Federal Deposit Insurance Corp. (FDIC) Chairman Sheila Bair became the first regulator to publicly shoulder some of the blame for foreclosure problems at several servicers, saying the agencies should have seen it coming.
In a speech Monday to a regulatory symposium on the future of housing and finance, Bair said regulators were not focused on the issue despite hints that some servicers were overloaded with foreclosures.
"In retrospect, there were warning signs that servicing standards were eroding," she said. "Those signs should have caused market participants and regulators alike to question current practices."
Bair cited a significant decline in servicing fees in recent years.
"We should have been asking how servicers were able to achieve such efficiencies without sacrificing quality," Bair said. "Sadly, those types of questions were not asked."
Bair said regulators must improve their oversight of banks.
"As regulators embark on changes to our supervisory programs, we need to get back to the basics and spend more time understanding — where necessary — [and] questioning the business models that drive the earnings and create risks present in the banking system," she said.
Her comments came as Federal Reserve Board Chairman Ben Bernanke said regulators were taking a closer look at foreclosure problems. Speaking to the same conference, Bernanke said regulators were working on a comprehensive review of foreclosure practices at the country's largest financial institutions.
"We take violations of proper procedures seriously," Bernanke said. "We are looking intensively at the firms' policies, procedures and internal controls related to foreclosures and seeking to determine whether systematic weaknesses are leading to improper foreclosures."
Bair said, ultimately, the litigation generated by this issue could be very damaging to housing markets if it ends up unduly prolonging foreclosures. "The robo-signing controversy underscored just how time-consuming and expensive foreclosure really is for all parties concerned," she said.
Bair warned several years ago that foreclosures would rise if lenders and servicers did not take steps to ensure mortgage payments were sustainable, and she recommended modifying such loans.
She said Monday that the industry should consider some form of "triage" on foreclosures, perhaps providing safe harbor relief if a property is vacant or if the servicer offered a minimum payment reduction of at least 25% and the borrower still could not perform on the loan.
"We know from experience that reducing the monthly payment through modification raises the chance that the borrower will make good on the loan," Bair said. "We also know that, in too many instances, servicers have not made meaningful efforts to restructure loans for borrowers who have documented that they are in economic distress."
Mortgage service operators, including Bank of America Corp. and Ally Financial Inc.'s GMAC Mortgage, have announced a resumption of foreclosures after taking a brief hiatus to review procedures at their subsidiary institutions.
Bair said the incident is proof that securitization practices need an overhaul.
It "is just another indication of the need to improve institutional practices all along the chain of securitization — from origination, to securities underwriting, to servicing," Bair said.
Bernanke acknowledged that dubious underwriting practices and mortgage products that were inappropriate for many borrowers contributed to the housing market's trouble.
Today, he said, more than 20% of borrowers owe more than their home is worth, and an additional 33% have equity cushions of 10% or less, putting them at risk if home prices decline further. "With housing markets still weak, high levels of mortgage distress may well persist for some time," Bernanke said.
Regulators were more tight-lipped when it came to housing finance reform, but Bair flatly rejected any possibility of an implicit mortgage guarantee, saying it should either be explicit or nonexistent.
"When it comes to reforming the mortgage entities, we must rule out a continuation of the type of implicit government backing they have enjoyed in the past," she said.
Instead, if government support for securitization is required to maintain stability in mortgage finance during crises, it should use the basic framework of the FDIC's deposit insurance program, Bair said.
"It must be publicly acknowledged, appropriately priced, clearly delimited, subject to audit and backed by the full faith and credit of the U.S. government," she said. "Any program of government support to the marketplace — no matter how well intentioned — that does not adhere to these basic rules potentially exposes taxpayers to unexpected and unpredictable loss and could undermine public trust in both the market and government."
Assumptions that an implicit guarantee existed for Fannie Mae and Freddie Mac before they were taken into government conservatorship in September 2008 should be regarded as a failure of government policy, she said.
"When investors are led to believe that policymakers will not allow a company to fail, market discipline is weakened," Bair said. "The inevitable result is more risk-taking that only raises the value of the implicit government backing."
Last week, the Federal Housing Finance Agency (FHFA) said the two GSEs could end up costing taxpayers $142 billion to $259 billion through 2013.
An example of a financial alternative being debated among policymakers that could result in an implicit guarantee unless carefully structured is covered bonds, Bair said. She remained critical of, yet open to, recent legislation proposed by Rep. Scott Garrett, R-N.J., to establish a legal framework for a covered bond market.
"Covered bonds could be a valuable source of liquidity to finance mortgages, and, properly structured, they provide a way to transfer risk broadly to private-sector investors, rather than the U.S. government," Bair said. "However, improperly structured, they could lead to another system of implicit government guarantee."
Unlike securitizations, in which mortgages are packaged into securities and sold into the secondary market, covered bonds remain on an institution's balance sheet and could require the collateral behind the bonds to be refreshed with new loans if the original assets stop performing.
Bair recommended using the European model, which gives virtual government backing to covered bonds.
Bair and Bernanke acknowledged the importance of homeownership to Americans but also noted it should be undertaken through measured actions and with risks in mind.
"Homeownership is good for families and communities if it can be sustained," Bernanke said. "Home purchases that are highly leveraged or unaffordable subject the borrower and lender to a great deal of risk."