Fed Governor Says Housing and Banking Industry Owes America

FederalrnReserve Governor Sarah Bloom Raskin called out housing finance players in arnspeech on Friday, reminding them of the “low road” they traveledrnbefore the housing collapse and the debt they owe the American people for rescuingrnthem from their excesses.  She also toldrnher audience that reforming the servicing industry is “the key to economicrnrecovery.”</p

Speakingrnto the Midwinter Housing Finance Conference in Park City Utah, Raskin said thatrnin an economic sense the recession is over, but “Americans still lookingrnfor work, living in cars or motels, or trying to keep their businesses out ofrnbankruptcy would beg to disagree.” rnThe lethargic pace of recovery has many causes but, in her view, the bigrndrag is the state of the housing sector. rnUsually it is the first to recover because of low interest rates andrnpent-up demand and is followed by consumer expenditures which magnifies andrnmultiples the effect of the housing recovery.</p

Today recovery is hampered both by losses in income and net worth andrnby persistent unemployment.  With thernpipeline full of distressed properties we might even see further downwardrnpressure on prices.  Uncertainty aboutrnprices destabilizes expectations outside of the sector as banks must increasernloss provisions, reducing their ability to lend.  Raskin quoting a Census Bureau study finding thatrnfalling homeownership rates have more than wiped out the increase inrnhomeownership that had taken place between 2000 and 2007.  This is not only a drag on the recovery butrnmeans millions of American families have lost their homes and their hopes and thernimpact is felt by the broader community as business investment is undermined,rnhomelessness increases, and health problems multiply. </p

To see the kind of economic recovery we want we should start at thernground level to prevent additional foreclosures; make sure they “takernplace only when there is no option available that would be preferable to bothrnthe borrower and the investor.” rnServicers must review all options before deciding that foreclosure isrnthe best course of action and investors need to be supportive of these efforts.  </p

For those in the servicing industry this means difficult changes andrnsignificant investments to rectify broken systems. “For those servicersrnwho are subsidiaries or affiliates of a broader parent financial institution, thernresponsibility for change and further investment absolutely extends up to thatrnparent company, many of which have enjoyed substantial profits while theirrnservicing arms have been run on the cheap.” </p

Raskin recalled a speechrnshe gave in November about the servicing problems that were undermining the performancernof the industry and said they remain unaddressed. Late last year, the federalrnbanking agencies began a targeted review of loan servicing practices at those largernfinancial institutions that are heavily into servicing and found widespreadrnweaknesses that risk mortgage servicing and foreclosure processes, impair thernfunctioning of mortgage markets, and diminish overall accountability tornhomeowners. “I have seen little to no evidence of improvement in thernoperational performance of servicers since the onset of the crisis in 2007:rnUntil these operational problems are addressed once and for all, thernforeclosure crisis will continue and the housing sector will languish.”</p

She called for strong corporate governance servicer procedures that arernmonitored and enforced system wide and sound policies and procedures againstrnwhich internal operations are assessed. Senior leadership must communicaternperformance expectations that hold all business lines accountable to strongrnprocedural controls. When errors occur, servicers must act swiftly to containrnthe damage and they must foster an operational environment that reflects safernand sound banking principals.  Regulatorsrnmust be prepared to monitor servicing functions on an ongoing basis.  “When servicers misapply payments, losernpaperwork, file incorrect foreclosure affidavits, or simply do not answer thernphone or make available knowledgeable staff persons, there are consequences tornthe consumer. With few adequate remedies to provide meaningful recourse in thernevent errors occur–after all, it’s not as if consumers have a choice regardingrnwho does their servicing–many consumers find themselves captive to practicesrnthat have emphasized speed and aggressive timeframes over responsiveness,rnaccuracy, and completeness.” “In my mind, massive foreclosures werernalways a sign of an equally massive market failure. Well, now it seems to me wernhave reached a point where this sign of failure is hindering our economy’srnability to rebound.” </p

Participants in the servicingrnindustry must change the pricing model.  rnIn addition to float income and ancillary fees, servicers earn moneyrnthrough an annual fee on each loan which must cover some wildly varying costs.  The current model is structured with the hopernthat, over a given period of time, there are enough of the low-touch performingrnloans to cross-subsidize the high-touch non-performing ones, so that thernoverall pool of servicing fee revenue is sufficient to cover expenses andrnreturn a reasonable profit. When that doesn’t happen, servicers are eitherrnbeing paid too much for their efforts or not enough. </p

The current model also rests on the expectation that, in good times,rnservicers are using some of the residual income to build out systems andrnprocedures to handle the pressures that come with worse times. Unfortunatelyrnthis also has not happened. </p

Raskin called for a business model that would:</p<ul class="unIndentedList"<liClosely tie expenses to compensation.rnServicers could be compensated modestly for routine processing of paymentsrnand required to have either sufficient capacity for loss mitigation orrncontracts with third parties that do. </li<liRequire contracts that obligate the investor to pay higher and morerndirect compensation for the labor-intensive work involved in delinquent loansrnwithout incentivizing them to encourage delinquency. </li<liProvide more clarity and specificity about loss mitigation standardsrnand systems for auditing internal procedures. </li<liLimit the extent to which servicers have to advance principal andrninterest on non-performing loans.</li<liSet up more detailed pooling and servicing agreements that providernclarity about what a servicer can and cannot do and that the servicer isrnexpected to work in the aggregate best interest of the investor regardless ofrntranche.</li<liFind ways to deal with conflicting interests of senior and junior lienrnholders.</li</ul

Raskin said, “Too many of the practices in the mortgage servicingrnindustry have been developed and defended solely on the basis of “standardrnindustry practice,” but many practices were not only standard but shoddy,”rnand we now see courts rejecting some of those practices. </p

To rebuild the system we must all play a role.  The Federal Reserve needs to consider reformsrnthat are needed in the realm of strong mortgage lending, but government canrnonly do so much.  Private sector actorsrnmust think beyond their bottom line and focus on how their firms’ actions arernor are not contributing to recovery. “It will be essential for each of usrnto commit to furthering the good of our nation, our neighborhoods, and ourrnfellow citizens.” </p

In concluding her speech, Raskin took on the past performance of the housingrnindustry saying there were too many players in all “functional componentrnparts” from origination to servicing, “who were interested only inrnmaking their own profits and were indifferent to the consequences of theirrnactions for homeowners and communities, much less the nation as a whole. Thisrnselfish free-for-all ultimately led to an economic slide the effects of whichrnare still visible in the boarded-up houses and sheriffs’ foreclosure noticesrnposted all over America.” </p

Only the massive infusion of public dollars into the banking systemrnprevented collapse. “In other words, the public was forced into a positionrnwhere it had to put a lot on the line to save the financial system from its ownrnfollies and from total ruin. And many were bitter about having to do so.” </p

She called on the industry to pay back the American citizenry in fullrnby supporting those who have been buffeted and injured by the housingrncrisis. “When we traveled the low road,” she said, “the onlyrnquestion was: Will this practice make me rich? Taking the high road means werncontinually ask: Do our financial and legal arrangements contribute to thernpublic welfare and the common good?

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