Federal regulators and the top law enforcement officers in all fifty states are eyeing big changes to the dysfunctional home loan industry. If these officials have their way, borrowers who take out home loans and the investors who buy them will work closer together and find common ground to minimize foreclosures, while the middle men who are supposed to be performing that job will see their power diminished.
That's the takeaway from a 27-page proposed settlement agreement a coalition of all 50 state attorneys general and five federal agencies sent last week to the nation's five largest home loan firms. The document details how mortgage companies should treat borrowers who fall behind on their payments.
It's the opening salvo in what will be a months-long negotiation between the nation's largest banks and the officials who oversee them to settle state and federal claims that they abused borrowers and illegally foreclosed on homes.
"Laws were not being followed by the servicers," Illinois Attorney General Lisa Madigan said Monday. "That absolutely has to change."
Regulators, investors and consumer advocates have long complained of a crooked system in which the firms that are supposed to collect payments from borrowers and distribute the proceeds to investors, known as mortgage servicers, have worked to their own advantage rather than working for those they're supposed to represent -- investors.
The proposed checklist of changes, the result of federal and state probes into big banks' foreclosure practices, tries to fix that. The Departments of Justice, Treasury, and Housing and Urban Development support the proposal. So do the Federal Trade Commission and the nascent Bureau of Consumer Financial Protection.
Currently, servicers have wide discretion in how they process payments and treat distressed borrowers and the investors who own those mortgages. If the state attorneys general had their way, that discretion would be narrowed, incentives would be altered, and a new system would emerge in which deserving homeowners would see their payments reduced and investors would experience decreased losses as a result of avoiding foreclosure.
But state and federal officials face an uphill climb. The banking industry and its allies in Congress howl that costs will skyrocket and the housing market will slide again as necessary foreclosures are delayed, threatening the recovery. The uncertainty of the final shape of a settlement also weighs on the market, undercutting efforts to fully investigate banks' loan files and possible wrongful foreclosures. Regulators don't want a dragged-out process. Iowa Attorney General Tom Miller, who's leading the 50-state effort, said Monday that he hopes the negotiations will only take a couple of months.
"We don't want uncertainty to linger too long," said North Carolina Attorney General Roy Cooper.
The preliminary term sheet is just one part of a comprehensive settlement. Fines will be levied, banks have said, and regulators are pushing for additional loan modifications. Those details were not disclosed Monday.
Some regulators are looking to levy up to $30 billion in penalties on the nation's 14 largest mortgage firms for their abusive practices. The penalties would come in the form of civil fines and losses from modifying home mortgages, according to people familiar with the matter. But the national bank overseer, the Office of the Comptroller of the Currency, is fighting that approach. The OCC wants a settlement that would cost the industry just a few billion dollars, sources said.
The state attorneys general want to penalize the industry for past misdeeds, and levy fines and change industry practices to minimize the chances that such transgressions will pop up again.
"We want to remedy losses that have occurred as a result of those problems," John Suthers, Colorado's attorney general, said of restitution due to bank errors.
The changes they're pursuing appear basic to those outside the industry: homeowners shall be afforded basic rights, investors will no longer have to jump through hoops to get the most basic information, mortgage servicers will be required to prove they have the necessary documentation to repossess a home, and banks shall subject themselves to regular audits to ensure compliance.
To those who work inside the industry, or help troubled homeowners navigate through it, the changes regulators seek appear to be the equivalent of a whole new mortgage system. That's how dysfunctional the industry has become.
Instead of an industry geared towards maximizing the value of a mortgage -- like modifying a home loan so investors lose $0.20 on the dollar rather than the $0.50 they'd lose if it was repossessed -- servicers are instead forcing through foreclosures, racking up fees through prolonged foreclosure proceedings, and effectively disregarding the rights of investors and borrowers in pursuit of their own profit.
By bringing investors and homeowners closer together, regulators are trying to minimize the power wielded by servicers.
The nation's five largest mortgage servicers -- Bank of America, Wells Fargo, JPMorgan Chase, Citigroup and Ally Financial -- handle about three out of every five home loans, according to newsletter and data provider Inside Mortgage Finance.
The document was posted online Monday by American Banker. Its authenticity was confirmed by regulators involved in the process who asked not to be named.
Among regulators' proposals:
-Mortgage servicers shall not use incentives that encourage their employees to take shortcuts, like the robo-signing debacle that forced firms to halt home repossessions once evidence emerged that banks were at times breaking the law in their rush to foreclose on distressed borrowers;
-Foreclosure documents will require hand signatures, rather than simple stamps or electronic signatures;
-Mortgage servicers will have to prove they have the original loan files in order to repossess a home (a recent study of foreclosures in bankruptcy by Katherine M. Porter, a visiting professor at Harvard, found that in 40 percent of cases creditors foreclosing on borrowers did not show proper documentation);
-Servicers will have to create divisions separate from their foreclosure units to mediate complaints from aggrieved homeowners, and those units will be subject to audits from other companies, which will then produce reports for regulators detailing servicers' efforts;
-Servicers will be required to create and pay for websites that will allow borrowers to track their individual cases when trying to get their loans modified, as well as websites that will allow borrowers to easily get in touch with housing counselors;
-New incentive structures within servicers will be mandated that encourage loan modifications over foreclosure;
-Servicers will have to operate under strict timelines when processing loans, requests for loan modifications, and pursuing foreclosures;
-Servicers will have to disclose specific reasons why homeowners weren't offered loan modifications;
-Conditional forgiveness of mortgage principal will be required in situations in which balloon payments are due at the end of a modified loan's term;
-Equivalent forgiveness of second mortgages will be required when part of the first mortgage is written off;
-Servicers should consider homeowners' total debt obligations, rather than just their first mortgage, when restructuring their home loans (this would have the effect of lowering borrowers' total debt payments);
-Homeowners should have only one person to deal with at their servicer when trying to modify their loan, a significant change from the present situation in which homeowners are subject to endless phone calls and letters from a variety of bank employees;
-And investors will have access to more information, loan files, and will have a more powerful voice to call for individual loan modifications, rather than being forced to trust that servicers are acting in their best interests. This could be one of the more powerful changes as investors have long called for more loan modifications of troubled borrowers' debt, only to be rebuffed by mortgage servicers. If investors can see individual loan files -- and borrowers can see who the investors are -- this could lead to a significant increase in mortgage modifications.
Banks, though, are already bristling at the proposals, according to people familiar with the matter. Asked about whether the industry would agree to adopt the changes, Miller wondered: "Will enlightened self-interest prevail?"