A Dysfunctional Fix to a Dysfunctional System

The new mortgage servicing regulation proposals are good for regulators, bad for homeowners.

Nearly six months after banks were caught rubber stamping foreclosures and wrongly evicting families from their homes—a scandal since dubbed "robo-gate"—state attorneys general have indicated that an agreement on restitution could be near. But a devil lurking in the details of the settlement agreement with the major mortgage servicers could make a housing recovery much further off than it needs to be.

Earlier this month the state regulators, in association with federal regulators, outlined in pinprick detail how they want the mortgage service industry to be run. From how to handle foreclosure notifications to letting the Consumer Financial Protection Bureau (CFPB) review economic models for determining the value of a home, a 27-page proposed set of standards would have regulators micromanaging the entire servicing industry. Not exactly inspiration for investors to jump back into the housing game.

Even more troubling, reports suggest that regulators may also force banks to modify $20 billion worth of underwater mortgages by writing down the principal balance of the loan and taking the losses themselves.

All this is said to be a punishment for the banks mistakenly foreclosing on a few homes and losing the paperwork on a number of others during robo-gate's last years. However, instead of getting justice for homeowners, this policy would hurt them by halting mortgage lending and expanding the shadow inventory even further, ensuring the housing market takes much longer to recover.

The proposed plan would certainly make it harder to get a loan. Facing an unprecedented $20 billion fine, mortgage servicing fees would certainly jump in the future, to account for the increased risk of federal penalties. This would mean more expensive mortgages for home buyers and those looking to refinance. And, as JPMorgan Chase warned in a research note in late February, some banks may exit the business altogether, reducing future securitization and increasing the cost of mortgage credit for borrowers.

There would also be substantial moral hazard problems associated with lowering mortgage balances, just because housing prices have fallen. There is currently $744 billion in negative equity in the American housing market, according to CoreLogic. Beyond the legal complexities of determining who in this pool would get one of the $20 billion in forced modifications, imagine if just a fraction of those who are falling behind on their mortgages decided to forgo payment in the hopes of getting further government concessions to force banks into modifying loans.

A nightmare on Wall Street, to be sure.

Even Fannie Mae and Freddie Mac, now wards of the Treasury Department, have been slow to embrace principle write-downs for fear that more homeowners would stop paying their mortgages in order to get in on the action.

More legal problems could arise from investors who don't want the mortgages they own modified. But at least regulators have recognized that investors in mortgage-backed securities should not be forced to take a loss, as reports suggest the restitution plan would require the banks to eat the losses stemming from writing down mortgages themselves.

The good news at this point for the banks is that the regulators are not in perfect accord. The CFPB wants a strong principal reduction program while the Comptroller's office prefers to focus on safety and soundness for the 14 largest servicers.

The competing views on how to penalize the banks stem from different ideas of why a fine should be levied in the first place. The administration has, for a long time, wanted to push banks to write down mortgage principal on a wide scale basis, in order to eliminate the high level of negative equity in today's housing stock. And Elizabeth Warren—the not-so-tacit director of the recently created CFPB—has repeatedly argued for reparations from the banks, which she sees as the villains who created the whole mess in the first place. This reflects her ideology more than it does an adequate review of financial history, even from the liberal perspective detailed in The Financial Crisis Inquiry Report.

State attorneys general are also seeking a political win, since they made a huge show out of joining forces to review the foreclosure scandals that emerged in the later half of 2010. A large settlement from the banks would certainly pay dividends in their next elections. These state officials argue that banks have hurt struggling homeowners by not having the appropriate staff and technology to provide timely assistance to borrowers.

And then there are some in the administration who simply want to unclog the pipeline of loans awaiting modification. In order to address this, they tried to enact "mortgage cramdown" legislation in 2009, which failed due to the threat it posed to the rule of law and long-term trust in contracts.

The administration then turned to the Home Affordable Modification Program (HAMP) to modify up to 4 million mortgages by spending $75 billion to give banks cash in exchange for modifying mortgage payments, reducing interest, and keeping homeowners in their homes. The program is now on the chopping block because it has only accepted 500,000 borrowers into the program, paid out only $1 billion in funds and, in several cases, made borrowers worse off than before.

This should provide a warning to policymakers that mortgage modifications really are not the panacea that many believe them to be. Recently released information about HAMP indicates that 75 percent of those who started modifications eventually fell back into delinquency, which was one of the reasons that, by the end of 2010, the shadow inventory has expanded to over a three years supply of homes.

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  • Tim||

    They're imposing a no buy zone?

  • ||

    "I'm crushing your head."

  • ||

    Should we make the cheap "I have seen Obama's penis and it is this big" joke? Of course we should, this is Reason.

  • Almanian||

    "I just put a pinch of Skoal between my cheek and gum, and I'm good for the whole game."

  • Old Mexican||

    "My sn**** is this big."

    Ok, that was nasty.

  • You got it!||

    I have this much patience with those who mock me.

  • West Texas||

    Please pixelate pictures of that nasty old biddy, please... or put it behind a link or something. I'd rather not see the personification of statism unless I choose to do so.

    (and don't tell me I chose to come to H&R)

  • Almanian||

    You know, you chose to come to H&R....

  • You got it!||

    "If the administration follows through with this, it will be much to do with politics and little to do with sound financial policy."

    Congratulations Andrew, you get a passing grade.

  • Pip||

    "Here's all you need to know about Max..."

  • Old Mexican||

    "Earlier this month the state regulators, in association with federal regulators"


    (Cue in "The Empire March" leitmotif)

    http://www.youtube.com/watch?v=-bzWSJG93P8

  • ||

    But at least regulators have recognized that investors in mortgage-backed securities should not be forced to take a loss, as reports suggest the restitution plan would require the banks to eat the losses stemming from writing down mortgages themselves.

    So, the banks/servicers will continue to contribute the same amount of money to the pool of funds distributed to the holders of the securities; more than they actually take in, post-writedown from the home "owners"?

    Presto!

    *Tyrannosaurus Rex emerges from top hat, devours shrieking audience*

  • ||

    "For those of you who disagree with me, I'm going to play a solo on a violin 'this' big."

  • Greybird||

    "[...] some banks may exit the business altogether, reducing future securitization and increasing the cost of mortgage credit for borrowers."

    Well, securitization has too often been tantamount to fraud thus far, with the packaging of viable loans and crappy loans together into homogeneous products, lubricated with the connivance of bond-rating firms. And with artifical props from Fannie, Freddie, and taxpayers.

    I'm not at all sure that even partially "reducing securitization" is a bad thing, as such, though this proposed regime goes far beyond that.

  • doomboy||

    Another name for my proposal: The Shocker!

  • alt text||

    I like them this long.

  • ||

    [Well, securitization has too often been tantamount to fraud thus far, with the packaging of viable loans and crappy loans together into homogeneous products, lubricated with the connivance of bond-rating firms. And with artifical props from Fannie, Freddie, and taxpayers.]

    Brought to you courtesy of the Community Reinvestment Act, designed to put the needy/financially challenged in houses. Those were the carrots. The stick was poor CRA audit scores for the noncompliant with this social engineering, making corporate bank growth and/or expansion nearly impossible.

    You see, it all starts with gubmint.

  • sevo||

    Q: How do you define a successful government program?

    A: "The program is now on the chopping block because it has only accepted 500,000 borrowers into the program, paid out only $1 billion in funds and, in several cases, made borrowers worse off than before."

  • ||

    Well, securitization has too often been tantamount to fraud thus far

    I don't think its been tantamount to fraud. In many case, I think it was actual fraud, with mortgage-backed bonds being issued that weren't actually backed by mortgages.

    See, if you don't transfer the mortgage to the trustee in accordance with state law, the trustee doesn't have the mortgage, and the mortgage isn't backing the bond. MERS failed dismally at complying with state law in many states, to the point where it is not at all clear who actually holds many mortgages.

    Strict application of state law (and we're talking people's homes and livelihoods here, so strict application seems appropriate) would probably result in an enormous number of mortgage-backed bonds defaulting, many banks being vaporized by bondholders, and many homeowners discovering their notes are actually unsecured, until such time as somebody re-perfects the mortgage.

    Fortunately, our diligent AGs are beavering away on a global settlement which will ensure that the banks which committed thousands of felonies and hundreds of billions in fraud survive, invalid mortgages are enforced, and bondholders get fucked in the ass.

  • Rock Action ||

    Maybe off-topic, but she's at least -- at least -- pushed for transparency regarding where the TARP funds are going, which is a hell of a lot better than the political class. And it's 4:20, isn't it? Yes.

  • Rock Action ||

    *shakes fist at preview button*

  • Tman||

    One thing that has bothered me about Warren is she was basically a hired gun that Obama brought in through the back door and handed her the keys to a new set of government regulations without so much as a "mother may I" to Congress.

    And her big credentials were the completely bullshit thesis papers on the increase in bankrupcty's being caused by medical bills ( Considering Elizabeth Warren, the Scholar).

    I know this is a broken record, but can you imagine the nightly prostration of the liberal media had Bush run an end-around similar to this? Obama does it and, well, he's Obama so it's ok.

    No one better be surprised that Warren isn't going to fix anything, and my only hope is she doesn't make it THAT much worse.

  • kc||

    well, you can hope, but I'm not holding my breath. She thinks all businesses (but especially financial firms) are bad and all consumers are rubes that aren't responsible for their decisions and have to be saved by government interference. And well-meaning but completely wrong to boot.
    Yep, not holding my breath.

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    Last quote heard from Toni’s dad after abruptly leaving for good upon hearing that his wife was pregnant with their one and only child.

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  • biomedical engineering salary||

    Yes, some banks may exit the whole rat race and that will surely change thngs as you say

  • clinical psychologist salary||

    Wow, do you really think there will be that much change to the system. I agree that it needs an overhaul and liked your article but wow.

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