcing A Hiring Spree

The fourth issue that becomes obvious is the amount of hiring the banks will have to undergo, to in order to comply. That hiring should make a meaningful dent in the unemployment rate. The term sheet demands adequate staffing, mandates several new borrower services, and sets basic standards for theoretically existing ones. The banks may not have enough employees to do regular banking; but boy would they have to staff-up to comply with the term sheet.

The final thing to mention at this point is the term sheet punts on MERS (Mortgage Electronic Registration Systems) for now. And that's too bad.

In sum: the scale of bank lawlessness and abuse of borrowers is so epic that far more than this term sheet is needed. The AGs and the rest need to find their backbone and recognize they should be giving dictation, not negotiating away from a term sheet that's at best a minimum demand.