It’s critically important that we understand what went wrong in the financial market institutions that manage the mortgage market, both during the bubble and the crash.
One of those institutions is the mortgage “servicing” industry, which is responsible for collecting payments and handling problems for securitized mortgages. It is at the center for those seeking justice for past wrongdoing, and crucial for writing new regulations to prevent trouble in the future.
But a new obstacle to this has arrived on the scene: federal regulators blocking the release of records they have collected documenting illegal abuses.
A heated exchange broke out at a Senate hearing this week, where Sen. Elizabeth Warren (D-Mass.) asked regulators from the Office of the Comptroller of the Currency and the Federal Reserve why they were not sharing the results of their investigations into mortgage servicing abuses and illegal activities with Congress and the people who were subject to abuses.
These investigations began two years ago, after the OCC found that there were "violations of applicable federal and state law” that had “widespread consequences” in the servicer markets at 14 large banks. This Independent Foreclosure Review (IFR) wrapped up suddenly earlier this year, and it isn’t clear what it found, though the servicers did manage to spend $2 billion on consultants. Paul Kiel at ProPublica found that the review was anything but independent.
Warren and Rep. Elijah Cummings (D-Md.) have been requesting this information for some time. According to the latest letter from Warren and Cummings, regulators at the Federal Reserve argued that their documents showing illegal behavior are "trade secrets" of mortgage servicing companies, while the OCC argues that this violates disclosure requirements. Warren and Cummings responded that “[b]reaking the law is not a corporate trade secret…concealing important information about these violations limits our ability to fulfill our responsibility to conduct oversight over the actions of mortgage servicing companies and to develop legislation to protect our constituents from further abuse.”
Why does this matter? Mortgage servicing is the business of collecting payments from homeowners and passing them along to mortgage bondholders, as well as handling modifications and foreclosures for homeowners that fall. This may sound like the most boring place possible to find a major, systemic crisis, but this is a relatively new system that plays a crucial role in our consumer debt markets.
When loans used to be held by banks, the banks themselves handled these functions. Now that mortgages are usually sliced and diced into bonds, this has moved to a small number of large mortgage servicers. And as securitization grew in size and importance, from 10 percent of outstanding family mortgages in 1980 to over 60 percent in 2009, this servicing issue has become more important.
As law professors Adam Levitin and Tara Twomey document, there are serious conflicts within this model. The business model contains two, contrasting parts. A high-volume low-fee payment collection business encourages a thin, scaled business footprint, while the business that handles conflicts needs expertise, local experience and developed systems. The first business model has won out.
Beyond that, servicers have an incentive to push borrowers into default, loading them up with fees, and keep them there. They collect fees that are paid first in a foreclosure, before investors collect anything. Also, since they are paid as a percentage of the principal, servicers have incentive to not do principal writedowns, even if that would be best for investors. These thin structures and bad incentives are a nightmare from the point of view of both investors and borrowers.
These problems have lead to serious injustices in our mortgage markets. According to some limited data released by the OCC this week from its investigation, showing how the payments will be distributed, servicers violated a range of bad practices, from the Servicemembers Civil Relief Act (SCRA) to foreclosing on people who were successfully negotiating a modification. Some 700 people who haven’t even missed a payment had a foreclosure proceedings started against them.
These are real damages, and the full scope of what has happened isn’t being publicly disclosed. Regulators told Warren that individuals could still have an action against the banks, and that this information would help them, but they aren’t sure whether they’ll be telling anyone.
Beyond the individual injustices, mass foreclosures have been a drag on the economy. Rather than freeing up individuals, they’ve decimated the housing value of local markets at a time when the Federal Reserve is already up against the zero lower boundary for its interest rate policy. The economists Atif Mian, Francesco Trebbi, and Amir Sufi found that foreclosures could be responsible for 15 to 30 percent of the decline in residential investments from 2007 to 2009, as well as a 20 to 40 percent decline in auto sales.
And most important, regulators are figuring out how to write the regulatory rules for these servicers required by Dodd-Frank right now, and the public and government officials don’t have access to this investigation. The Consumer Financial Protection Bureau has proposed rules, which, as David Dayen wrote at the Washington Monthly, many reformers worry are too weak to be effective. Whether that’s true depends on how the market is functioning right now and how it was in the past. Regulators, Congress and the public need access to this information to judge how effective the proposed Dodd-Frank rules will be. And federal regulators are in the way of this.
Reps. Maxine Waters, Elijah E. Cummings, Al Green and John Conyers, Jr. have introduced a bill that would respond to this issue. It would reform compensation and combat conflicts-of-interest for independent contractors. But it would also move the power of a Special Inspector General on the issues of consultants and this settlement from Treasury to the special inspector general created to monitor the 2008 bank rescue, known as the SIGTARP. It’s been remarkable that the GAO has had to function as a de facto Inspector General in this situation with its report reviewing the investigation; this bill would try to get more serious traction on this crucial topic from tougher SIGTARP oversight, instead of the lack of oversight we’ve seen from Treasury.
As much as the government wants to bury its head in the sand, this problem isn’t going away on its own. The housing market is the last part of the economy that needs to recover, and private capital is going to sit on the sidelines until these abuses are gone. And consumer are right to be worried about whether regulators will have their back if something goes wrong based on this behavior.