While much of the next Congress will focus on making changes to the Dodd-Frank Act, lawmakers are also likely to deal with problems in mortgage servicing.
The robo-signing scandal this fall emerged too late for lawmakers to tackle in legislation, and while House Republicans may be reluctant to take it on, mounting litigation over the legality of foreclosure proceedings could force the issue.
The key question is whether lawmakers or regulators will try to craft new national servicing and foreclosure standards.
"I would not be surprised if we see some attempt to remedy the mortgage situation," said Chris Low, chief economist with First Horizon National Corp.'s FTN Financial. "It's such a mess right now that I think even the banks might welcome some standards."
Both the outgoing Democratic committee chairmen, Rep. Barney Frank of the Financial Services Committee and Sen. Chris Dodd of the Banking Committee, have said the issue requires attention.
Frank has been calling for new servicing standards since problems with loan modifications surfaced, indicating conflicting incentives to foreclose or seek other loss-mitigation options.
"There needs to be legislation," the Massachusetts Democrat said. "We have to come up with a situation where there is one entity responsible for any mortgage and any individual who invests in a mortgage has to know that that's there. … I think it will require legislation to clean this up, going forward, to prevent the recurrence of" a foreclosure mess.
Republicans understand something needs to be done, Frank said. "In general I think there is a recognition."
In a brief interview, Dodd said that he had not heard about any interest in the idea from the GOP but that he thought the idea of creating national servicing standards has merit. At a Dec. 1 hearing, he asked regulators to submit a legislative proposal to the Hill through the Financial Stability Oversight Council.
"I think it would make some sense to have a national standard," Dodd said in the interview.
Sen. Tim Johnson, who is expected to chair the Banking Committee this year, said in an e-mail to American Banker: "I join Senator Dodd in his request that regulators submit suggestions for national mortgage servicing standards to reduce this confusion and help address some of the problems homeowners, investors and servicers are currently experiencing. If the regulators do not have the ability to establish standards, what are their recommended legislative changes?"
Regulators may attempt to confront the issue in other ways first. The Federal Deposit Insurance Corp. is urging fellow regulators to establish new servicing standards as part of a rule that would create risk-retention rules for selling loans into the secondary market.
Such standards would not necessarily take the place of new legislation, however.
Regulators and lawmakers are particularly focused on conflicts that are created when one company services a first mortgage for an investor pool and a second one for a different party.
Rep. Brad Miller, D-N.C., has sponsored legislation that would attempt to prevent such a situation. "You can hold second mortgages or you can service first mortgages that are owned by others, but you can't do both," Miller said in an interview. "They would have to divest, they would have to spin off the servicer. They could not begin to sell the second mortgages."
The fact that regulators pointed out the issue during the Dec. 1 hearing gave his bill some momentum, Miller said.
"It certainly helps. … Having the regulators talk about it helps create more support for that proposal," he said.
But Miller, who serves on the Financial Services Committee, said he did not want regulators to wait for a bill to make changes to the servicing industry.
"I would hope that the first thing they would do is look at whether they have the regulatory authority to require divesting of servicing without legislation specifically requiring it," he said. "Most people thought it was just coming out of nowhere when I first introduced the bill several months ago, but more and more that is seen as a real problem."
Sen. Michael Bennet, D-Colo., a Banking Committee member, said in a brief interview that he hopes to determine whether conflicts of interest are preventing modifications. "My main concern is understanding better how the incentives and the disincentives in the entire system work and whether or not the incentives are aligned in a way that is actually leading to a modification of mortgages for consumers," Bennet said.
Sen. Jack Reed, D-R.I., said in an interview that in servicing, "several issues … are coming together."
"One is the irregularities in foreclosure proceedings that the state attorneys general are considering," Reed said. "Another is the action by debtholders of trying to recoup bonds issued by financial institutions. And then what I don't want left out is the plight of homeowners."
Servicing weaknesses are preventing sufficient modifications, Reed said. "We have to do a much more vigorous job about modification of mortgages," he said. "I think the report by my colleague Ted Kaufman about the ineffectual aspects of Hamp has to be addressed. One of the issues that has emerged from our hearings is that these servicing companies were never designed to modify mortgages; they were put together much differently."
Dual tracking modifications and foreclosures and the narrow criteria for participation in the Home Affordable Modification Program (HAMP) have also worsened the problem, Reed said.
"It's not only ineffectual, it is driving homeowners to the brink in terms of thinking they are one day going to lose a house and the next day they are going to have a modified mortgage," he said. "Obviously the first step is get the regulators to start pushing harder for regulated institutions to do more Hamp-like projects, to get them to move more resources into the servicers, to make this something that is rewarded by their organization as much as many of the other things they reward."
Beyond that, Reed said Congress could take several steps, but he said he worries it would take too long.
"We all have to do more," he said. "I think you'll see financial institutions that have made some resource changes that are doing things differently but the results are not there. It's like you are seven or eight runs behind and you can't just say, 'Well, we tried.' You've got to get in there and do better."
Tony Plath, an associate professor of finance at the Belk College of Business at UNC Charlotte, said the servicing issues and potential cost of loans being forced back onto banks' books will compel lawmakers to intervene.
"We've got to do something with the foreclosure mess," he said. "You can't continue this overhanging liability on put-back mortgages to the big mortgage lenders in the U.S. without in turn leading to another Tarp bailout, and there's just no appetite for that in Washington."
Spencer Bachus, the incoming chairman of the House Financial Services Committee, could strike a deal, Plath said.
"Bachus is going to have to take a leadership role on the committee in terms of giving something to the banks, and that is giving them some relief from all these lawsuits that they face with respect to put-backs on mortgages," Plath said. "In exchange for that, the banks would have to be more agreeable to rewriting and writing down principal balances on loans that are upside down, even if they are up to date."
There is a way to appease all sides, Plath said. "The Financial Services Committee and the White House broker some kind of solution that provides some kind of a bone to the banks and at the same time provides something back to the holders of investment securities and resolves the foreclosure mess all at the same time," he said. "That's going to be a delicate sort of compromise to reach."
But for now, Republicans appear more focused on the efficacy of government modification programs.
At a recent House Judiciary Committee hearing, Rep. Darrell Issa, D-Calif., questioned the need for the $30 billion from the Troubled Asset Relief Program that has gone into government modification programs. So far, only a half billion of the money has been spent.
Issa, who will chair the House Oversight and Government Reform Committee this year, said in an interview that he plans to concentrate on government programs that provide incentives to modify loans.
"If lenders will modify loans on their own, why should the government provide financial incentives to them?" he asked. "Obviously when we look at Hamp, that's $30 billion of obligated funds." If "[t]hose home mortgages would have been renegotiated without the HAMP program in almost all cases, maybe all cases, then it's a question of why did we spend $30 billion?"
Issa acknowledged that only $500 million has been spent so far but said he worries the money allotment could allow the program to become permanent.
"The rest will be spent at some point," he said. "We have an obligation not to let something go on in perpetuity, just because it was a temporary program."
Other Republicans, including Rep. Shelley Moore Capito of West Virginia, who will chair the financial institutions subcommittee this year, have raised similar concerns.
"I would like to see some greater oversight into the foreclosure programs that the administration has put forward — the effectiveness, the money, where it is and what it's being used for and how effective has that been," Capito said. "That to me is a big issue."