WASHINGTON -- A top federal regulator told bankers on Friday that a major investigation into Wall Street's foreclosure system has revealed a "broken" process that takes advantage of homeowners, further intensifying the debate over regulatory remedies to potential foreclosure fraud.
Mortgage companies have been accused of submitting fraudulent paperwork in the foreclosure process, prompting a brief suspension of foreclosures by several major servicers in the fall. This spectacle has undermined public faith in President Barack Obama's signature foreclosure-relief effort, the Home Affordable Modification Program, which relies on servicers to implement all of its critical components. The National Consumer Law Center estimates that half of the foreclosure cases it takes on are driven by improper actions by mortgage servicers, rather than fundamental problems with a borrower's ability to pay off a mortgage.
Those concerns were highlighted on Friday during a speech by Federal Reserve Governor Sarah Bloom Raskin during a housing conference in Park City, Utah. Raskin, who was named to the Fed board last year by President Barack Obama, said that the "preliminary" results of a regulatory investigation into the servicing business indicate "widespread" problems at banks and "broken" systems. Her speech was notable for its unusually-critical tone -- she even suggested that servicers had broken the law, a rare step for a federal official.
"Going forward, the servicing industry must foster an operational environment that reflects safe and sound banking principles and compliance with applicable state and federal law," Raskin said, according to prepared remarks released by the Fed.
The Fed governor also rejected an argument put forward by banking executives last year that the documentation problems uncovered at mortgage servicers were minor technicalities. "When servicers misapply payments, lose paperwork, file incorrect foreclosure affidavits, or simply do not answer the phone or make available knowledgeable staffpersons, there are consequences to the consumer," she said.
But fixing the servicing business will require significant improvements in the overall structure of the market for mortgage securities that banks sell to investors. When a bank packages mortgages into a security and sells them off, a servicer is assigned the task of processing payments from borrowers and negotiating with homeowners who have trouble making payments. When banks issue securities, they draw up "pooling and servicing agreements" that dictate exactly what servicers can and cannot do, and explain how various investors will share in any profits or losses. But some elements of the agreements have been vaguely worded, leaving servicers wide leeway to act against the interests of both homeowners and investors.
"Future pooling and servicing agreements will need to look different than those of the past," Raskin said. "They will need to be much more detailed and provide clarity about what the servicer can and cannot do."
Other experts agree, emphasizing that stronger federal standards are needed to rebuild investor confidence. "We need a standardized mortgage and a standardized PSA so that investors know what they're buying," Graham Fisher & Co. managing director Joshua Rosner told HuffPost.
"We have a mess on the servicing side of the mortgage-backed securities business right now that's going to have to get fixed before the private folks come back in at all, in any volume," former bank regulator Ellen Seidman said.
In Washington, a regulatory dispute over a key new rule for mortgage servicing and securitization is escalating. Last year's financial regulatory reform legislation requires federal agencies to write new rules mandating that banks who sell mortgage bonds keep at least 5 percent of the risk on their own books. But standardized, top-quality loans dubbed "qualified residential mortgages" will not be subject to these so called "skin-in-the-game" rules. Regulators are now hashing out definitions for these top-quality loans, and some key regulators hope to see standards of conduct for mortgage servicers included in the definitions.
In recent weeks, the conflict has escalated from discussions among lawyers and other staffers to a feud between the heads of two key federal agencies, the Federal Deposit Insurance Corporation and the Office of the Comptroller of the Currency, according to a source familiar with the discussions. FDIC Chair Sheila Bair is pushing for stronger regulations on mortgage servicers, the source said, while Comptroller John Walsh, whose office has never publicly sanctioned a mortgage servicer for abuses, is resisting them. The OCC declined to comment for this story, as did representatives of the Fed and the Treasury Department, which also have regulatory authority.
In July, the new Consumer Financial Protection Bureau will get authority over mortgage servicing, and will be able to issue rules on servicer conduct. The CFPB will not have authority over securitization standards and agreements, however, making the current fight a major issue for investor advocates.