Mortgage Servicers Under the Congressional Microscope

The mortgage foreclosure crisis has a new villain, or rather a co-villain to the banks: the mortgage loan servicer who makes more money foreclosing on delinquent borrowers than it does modifying loans.

The news may have surprised some Senate Banking Committee members who heard testimony from two top level banking officials, state officials, and experts in law and consumer protection during an oversight hearing Wednesday. But it has been apparent to thousands of homeowners trying in vain to hold onto their homes.

The hearing was prompted by the robo-signing scandal that hit the press more than a month ago revealing the major banks’ practice of fraudulently filing thousands of affidavits swearing that their representatives had personal knowledge of the debt owed. Lawmakers called banks to task for the robo-signing scandal, but said letters from their constituents showed there were more systemic problems with mortgage servicing.  It didn’t take long for lawmakers to learn that there is no incentive for banks or their servicers to halt the foreclosure process, even for homeowners who have entered agreements to make lower payments based on a modified loan.

“Even the industry now acknowledges that the current mortgage servicing business model is broken and is simply not equipped to deal with the current crisis,” said Sen. Christopher Dodd of Connecticut, the committee’s chairman. “Many observers point out that the interests of third party mortgage servicers are not aligned with the interests of either homeowners or investors.”

Adam Levitin, associate law professor at Georgetown University, explained why.  “Foreclosure is either less costly or more profitable than modification in many cases. Servicers’ financial interests do not match those of the investors,” he said.

After loans are originated, a mortgage servicer bills and collects monthly payments, addresses borrower inquires, maintains records of payments and balances, and pays taxes and homeowners insurance associated with the property. Servicers also distribute principal and interest to investors if the loans are packaged into a mortgage-backed security.  All of this is done for a fee.

Barbara Desoer, President of Bank of America Home Loans, told lawmakers that B of A’s contracts with investors limit their ability to extend or modify loans. However, Levitin said it’s the banks that would rather foreclose than modify partly, because many of the third party servicers are owned by the banks.  Foreclosure also is preferable because a loan modification would require a bank to take an immediate loss on its books. Foreclosing, on the other hand, allows the bank to stretch out the loss over a period of time.

Modifying loans also means the banks would have to write off thousands of second lien mortgages. Levitin estimates those second lien mortgages have a value of $400 billion, which is roughly the market value of the four largest banks.  Large scale modifications, he said, would show the banks to be insolvent.

“That creates a strong incentive to not recognize losses and just pretend that they are not there,” Levitin said.

Levitin said the real problem is that there are losses in the system that need to be allocated.  Currently, those losses are being absorbed by the investors who were misled about the risks associated with the loans and by homeowners who are still current on their mortgages tied to properties that are being rapidly devalued.

“We have to figure out how to deal with those losses,” Levitin said. “As long as we don’t specifically address the loss allocation, we are making a choice and that choice is to stick the losses on the homeowners or the investors and that’s really not where they should be.”

The committee has conducted several hearings on the problems in the mortgage industry, including one last year on mortgage modifications.  Dodd said he intends to hold another hearing with regulators to better understand servicing issues brought up at Wednesday’s hearing.