A Look at How Unregulated Servicers Are, and the Consequences for Leaving this Crisis

The mortgage servicers (who we introduced here), the group of financial workers who have been involved with the wave of fraud and the reason foreclosures have shut down, aren’t really regulated. I want to continue to emphasize this, and I want to quote from Andy Kroll’s January 2010 Mother Jones piece Can Anyone Stop the Predatory Lenders?

Oversight of this troubled industry is spotty. “This is a very underregulated part of the system,” says Jack Guttentag, an industry expert and professor emeritus of finance at the Wharton School. “It shouldn’t be, because it’s the part where the consumer has no place to protect themselves.” Federal law allows servicers to send borrowers only one account statement a year—even if there are scheduled interest rate increases or new fees added during that time. If a borrower has a problem, HUD encourages her to first file a complaint with the servicer, and if there’s no resolution after nearly three months, she can then appeal to the agency—assuming she hasn’t been evicted in the meantime. While HUD can step in to fix the problem, it lacks the power to impose tough sanctions on servicers.

The Federal Trade Commission (FTC), Office of the Comptroller of the Currency, and Office of Thrift Supervision also have limited oversight over the mortgage industry. An OTS spokesman could name only one formal action the agency has taken against a servicer—Ocwen, in 2004. An OCC spokesman said his agency has never taken action against servicers.

The FTC has settled three major cases since 2003, resulting in settlements totaling almost $70 million. But even that hasn’t kept servicers in check. EMC Mortgage, a JP Morgan Chase subsidiary, settled with the FTC in 2008 for misleading and ripping off borrowers. That settlement, however, didn’t help consumers like Tammy Cothran, who says EMC foreclosed on her house outside Pensacola, Florida, even though she wasn’t in default. She has appealed to state and federal agencies, and even faxed the White House daily for five weeks. Those efforts left her frustrated: HUD told her it couldn’t help because her mortgage isn’t insured by the Federal Housing Administration, and the FTC said it was “not in a position to intervene.”

Check that out again. The OCC regulates servicers who are attached to banks or thifts, and the FTC sort of regulates them as well. But there is no dedicated regulator here with expertise. If you check out the Mother Jones’ Resources for Dealing With Mortgage Servicers (which has an excellent list of readings about servicers) there’s really no government recourse in the list. And the government agencies we see have simply never shown an interest in this topic.

Why is that important? Because in one month, when the largest banks who run the servicers come back and say that everything is fine, it’s not clear which regulators would also give a thumbs up after reviewing their evidence. In fact I’m not sure anyone would review the evidence, and the ones that might don’t have first-hand knowledge of what would constitute good proof that things are well and functioning.

So plans for dealing with the foreclosure crisis that puts the solution to this crisis on the banks swearing that the problem is gone and on the servicers signing off that they are doing the right thing now is going to be problematic, because who can reasonably keep them honest? Like specifically can anyone legally do it, and even if they could do they have any expertise? And would the market have any reason to believe them?

Kroll writes that this alone is why we need a consumer protection bureau, and I agree. Kroll notes: “In 2009, the Department of Housing and Urban Development received almost 2,500 complaints about mortgage servicers, a 379 jump from two years earlier.” And we also need some sort of government response directly targeted at clearing the air on this topic before the capital markets can move on with certainty.

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10 Responses to A Look at How Unregulated Servicers Are, and the Consequences for Leaving this Crisis

  1. ThomasL says:

    I like your posts, but I am continually amazed by your optimism that the right regulator would have prevented this, or will prevent the next one.

    As one point, the main thing here is the explosion in securitized mortgages. Short of regulatory distortion, while there is an obvious seller, there is no obvious buyer. What advantage is there is purchasing mortgages where the quality of the origination is entirely opaque to the buyer?

    The reasons were purposefully created capital ratio advantages, and rating advantages (ie, AAA), which allowed them to be sold to tightly regulated entities like pension funds, opening a broader market for the sellers, and a chance at much higher returns than that class of regulated borrow was wont to get.

    Those operations were not only allowed, but actively encouraged by regulators. The regulators eventually worked to cut down the amount of capital required to hold a securitized mortgage to 0% (yes, zero), as opposed to 4% for a traditionally held mortgage (regardless of the riskiness of the mortgage). There was also the encouragement of the use of off-balance sheet items SIVs.

    I want to be clear that I’m not saying only that the regulators allowed it, I am saying they actively promoted it through capital ratio advantages and others.

    Here is from David Jones (Fed) ca2000:

    “By reducing banks’ effective capital requirements against such activities to levels more consistent with the underlying economic risks, [regulatory capital arbitrage] may permit banks to compete efficiently in relatively safe businesses they would otherwise be forced to abandon.” (ht: Arnold Kling for the quote, http://ideas.repec.org/a/eee/jbfina/v24y2000i1-2p35-58.html )

    Short version is that I appreciate and share your skepticism of the banks, but I can’t share your appreciation and optimism for the regulators.

  2. David Merkel says:

    Excellent series. It looks like you put in a lot of hard work, and I thank you for it.

  3. ThomasL says:

    Amid several typos, this one might is odd enough to be confusing:

    s/regulated borrow/regulated buyer/

  4. Pingback: Links 10/14/2010 « naked capitalism

  5. in my country bank loans will be easier in getting to the ethnic Chinese, because the bank rate, the people like they have a high work ethic, when we the hardworking natives are really dramatic for us ..

  6. Pingback: Links 10/16/10 « naked capitalism

  7. hermanas says:

    We need Petraeus not Warren.

  8. Pingback: FT Alphaville » The least ‘advanced’ mortgage servicers

  9. Pingback: FT Alphaville » Mortgage scandal du jour – forced-place insurance

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