More than three years into the foreclosure crisis, mortgage servicers remain "behind the curve" in dealing with distressed homeowners, and risk triggering a double dip in U.S. housing markets, FDIC Chairwoman Sheila Bair told mortgage bankers today.
Bair said regulators should use new authority granted to them under the Dodd–Frank Wall Street Reform and Consumer Protection Act to draft national standards for loan servicers. The standards would address "misaligned incentives" that allegedly left loan servicers without the expertise and resources they needed to engage in effective loss mitigation, she said, laying the groundwork for the "robo-signing" scandal.
In implementing provisions of the Dodd-Frank bill governing standards for risk retention, Bair said regulators also have "a unique opportunity to better align the incentives of servicers with those of mortgage pool investors."
Federal agencies writing the risk-retention rules — which will require that lenders retain a stake in riskier loans — have been charged with establishing securitization standards that will align incentives in the securitization process, Bair said.
Misaligned incentives in mortgage lending "drove the origination of trillions of dollars of unaffordable subprime and Alt-A mortgages that triggered the crisis," Bair said. Mortgage brokers and lenders had little or no incentive to worry about whether borrowers could repay their mortgages, she said, nor did investment banks putting together securitizations.
As regulators implement Dodd-Frank to better align incentives for loan originators and investors in the securitization process, the task "cannot be considered complete unless they have (also) addressed the misaligned incentives in servicing that created the present foreclosure crisis," she said.
"Paying servicers a low fixed-fee structure based on volume may be sufficient to ensure that payments are processed and accounts are settled during good times, when most mortgages are performing," Bair said. "But it does not provide sufficient incentives to effectively manage large volumes of problem loans during a period of market distress."
In a Jan. 10 letter to Bair and other federal officials, Mortgage Bankers Association President and CEO John Courson expressed "deep concern" over such an approach, calling risk retention and mortgage servicing standards "highly complex and critically important issues" that should be addressed separately.
"MBA supports efforts to improve residential mortgage servicing practices, especially in ways that protect consumers who are at risk of losing their homes," Courson said. But combining efforts to create national servicing standards with proposed risk retention regulations would be "dangerously short-sighted," he said.
"The risk retention debate has been ongoing for over a year, and is nearing a new phase as proposed regulations are expected this month. It is essential that any final risk retention rules be timely, balanced, fair and workable if private investment capital is to return to the housing sector in a meaningful way," Courson said.
"This issue is challenging enough in its own right — we think it would be a mistake to add a second highly complex topic like national servicing standards into the same policy-making process."
Addressing mortgage bankers today at a servicing summit sponsored by the MBA, Bair was undeterred.
Prompt action to modify subprime loans in 2007 could have helped limit the crisis in its early stages, she said, but loan servicers were too slow to act. As a result, there were 1.5 million foreclosures that year.
Today, Bair said, loan servicers remain behind the curve in dealing with underwater mortgages and "robo-signing" foreclosure practices that "sow confusion and fear on the part of homeowners" and skirt state and local legal requirements.
"There is no question that the fee structure currently in place for most servicers provides insufficient resources for effective loss mitigation and has led servicers to cut corners in their legal and administrative processes," Bair said.
"While we cannot fix these incentives after the fact, we should insist that servicers do the right thing now and devote a level of resources that is commensurate to the scale of the problem."
The Federal Housing Finance Agency (FHFA) this week directed Fannie Mae and Freddie Mac to propose new models for compensating loan servicers. As it stands now, loan servicer compensation is generally based on a minimum servicing fee that is part of the mortgage rate, which decreases the flexibility necessary for "optimal servicing of nonperforming loans from both the borrowers’ and guarantors’ perspectives," the agency said.
But the FHFA said implementation of the new loan servicing compensation models would be "prospective in nature" and not expected before the summer of 2012.
Blair said loan servicers must act now, and work with federal regulatory agencies and state attorneys general who are investigating "robo signing" practices to provide clarity and fairness to loss mitigation and foreclosures.
"If we fail to act decisively now to deal with the foreclosure crisis, we risk triggering a double dip in U.S. housing markets that could roll back the progress that has been made to date," Bair said. "The problem is serious, and the need for action is urgent. We cannot afford to wait for Congress to take action on this issue."
She said loan servicers can take two steps right away to improve results: Provide a single point of contact to borrowers throughout the loss mitigation process, and boost staffing and training.
To expedite loan modifications and help "clear the market," loan servicers should look for opportunities to greatly simplify loan modification offers in exchange for waivers of claims, Bair said.
Bair also outlined provisions that should be included in any settlement loan servicers reach with state attorneys general over their alleged robo-signing practices.
Borrowers should have the right to appeal denials of loan modification requests to an independent party who has access to relevant information and the power to correct "erroneous determinations," she said.
Addressing robo-signing practices, Bair said banks and other servicers should be required to foreclose in their own names instead of allowing MERS (Mortgage Electronic Registration Systems) to foreclose, and provide complete chain of title and note transfer history in the notice of default.
Bair suggested that a foreclosure claims commission, modeled on the BP or 9-11 claims commissions, could be set up and funded by loan servicers to process complaints by homeowners who have wrongly suffered foreclosure through servicer errors.
She also called for establishing a fixed formula to govern the treatment of first and second mortgages when the servicer or its affiliate owns the second lien.
Bair said many loan servicers are likely to resist such settlement terms. In the past, she said, when loan servicers have fought changes in order to minimize their short-term costs, "they have seen a deepening of the crisis that has cost them — and the rest of us — even more."
Mortgage markets today remain "deeply mired in a cycle of credit distress, securitization markets remain frozen, and now chaos in mortgage servicing and foreclosure is introducing a dangerous new uncertainty into this fragile market," Bair warned.