The mortgage mess isn't going away. Loans, sold as many as 12 times before ending up in a complex security or on a financial institution's balance sheet, have been found with key legal paperwork misplaced or incorrectly transferred. If you've followed the issue, you know documentation problems prevent mortgage servicers from foreclosing on homes: They lack proof of their legal right to do so. It's a symptom of underlying irregularities, not the end of the story. The infamous "robo-signer," who approved 400 foreclosure filings a day without determining their validity, helped reveal these problems, but they appear to go much deeper.
The observer most well positioned to see what was happening with the servicing industry was the U.S. Treasury, which administered HAMP -- the Home Affordable Modification Program -- an anti-foreclosure initiative that paid servicers to craft sustainable loan modifications according to government standards. Today, Treasury maintains that the foreclosure fiasco won't affect HAMP or the government's efforts to maintain financial stability, but independent experts, government oversight committees, and the experience of borrowers on the ground suggest that the administration needs to ramp up its response.
"Many believe that the robo-signing errors are simply the tip of a much larger iceberg," Senate Banking Committee Chairman Chris Dodd said after yesterday's raucous hearing on these issues. "They are emblematic of much deeper problems in the mortgage-servicing business, problems that have resulted in homeowners losing their homes in unjustifiable foreclosures."
It's clear that the serious problems among mortgage transfers have a range of implications for banks, homeowners, investors, and taxpayers, but we don't yet know how widespread these problems are. A new report from the Congressional Oversight Panel, instituted to oversee the Treasury's Troubled Asset Relief Program, notes that the issue could remain a contained legal squabble, but if problems are endemic to the market, they "could call into question the validity of 33 million mortgage loans."
Treasury's HAMP has helped nearly half a million borrowers but is considered a disappointment because it will not meet the administration's initial goal of helping 3 million to 4 million homeowners over four years. It has also been plagued with problems of lost documentation and bad customer assistance -- initially the owners of mortgage-backed securities simply set up servicers to collect payments from a large groups of borrowers, rather than negotiating with individuals about their specific circumstance.
The response to HAMP's early troubles was not a shift in policy but an effort to hold servicers accountable. Last fall, Assistant Treasury Secretary Michael Barr told reporters that "servicers to date have not done a good enough job of bringing people a permanent modification solution. ... Servicers who don't meet their obligations under the program are going to suffer consequences." Treasury prevailed on banks to hire more employees, but problems persisted.
HAMP forced servicers to offer eligible borrowers modifications before foreclosing on loans, and for that reason, Treasury maintains the position that the burgeoning problems in mortgage documentation will have no impact on HAMP. According to Phyllis Caldwell, chief of Treasury's Homeownership Preservation Office, the program "is not directly affected by 'robo-signers' or false affidavits filed with state courts. ... To modify a mortgage, there is not a need to have clear title."
Independent experts disagree with that assessment.
"There have in fact been cases in which homeowners have made modification agreements with one servicer that were then disavowed by another servicer, and the same has happened when there was an error about ownership of the loan," Valparaiso University law professor Alan White told the Prospect. "As a basic legal matter, the servicer acts as an agent of its principal, the investor. If the servicer's principal does not own the loan, the servicer has no authority to modify the loan. "
If it turns out a modified loan is owned by a third party, then modification efforts could be meaningless. The COP report highlights several problematic interactions between the HAMP program and the mortgage mess. For one, if servicers without the legal standing to foreclose are accepting payments to modify loans, Treasury is essentially paying them taxpayer funds to do something they are legally forbidden to do. More subtly, if cutting corners in the foreclosure process leads servicers to underestimate the cost of seizing a home, servicers will be less likely to consider the incentives offered by the government to modify loans.
All this may be compounded by the fact that Treasury, as part of its standard HAMP procedures, does not require participants in the program to verify that they have legal ownership of the loan, as several jurisdictions, including Washington, D.C., are now requiring before any foreclosure.
However, despite the likely problems HAMP will suffer from the mortgage mess, the program isn't the right vehicle to address it. "They already have such a low success rate, they should be streamlining paperwork, not increasing it," White says. "The mortgage ownership issues will need to be resolved through some other process, probably at the state level."
That means a lot of time spent in court as people with troubled loans try to sort out who owns their home and can legally foreclose on it. Delaying foreclosure will put snags in the housing market and likely disrupt investors' efforts to collect interest and fees on loans, and hinder the sales of foreclosed homes. Depending on how judges rule, troubled borrowers could see their debt erased or their loans modified over the objection of servicers. Fifty state attorneys general involved in a lawsuit against the servicers are trying to negotiate an omnibus settlement with Treasury's support.
"We strongly believe that the reported behavior within the mortgage-servicer industry is simply unacceptable, and servicers who have failed to follow the law must be held accountable," Treasury spokesperson Mark Paustenbach said in a statement.
But while we've been focused on problems between borrowers and servicers, the chain works in the other direction, as well: If investors stuck with failing mortgage-backed securities force the institutions who originally sold them to buy them back, it could put hundred-billion-dollar holes in the balance sheets of already weak banks. While industry estimates of repurchasing costs range from $50 billion to $120 billion, federal regulators say they see no systemic threats. However, a worst-case scenario could force regulatory action from the newly established council of top regulators, the Financial Stability Oversight Committee.
Treasury is cooperating with the Department of Housing and Urban Development, as well as regulators and state officials, to continue a broad review of servicing practices. However, not recognizing the full impact of the documentation problem -- as Treasury appears to do with the HAMP program -- is a recipe for failure. Government policy has consistently underestimated the effects of the recession and the financial crisis, and because of that, government programs have underperformed. Let's not get caught playing catch-up again.