More on the Mortgage Mess

Another opinion supporting real enforcement of banks’ foreclosure practices.

From the New York Times
November 1, 2010

Ben Bernanke, chairman of the Federal Reserve, said recently that federal regulators are “looking intensively” at banks’ foreclosure practices. An investigation is long overdue, though it shouldn’t take a lot of digging.

Consumer advocates, the press, investors and homeowners have already compiled a compelling list of transgressions: conflicts of interest that have banks pushing foreclosures, without a good-faith effort to modify troubled loans. Dubious fees that inflate mortgage balances. The hundreds of thousands of flawed foreclosure affidavits that violated homeowners’ legal protections. The misplaced documents. And it goes on.

For years these problems have been the focus of research reports, Congressional testimony and court cases. Regulators, however, looked the other way, which is how we got into the mortgage mess.

What makes the latest scandals so outrageous is that even after the financial meltdown and taxpayer bailout— and all those vows about accountability — the regulators are still behind the curve. The fundamental problem is that the banks’ drive to profit from the foreclosure process is all too often at odds with the interests of mortgage investors, homeowners and the economy’s health.

That is a big reason that the Obama administration’s antiforeclosure effort, with its voluntary participation by banks, has fallen so short.

Here is the background. The big banks — Bank of America, JPMorgan Chase, Citibank, Wells Fargo — service most of the nation’s home mortgages for investors who own the loans. They are paid a fee by the investors and also make money from fees on delinquent loans.

Servicers are obligated to manage the loans in the best interest of the investors. That means modifying a troubled loan, if reduced payments would bring in more money over time than a foreclosure. Or foreclosing if a borrower cannot make the payments on a modified loan.

If only it worked that way in practice.

Take, for example, underwater borrowers — the millions of Americans who owe more on their loans than their homes are worth. For them, the best modification is often to reduce the loan’s principal balance, lowering the monthly payment and restoring some equity. That could be best for investors too, because even reduced payments are often better than a foreclosure sale. A bank’s servicing fee is based on the principal balances of the loan — a strong incentive not to reduce a troubled borrower’s balance.

Another conflict occurs when the bank that services a primary mortgage is also the owner of a second lien on the same property. Resolving a troubled first mortgage generally requires a write-down of the second lien, a step that banks have been loath to take.

Banks also profit from late fees and other default-related charges assessed on borrowers. And there is an additional incentive to pile on charges, since the bigger the loan balance, the higher the fee to manage the loan. A group of prominent investors — including Freddie Mac, the Federal Reserve Bank of New York and Pimco, the world’s largest bond fund — recently accused Bank of America of fee-padding. The bank denies wrongdoing.

High default charges harm homeowners because they make it increasingly difficult to catch up on late payments and avoid foreclosure. They also disadvantage investors, because the servicer collects the charges from the foreclosure sale before the investors see any money. Everyone loses, except the bank.

Mr. Bernanke said that the regulators’ findings would be released in November. What is also needed is real enforcement — and new rules and possibly new laws — to make banks change their ways.