In my prior post on mortgage servicing, I talked about the potential of mortgage servicers to be harmful barriers between homeowners and investors, both of whom may want to negotiate a loan modification. Recognizing such a problem raises the question of a solution. U.S. Representative Maxine Waters recently introduced legislation that would profoundly alter the duties of mortgage servicers. The bill, HR 5679, The Foreclosure Prevention and Sound Mortgage Servicing Act of 2008, would prohibit the initiation of a foreclosure if the mortagee or servicer has failed to engage in "reasonable loss mitigation activities." The bill lays out exactly what counts as loss mitigation and offers up non-binding guidance on standards of affordability for loss mitigation. Servicers would have to report data on their loss mitigation activities, disaggregated by the type of mitigation activity (separately accounting for things like modifications, deeds in lieu of foreclosure, or repayment plans).
The bill also takes aim at the communication problems between servicers and homeowners. The bill requires services to provide a toll-free number that provides borrowers with direct access to a person with the information and authority to fully resolve issues related to loss mitigation and specifies that such a person must be physically located in the United States. Servicers are also required to forward borrower's information to HUD-certified housing counselors whenever a borrower is 60 days or more overdue.
In the hearing last week on the bill (which you can watch as an archived webcast), Chairwoman Waters kept returning to a fundamental point--mortgage servicing is an unregulated industry. The witness testimony was essentially unanimous that mortgage servicing has a tremendous impact on American families and on the resolution of the current crisis. Of course, the debate was over whether this regulation was the right approach. The bill hasn't gotten much publicity yet, but I encourage readers who are interested in the foreclosure crisis to take a look and post their feedback.
At the heart of a loan modification is communication between a creditor and a debtor that leads to an agreement on new contract terms. If the debtor cannot get reach a person with authority to negotiate, a modification won't be possible. If the creditor can't get the debtor to return its calls or read its mail, a modification also won't be possible. The communication problems in today's securitized mortgage market are very different than during past real estate downturns, such as the Midwest farm crisis of the 1980s or the wave of foreclosures in the 1930s. Why? Because of the widespread use of mortgage servicers, third-party agents who collect payments from borrowers and remit them to the mortgage note holders (usually investors, often via a trust). Mortgage servicers are responsible for enforcing defaults, including pursuing foreclosures, and for engaging in loss mitigation. Gone are the days of sitting down with the bank that originated your loan and negotiating a new deal. Why am I making this very basic point? Because I am concerned that policymakers, including legislators, judges, and regulators still do not understand the barrier that loan servicing presents to voluntary or consensual loan modification.
I keep seeing reference to the willingness of "lenders" to negotiate, but the reality is that it is a diffuse group of investors (including people like me whose 401(k) plans bought securities backed by mortgage receivables), not lenders who own the note. And the investors contracted with mortgage servicers via pooling and servicing agreements to service the loans. The terms of those contracts may limit servicers' freedom to negotiate or offer loan modification. Perhaps the bigger problem though is that mortgage servicers actually PROFIT from default. To be clear, I wrote servicers, not investors, who do face large losses when foreclosures occur. How can servicers profit when a borrower defaults? Because servicers typically retain fees, such as late fees, that are paid by consumers. Servicers may also assess other default charges such as property inspections or attorneys fees when a loan goes into default. Allegations are swirling around that servicers up-charge for these default costs, tacking on profit to the actual charges they paid for the servicers when they bill the consumer. Even if this isn't happening, simple late fees are a huge source of revenue for mortgage servicers--millions of dollars each quarter. The flip side is, that while default can be profitable for servicers, modifications are very costly. The available estimates suggest that loan modifications cost $500-$1000. What incentive do servicers have to spend this money? The answer to this question may change with new legislation introduced by Representative Waters. More to come on that in a future post.