The biggest obstacle to reforming mortgage servicing may be that regulators cannot agree on the proper vehicle for it.
The Office of the Comptroller of the Currency (OCC) raised the stakes this week with an outline for a stand-alone rule, continuing to challenge the Federal Deposit Insurance Corp.'s (FDIC) proposal to include servicing standards in a risk-retention rule now being devised. Meanwhile, the Federal Reserve Board, said to be open to either approach, has sent a draft of its servicing principles to Capitol Hill.
Observers said policymakers need to speak with one voice before they proceed. Ideas have also been contributed by state attorneys general as well as the Federal Housing Finance Agency (FHFA).
"It's chaos," said Pete Mills, a principal at Mortgage Banking Initiatives. "Everybody is racing ahead with a different plan. The Fed has a plan. The FDIC has a plan. The FHFA has a plan. The OCC has a plan. And then you have the AGs working on something they hope to be an industrywide plan. It feels like complete process confusion. There is no single venue to coordinate and try to get this right."
To be sure, everyone appears serious about clamping down on the servicing sector. The OCC outline and the Fed principles, both obtained by American Banker, would address the issue broadly, taking steps to improve the loan modification process, the tracking of mortgage-related documents and the treatment of borrowers.
"Standards should apply to mortgages whether securitized or held in portfolio, and whether originated privately or through government or government-sponsored channels," wrote Fed. Gov. Daniel Tarullo in a letter Thursday, accompanied by the Fed principles, to Sen. Tim Johnson, the presumptive chairman of the Banking Committee.
But any idea for a stand-alone servicing rule deeply contrasts with the FDIC approach. The agency strongly advocates including servicing standards in the rule agencies are drafting on risk retention.
This rule, required by the Dodd-Frank Act, would enforce new requirements forcing lenders to retain 5% of the credit risk in a mortgage they securitize.
It would also create a special class of highly safe loans — known as "qualified residential mortgages" (QRM) — that would be exempt from retention. (None of the regulators agreed to speak publicly for this story.)
The agencies are expected to formally discuss their various proposals last week, as early as Monday, but it remained unclear how they will resolve differences over process.
The FDIC, and observers who back its plan, believe the QRM rule is the more comprehensive and timely vehicle to deliver standards.
They note that the securitization rule would affect all players, whereas a stand-alone measure would only affect depository institutions and may exclude private-label securities.
Josh Rosner, a managing director at Graham Fisher & Co., who supports the FDIC plan, said servicing requirements are a natural fit for the rule on risk retention.
"If the intent of the QRM is to define those mortgages less likely to default, there is no way to ignore servicing standards," Rosner said.
The OCC, which appears to have more industry support for its point of view, and its backers believe that a stand-alone rule could get done more quickly and cover more of the industry. The Dodd-Frank rule would only address securitized mortgages — not those held in portfolio — and they argue that the retention rule under the law would not take effect until April 2012.
"Doing servicing standards through the QRM is both legally questionable and the least effective because it can only reach a slice of the market," Mills said. "That would be a far cry from comprehensive national standards."
Under the standards outlined in the OCC draft, a stand-alone rule would address procedures for loss mitigation, documentation and foreclosure proceedings.
Specifically, the agency said, "servicers should make reasonable and good-faith efforts, consistent with customary business standards and in accordance with applicable laws and contracts, to engage in loss mitigation activities and foreclosure prevention for delinquent loans, where appropriate."
The rule would also require servicers to "ensure maintenance of sufficient documentation and servicing systems to support foreclosure decisions and actions" and "ensure appropriate oversight of third-party vendors, including outside legal counsel."
The Fed's principles, submitted with Tarullo's letter, meanwhile, include measures to "address shortcomings in servicer operations and internal controls that came to light during the crisis." The Fed outline also suggests giving troubled borrowers "a single, reliable and accessible point of contact for all information and negotiations on their loans."
The plan would also "establish standards for the filing, storage, assignment and transfer of mortgage-related documents over the life of the loan."
The two versions suggest that all the regulators have some common opinions on what standards should include.
FDIC Chairman Sheila Bair articulated her agency's view in remarks this week to the Mortgage Bankers Association (MBA).
Bair is seeking the disclosure of cases in which a servicer manages both the first and second lien of a mortgage and the establishment of a predefined process to address conflicts from second liens. Bair also said regulators should require an independent master servicer to oversee and resolve disputes on servicer actions, cap servicer principal and interest advances and provide a means other than a foreclosure for a servicer to be repaid.
Stephen O'Connor, the MBA's senior vice president of public policy and industry relations, said that, though regulators may agree broadly on the types of standards needed, getting into further detail on a common solution will be more difficult.
"You can find agreement on principles," he said. "Everybody can agree for instance that you need loss mitigation efforts that make a good-faith effort to help borrowers avoid losing their homes. But how do you operationalize that principal? It's not an easy subject when you look at all of the pieces."
Others expressed concern that including servicing in the risk-retention rule could make standards too limited.
"QRM will only affect securitized mortgages," said Jeff Naimon, a lawyer at BuckleySandler.
"You don't need the QRM to get to Fannie and Freddie. They are obviously able to look at this themselves. QRM doesn't look at FHA. … You're going to miss some entities no matter what you do unless you issue a new federal statute, and that may be the new direction to go."