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Mortgage-servicing conflicts baked right into the cake

By Mike Konczal

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 J.P. Morgan Chase, they call those who fill these position the “Burger King kids."

There's a narrative that mortgage servicers are an otherwise okay 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 (click through for larger image):

servicer_compensation_effects.jpg

These are 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 toward 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 (such as 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 percent of mortgage modifications fall into this category of increasing principals by capitalizing arrears and fees.)

This structure gives 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 Web site 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 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.")

We need a system that effectively sets the ground rules that allow for lenders and borrowers coming together and negotiating a situation that is best for both of them. Because the first rule of mortgage lending is that you don’t foreclose. And the second rule of mortgage lending is that you don’t foreclose. I’ll let Lewis Ranieri, who created the mortgage-backed security in the 1980s, tell you: “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." Too bad our newest financial innovations have forgotten this.

Mike Konczal is a fellow at the Roosevelt Institute. He blogs about finance, economics and other topics at Rortybomb and New Deal 2.0, and you can follow him on Twitter.

By Mike Konczal  | November 9, 2010; 12:10 PM ET
 
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Next: The latest on servicing and modifications

Comments

A very good post regarding the convoluted mess that is the current state or mortgage modification. At least regarding Arizona (and probably other states such as CA, NV, and FL where there is a high percentage of houses underwater) I can boil down the issue into two statements:

1. For most borrowers facing foreclosure that are underwater the only thing that is going to ultimately stop the foreclosure is principal reduction, all other solutions simply allow the homeowners to stay in their house a little longer while the servicers make big fees.

2. Banks are never going to reduce principal balances, not because they don't think it might make sense on an individual basis, but because setting the precedent will induce alot of borrowers who otherwise would still make their payments to demand principal reductions as well and render the banks insolvent.

I don't see an easy way out of this short of the coercing the banks into insolvency and taking them over. The only other solution that seems more palatable right now is for Fannie and Freddie to provide cost free refinancing (regardless of how underwater you are) without paperwork or appraisal of all existing loans at a 4% 30 year fixed (with no principal reduction). This would obviously require another big bailout package but at least we could separate the people who could potentially make their payments with good loan terms from those who are going to likely foreclose under any circumstance.

Posted by: ArizonaGlen | November 9, 2010 1:55 PM | Report abuse

My new BFF MIke:

Here's what I have been TOLD by some people in the business. Note, I don't discount the possibility that they are blowing smoke you know where. So don't kill me if this is not actually correct.

I have been told that in a foreclosure the bank still has the option as to valuation, until a resale is complete. In a modification that includes writing down principal, the bank has to take that loss immediately.

You can see why in normal times there is no real disadvantage to modifications. However given current bank restructuring problems and capital requirements, AND reserves rules, AND the unprecedented number of foreclosures, AND given that Bank of America holds an awful portfolio (courtesy of Countrywide)that would under some types of accounting make them technically insolvent (he pauses for breath), foreclosure may be preferable to certain institutions.

Posted by: 54465446 | November 9, 2010 4:16 PM | Report abuse

Check out this suit filed earlier this week in federal court in Florida: http://market-ticker.org/akcs-www?post=171519.

Posted by: jackie_chiles | November 9, 2010 6:37 PM | Report abuse

54465446 above hits the target: many lenders are now technically insolvent and can be saved only by [technically] foreclosing on mortgaged properties.

Some of the poorest properties have been leveraged by various banks at 3000% or more -- which is intuitively silly but technically possible (at least since the 1980's, when reality gave way). It's interesting to go back to those days 20 years ago to re-read & re-view the printed and televised reports: the situation we are in today was predicted... but scholarly economists said foreclosures (and international monetary policies, including default by nation-states) was nothing to worry about. Buckley's program on PBS brought together a lot of voices & transcripts are available.

Posted by: rmgregory | November 9, 2010 11:19 PM | Report abuse


With mortgage rates at all-time lows, now may be a great time to refinance -- if you meet new stringent criteria. Search online for "123 Mortgage Refinance" they got me the 3.21% rate even with my not so good credit history.

Posted by: alexpablo | November 10, 2010 4:22 AM | Report abuse

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