The housing crisis may now get as personal for bank executives as it has for individual homeowners.
As the foreclosure document scandal reaches the "material weakness" level for the largest banks, attorneys representing foreclosed borrowers want to hold servicing executives personally liable for overseeing processes such as robo-signing, in which some employees rubber-stamped foreclosure affidavits without verifying the information.
At issue is how the big banks' internal audit and Sarbanes-Oxley controls failed to catch such systemic problems, mortgage executives and risk management experts contend.
"Yes, there was material weakness and the proof is material losses," said David C. Stephens, chief financial officer and chief operating officer at United Capital Markets, a Greenwood Village, Colo., firm that provides hedging services on mortgage servicing rights. "The question then becomes, 'Is anyone that signed off on Sarbanes-Oxley responsible?' "
Servicing executives were required by the Treasury Department to sign Sarbanes-Oxley-type agreements by Sept. 30 certifying they were in compliance with the Making Home Affordable Program. Some servicing executives initially balked at signing personal requirements akin to the Sarbanes-Oxley Act of 2002, which required that executives take personal responsibility for the accuracy and completeness of a company's financial statements.
The agreements make it a federal crime to provide false or misleading information to Fannie Mae or Freddie Mac.
While the issue of robo-signing foreclosure documents is not addressed specifically in the 17-page servicer participation agreement, it does state that the "servicer is in material compliance with, and certifies that all services have been materially performed in compliance with all applicable federal, state and local laws, regulations, regulatory guidance, statutes, ordinances codes and requirements."
Some mortgage experts and lawyers say servicers now face the risk of lawsuits brought under the False Claims Act if they certified that their own internal servicing processes were in compliance with applicable law.
"There is a legal obligation to deal in good faith with the borrower," said Matthew Weidner, a Tampa, Fla., attorney who represents hundreds of borrowers.
"In addition to Sarbanes-Oxley, they had an obligation in the pooling and servicing agreements to do proper default servicing before a borrower even got to foreclosure."
Laurence Platt, a partner in the financial services group at K&L Gates in Washington, said servicers have acknowledged problems with some of their processes, but it would still be difficult for borrowers to prove that those processes led to an improper foreclosure.
"There might have been a breakdown in procedures, but there was not an intent to proceed or to foreclose on borrowers," Platt said. "These are overworked people just trying to keep up with mountains of paperwork, trying to comply with their requirements."
Peter Swire, a law professor at Ohio State University and a former special assistant to the president for economic policy, said most servicers still fail to recognize that problems with foreclosure documentation have risen to the level of being a "material weakness."
"If you knew that your company was making many misrepresentations to judges that could put many foreclosures at risk, that would be a question as to whether it was material," Swire said. "An executive who is supposed to know what is going on should have realized that."
A few analysts have tried to quantify the magnitude of the problem.
David George, an analyst at Robert W. Baird & Co., wrote in a research note on Monday that the three largest servicers face $13.1 billion in repurchase losses. Analysts at JPMorgan Chase estimated $55 billion to $120 billion in repurchase losses. Paul Miller, an analyst at FBR Group, said foreclosure delays will cost at least $10 billion, or roughly $1,000 per loan for every month that a foreclosure is delayed.
Some risk management experts said banks continue to give short shrift to internal audit functions and that the systemic problems with robo-signers are further proof that the internal cultures at some of the largest banks have not changed.
Clifford J. Rossi, a professor and managing director at the University of Maryland's Center for Financial Policy, attributed the document failures to the same "herd mentality" that caused lenders to underwrite "no doc low doc" loans in the first place.
"None of these guys thought these process issues — legal as they are — would come back and be significant," said Rossi, a former chief risk officer at Citigroup, Washington Mutual and Countrywide Financial Corp.
"Every quarter, they are filling out risk-control agreements and self-assessments, and that's where they are supposed to call out the risks that could come back to bite them.
"It goes beyond sloppiness, it's a fiduciary responsibility, and they looked the other way," Rossi said.
"But a lot of it is just going through the motions, and the internal audit function becomes problematic because it's just not taken seriously enough in these firms."
Dan Borge, a director at the consulting firm LECG Corp. in New York, said he was trying to guard against a principle of behavioral economics known as hindsight bias, in which people tend to exaggerate the degree to which something was foreseeable in the future.
The servicers "might have just missed it," Borge said. "It doesn't matter if you have smart people looking at risk if the business lines don't find it in their interest to pay attention."
Others said the servicing problems are indicative of a more serious deficiency in bank supervision and in the lack of penalties for wrongdoing.
"Who is ultimately accountable and are they going to be held accountable for these actions?" Rossi said.
With 50 state attorneys general, the Justice Department and other federal agencies investigating mortgage servicing practices, banks may be about to find out.