Marian Wang of ProPublica combs through recent mortgage debt servicer job postings and finds things like “$10.00-$12.00/Hour. High-school education required.” And that’s for a “Supervisor of Foreclosure Department” position.
These positions are the people who are going to determine a large part of the future of the American macroeconomy. They have to figure out how to renegotiate bad mortgage debt in the middle of mass unemployment amid complicated, financially engineered legal and financial instruments. The destroyed economic capital, the spillover economic and social effects of foreclosures on neighborhoods, the destruction of a household’s primary asset, the uncertainty of investment decisions and the debt overhang preventing economic expansion are all the obvious results if the servicing industry slips even an inch on the highwire balancing act they have to pull off. And they are hiring at $10 an hour. They are often outsourced to countries with the cheapest call centers. At JPMorgan Chase, they call those who do fill these position the “Burger King kids.”
There’s a narrative that mortgage servicers are an otherwise ok business that has been overwhelmed in the middle of this foreclosure crisis. What’s important to remember is that this is a brand new business, a brand new way of organizing our financial system, and that the conflicts and breakdown are built right into the structure. This crisis has just shown how weak the plumbing is on one of our most crucial pieces of financial infrastructure.
To chart this, I’m copying this excellent table from the National Consumer Law Center’s Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior, (pdf) by Diane E. Thompson:
This is the problems in normal mode, not crisis mode. Notice how the very piping and nature of the way this infrastructure is set up creates conflicts of interest and sets the default mode on servicers away from win-win modifications and towards lose-lose-lose foreclosures. I really want to flood Ezra’s blog with 10,000 words explaining each and every line in that graph, but for the sake of being a good guest I’ll just encourage those interested to check it out.
And quickly explain how the servicer compensation plays out. As it is structured servicer fees (like late fees and foreclosure frees) create an incentive to keep a borrower in default. The servicer’s monthly servicing fee, computed as a percent of the outstanding balance, is more interesting. That gives an incentive where servicers benefit from any and all delays in reduction of principal and suffer a permanent loss of income when they agree to a principal reduction. Loan modifications that increase principal by capitalizing arrears and fees give a boost to these fees. (It won’t surprise you that 70% of mortgage modifications fall into this category of increasing principals by capitalizing arrears and fees.) This structure give servicers a huge incentive to do make-work modifications, ineffectual interest-rate adjustments and principal forebearance, because even though the monthly payment might be a bit lower the principal is the same and their servicing fee comes off the top (before the interest payment to bondholders).
The only way I could imagine this situation being worse is if we doubled-down on it by stuffing it full of taxpayer money, thinking that greasing the wheels with “nudges” could overcome this broken system. Which is exactly what the Treasury Department’s Home Affordability Modification Program (HAMP) has proceeded to do.
I also want to give journalists and interested parties reading this another source that this is a problem baked into the cake, and that is the Mortgage Study website of Tara Twomey and Katherine Porter. They began the project in 2004 to explore the intersection of homeownership and bankruptcy and suddenly started finding all kinds of interesting problems with servicers, problems that resulted in the paper, Misbehavior and Mistake in Bankruptcy Mortgage Claims. They’ve also compiled a list (pdf) with, among many other links and references, a list of judicial decisions in which the court finds inappropriate foreclosure practices or misbehavior by mortgage servicers or their agents. (Porter (pdf): “It should be noted that we stopped updating the document in July 2009. We did so because we were becoming overwhelmed with the number of cases affirming violations of foreclosure practices and servicing duties.”)
I think it surprised a lot of people around 2006 when, pulling back on what the deregulated financial industry had managed to create for handling problem situations in one of the primary investment assets in the country, they realized how broken it was. And this broken system is where our economy recovery needs to overcome.
Kevin Drum wants to know what the latest empirical work tells us about the servicer industry. Let’s do this: hot off the presses (October, 2010), here’s Sumit Agarwal, Amromin, Ben-David, Chomsisengphet and Evanoff, Market-Based Loss Mitigation Practices for Troubled Mortgages Following the Financial Crisis. The abstract, my bold:
Using a unique dataset that precisely identifies loss mitigation actions, we study these methods—liquidation, repayment plans, loan modification, and refinancing— and analyze their effectiveness. We show that the majority of delinquent mortgages do not enter any loss mitigation program or become a part of foreclosure proceedings within 6 months of becoming distressed. We also find that it takes longer to complete foreclosures over time, potentially due to congestion. We further document large heterogeneity in practices across servicers, which is not accounted for by differences in borrower population. Consistent with the idea that securitization induces agency conflicts, we confirm that the likelihood of modification of securitized loans is up to 70% lower relative to portfolio loans. Finally, we find evidence that affordability (as opposed to strategic default due to negative equity) is the prime reason for redefault following modifications.
To continue: “We find that within six months after becoming seriously delinquent, about 31% of the troubled loans that enter our sample in 2008 are in liquidation (either voluntary or through foreclosure), 2.4% enter a repayment plan, 2.2% get refinanced, and 10.4% are modified. The rest (about 54%) have no recorded action. The staggering amount of delinquent loans that see no action from lenders/investors is consistent both with the idea of an industry overwhelmed by the wave of problem mortgages and with the difficulty in overcoming the severe asymmetries of information that inhibit active loss mitigation.”
So both: they appear to be ineffectual in general but also doing a better job for themselves than for the mortgages they service. Bad information and terrible conflicts of interest.
Speak of conflicts: “In terms of magnitudes of the estimated coefficients, second lien loans are the least likely to be modified, controlling for all other loan characteristics. This is hardly surprising, as junior liens likely suffer most severe losses in modifications.” The difference in the modification rate when a second lien is involved is on the order of 11-13%, significantly higher. Second liens are largely held by the four largest banks, who also do a disproportionate amount of the servicing (there’s a longer story about the conflict in junior and second liens have with first mortgages, valuation and the way servicing is carried out, see here for starters).
In case you are interested, here are the rates of redefault by modification type:
Paul Willen of the Federal Reserve Bank of Boston points out that when we look at this we should focus more on the fact that there are so few modifications being carried out, the conflict of interests – that mortgages that are owned by the servicers get favorable treatment relative to other investors – aren’t huge in the aggregate. That’s true, and points to both answers being correct. So a lot depends on your framing. While at the margins there is clear evidence that servicers are creating modifications for mortgages in their own portfolios but not those that they service for others, there aren’t that many modifications going on in general.
Which points to a broken system. As Georgetown University law professor Adam Levitin notes “mortgage servicing is a failed business model. Their solution? Attempt to automate default management by shuffling all defaulted loans off to foreclosure and to use robosigning and other corner cutting techniques to lower costs while charging junk fees on defaulted loans to increase income.
The critical thing to realize about servicers is that they are not subject to any oversight. Investors lack the information to evaluate servicer decisions, while securitization trustees are paid far too little to want to stick out their necks and supervise servicers (with whom they often have cozy business relationships). A securitization trustee is not a general purpose fiduciary; it is a corporate trustee with very narrow duties defined by contract, and entitled to rely on information supplied by the servicer. So we’ve got a case of feral financial institutions, a sort of servicers run wild, with both homeowners and MBS investors bearing the costs of unnecessary foreclosures, all because servicers misjudged the housing market and didn’t charge enough to cover the costs of properly performing their contractual duties.”