The American Prospect has a special report on housing this month. Some of my favorite people who work on housing are in the issue, including Alyssa Katz, Marcus Stanley (from Americans for Financial Reform, who critiques HAMP), James Carr from the NCLC, Dan Immergluck, who calls for a public option for mortgages, and more.
I have a piece in there about the current foreclosure fraud crisis and what needs to be done to fix it. I tried to emphasize the dual nature of the mortgage servicing business — which contains both a high-volume, low-information loan processing business and a default management business that should be low-volume and high-information — as the original problem, which is made worse by other factors. I also wanted to convey that if the mechanisms for payment and default management in the largest lending market in the largest economy in the history of the world aren’t trustworthy, there will be serious consequences. These companies should function as reliable, accountable utilities, not businesses willing to cut corners, fake documents, or proceed with phantom referrals in order to increase margins by a tiny percentage.
I wrote this article before the excellent news came out that individual state Attorneys General will be taking the initiative to actually investigate these problems, lead by New York AG Eric Schneiderman. Now word is coming out that Connecticut and Ohio are also investigating this matter, and that California and Illinois are specifically looking at Lender Processing Services (LPS).
Luckily Yves Smith just posted a class-action lawsuit filing by shareholders against LPS, which is a fantastic read. At 200 pages the lawsuit is long, so I’ll summarize the main argument as a way of reintroducing what the AGs want to find out about LPS. The lawsuit is important because many people understandably don’t think that foreclosure fraud is a big problem. They don’t believe it’s a major, systemic issue that cuts to the core of the country’s foreclosure system. There are millions of foreclosures and no doubt here and there you can find problems. They also likely don’t think homeowners suffer real damages from this fraud. If there are any consequences to real people, they are likely for bond holders and servicing banks, or within different entities that created the securitization in the first place. Which is to say, rich people with lawyers screwing other rich people with lawyers, who have the means and incentives to respond. This lawsuit ends up making the case against these ideas.
Problems in Theory
LPS is the very definition of the problematic dual business model. It started as a technology company designed to provide software and web-based applications to automate payments. Then in 2008 it added a default management services wing to its business lines.
Default management is the business line that is difficult to automate. What’s worse, LPS made a series of decisions to further exacerbate this problem in a way that would increase its market domination and revenues. It gave away business free to clients and decided to generate revenue by coordinating a network of attorneys, making its money through charging them fees. It acted as a filter between clients and attorneys handling defaults, which broke the client-attorney relationship. It then created a series of incentives to maximize speed over quality. As Reuters has noted about this system:
Interviews, deposition transcripts and LPS’s own records underline that the company keeps its clients happy and maximizes its own fee income by whipping law firms to gallop cases through the courts.
The law firms are on a stopwatch: Kersch confirmed that the LPS Desktop system automatically times how long each firm takes to complete a task. It assigns firms that turn out work the fastest a “green” rating; slower ones “yellow” and “red” for those that take the longest.
Court records show that green ratings go to firms that jump on offered assignments from their LPS computer screens and almost instantly turn out ready-to-file court pleadings, often using teams of low-skilled clerical workers with little oversight from the lawyers. Copies of company newsletters from shortly before LPS was spun off show that the company each year gave awards to the law firms that were consistently the fastest.
Firms that move more slowly were slapped with “red” designations. For them, work offers dried up.
LPS handled more than 50% of the industry’s residential mortgage volume. Their business model was designed to strip the legal work necessary for foreclosure to its bare minimum. With no market pressure from consumers — they don’t know if their mortgages will be securitized, and certainly have no say in who will be managing payments if they are — and with the default management system working to obscure cut corners and emphasizing speed over reliability or quality, it is up to the legal system to provide a necessary check.
Problems in Practice
So that business model turned out poorly. What’s worse is that in the attempt to maximize the rate of foreclosures, they are doing untold damages to both the system of records and to consumers. The report points out six distinct things LPS was doing wrong.
First, in order to foreclosure on a home, the foreclosing entity has to show ownership, and during the boom these documents weren’t correctly stored or ordered. This isn’t a trivial point — centuries of law have required strict adherence, and even more so for trust law (whose special tax provisions were necessary for the securitization structure to work). A special wing of LPS called DocX would, according to documents and testimony, recreate missing documents, missing assignments, and an entire collateral file.
How would they do this?
CW724 explained the process by which documents such as assignments were generated at DocX. Indeed, he explained that Data Entry employees took information from scanned documents on their computer screens and entered it into LPS Desktop software to create assignments of mortgage. These employees entered data such as the loan amount, person’s name, address and a property description. Data Entry employees did not perform any analysis or verify any information; they just pulled information from one screen and entered it into another. CW7 then printed those documents through LPS Desktop and took them into the “Signing Room” at DocX, where a supervisor took the documents and handed them out to signers…
Indeed, LPS executed assignments fraught with deficiencies, including but not limited to: (1) signatures and dates after foreclosures were initiated for mortgages that should have been handed over to trusts; (2) signatures by LPS employees purporting to be officers of lenders that no longer exist; (3) incomplete or non-existent grantees or grantors such as “bogus assignee” or “bad bene”; (4) improper effective assignment dates such as “9/9/9999;” and (5) blank signature lines witnessed and notarized.
Any computer coders should note that the code prints out all 9s for dates when they are improper, yet documents went out that way anyway. This is scary, as these documents are used as proof of the amount, conditions, and terms of the loans.
The second is robosigning, which is really a document signing sweatshop. Because LPS managed default services for such a large portion of the industry, it ended up with millions of documents to sign. From the report: “CW7 explained that each person pulled a page off the top of the stack near them, signed that page and moved it to another stack next to them. They did not appear to perform any analysis, review or verification of any details in the documents they were signing. These documents included mortgage or promissory notes, and assignments of mortgages.” Given that some of these documents were recreated (i.e. faked), this is a bad sign.
Third is that employees would forge signatures. Check out the variety of signatures from Vice-President Linda Green:
Fourth, mirroring the incentives for lawyers, robosigners and document processors within LPS were paid for speed, often with a very high minimum number of signatures required in order to not be fired and with no penalty for errors.
So when you add this all up, what kind of problem does it generate? A fifth one that created false problems and then abused the important, minute details:
According to CW16, there were serious problems in the automation process that led to “phantom referrals,” when the LPS MSP software system generated “processes” or attorney referrals that did not really exist… While attorneys who were honest would review the file and realize there was not sufficient information to justify the referral, many other attorneys who were not honest or who had organizations with a lot of low-level employees handling the intake “would just file it even though created by error.” CW16 noted that the David J. Stern law firm would make fees wherever they could…
According to CW16, on top of the 20% of files with phantom referrals, approximately another 35% of files had some problems in them. Those problems varied, and included among others, an ARM that had improperly adjusted up, a failure to properly account for a borrower’s principal and interest payments, and a failure to properly attribute payments between pre-petition and post-petition that led the banks to try to collect pre-petition obligations they were not permitted to pursue.
False referrals were coupled with manipulating payments and numbers. This all undermines the sanctity of the court and the foreclosure process, harms consumers, and makes a mockery of the largest lending market in the world. We don’t know the extent of these problems, and it is likely the banks themselves don’t know the extent. But we know this is the problem, and it requires a government response.