Regulating the servicers now is continuing to grow as a political issue. This Zach Carter story, House Democrats Push For New Foreclosure Regulations, explains how a new letter from Representative Miller is being signed by House Democrats. This letter joins and references a letter from 52 economists, financial experts and activists. Cheyenne Hopkins of American Banker has an excellent article explaining the different positions taken by regulators and lobbyists.
There are a lot of things in the world you can worry about. I want to make the case you should worry about this topic beyond the large amount of abuse stories you are hearing each and every day. First we need to go back over two years ago to Lewis Raneri, the creator of the mortgage-backed security, at the April 2007 Milken Conference. (Sources for both conferences.)
Raneri tried to warn the crowd of financial types that his invention, which had taken over the residential mortgage market, wasn’t capable of doing mass modifications, the kind of thing lenders needed to do to in the aftermath of a nationwide housing bubble. He said that “the real dilemma for me and I think the real issue . . . will be, we’ve never had to do substantial restructurings in housing in mortgage securities…We restructured the loans and it was always better to negotiate around the borrower, We basically assume that was a renegotiation, end of story because it was in our best interest, as the lender, to do that but in a mortgage security, you don’t have that freedom…That’s an incredibly dopey idea.”
Flash forward one year later to May 2008. No progress has been made on fixing the servicer problem. Now the Milken Conference has some of the highest density of true believers in deregulated financial markets being able to take care of themselves without any type of government intervention. Ranieri, either because he believed it or because he wanted to speak their language, implored the audience to use “financial innovation” to get the servicer problem fixed:
Lewis Ranieri: The cardinal principle in the mortgage crisis is a very old one. You are almost always better off restructuring a loan in a crisis with a borrower than going to a foreclosure. In the past…the bank, or someone like a bank owned them, and they always exercised their best judgement and their interest. The problem now with the size of securitization and so many loans are not in the hands of a portfolio lender but in a security where structurally nobody is acting as the fiduciary.… have to cut the gordian knot of the securitization of these loans because otherwise if we keep letting these things go into foreclosure it’s a feedback loop where it will ultimately crush the consumer economy.
Moderator: How optimistic are you Lou? You used crisis, you used Great Depression a few minutes ago. That’s a little strong…
Lou: It’s not strong. I believe we know what to do because it is not remarkably different than what we’ve done in the past in the context of the housing bubble. if we are allowed to do it. We know how to restructure loans…So no this isn’t a government issue, it is something the market needs to do.
It has been over three and a half years since that first warning, and the market has made no progress in fixing this problem. If anything, the situation has gotten far worse than anyone imagined.
Again, why should this bother you?
Integrity of the System This system of mortgage lending is new.
(Source: Mortgage Servicing. There are a lot of ways to represent the newness, the post 1980s, of this system. The number is higher if you consider the number of mortgages, instead of dollar amount, as jumbo mortgages are less likely to be securitized.)
It is brand new when you consider the centuries of law tying debt and land that has tried and tested. And it is broken. There is an extensive empirical debate over whether or not the lost value of lack of modifications is a problem of servicers being too “thin”, too poorly resourced to be up for the job, or if they are purposely pushing mortgages into foreclosures for their own profit or keeping them in limbo to collect second-lien income. The numbers say it is a matter of both.
Deleveraging, Defaulting Many economists believe that “deleveraging”, or the process of paying and marking down the debts consumers and corporations took on during the credit bubble, is essential for the economic recovery. And since 2008, consumers have become net savers, on average paying down debt.
(Source.) However this is happening in large part through defaults and foreclosures. Foreclosures are nasty affairs – they have well-documented spillover effects, driving down neighborhood values leaving neighbors more leveraged and more likely to default, increasing uncertainty and difficulty in selling properties. They decimate the balance sheets of municipalities, who are faced with the decision to lay off school teachers to pay to upkeep abandoned properties. They increase disorder, bloat a “shadow inventory” of homes, create confusion over the worth of our banks to investors, and really hurt investors, who are left with a property they didn’t want that they have to sell at a deep discount when they could have kept someone in there paying some rate.
It’s a good thing that bad debt is getting vetted out of the system. It is essential for our macroeconomic recovery. But this is an extra painful and disordered way to do it, and with simple reforms the servicers can be brought to accountability by investors and the market.
Still a Problem Going Forward This isn’t going away as a problem in two important ways. The first is that, with current estimates, there will be 2 million foreclosures next year, same as there was this year. There will be 2 million foreclosures the year after that. Foreclosures will remain very high after that – we can easily imagine ourselves being here in 2013 saying “Why won’t our government get off there butts, stop protecting the biggest banks, and do something about this problem?” It is time to act.
The second way is more disturbing. Even after a recovery the housing markets will still be broken. Consumers will have to worry their documents are not transfered and recorded to the correct place. Consumers could have their payments misallocated by a servicer, and there is little recourse they’ll have other than to pay massive, illegal fees or lose their home.