For the first time since significant mortgage servicing problems came to light, federal regulators called on Congress Wednesday to establish national standards for the foreclosure process.
Citing the potential economic cost if banks are forced to buy back improperly handled mortgages and weaknesses in the protocol for examining servicers, regulators suggested federal standards could help avoid a repeat of current issues.
"While quite preliminary, the banking agencies' findings from the supervisory review suggest significant weaknesses in risk management, quality control, audit and compliance practices as underlying factors contributing to the problems associated with mortgage servicing and foreclosure documentation," said Federal Reserve Board Gov. Dan Tarullo. "In light of the range of problems already encountered, and the prospect of further changes in the industry … it seems reasonable at least to consider whether a national set of standards for mortgage servicers may be warranted."
He was backed by other regulators testifying before the Senate Banking Committee hearing as well as the departing Chairman Chris Dodd, who asked the agencies to submit specific legislative recommendations for lawmakers to consider.
"I would like you to submit very specific ideas," Dodd said. "Maybe this is something that the Financial Stability Oversight Council might submit to us, some legislative ideas and language that could be part of this committee's consideration over the next months. It would be very, very helpful."
Sen. Tim Johnson, who is expected to chair the panel next year, agreed. "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," he said in a statement to American Banker. "If the regulators do not have the ability to establish standards, what are their recommended legislative changes?"
Regulators offered grim assessments of their preliminary analysis of mortgage servicers, identifying a slew of problems that need to be resolved.
For example, acting Comptroller of the Currency John Walsh urged servicers to stop dual tracking modifications and foreclosures whenever legally possible.
"Questions have arisen about the practice of continuing foreclosure proceedings even when a modification has been negotiated and is in force," Walsh said. "We agree that this dual track is unnecessarily confusing for distressed homeowners, and the OCC is directing national bank servicers to suspend foreclosure proceedings for successfully performing modifications where they have the legal ability and are not already doing so. It is important to remember, however, that [the government-sponsored enterprises] and private investors dictate the terms for non-HAMP modifications, so this option may not always be available to servicers."
Senate lawmakers criticized Bank of America Corp. and JPMorgan Chase at a hearing two weeks ago for pursuing foreclosures and modifications at the same time.
Federal Deposit Insurance Corp. Chairman Sheila Bair said Wednesday that servicers need to pursue modifications more aggressively and called on them to assign a single point of contact to homeowners so that they could explain why the modification and foreclosure processes are occurring concurrently.
Bair said that given certain legal obligations to investors there might be valid reasons to dual track but, "there needs to be someone to talk to homeowners to explain it and I think it would be operationally challenging for the servicers but I think servicers should do it because borrowers … are scared and confused."
Bair also offered other potential solutions, including that servicers should initiate modifications earlier in the process and as a matter of routine. "Servicers should be required to intervene with troubled borrowers from the earliest stages of delinquency to increase the likelihood of success in foreclosure mitigation," she said.
Bair also said it's time for servicers to "tackle the second-lien issue head on" and invest more resources in staffing, training and strengthening internal controls.
Much of the hearing delved into concerns over the unclear cost of the foreclosure problems, with several regulators citing "putback" risk if lenders are forced to buy back improperly handled mortgages from servicers.
Asked by Sen. Bob Corker, R-Tenn., about the extent of banks' liability, Tarullo said the issue will remain a significant threat until the problems with the servicing process are resolved.
He said that the Fed is requiring servicers to self-assess their putback risk, but that among private-label mortgage-backed securities the potential costs vary considerably. "On the order of magnitude I don't want to give you a number. … With respect to some institutions this could be a significant exposure," he said. "I would guess that for a few institutions that number would be reasonably high and for many it will be reasonably low; even if the dollar amount is significant; because of the significant size of the institutions."
Although regulators are still reviewing servicing practices, what they have found to date is troubling, they said. "The problems are sufficiently widespread that they suggest structural problems in the mortgage servicing industry," Tarullo said. "The servicing industry overall has not been up to the challenge of handling the large volumes of distressed mortgages. … It has now become evident that significant parts of the servicing industry also failed to handle foreclosures properly."
He also said that the problems proved the need for new powers given to the Fed under the Dodd-Frank Act that would allow it to conduct exams of nonbank affiliates of bank holding companies.
For their part, lawmakers continued to express frustration that regulators once again were caught off guard by a problem rather than detecting it ahead of time. They also questioned why major market players like Fannie Mae and Freddie Mac were not forcing servicers to improve their practices or be shunned by the government-sponsored enterprises.
Retiring Sen. Jim Bunning, who has been well known for criticizing the Fed, took a parting shot at the agencies, essentially calling them inept.
"All you people here have not come up with a solution," said the Kentucky Republican. "All of your brains, and you have a lot of them, have not come up with a solution. I've sat on this committee for 12 years and listened to the same absolute gobbledygoop from everyone who has come up here. You have not had an answer to any of the questions. All you do is deal in hyperbole. You don't deal in fact. How do you solve the problem?"
Dodd was less hostile in tone, but asked why the newly created Financial Stability Oversight Council (FSOC) had not been more ambitious in taking up the foreclosure issue.
"The question is why haven't we come up with some answers given the regulatory authority we have," he said. "Why is the FSOC not meeting when it's a commission specifically formed for the purpose of something like this and they are not doing anything about it? What's going on?"
Walsh said that the council is waiting for the regulators to complete their investigation.
"In our last FSOC meeting, we did have a discussion in the private session on the foreclosure issue and by Assistant Secretary [Michael] Barr in the public session on the state of play and we have a number of efforts underway," he said. "So it is certainly something that is being taken up by the council."
Dodd pointed out that in the hearing Bair suggested servicers give borrowers a single point of contact and Tarullo called for national servicing standards. He asked Walsh if this was news to the FSOC members at the hearing or if they had discussed it. "Were those talked about in the meeting?" Dodd asked.
Walsh responded that he "would characterize the discussion as being at a more general kind of systemic level. … Once we have details of the major problems I think we'll move on to solutions."
Dodd said he was mystified by the lackluster use of the FSOC.
"I wasn't expecting miracles to come out of it … but good Lord, I expect something to come out of this operation," he said.
In a second panel with representatives of Fannie Mae and Freddie Mac, Dodd asked why the GSEs were not doing more to insist upon improvements in servicing given the market force Fannie and Freddie wield.
You know you talk about market power and there is no better market power than the two of you in my view with FHA," Dodd said to representatives from Fannie and Freddie. "The amount of influence you could have in the process short of regulatory and congressional mandates, what's the answer?"
When Terry Edwards, the executive vice president of credit portfolio management at Fannie Mae, started to answer that they start by first trying to identify the problem, Dodd interrupted by saying "You're telling me if you threaten to strip away the GSE protection, don't you believe they would jump back through hoops to respond to your concern?"
Edwards said that in some instances Fannie has taken servicing away from nonperforming servicers but the problem is that most lack the capacity to deal with a problem of this magnitude.
"At the end of the day this problem is a servicer capacity problem," he said. "Servicers haven't staffed up where they need to staff up and they haven't fixed their processes."
