A lot of people have asked me why I took a break from writing lately. Well, it is largely because I didn’t have much to say anymore besides “I told you so,” and I don’t want to appear snippy.
So while I will try to maintain an appropriate tone, recent talk about national servicing standards and conflict between modifications and foreclosures takes me right back to October 2007, the month I released a white paper summarizing the history of such concerns and the need to avoid stepping in the obvious policy traps
. Subsequently I covered much of the topic in congressional testimony as well as press interviews.
Could it be that policymakers are just now catching on?
Back then, the problem was modification proposals. I said, back then, that refusing to give modifications standing as "new loans" or other status to which regulatory processes and measurements are applied would be a problem for the industry and borrowers, alike.
Over the ensuing three years, such problems have indisputably come to light. The government's Home Affordable Modification Program, or HAMP, and private modifications have failed consumers and investors, as they have not only substantially duplicated costs in the foreclosure pipeline but also have been found wanting as potentially good modifications have been foreclosed upon anyway.
But those who are pushing for strict servicing standards had better get ready for some reality. As I discussed back in 2007, none of what they are discussing is new. Quoting from my white paper:
Predatory servicing was a common concern among regulatory officials and servicers in 2003 and 2004. In November 2003, Select Portfolio Servicing (formerly Fairbanks Capital Corp.) signed a consent order with the Federal Trade Commission and the Department of Housing and Urban Development due to predatory servicing concerns. In April 2004, Ocwen Federal Bank FSB reached a supervisory agreement with the Office of Thrift Supervision based on similar concerns. Soon after that, Ocwen Financial Corp., Ocwen Federal Bank FSB's parent company, filed an Application for Voluntary Dissolution with the OTS in November 2004 to explore the possibility of the bank terminating its status as a federal savings bank under OTS and Federal Deposit Insurance Corp. supervision. (Moody’s, 2004 Review and 2005 Outlook: US Servicer Ratings, Jan. 12, 2005)
Following those regulatory actions, many servicers re-evaluated their operations to identify potential exposure to predatory servicing concerns. Servicers implemented 100% call recording, itemized monthly statements, and issued paper notification to borrowers when fees are charged. Servicers added transparency to force-placed insurance programs (hazard insurance coverage that is assigned to mortgaged property when the borrower fails to maintain his or her own coverage) and reduced or eliminated ancillary fees.
One big concern of consumer advocates with respect to predatory servicing was quick foreclosure, particularly for lenders that refer loans to foreclosure in a 60 to 75 day timeframe following delinquency. In response to concerns that early foreclosures were not warranted, servicers added pre-foreclosure activities to ensure that collection and loss mitigation attempts on a loan were thorough and that proper notices were provided to the borrower. Loans were also reviewed pre-foreclosure for potential legal issues and headline risk that could be associated with a foreclosure action. Foreclosure referrals are now more common beginning after the 90th day of delinquency. But the new pre-foreclosure activities also paved the way for servicers to make more detailed loan-level decisions, including using more loan modifications. (Moody’s, 2004 Review and 2005 Outlook: US Servicer Ratings, Jan. 12, 2005)
The fact that the opportunities for more loan modification originated from attempts to more thoroughly investigate loans prior to foreclosure to avoid predatory servicing concerns should not be a source of comfort. Rather, that means the processes surrounding modification are still new enough that they can be misapplied to consumers’ detriment.
The decision to modify a loan is identical to a decision to refinance a loan, but the modification decision is not currently treated as a new loan decision. That means that the modification proposal and acceptance by the consumer are not required to generate any of the records, disclosures and restrictions placed upon the new loan process. Therefore, modifications can impose exorbitant fees or back-end payments or other conditions upon consumers without adequate record-keeping to pursue even a legal remedy.
The reason for concern lies in the fact that major industry groups and regulatory officials, having characterized the conditions for a successful modification as raising the net present value of the loan, have effectively advocated maximizing income to the lender as the primary goal of modification. Fitch Ratings reports that servicers express, "the belief that that ultimate loss to the transaction should be the only consideration in determining the execution of the best loss mitigation strategy." (Fitch Ratings, U.S. RMBS Servicer Workshop, May 18, 2007.)
Even Moody’s recognizes, however, that if borrowers cannot meaningfully qualify for a modified loan under transparent and duly reported and defensible underwriting guidelines, the modification may, “simply serve to postpone an eventual foreclosure and increase, rather than decrease, the ultimate loss on the loan.” (Moody’s, US Subprime Mortgage Market Update, April 2007) Work by JPMorgan prior to the present market difficulties illustrates that the kinds of flags that can indicate predatory modification are, “...liberal repayment terms with extended amortizations, moving accounts from one workout program to another, multiple re-aging and poor monitoring of performance. Principal reduction should be the main goal of workout programs, not maximizing income recognition (emphasis added).” Servicing that does not promote principal reduction can therefore be considered predatory. (JPMorgan, ABS Monitor 2003 Year Ahead Outlook, Dec. 23, 2003.)
So while we go about reinventing the wheel again, let’s look hard at some of the realities of the industry. Major improvements to servicing best practices have been implemented over the past decade. The problem is that we are not sure which servicers are using those or how consistently.
So before we go changing regulation, let’s first look at what works and what doesn’t. Let’s look at individual servicers and examine how well they have implemented the types of improvements discussed over the past decade. I suspect we will find that good servicers — those complying with the above — are not experiencing the types of problems hitting recent headlines. The ones that are obviously need rehabilitation. For once in this crisis, however, let's act rationally and reward good market behavior and punish bad, rather than just alleging systemic shortcomings and doing the opposite.
Joseph Mason is Hermann Moyse, Jr./Louisiana Bankers Association Professor of Finance, Louisiana State University, and Senior Fellow at the Wharton School of the University of Pennsylvania.
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