[Senate Hearing 112-139] [From the U.S. Government Publishing Office] S. Hrg. 112-139 THE NEED FOR NATIONAL MORTGAGE SERVICING STANDARDS ======================================================================= HEARING before the SUBCOMMITTEE ON HOUSING, TRANSPORTATION, AND COMMUNITY DEVELOPMENT of the COMMITTEE ON BANKING,HOUSING,AND URBAN AFFAIRS UNITED STATES SENATE ONE HUNDRED TWELFTH CONGRESS FIRST SESSION ON EXAMINING THE IMPORTANT NEED FOR NATIONAL MORTGAGE SERVICING STANDARDS __________ MAY 12, 2011 __________ Printed for the use of the Committee on Banking, Housing, and Urban Affairs
Available at: http: //www.fdsys.gov / _____ U.S. GOVERNMENT PRINTING OFFICE 70-857 PDF WASHINGTON : 2011 ----------------------------------------------------------------------- For sale by the Superintendent of Documents, U.S. Government Printing Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC 20402-0001 COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS TIM JOHNSON, South Dakota, Chairman JACK REED, Rhode Island RICHARD C. SHELBY, Alabama CHARLES E. SCHUMER, New York MIKE CRAPO, Idaho ROBERT MENENDEZ, New Jersey BOB CORKER, Tennessee DANIEL K. AKAKA, Hawaii JIM DeMINT, South Carolina SHERROD BROWN, Ohio DAVID VITTER, Louisiana JON TESTER, Montana MIKE JOHANNS, Nebraska HERB KOHL, Wisconsin PATRICK J. TOOMEY, Pennsylvania MARK R. WARNER, Virginia MARK KIRK, Illinois JEFF MERKLEY, Oregon JERRY MORAN, Kansas MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi KAY HAGAN, North Carolina Dwight Fettig, Staff Director William D. Duhnke, Republican Staff Director Dawn Ratliff, Chief Clerk Brett Hewitt, Hearing Clerk Shelvin Simmons, IT Director Jim Crowell, Editor ______ Subcommittee on Housing, Transportation, and Community Development ROBERT MENENDEZ, New Jersey, Chairman JIM DeMINT, South Carolina, Ranking Republican Member JACK REED, Rhode Island MIKE CRAPO, Idaho CHARLES E. SCHUMER, New York BOB CORKER, Tennessee DANIEL K. AKAKA, Hawaii PATRICK J. TOOMEY, Pennsylvania SHERROD BROWN, Ohio MARK KIRK, Illinois JON TESTER, Montana JERRY MORAN, Kansas HERB KOHL, Wisconsin ROGER F. WICKER, Mississippi JEFF MERKLEY, Oregon MICHAEL F. BENNET, Colorado Michael Passante, Subcommittee Staff Director (ii) C O N T E N T S ---------- THURSDAY, MAY 12, 2011 Page Opening statement of Chairman Menendez........................... 1 WITNESSES A. Nicole Clowers, Acting Director, Financial Markets and Community Investment, Government Accountability Office......... 2 Prepared statement........................................... 26 Diane E. Thompson, of Counsel, National Consumer Law Center...... 6 Prepared statement........................................... 42 Responses to written questions of: Chairman Menendez........................................ 185 Laurie F. Goodman, Senior Managing Director, Amherst Securities.. 8 Prepared statement........................................... 122 Responses to written questions of: Chairman Menendez........................................ 186 David H. Stevens, President and Chief Executive Officer, Mortgage Bankers Association............................................ 10 Prepared statement........................................... 129 Responses to written questions of: Chairman Menendez........................................ 187 Anthony B. Sanders, Professor of Finance, George Mason University School of Management........................................... 14 Prepared statement........................................... 172 Responses to written questions of: Chairman Menendez........................................ 188 Richard A. Harpootlian, Attorney, Richard A. Harpootlian P.A..... 15 Prepared statement........................................... 175 (iii) THE NEED FOR NATIONAL MORTGAGE SERVICING STANDARDS ---------- THURSDAY, MAY 12, 2011 U.S. Senate, Subcommittee on Housing, Transportation, and Community Development, Committee on Banking, Housing, and Urban Affairs, Washington, DC. The Subcommittee met at 2:12 p.m., in room SD-538, Dirksen Senate Office Building, Hon. Robert Menendez, Chairman of the Subcommittee, presiding. OPENING STATEMENT OF CHAIRMAN ROBERT MENENDEZ Chairman Menendez. Good afternoon. This hearing will come to order, the hearing of the Banking Subcommittee on Housing, Transportation, and Community Development. This is the first Subcommittee hearing that I have called as Chairman in the 112th Congress, and for this hearing I have chosen to focus on the need for national mortgage servicing standards, which speaks to just how important I believe this subject is not only for homeowners and mortgage investors, but for the entire lending industry. It is of particular concern to the countless New Jersey homeowners who have contacted my office, almost all with terrible stories about their experience going through foreclosure, and many with stories of being either mistreated or neglected by mortgage servicers. The typical problems they encounter are servicers losing their paperwork, not understanding what already happened the last time they called since they get a different person each time they call, asking them to reapply for modifications numerous times with new documentation each time, a lack of transparency as to whether their modification requests are being calculated properly, ineffective appeals, excessive delays in coming to decisions, and a general reluctance by servicers to modify loans in ways that would be sustainable in the long run. And we are going to hear from some witnesses as to why that might very well be the case. Overall, the current process is both emotionally draining and ineffective in keeping people in their homes. Closely related to homeowner concerns are mortgage investor concerns about the conflicts of interest that many mortgage servicers face when deciding whether to foreclose or modify a loan. In response to all of these concerns, numerous commentators have suggested that national mortgage servicing standards may be a way to provide consistency, accountability, and better homeowner and mortgage investor protections. There seems to be an increasing consensus that at least some kind of national mortgage servicing standards are warranted, and I believe that if they are done in the right way, they can actually make mortgage servicers' jobs easier as well. This is also a timely topic because Federal banking regulators, including the OCC, the Federal Reserve, FDIC, and OTS, recently issued consent orders as enforcement actions against some of the largest banks to require changes in their mortgage servicing practices. These actions take a step in the direction of developing national mortgage servicing standards, but they are also too little and too late. The independent Government Accountability Office, the GAO, has also released a report recently that speaks to the need for national servicing standards related to foreclosures. There have also been numerous bills introduced in Congress requiring various kinds of national mortgage servicing standards. So I have convened this hearing to solicit the views of various experts and market participants. I have asked them to comment on whether they believe national mortgage servicing standards are needed and what exactly should be in those standards, and I want to thank all of the witnesses in advance for their testimony here today. I want to apologize. We were a few minutes late in starting because we have a vote that is taking place on the floor. I know Senator Merkley, who is very involved in these issues, has voted and is on his way here, and so if he wishes to, when he gets here I will recognize him. But in the interest of moving our process ahead here, let me start off with our first witness on this first panel, Nicole Clowers. She is the Acting Director of Financial Markets and Community Investment, Government Accountability Office. She has testified here before, and she is the lead author of a GAO study that Senator Franken and I requested and that just came out last week on the Federal banking regulators' response to the so-called robo-signing, which is the illegal rubber-stamping of foreclosures by mortgage servicers in court documents. So, Ms. Clowers, thank you for your work. Thank you for being here for testimony. I would ask you to summarize your testimony in about 5 minutes or so. We are going to include your full testimony in the record, and with that, I would like to recognize you to start off. STATEMENT OF A. NICOLE CLOWERS, ACTING DIRECTOR, FINANCIAL MARKETS AND COMMUNITY INVESTMENT, GOVERNMENT ACCOUNTABILITY OFFICE Ms. Clowers. Thank you, Chairman. Thank you for having me here today to talk about our recent work on mortgage servicing issues. As you know, last fall a number of servicers announced that they were halting or reviewing their foreclosure practices after allegations that foreclosure documents may have been improperly signed or notarized. While the servicers resumed their foreclosure activities after completing their reviews, concerns about servicing practices and the impact of reported problems remain. In light of these concerns, you and several others asked us to review Federal oversight of the servicing industry. We issued our report last week and concluded that the documentation problems revealed the need for ongoing oversight of servicers. Although Federal regulators have taken steps in recent months to increase their focus on servicing issues, the resulting delays in completing foreclosures and increased exposure to litigation highlight how the failure to oversee whether institutions follow sound practices can heighten the risk these entities present to the financial system and create problems for the communities in which foreclosures occur. As a result, we recommended that the banking regulators take various actions, including: one, developing and coordinating plans for ongoing oversight of the servicing industry; two, ensuring that foreclosure practices are included as part of any national servicing standards that are developed. In my comments today, I will discuss each of these recommendations in more detail. First, we recommended that the banking regulators and the new Bureau of Consumer Financial Protection work together to develop and coordinate oversight plans. Until the problems regarding foreclosure documentation came to light, Federal oversight of the servicing industry had been limited, in part because regulators viewed such activities as low risk to safety and soundness. Furthermore, past Federal oversight was fragmented and not all servicers were overseen by Federal banking regulators. In response to reported foreclosure documentation problems, banking regulators conducted a review of foreclosure processes at 14 servicers. This review found that servicers had generally failed to properly prepare documentation and lacked effective supervision and controls over their foreclosure processes. Examiners also identified a limited number of cases in which foreclosures should not have proceeded, even though the homeowner was seriously delinquent, including cases where foreclosures proceeded against military servicemembers on active duty in violation of the Servicemembers Civil Relief Act. Banking regulators plan to follow up with servicers to better ensure that they implement agreed-upon corrective actions, and the new Bureau also plans to conduct oversight of servicing activities. However, the extent to which the regulators will conduct ongoing supervision of servicing activities in the future as well as the goals for the supervision and the roles that each regulator will play have not been fully determined. Until these plans are developed, the potential for continuing fragmentation and gaps in oversight remain. Second, we recommended that the banking regulators and the Bureau of Consumer Financial Protection take steps to include foreclosure practices in any national servicing standards that are developed. To help address the identified problems and concerns with servicing activities, various market participants, as you noted, Chairman, have begun calling for the creation of national servicing standards, and most of the regulators have stated that national servicing standards could be beneficial. Regulators and others cite a number of potential benefits of implementing standards, including creating clear expectations for all servicers, establishing consistency across the servicing industry, increasing transparency of servicing practices, and promoting accountability in dealing with consumers. Regulators have established an interagency process to consider these issues in developing national servicing standards. While servicing standards could cover a wide range of activities, it is unclear the extent to which they would address the identified weaknesses and lack of consistency among servicer foreclosure practices and how the standards would be implemented. If national servicing standards are developed, ensuring that they provide clear expectations for servicers to follow as part of the foreclosure process could be a way to improve consistency in the servicing industry. Consistent expectations for the foreclosure process could also help address the limited oversight of the servicing industry that we have seen in the past. In conclusion, regulators have recently increased their oversight of the servicing industry, but additional actions are warranted. We made several recommendations to the regulators to help strengthen the oversight of this industry. The regulators generally agreed with our recommendations, and some are taking steps to implement them. We look forward to working with the regulators and this Subcommittee to ensure these recommendations are fully implemented. Mr. Chairman, this concludes my prepared statement. I would be happy to answer any questions you may have. Chairman Menendez. Well, thank you very much, and you are so effective. You had 5 seconds left. [Laughter.] Chairman Menendez. Let me ask you just a couple of questions. One is you reported that past Federal oversight was limited and fragmented. So if we were to have national servicing standards, would that help address this problem? Ms. Clowers. It could help address the limited and fragmented oversight that we saw. In terms of addressing the fragmentation, the servicing standards could help increase consistency in both the treatment of the borrower as well as increase consistency in regulator oversight of the servicers. It could also increase the attention that the regulators give to the servicing process and the servicing industry and, therefore, help address the limited oversight that we saw. Chairman Menendez. And if we were to have national servicing standards, what should be included in them? Ms. Clowers. The servicing standards could cover a wide range of activities, from loss mitigation to the compensation model for servicers. We did not evaluate all the potential elements. Rather we found that if servicing standards were developed, the foreclosure process should be included. OCC has developed a set of potential standards that I think could be used as a starting point in considering what type of foreclosure processes to include. The enforcement orders that were recently issued by the regulators also contained elements such as a single point of contract that could be another starting point as the stakeholders work to develop the standards. I would also note that in 2009 we issued a report outlining principles for financial regulatory reform, and I think these principles could be useful in the context of developing servicing standards as they relate to the foreclosure process, including making sure that the goals that we set are clear and not conflicting, making sure that all parties are treated consistently, considering the regulatory burden placed on the industry versus increasing oversight, as well as ensuring that they are flexible and forward looking so that we are not necessarily fighting the last fight. Chairman Menendez. Finally, the banking regulators just recently issued a report themselves with reference to their review of servicers' practices, and I wonder if you have had an opportunity to review that and some of their findings. Ms. Clowers. I have. The regulators found significant weaknesses in the foreclosure practices of the 14 servicers they reviewed. The weaknesses fall into three general categories. There were weaknesses with the documentation process, which would include such things as the person signing the affidavit not having the personal knowledge of the facts and circumstances of the loan as required by law. There were also weaknesses with regard to vendor management in that the servicers were not providing sufficient oversight and due diligence in their oversight of the vendors that they use, such as the law firms. And, finally, there were a number of weaknesses in what would be categorized as governance issues, and this ranged from a lack of documented written policies, lack of staffing capacity, lack of training, and a lack of controls and quality checks to make sure that documentation errors did not occur. Chairman Menendez. Good. Let me thank you for your work and your testimony. We may have colleagues who are going to ask questions in writing in the next couple days, so we appreciate your responses to those. Ms. Clowers. Absolutely. Chairman Menendez. And thank you for coming before the Committee. Ms. Clowers. Thank you. Chairman Menendez. Let me introduce the second panel as we excuse Ms. Clowers and ask them to come up and we will dictate the order here as we introduce them. Diane Thompson is Of Counsel at the National Consumer Law Center and has represented low-income homeowners since 1994, and she has testified here before on foreclosure-related issues, so welcome back. Diane, please come on up. Laurie Goodman is a senior managing director at Amherst Securities where she is responsible for research and business development. Before joining Amherst, she was the head of global fixed income research and manager of U.S. Securitized Products Research at UBS, and she is one of the most well respected mortgage investor analysts in the country, so we welcome her. David Stevens is president and CEO of the Mortgage Bankers Association, and he just assumed that role. I think this may be his first hearing, so, David, welcome. Members of the Committee may recognize Mr. Stevens from his previous role only a few months ago as the head of the Federal Housing Administration at HUD. He has had a long and distinguished career in the public and private sectors. Anthony Sanders is a professor of finance at George Mason University School of Management. He has written extensively about real estate finance and securitization. Thank you, Professor. And I am told he is from Rumson, New Jersey, so you can have all the time you want. [Laughter.] Chairman Menendez. All politics is local. Welcome. And Richard Harpootlian is a distinguished attorney who has tried cases in South Carolina for over three decades, and he currently represents thousands of military members, many of whom were illegally foreclosed on or overcharged in a class action lawsuit, and so we welcome you and your insights in that respect as well. So thank you all for coming before the Committee. We would ask you to limit your oral testimony to about 5 minutes. Your entire written testimony will be included in the record, and this way we will have some opportunities for some Q&A with you. With that, Ms. Thompson, would you begin? STATEMENT OF DIANE E. THOMPSON, OF COUNSEL, NATIONAL CONSUMER LAW CENTER Ms. Thompson. Thank you, Chairman Menendez. Chairman Menendez. You want to put your microphone on. Ms. Thompson. Thank you. Chairman Menendez. We want to hear you. Ms. Thompson. Thank you for inviting me to testify today. I am an attorney, currently of counsel to the National Consumer Law Center. In my work at NCLC, I provide training and support to hundreds of attorneys representing homeowners from all across the country. For nearly 13 years before that, I represented low-income homeowners East St. Louis, Illinois. I testify here today on behalf of the National Consumer Law Center's low-income clients and the National Association of Consumer Advocates. The time for national mortgage servicing standards has come. We have tried reliance on servicers' good faith and competent execution. Servicers' good-faith efforts 4 years into this Nation's most devastating foreclosure crisis have failed to produce results. Serious delinquencies continue to outpace modifications by nearly five to one. Homeowners wait on average 14 months for approval of a permanent HAMP modification and often face wrongful foreclosure even after entering into a permanent modification. The loan modification process is dysfunctional in the extreme. For example, high-level Bank of America employees recently promised a California homeowner that they would honor a modification they had granted the homeowner and cancel a pending sale. And yet the foreclosure sale went forward. Despite repeated orders from a New York State court judge tolling interest on the loan for over 14 months percentage Chase's participation in court-supervised mediation, Chase has still not complied with its undertakings in that process. Litton denied a North Carolina homeowner for failure to provide documentation, after sending all requests for additional documentation to an address that corresponded to neither the homeowner's nor her attorney's. Chase foreclosed on a Washington State homeowner who was making payments and, then when she called after receiving the eviction notice in connection with the foreclosure, denied that it had foreclosed. That woman and her family are now living in an apartment and are no longer homeowners. Loan modifications make economic sense, but servicers nonetheless deny modifications because they, the servicers, can do better financially by foreclosing than providing permanent sustainable modifications and because there are no consequences to servicers for failing to provide the modifications. The lack of restraint on servicer abuses has created a moral hazard juggernaut that at best prolongs and deepens the current foreclosure crisis and at worst threatens our global economic security. State regulators have attempted to rein in these abuses, but servicers have often sought protective shelter in the preemption rulings issued by the Office of the Comptroller of the Currency. Recent consent orders announced by the Federal banking agencies are of limited reach and threaten to undermine the combined and unprecedented efforts of the Department of Justice and the Attorneys General of all 50 States. The GSEs--Fannie Mae and Freddie Mac--and their oversight agency, the Federal Housing Finance Authority--have failed to prioritize loan modifications over foreclosure. Even new guidance from the FHFA fails to end dual track--the practice of proceeding with a foreclosure and a loan modification at the same time. The dual-track process must be ended. Key to any national servicing standards is the evaluation of a homeowner for a loan modification prior to the initiation of a foreclosure. Homeowners must be evaluated for and, when appropriate, offered a loan modification before a foreclosure. Once a foreclosure is started, it takes on a life of its own. Fees mount up and legal deadlines must be met. A modification becomes increasingly out of reach and accidents happen. Initiating foreclosure before completing the loan modification review guarantees wrongful foreclosures. Failing to stop an existing foreclosure proceeding while a modification review is underway has the same costs, the same risks, and the same results--families turned out on the street while awaiting a review on their application or even while making payments on a modification. In order to prevent wrongful foreclosures, reduce costs for both homeowners and investors, and encourage the timely evaluation of loan modification applications, the dual-track system must be stopped, and stopped absolutely. Recent bills introduced by Senator Reed, Senator Brown of Ohio, and today's bill introduced by Senator Merkley take this and other important steps. To promote responsible servicing that serves the interests of both homeowners and investors, principal reductions must be mandated, fees limited, transparency provided throughout the modification process, including the calculation of the net present value. Servicers should be prevented from foreclosing if they have not complied with these baseline servicing standards. We are at a watershed moment. To date, we have imposed no restraints on servicers' excesses. The existing proposals for servicing reform from the banking agencies and the FHFA would leave the existing dysfunctional system intact. We can do better. In my written testimony, I detail the reforms needed. We must hold mortgage servicers accountable to the stakeholders, homeowners, investors, and the American public. I thank you for the opportunity to testify today, and I am happy to answer any questions you may have. Chairman Menendez. Thank you, Ms. Thompson. I want to interrupt the panel for a moment and ask my colleague--I know he is under time constraints--whether he wishes to make any statement or let the rest of the witnesses go, and I would be happy to yield to you first for questioning. It depends on your time constraints. Senator Merkley. I simply deeply appreciate the folks who have come to testify on such an important issue to the health of our families and the health of our economy, and I would like to have them continue. Thank you. Chairman Menendez. Thank you. Ms. Goodman. STATEMENT OF LAURIE F. GOODMAN, SENIOR MANAGING DIRECTOR, AMHERST SECURITIES Ms. Goodman. Mr. Chairman and Members of the Subcommittee, I am honored to testify today. My name is Laurie Goodman, and I am a senior managing director at Amherst Securities Group, a leading broker/dealer specializing in the trading of residential mortgage-backed securities. I am in charge of the strategy and business development efforts for the firm. The purpose of my testimony is to discuss conflicts of interest facing mortgage servicers that may stop them from acting in the best interests of mortgage investors and homeowners. Let me begin by pointing out that the interests of mortgage investors and homeowners are largely aligned for two reasons. First, the mortgage market is reliant on investors to continue to extend credit, allowing borrowers to achieve competitive mortgage rates. Second, foreclosure is, without question, the worst outcome for both investors and borrowers. It is a long and drawn-out process in which a borrower is forced from his home, and an investor typically suffers a loss on his investment of between 50 and 80 percent of the loan amount. Here are the five inherent conflicts that we see. Conflict number one, large first-lien servicers have significant ownership interests in second liens and often have no ownership interest in the corresponding first lien. The four largest banks--Bank of America, Wells Fargo, JPMorgan Chase, and Citigroup--collectively service 54 percent of the 1-4 family servicing in the United States. They own approximately 40 percent of the second liens and home equity lines of credit outstanding. This is a conflict because the servicer has a financial incentive to service the first lien to the benefit of the second lien holder. Some examples: Short sales and deeds in lieu are less likely to be approved. If the servicer accepts a short sale offer, the second lien, which is held on the balance sheet of the financial institution, must be written off immediately. As a result, the servicer may be more inclined to reject the short sale offer, even if the offer makes sense for the investor and borrower. In addition, loan modification efforts are suboptimal. Principal reduction is used far less often than it should be. National servicing standards should require servicers to perform the modification to maximize the net present value of the loss mitigation options. Conflict two, the servicer often owns a share in companies that provide ancillary services during the foreclosure process and charges above market rates. These services included force- placed insurance and property preservation. Even when a servicer is not affiliated with the company providing the service, they often mark up the fees considerably. These fees are added to the delinquent amount of the loan, making it much harder for a borrower to become current. Moreover, when a loan is liquidated, the severity on the loan will be much higher, to the detriment of investors. National servicing standards can be used to require servicers to keep existing homeowners insurance policies in place as long as possible. There should be a prohibition on marking up third-party fees. Moreover, following the lead of the proposed Attorney General settlement, national servicing standards should prohibit a servicer from owning an interest in an entity that provides foreclosure-related services. Conflict three, conflicts of interest in the enforcement of representations and warranties are becoming an increasing issue for the market, as indicated by recent litigation. Once a ``rep and warrant'' violation is discovered, the trustee is charged with the enforcement. However, the trustee does not have the information to detect the violations as they do not have direct access to the loan files. Servicers who do have the information to identify ``rep and warrant'' violations often have a financial disincentive to do so as they would be putting the loan back to an affiliated entity. It is critical to have an independent third party that is incented to enforce reps and warrants and has both access to the information and enforcement authority. This must be achieved through the deal documents. National servicing standards should, however, direct servicers to make sure that there is an adequate enforcement mechanism for reps and warrants. Conflict four, the servicing fee structure is unsuitable to this environment. There are many situations in which transferring the servicing of a loan on which the borrower is delinquent to a servicer that specializes in loss mitigation would be the best outcome for both borrowers and investors. A number of special servicers have had considerable experience tailoring modifications to the needs of individual borrowers and tend to provide more hand holding to the borrower post modification than what a major servicer can offer. Servicing transfer issues are made very difficult as servicers are compensated too highly for servicing current loans, not highly enough for servicing delinquent loans. If fees for servicing current loans were lowered while fees for servicing delinquent loans were raised, it would allow the special servicer to be adequately compensated for his high-touch efforts. This, in turn, would make it much easier to transfer delinquent loans to servicers who would do a better job of loss mitigation. Conflict number five, transparency for investors is woefully inadequate. In a private label securitization, there is often a large difference between the monthly cash payment the investor expected to receive and what is actually received. Moreover, an investor is unable to delve into the cash-flow information further as transparency on the action of the servicer that would be necessary to reconcile the cash-flows is not available. When I receive the statement from my bank each month, I balance my checkbook, reconciling the differences. Investors want to be able to do exactly this with the cash- flows from the securitizations in which they have an interest. They are unable to. We believe the remittance reports for future securitizations should contain loan-by-loan information, and that loan-by-loan information should be rolled up into a plain English reconciliation. National servicing standards should encourage this transparency. In conclusion, national servicing standards can go a long way toward dealing with the conflicts of interest between servicers on the one hand and borrowers and investors on the other. We appreciate the opportunity to testify on this important set of issues. Thank you. Chairman Menendez. Thank you. Mr. Stevens. STATEMENT OF DAVID H. STEVENS, PRESIDENT AND CHIEF EXECUTIVE OFFICER, MORTGAGE BANKERS ASSOCIATION Mr. Stevens. Thank you, Mr. Chairman, for the opportunity to testify here on the need for national mortgage servicing standards. On May 1st, I began my tenure as president and CEO of the Mortgage Bankers Association, and most recently I served as Assistant Secretary for Housing and the Federal Housing Commissioner. I have also been actively involved in this industry for three decades. In 2008, we faced the perfect storm. As the global economy collapsed, the subprime market imploded. Many Americans lost their jobs. Millions of Americans defaulted on their mortgages, putting extraordinary strains on the existing servicing system. It is clear that our industry was unprepared to handle these unprecedented events and that we made mistakes. Acknowledging our mistakes is the first step to rebuild trust in industry and our actions. Without trust, the industry is nothing, and by trust, I mean the ability of policy makers, thought leaders, borrowers, and the industry at large to have faith in the products and services that we provide, and we absolutely have to do better moving forward. I can assure you that the mortgage finance industry and servicers in particular have not stood still in addressing the mistakes. Many have put in place training, internal controls, independent third-party auditors, adding thousands of people and improved technology needed to move forward. Presently, servicers face a growing number of checks and balances ranging from Federal laws and regulations, RESPA and TILA, to 50 State laws, regulations that vary, local ordinances, as well as court rulings, FHA, VA, Rural Housing Service requirements, et cetera. These requirements are in addition to Fannie Mae standards, Freddie Mac standards, and other contractual obligations. In short, servicers are faced with complex, often contradictory rules and regulations, many of which are emergent. So what is the answer? A consolidated servicing standard could drive these reforms. Creating a servicing standard would streamline and eliminate many of the overlapping requirements, provide clarity and certainty for borrowers, lenders, and investors alike. It is critical that all of the Federal regulators involved act in a coordinated manner to establish one national consolidated servicing standard that applies to the entire industry rather than piling on requirement after requirement. A national standard should start with a complete analysis of existing servicer requirements and State laws governing foreclosures. Developments should include an open dialog with stakeholders in the servicing arena, all of whom must ultimately implement and comply with the national standard. The MBA has initiated this process by convening a blue ribbon Council on Residential Mortgage Servicing. The council examined the entire servicing model and is forming recommendations to improve the system for all stakeholders. I am pleased to announce that today we actually rolled out a white paper, which I believe is the first white paper on the subject, and ask that it be included as part of my testimony. In the white paper, the council aims to examine the current servicing model, address public misconceptions relating to servicing practices and incentives, and educate the public on the role and compensation of servicers. I believe this white paper will provide useful information to you and other policy makers that are currently debating the national servicing standards, and I encourage the Subcommittee to use the MBA and its Council on Residential Mortgage Servicing as a resource going forward. In conclusion, as we develop servicing standards, I will urge you to pay careful attention to the interdependence of servicing and the impact that change to the servicing system will have on the economics of mortgage servicing, tax and accounting rules and regulations, and effects of the new requirements on Basel capital requirements and on the TBA market. Servicing does not exist in a vacuum. Instead, it is part of a broader ecosystem which involves all the varied elements of the mortgage industry. The housing market remains very fragile and, therefore, when considering changes to the current model, policy makers we ask be mindful of unforeseen and unintended consequences that could ultimately result in higher housing costs for consumers and reduced access to credit. As I mentioned at the beginning of my remarks, I have spent more than three decades in this industry. Despite what we have just lived through and the challenges we continue to face, I am optimistic we can successfully address the challenges of the mortgage servicing system going forward. And, Mr. Chairman, MBA supports reasonable, rational national servicing standards that apply best practices to the process to better serve the needs of borrowers, servicers, and investors alike. We want to be part of the solution and look forward to working with you and other policy makers toward that end. Thank you. Chairman Menendez. Well, thank you, Mr. Stevens. Thank you for the spirit in which the association comes here. I want to accommodate Senator Merkley, who has been very involved in these issues, so to our final two witnesses, if you would just forbear with us a moment or a few minutes and recognize Senator Merkley, who has some questions of the panel at this time. Senator Merkley. Thank you very much, Mr. Chair, and thank you for holding this hearing, because I think this issue of the complexity of the mortgage markets and the role servicers play within the set of parties is an extremely important one to figure out. And, Mr. Stevens, thank you for your work at the FHA. I appreciate the spirit that you bring to trying to address some of these key complexities. Ms. Goodman, I wanted to ask you one question about the conflicts of interest, and that is you put forward--one of your concepts was to increase the fees for dysfunctional mortgages and decrease the fees for servicing current mortgages, and one concern I have had about that is it creates perhaps--well, let me explain that I have had many Oregonians tell me that the first time they missed a payment was after they had talked to their servicer about the change in their financial circumstances and the servicer said to them, well, what you do is you are eligible for a mortgage modification, and so--but first, you have to--you cannot be current, so you need to miss three payments or make half-payments for 3 months. One of the issues that has come up as to whether there was kind of a perverse incentive in the servicer structure in which they were getting paid more for loans that were not current versus loans that were current, and to put salt into the wound, the same families then report that after they missed those payments, they were often told, because you are not current, you are not a good credit risk for a mortgage modification. This is kind of a hellish nightmare position to be in, and your recommendation about accentuating the difference between those fees, could that make this problem worse? Ms. Goodman. I would be very careful about how I would do it. I agree that that is definitely a moral hazard issue, and what I actually suggested in my written testimony is there is a very simple solution to this. Give the GSEs or private label investors the ability to move the servicing when the higher fees are scheduled to take effect. So what that does is I am servicing a current loan. That loan goes delinquent. If I do not make that proactive phone call to keep that loan from going delinquent, I stand a chance of losing that servicing when the higher fee takes effect. You have to have something like that in there in order to eliminate the moral hazard. Senator Merkley. Yes, eliminate that conflict of interest. Thank you. That is helpful. And, Mr. Stevens, one of the ideas that Ms. Goodman put forward was to try to reduce or eliminate the conflict of interest, where the servicer who may have originated the loan still holds the second mortgage, but no longer the first because the first has been sold. It creates distinctions between operating on behalf of the trust that holds the first mortgage and the interest of the second mortgage. Do you have any particular insights on the concepts that she put forward to address that? Mr. Stevens. These are all subjects I would love to engage in a longer discussion with you, Senator, as we have in the past on these issues. We have struggled as we work through these foreclosure processes over the past several years with incentives in the process, incentives on first mortgage modifications or principal write-down or foreclosure resolution, incentives on seconds, loans held, loans sold. The one thing I am challenged by is does the mere act of having someone else service the second in any way change the outcome as to what could ultimately be write-down on the second, and just to articulate that, whether the first lien gets modified or protected in any way--in some form, whether that second is held on the first lien holder's--on the same servicer's balance sheet or another servicer's balance sheet, both of those can cause challenges ultimately to having anything happen to the second lien. It will ultimately depend on how that second lien is valued. I think, fundamentally, the thing that is absolutely clear is when the loan goes to foreclosure, the second lien gets wiped out in its entirety and the bank loses. So fundamentally, there should be an incentive to have that loan perform and to engage in some sort of modification. I think we have communication challenges. Seconds are often held on bank balance sheets. First mortgages are held on the mortgage side balance sheet. But I am not certain that having two sets of servicers in any way resolves the complexity around the incentive structure and the ultimate resolution of that foreclosure. Senator Merkley. And to add to this dilemma, the servicer of the second, even if the servicer is separate, may find the second is fully performing when the first is not, in part because there is a line of credit. The family may have chosen to say, I need to keep this line of credit valid because it is the only way to rescue myself from difficult financial bumps I might encounter. Mr. Stevens. That is right. Senator Merkley. So then you are asking the servicer of the second to essentially engage in a process in which the loan that is current is--yes, it is messy and difficult---- Mr. Stevens. Well, and---- Senator Merkley. ----and I am glad to have you all working on it. Mr. Stevens. And, Senator, the only thing I would just add as a follow-up to that, it needs to be a consideration, is many of these second loans were set up as home equity lines of credit, as you know. You know this very well. And many small businesses in America basically use that as their funding resource to operate a small business in this country. That is just one example. So these are solutions that, as I said in the outset, we fully realize the mistakes and lack of preparedness that our industry did not have at the time and the mistakes we made, but working through these resolutions is critically important, as well, because we need to make certain that we are not disrupting, again, small business access or the kind of incentive misalignment that you just referred to in terms of the performing versus the nonperforming first. Senator Merkley. Well, thank you all. I am sorry I have to leave, but I think just this short conversation shows how important this set of issues is in order to taking and restoring a healthy mortgage market, which is essential to working families being successful in home ownership and rebuilding their wealth. Thank you. Chairman Menendez. Thank you, Senator. Dr. Sanders. STATEMENT OF ANTHONY B. SANDERS, PROFESSOR OF FINANCE, GEORGE MASON UNIVERSITY SCHOOL OF MANAGEMENT Mr. Sanders. Chairman Menendez, Ranking Member DeMint, and distinguished Members of the Subcommittee, thank you for inviting me to testify today. I have been asked to opine on the need for national mortgage servicing standards. The recent crash of the housing market and the rise of unemployment led to a historic surge in serious delinquencies and requests for loan modifications, short sales, and related transactions. As a result, the residential mortgage servicing industry was overwhelmed. Going forward, it is helpful to recommend changes to both servicing and securitization industries so they can avoid problems going forward as we attempt to revive the securitization market. In December, Christopher Whalen, Nouriel Roubini, Josh Rosner, and others, including myself, wrote a letter to the U.S. financial regulators regarding national loan servicing standards. Again, I am one of the signors of the letter, but not because I wanted to have necessarily a national loan servicing standard created by the Government. Rather, I wanted to facilitate consideration for servicing companies on how to proceed forward. Many of the items that were discussed in our letter were plausible recommendations, with a few exceptions. And one thing I want to point out is that Fannie Mae and Freddie Mac have their own servicing standards, which are, again, quite good and have been the industry standard for a long time. Since Fannie and Freddie can actually mandate servicing standards, that is a good place to begin. You have just heard Dave Stevens for the Mortgage Bankers Association talking about the Blue Ribbon Committee to modify the standards that Freddie and Fannie use for the private label market and general mortgage servicing in general, and while it is very tempting to have the Federal Government regulate loan servicing, I would argue that, in fact, since Fannie, Freddie, and the FHA basically occupy 95 percent of the space now, they are, in fact, regulating the market for national loan servicing anyway. But one recommendation that the Whalen letter had that I disagree with was risk retention by securitizers, where Dodd- Frank requires that securitizers retain at least 5 percent of the risk of the loans or they do not qualify as QRMs, or qualified residential mortgages sold in the securitization market. In theory, that retention would lead securitizers to be more careful in loan origination, underwriting, and even servicing process since many of the services are actually captured by the banks. To be sure, 5 percent risk retention would be the simplest approach to implement to improve all these things. However, risk retention also appears to be the least useful approach. Once again, housing prices in Las Vegas fell 56 percent from peak to trough. Five percent risk retention would have been knocked out of the box within months. Therefore, that also complicates and exaggerates, or exasperates--makes it worse. [Laughter.] Mr. Sanders. Sorry. My coffee machine broke this morning. Fannie Mae and Freddie Mac along with the FHA do control a large segment of the market, but even they have had to file repurchase claims on some of the loans sold to them in regards to servicing. Therefore, one thing I recommend that bypasses both the 5 percent risk retention and also addresses what Ms. Goodman talks about is transparency to investors and regulators. Greater transparency would permit more accurate pricing, better loan servicing, and reduce the asymmetric information between securitizers, investors, regulators, and homeowners. There has already been a movement, as witnessed by what the Mortgage Bankers Association is doing. But again, we have relied heavily on the reps and warranties which served very well to kind of back up the claims on securitized issues. But again, just that simple tsunami of requests of loan buy-backs and defaults, et cetera, by consumers has made that market a little bit tough to deal with. Therefore, I recommend in addition to greater transparency such as loan level files and also whatever the servicing standards are, and I think some of Ms. Goodman's ideas are very good, I would also like to propose a securitization certificate, which is a little change to the model, but what that does is the certificate at origination which follows the loan from hand to hand, including all of the relevant information, chain of title, but would also include the servicing guidelines so everyone is clear that purchases the loan exactly what those guidelines are. And again, following Freddie and Fannie, I think this would actually be a very simple thing to do. Thank you very much. Chairman Menendez. Thank you, Doctor. Mr. Harpootlian. STATEMENT OF RICHARD A. HARPOOTLIAN, ATTORNEY, RICHARD A. HARPOOTLIAN P.A. Mr. Harpootlian. Mr. Chairman, thank you for allowing me to be here today. I want to tell you, it is my honor to represent over 6,000 service men and women who were wrongfully overcharged or foreclosed on by Chase Bank. We resolved this case by settlement last week and they are going to receive payment of about $56. And Chase has stepped up to the plate and is going to do a number of things that are going to benefit these 6,000 service men and women and other service men and women. But what I think is important for this body to know is that prior to being caught, if you will, there was no effort on the part of Chase--and we can find seeing other financial institutions--to monitor the accounts of these service men and women. Now, the Servicemen's Civil Relief Act goes back to the 1940s. The concept is fairly simple. If you are deployed and fighting in a foxhole in Afghanistan, you should not have to worry about the bank taking your house because you cannot keep up with the financial affairs at home. Likewise, the Act requires that the mortgage interest rate be no more than 6 percent during that period of time to alleviate some of the financial burden on these men and women in uniform. What we find is, again, a dysfunctional system. There is no way, no method by which the Pentagon or any of the Department of Defense informs banks when someone is deployed. There is no method other than going to a Web site for the bank to know before they foreclose that someone is deployed. Everything is put on that servicemember to send their orders to the bank, and we found in most instances those got lost somewhere. The most important thing to understand is this process affects the quality of defense, the quality of effort we get from our men and women in the field. I talked to hundreds of service men and women, some of whom had SCRA protection, many of whom did not, that are worried about the financial welfare of their family while they ought to be worrying about bullets coming in and shells coming in. And this is a national disgrace. It is a national disgrace because these men and women are putting their lives on the line for us. Even the ones that are not deployed are performing a valuable defense effort and function. So in my prepared remarks, I have outlined a couple of things I think that are important that ought to be enacted. A much more streamlined way of financial institutions knowing who is deployed, who is not deployed. But more importantly, the military itself ought to have resources available. JAG officers do a great job, but they are not tasked, if you will, with ensuring that the men and women in uniform understand what their rights are under the SCRA and they are protected against harassment and, I mean, the main plaintiff in this case got 100--his wife and he got 140 collection phone calls from the bank while he was deployed while she was 8 months pregnant and while he is flying an airplane in combat. That is wrong and we need to stop that. The last thing I would say, which may have applicability to what the other speakers said here, is things have gotten so bad in South Carolina that our Chief Justice has enjoined mortgage foreclosures--all mortgage foreclosures--and I put in my remarks, unless and until a financial institution certifies certain things, and all of those things are--I will briefly summarize them. One, that the mortgagor has been served with notice of the mortgagor's right to foreclosure intervention by means of loan modification or other means of loss mitigation; that the mortgagor has been given an opportunity to do that; that they have had a full and fair opportunity to submit information or data to the mortgagee; that after completion of foreclosure intervention process, the mortgagor does not qualify and why; and that the notice of the denial of loan modification or other means of loss mitigation has been served on the mortgagor by mailing and there has been a 30-day period after that mailing before they can begin foreclosure. This is not a model, but it certainly shows that, at least on a State level, our Chief Justice has said this thing is a mess and too many people are not being given the opportunity to try to modify their loans. Most of the people I talk to in uniform could work some sort of modification out if the financial institutions allowed them to do so. What we have heard here today about beginning this process, being told, well, you should miss--you know, we cannot help you unless you miss two or three payments, I heard that over and over again. Thank you for the opportunity to be here today. Senator Merkley. Thank you. Thank you all. Mr. Stevens, without objection, your white paper is included in the record as part of your testimony. Let me ask all of you, do all the witnesses here agree that some national mortgage servicing standards would be helpful? Ms. Thompson. Yes. Ms. Goodman. Yes. Mr. Sanders. Yes. Mr. Stevens. Yes. Chairman Menendez. OK. Now, in that respect, I want to ask you, if you had to name just three specific national mortgage servicing standards that you believe would be most helpful in your area of expertise, what would those be and exactly how would they be helpful? Ms. Thompson? Ms. Thompson. End dual track, both for loans that are in foreclosure and for loans that are not yet in foreclosure. Dual track must be ended, absolutely. The other large recommendation that has many sort of subparts is that you have got to create transparency in the entire process, so that includes dealing with tracking systems. It includes making available publicly the net present value test and holding servicers to account to actually make the net present value test. And the third critical point is that you have to have enforceability of all these--of everything you do, there has to be enforceability, and one of the things that that means is that homeowners have got to be able to raise violations of the servicing standards as a defense to foreclosure, because if homeowners cannot raise violations as a defense to foreclosure, there is really, in the end, not much to stop servicers from conducting business as usual. Chairman Menendez. Ms. Goodman. Ms. Goodman. My number one is that national servicing standards should require servicers to perform the modification to maximize the net present value of the lost mitigation options, and regardless of the conflicts of interest that entails for the servicers. Second would be addressing the fact that the servicer also provides ancillary services during the foreclosure period and prohibiting a servicer from owning an interest in an entity that provides foreclosure-related services. And my third would be better disclosure. That is, better transparency in terms of what is happening on the modification side, what the cash-flows are on these loans. Again, those are my three. Chairman Menendez. Mr. Stevens, if you have some. I do not want to force people to have some. If you have some. Mr. Stevens. I think, generally speaking, getting uniform foreclosure time lines, uniform time lines for modification, uniform foreclosure requirements nationally versus all the State variations would help. I think there is an opportunity, Senator, to have some discussions about both dual track and single point of contact, which I think are the two most commonly vetted items to support better foreclosure processes by servicers. And I would also suggest that there is an opportunity to have a further dialog around minimum servicing compensation, as I think all of these things have potential unintended consequences that we should talk through. I would love to talk through and engage with you or your staff as you work through these processes. But clearly, aside from what the two previous comments were is that the difficulty of all the various rules and regulations State by State, I think, add a level of confusion that is unnecessary to the overall process. Chairman Menendez. Doctor, do you have any? Mr. Sanders. Chairman, first of all, I would recommend that the industry move toward more standardization of pooling and servicing agreements. Those are the PSAs. Whether it is regulated or the industry moves toward it, I am sure as Mr. Stevens's MBA is working on, that would be very helpful in reducing problems in the future. Second, transparency. Not only transparency of the process to the consumer, but again, and I want to say this, had we had loan-level details about the private label market in the first place, we might not have seen the problems that we saw, and therefore we might not be sitting here today. But again, whether it is loan-level transparency or servicer transparency, I think that is an excellent idea. And in addition, the one thing that has been left off the table, and there is nothing we can do about it, is that, in part, the huge housing bubble that blew up and collapsed so many consumers and caused us grief and heartache was attributable to the Federal Reserve keeping interest rates so low for so long and creating a huge asset bubble. There is nothing we can do about that, but I just wish we could throw that into a servicing standard. Please stop printing money. But thank you very much. Mr. Harpootlian. I have nothing really to add. Thank you. Chairman Menendez. Ms. Thompson, what are the views of homeowner advocates on the draft consent orders that were recently promulgated by several of the banking regulators, such as OCC, the Fed, and FDIC? And let us try to split this, if I can, your answer into three parts. What did they get right about mortgaging service standards? What did they get wrong, from your perspective? And what do they not address that they should have addressed? Ms. Thompson. Thank you, Chairman. I will start with what did they get right. What they got right was that there are problems that are endemic throughout the servicing industry, that the servicing industry has failed to document virtually everything and has gross inadequacies in its foreclosure process. That is part of the review, I think, that supports the allegations that have been widespread for many years about servicer abuses and loss mitigation. Beyond that, the orders are not very helpful and are potentially harmful in some ways. The orders are vague. They do not set out clear standards. They lack any meaningful enforcement action. At best, they suggest that the agencies may come back and do some enforcement action. These are agencies that, unfortunately, do not have a good track record of enforcement actions. They only look at loans for a very limited timeframe. It is 2009 and 2010. So we provide no protection for loans going forward, no remedies for homeowners who were wrongfully foreclosed on before then, even if remedies to homeowners are provided. I think we could safely say that we are disappointed. Chairman Menendez. Any other comments from any other members of the panel on those consent orders? Ms. Goodman. They are relatively teethless. I agree with Diane 100 percent. Chairman Menendez. All right. Let me ask, Ms. Goodman, you outlined a series of the conflicts. What do you think is the most important of those conflicts of interest from a mortgage investor's perspective? Ms. Goodman. I actually think the first lien-second lien issue, and more broadly the fact that first lien servicers oftentimes do not own the first lien. In a GSEs loan, the GSEs have the first loss position in the first lien. Servicers do, however, own the second lien. In addition, they also own credit card debt and auto debt of the borrower. You will notice that in a modification, the only thing that is really affected is mortgage debt. There is no restructuring of the borrower's entire debt. There are two reasons why modifications fail. The first is that the borrower has substantial negative equity. The second is that he has a back- end debt-to-income ratio, that is, a total debt burden that is unsustainable. And for more successful modifications, you really have to address the borrower's overall debt situation. There has been an extreme reluctance to do that. And even in terms of more successful modifications, respecting lien priority and writing off the second completely, or at least a greater than proportionate write-down on the second lien versus the first lien would help a great deal in eliminating negative equity. So my first order of business would be looking at the conflicts of interest between the servicers who own the second lien and other borrower debts and do not own the first lien. Chairman Menendez. Mm-hmm. And I just want to just stay with this conflict of interest question. Flesh out for me a little bit more how, number 1, how it is a conflict of interest for the mortgage servicer for the primary mortgage on a property to also own the secondary mortgage, and how do we best address that conflict of interest, from your perspective? Ms. Goodman. There are a couple of different ways to address that. The reason it is a conflict of interest is because you own the second lien, you can make decisions, or there is an incentive to make decisions that basically help the second lien holder at the expense of the first lien holder. So, for example, if a borrower gets a short sale opportunity, the servicer may reject that even though it is in the best interest of both the investor and the borrower because it essentially requires them to wipe out the second lien. How do you address it? I think, as Dave mentioned, it is an extraordinarily difficult, difficult problem. You can--one way is basically to say---- Chairman Menendez. That is why we get paid the big bucks here. Ms. Goodman. One way--basically, the easiest way to address it is to say if you own the second lien, you cannot also service that first lien, or alternatively saying if you service that first lien, you cannot own the second lien. Let me also mention that in the modification process, the first and second liens are oftentimes treated pari passu. So if I am making a first lien mortgage going forward, the costs of that may well be higher if this becomes institutionalized. So you really have to consider how to make it clear to investors that lien priority is, in fact, lien priority. I think that is just a critical point. There are a variety of ways to do that. We seem to be unwilling to address the second lien situation on any level. We have gone to great lengths to put out QRM standards, which I have some real issues with, but basically, there is nothing that prohibits that borrower from going out, taking out a second lien tomorrow and essentially negating the whole purpose of those standards. So I think you have to basically put some up-front restrictions on second liens, as well, in order to have better mortgages going forward. But certainly, you have to respect lien priority. Chairman Menendez. Mr. Stevens, do you have any views of that? I sort of like heard---- Mr. Stevens. I do, and actually---- Chairman Menendez. I thought you might, so---- [Laughter.] Mr. Stevens. Ninety-nine percent of the time, I agree with everything Laurie says. I think the challenge here is that I am not at all certain that by having someone else service the second lien, it is going to change the outcome. I think---- Chairman Menendez. I heard that in response to a separate question. Mr. Stevens. And I think, actually, one of the things we ought to test for and we ought to think about--``test'' sounds a little too clinical--is whether, if it is two different servicers, is there perhaps even less incentive? Again, as I said earlier, when the first lien ultimately goes to foreclosure, if the investor owns a second, as well, they are completely wiped out on the second. So I am not sure that is necessarily the case when--and I will just take this to an extreme--many of the loans originated during this boom period in this low-interest rate market when stated income loans were created, et cetera, so were not very sustainable loans on the first lien basis. So a stated income, negatively amortizing ARM on the first lien that some PLS investor was ready and willing and able to buy, you know, that fundamentally could be part of the challenge of why the borrower ultimately went into default. So I understand why the investors would like the second liens expunged and have the first lien written down, because they hold the--their whole interest is in that first lien, just as in the second lien holder, their objective is to keep whole on their second lien. I spent a couple of years in my last position talking to everybody who would come in and talk about their interests, and it clearly reflected the businesses they were in. You know, in the end of the day, it is a very complicated subject---- Chairman Menendez. Let me ask you two questions. Mr. Stevens. Yes. Chairman Menendez. First of all, the mere fact that you are a second lien holder basically says, yes, you have certain legal rights, but you have inferior rights to the first lien holder. Mr. Stevens. Absolutely. Chairman Menendez. So as such, you know that you are taking another level of risk, right? Mr. Stevens. Correct. Chairman Menendez. Second, I understand your view that maybe not having different servicers is the answer, but by the same token, if I am the servicer and owner of the second lien and not the owner of the first, I truly have a, if not an actual conflict, a potential conflict in ensuring that, somehow, my legal interests and my economic interests are preserved. And so I am more reticent to find a way to either do a mortgage adjustment or, you know, some principal pay-down or reduction because I will be wiped out. I mean, that is, to me, pretty obvious. Now---- Mr. Stevens. Yes, and Senator, I am going to tell you, I do not have the answer to this as some others may feel they do. My view on this is I do not think it ultimately ends up being that simple, because the one thing for certain, having been a banker for most of my career, is if I do not keep that first performing, I am going to get wiped out completely if I hold both. And I am not so certain if you separate those interests that second lien holder is going to have any additional incentive whatsoever to write down the second when they have absolutely no interest in the performing of the first due to an obligation as the servicer. So, again, I am not arguing necessarily that one solution is better than the other. I just think we ought to be very thoughtful to make sure that is really the answer to this thing, because I can see challenges with the outcomes if we said we separate them. That can even make it more dysfunctional. Chairman Menendez. Ms. Goodman, let me hear your response. Ms. Goodman. My response is twofold. First, the fact that you have got the same guy servicing the first and owning the second actually does produce some distortions in terms of the type of loan modifications you get. You end up with a lot of sub-optimal loan modifications. So, for example, if you do a first lien proprietary modification, you do not have to touch the second. That may not be necessarily the best modification for the borrower, but it is sure as hell the best modification for the servicer, and it is certainly not the best modification for the investor, either, because the borrower and investor are fairly well aligned there. Another instance is the reluctance to approve a short sale because you wipe out the second. It may well be the best interests of the borrower and the investor, but it is not the best interest of the servicer. So I think you get sub-optimal loss mitigation because of the conflicts of interest in terms of the liens. Chairman Menendez. Doctor, did you have an opinion on this? I saw you raise your hand. Mr. Sanders. Yes. What I wanted to comment on is the commercial mortgage, or CMBS market, went through these gyrations years before we had the big housing bubble burst, and I actually have a study on adverse selection and mortgage servicing in the commercial sector, and what we found is that the difference between what we call same servicer and different servicer was negligible. So I would agree that it is a very complicated problem, and in defense of Ms. Goodman, it could be a little different for the residential market, but I agree with Mr. Stevens that this is going to be such a--you know, there are so many competing problems in this industry, I would just say that would not be the focal point. I would go to, again, examining or total debt as something we really had to consider. And bear in mind that many of the PSAs, the servicing agreements, were all written back in the day when we were not thinking about second mortgages or the big HELOC problem, and I think those definitely should be amended going forward. Chairman Menendez. Let me ask you just one or two more questions and then I will let you go. Principal deductions-- they are not typically offered very often today to borrowers, even though we know the borrowers are more likely to simply walk away from their homes and decide it is not worth it to stay if they are deeply underwater. Why are servicers not doing more about principal reductions? Ms. Thompson? Ms. Thompson. Principal reductions are the one kind of modification that servicers will unequivocally absolutely lose money on by doing. Servicers' largest source of income is the monthly servicing fee, which is based on the outstanding principal. So if they reduce the principal, they are guaranteeing themselves a loss of future income. Ms. Goodman. Let me also mention that while banks are-- while servicers are not doing principal reductions for others, they are doing it for their own portfolio loans. According to the OCC OTS Mortgage Metrics Report from the fourth quarter of 2010, overall, principal reduction was done on 2.7 percent of modifications. Seventeen-point-eight percent of portfolio loans, however, received principal reduction as part of the modification package, 1.8 percent for private investors, and 0 percent for Fannie, Freddie, and Government-guaranteed loans. I realize there are some institutional constraints on Fannie, Freddie, and Government-guaranteed loans, but there are basically no--there are very few institutional constraints in terms of why private investor loans do not receive principal reduction in the same proportion as banks' own portfolio loans. Chairman Menendez. Mm-hmm. Mr. Stevens. I would just add, having been the architect for the FHA Short Refi program, which was designed around principal write-down, one of the big resistance points is that the--for Freddie Mac and Fannie Mae, FHFA put out a letter that they will not participate in the principal write-down. That is why, I think, one of the reasons why the percentage is point- zero-one, or whatever it is---- Ms. Goodman. Yes. Yes. Mr. Stevens. ----and it is such a large part of the market. It is also, unfortunately, and I hate to make it all sound like--I think there are solutions if we work deliberately at it, but in the PLS market with trustees in the middle of the ultimate investor, getting ultimate authority to do the principal write-down with no real safe harbor that would likely stand up in the courts becomes a problem for the servicers. But without question, as Laurie points out, and I was going to say the same, you do see a lot of principal write-down mostly where it is occurring on whole loans held by the servicers on their own balance sheet, the banks, where clearly there are no impediments to them doing the write-down because they own the asset themselves. You could also say it is in their best interest to do so, potentially, but there are clearly restrictions from the secondary market to be able to allow the servicer to simply do a principal write-down. Ms. Goodman. Can I just say one other thing, and that is I would argue that there actually is a safe harbor for doing principal reductions on private investor loans and that safe harbor comes through the principal reduction alternative of the HAMP program. I would like to see that become mandatory if it is the highest NPV. Ms. Thompson. Senator---- Chairman Menendez. Net present value. Ms. Goodman. Net present value, yes, thank you. Chairman Menendez. Just for the record for everybody who does not have the acronyms down, so yes? Ms. Thompson. Yes. Indeed, I think the HAMP principal reduction alternative should be mandatory. It should be encouraged. It has been radically underused. There is no reason not to use it. That produces modifications that are more sustainable, better return for everybody, really. On the FHFA point, that underscores the need for national servicing standards. The fact that Fannie and Freddie have stood in the way of principal reductions, there is no need to allow that to continue. They are in a conservatorship. It should be possible for Congress to indicate strongly to them that they should step out of the way and allow principal reductions to happen. Their failure to allow principal reductions to happen, I believe, is ultimately costing the American taxpayers money. Chairman Menendez. That is a concern that I have of my own. Mr. Sanders. Well, again---- Chairman Menendez. I will let you go in a minute, Doctor. The largest owner is the Federal Government. At the end of the day, it seems to me that there are two interests of the Federal Government, and therefore the Federal taxpayer, which is, one, whatever we can do to have property values rise, and two, whatever we can do to mitigate that loss. But when we fail to do principal reduction when it is fitting and appropriate, we are not mitigating the loss. We are taking, in my view, a much larger loss. And we have the displacement of individual families from their homes and we have the consequential fact of property values being diminished, which ultimately means that ratable bases are diminished, and when ratable bases are diminished, mayors have just one of two choices. Either they cut services or they raise taxes. It is all a bad scenario. Doctor? Mr. Sanders. Yes. Let us not take this one too lightly, because I gave a presentation at Treasury when the Obama administration first came in and I said that, really, the only solution to this, the negative equity states, will be massive principal reductions. Otherwise, we probably are not going to have any resolution. On the flip side, the moral hazard problem of putting up the sign saying, we will do principal reductions or short sales, could cause a kind of a massive entrance into doing loan modifications with everybody. I would like to have a principal write-down, but again, you do not apply for it. Again, it is just one of those touchy issues that--I think Mr. Stevens probably has looked into this, I think, quite intensively, but that is---- Chairman Menendez. I think there are a lot of moral hazards that crossed when we gave out mortgages to individuals who should never have been enticed into a mortgage for which they did not have the wherewithal to live up to, and there was a lot of moral hazard crossed there. There was a lot of moral hazard when, because of systemic risk to this entire country's economy, we had to go in and resolve for every American taxpayer the consequences of institutions that would have collapsed but would have created a consequence to every American. So I agree with you. There is a lot of moral hazard here. At some point, though, my concern at this point in time, having seen many of those moral hazards already crossed, is the question of how do we mitigate the consequences to the Federal taxpayer at this point for that which has already been determined. And we have, by virtue of Fannie and Freddie, the largest single portfolio of that, and that means that the Federal taxpayer has the largest single risk. And so in my mind is how do we mitigate that so that we walk out as best as we can under the circumstances. Mr. Harpootlian, I want to close on a note. I appreciate the service that you rendered to the men and women in uniform. You know, it is pretty incredible that we find ourselves at a time in which we have two wars raging abroad, largely unpaid for but nevertheless raging abroad, that the men and women in uniform would have to worry about their homes being lost where their wives or husbands and children are. It is not how a grateful Nation says thank you, and it is not how institutions who are benefiting from the investments of those individuals in their companies should act. So I read your greater testimony with interest. I know you recommended greater legal support for servicemembers to understand and enforce their rights and more cooperation with the Department of Defense and financial institutions, and I wholeheartedly agree. With reference to your recommendation that we should incentivize mortgage modifications and discourage foreclosures when it comes to service people, that is what some of our current mortgage modification programs are trying to do more broadly, not as successful as we would like. Do you have any ideas of how that would be tailored to service people? Mr. Harpootlian. Well, I think that, again, our men and women in uniform are sacrificing--I mean, I have heard story after story of folks that were in the Reserves that were making a pretty good salary ending up in Afghanistan or Iraq. Salaries come down dramatically. They cannot make their house payments anymore. It just seems to me that at the front end, before-- when they are deployed, somebody in the military ought to sit down and do some sort of financial analysis of what their situation is. There is a Lieutenant Colonel from California who was a Reservist in military intelligence. Her husband was making about a half-a-million dollars a year and she was making about $125,000 a year. She got deployed. His business, RV business, shut down. She went from making $125,000 to about $30,000 or $40,000. And all that--nobody there to help them, nobody to talk to the financial institutions, and they foreclosed on her and she is one of our class members. But that is an extreme case. I think the Department of Defense ought to work something out with the financial institutions so when folks, both deployed and not deployed, have issues, that there is somebody advocating for them, because they are distracted. They are distracted in some instances by incoming. In other instances, if they are maintaining a jet at Shaw Air Force Base in South Carolina, I want them focused on maintaining that jet, not worrying about their financial issues. And I think, again, the pay is not good, the life is pretty hard, and we ought to do something in addition to all this that you are talking about in terms of servicing standards, we ought to do something in addition for our men and women in uniform. Chairman Menendez. All right. Thank you very much. Well, I do know this much, and you all have been very helpful in beginning, and I underline ``beginning,'' to help us understand some of the challenges here. The present system as it is is not acceptable and not working, so there has to be change. And those who are involved, I hope, will come forth in the spirit of embracing the change and helping us structure it in a way that both meets the desire to have people obviously live up to their obligations, but also be able to stay in their homes. In the absence of having those who are in the industry come forth and embrace the necessary changes, then I think that there will be changes forthcoming that they might not very well appreciate when they have an opportunity to engage. So I hope this hearing starts the highlighting of what some of these critical issues are and we have to think through as to how we best resolve them and have the pendulum strike in the right balance. But just the belief that we can tough it out is the wrong belief. With that, I want to thank all the witnesses for sharing their expertise today. I hope, as I said, that we can come together to try to improve this process pretty dramatically. The record will remain open for 7 days to give everybody an opportunity to answer questions in writing. I still have some, but I did not want to keep you here longer. And we would appreciate your answers as expeditiously as possible. So with the thanks of the Committee and with no other Senator present, this hearing is adjourned. [Whereupon, at 3:33 p.m., the hearing was adjourned.] [Prepared statements and responses to written questions supplied for the record follow:] PREPARED STATEMENT OF A. NICOLE CLOWERS Acting Director, Financial Markets and Community Investment, Government Accountability Office May 12, 2011
PREPARED STATEMENT OF LAURIE F. GOODMAN Senior Managing Director, Amherst Securities May 12, 2011 I am honored to testify today. My name is Laurie Goodman and I am a Senior Managing Director at Amherst Securities Group, a leading broker/ dealer specializing in the trading of residential mortgage-backed securities. I am in charge of the strategy and business development efforts for the firm. We perform extensive, data-intensive research as part of our efforts to keep ourselves and customers abreast of trends in the residential mortgage-backed securities market. I would like to share some of our thoughts with you today. A few quick numbers will serve as background. There is $10.6 trillion worth of 1-4 family mortgages outstanding in the United States. Of those, one half, or $5.4 trillion, is in Agency MBS (mortgage-backed securities), $3.0 trillion consists of first lien mortgages in bank, thrift and credit union portfolios plus the unsecuritized loans on Freddie Mac and Fannie Mae's balance sheet, and $1.2 trillion is in private label MBS. Second liens, which are mostly held on bank balance sheets, total just under $1 trillion. It is important to note that while private label securitizations represent only 12.8 percent of the first lien market, they represent 40 percent of the loans that are currently 60+ days delinquent. Servicers play a critical role in the housing finance market. They are the cash flow managers for the mortgage system. If the borrower is making his payments, the servicer collects and processes those payments, forwarding the proceeds to the investor in a securitization. If there is an escrow account, the servicer is charged with making the tax and insurance payments. If the loan goes delinquent, the servicer is responsible for running the loss mitigation efforts, an endeavor that many servicers, especially so-called ``prime'' mortgage servicers, had little experience at prior to the crisis. It was never contemplated that these servicing platforms would be used to perform default management on the current scale. As a result, they have never built up a loss mitigation infrastructure. A set of national servicing standards, addressing minimum infrastructure requirements to handle the servicing of delinquent borrowers within a servicing platform is the best way to address this issue, and I am pleased to have input on this important topic. The servicer is generally paid a fixed percentage of the outstanding loan balance for servicing a mortgage. This fee is generally too large for servicing loans that are not delinquent, and too small to cover the costs of servicing loans which have gone bad. There are other sources of income as well. The borrower often makes his payment early in the month, and the monies are not required to be remitted until mid-month, giving the servicer the right to invest these proceeds in the meantime (float). When the borrower goes delinquent, servicers charge late fees. There are a number of ancillary fees that are charged during the loss mitigation process. Finally, servicing a loan allows a firm to cross-sell other financial products to the borrower, including auto loans, credit cards, and home equity lines of credit. As a result, the servicer often interacts with the borrowers across a number of different products, some of which may be in the investment portfolio of a related entity. There are some costs as well--the servicer will generally advance tax and insurance payments, and in private label securitizations are usually obligated to advance principal and interest to the extent deemed recoverable. The purpose of my testimony is to discuss conflicts of interest facing mortgage servicers that may stop them from acting in the best interests of mortgage investors and homeowners, and to discuss which of these conflicts can be addressed through national mortgage servicing standards. Let me begin by pointing out that the interests of mortgage investors and homeowners are largely aligned for 2 reasons. First, the mortgage market is reliant on investors to continue to extend credit, thereby providing the necessary capacity to encourage competitive rates for borrowers in pursuit of home financing. Second, foreclosure is, without question, the worst outcome for both investors and borrowers. It is a long and drawn-out process in which a borrower is forced from his home, and an investor typically suffers a loss on his investment in the mortgage loans of between 50-80 percent of the balance of the loan amount after the home is sold and the various costs are deducted. The interests of both the borrowers and investors can be marginalized when the loan is serviced by a conflicted party. Here are the inherent conflicts we see. CONFLICT #1: Large first lien servicers have significant ownership interests in 2nd liens and often have no ownership interest in the corresponding first lien mortgage loans that are made to the same borrower and secured by the same property. In such cases, the first liens are typically held in private label securitizations, the second lien and the servicing rights are owned by the same party, often a large bank. The 4 largest banks (Bank of America, Wells Fargo, JPMorgan Chase, Citigroup) collectively service 54 percent of all 1-4 family servicing in the United States. They own approximately 40 percent ($408 billion out of $949 billion) of second liens and home equity lines of credit outstanding. The securitized second lien market is very small. Thus when a first lien in a private label securitization is on a property that also has a second lien, that second lien is very likely to be held in a bank portfolio, and if it is inside a bank portfolio it is often in one of the big 4 banks. This is a conflict because the servicer has a financial incentive to service the first lien to the benefit of the second lien holder. Many time this incentive conflicts with the financial interest of the investor or borrower. We outline some of the consequences of this conflict. Consequence: Short Sales and Deeds-in-Lieu Are Less Likely To Be Approved. An example makes this more intuitive. Assume that a borrower has a $200,000 first lien and a $30,000 second lien ($230,000 lien total) on a home that suffered a valuation reduction down to only $160,000. The borrower is paying on his second lien, but not on the first lien. The borrower receives a short sale offer at the market value of the property, and asks the servicer (a large financial institution) to consider it. If the servicer accepts the offer, the second lien (held on the balance sheet of the financial institution) must be written off immediately. If the servicer is also the second lien holder, he may be more inclined to reject the short sale offer. In this case, accepting the short sale offer was clearly in the best interests of both borrower and first lien investor. Similarly, a servicer will be less likely to accept a deed-in-lieu of foreclosure. We believe that national servicing standards should explicitly address this issue. Consequence: Loan Modification Efforts Are Sub-Optimal. Loan modification programs have two issues: they do not address the borrower's total debt burden, and they do not address a borrower's negative equity position. As a result, the redefault rate has been enormous. We believe that both of these shortcomings share, at their core, one common trait: conflicted servicers. We look at each in turn. Modifications Fail To Address the Borrower's Total Debt Burden. In a loan modification, only the mortgage debt is affected. That is, most modification programs, including HAMP, the Government's Home Affordable Modification Program, look at the payments on a borrower's first mortgage plus taxes and insurance, and compare that to the borrower's income. This is called the front-end debt-to-income ratio, and an attempt is made to reduce the payments to a preset percentage of the borrower's income. Consider a bank who services a borrower's first lien, second lien, credit card and auto loan. The first lien is in a private label securitization, all other debts are on a bank's balance sheet. The bank is obligated to modify only the mortgage debt, leaving the credit card and auto debt intact. Moreover, the second lien mortgage debt is generally treated pari passu with the first lien. There are situations in which only the first lien is modified, and the second lien is kept intact, making even less impact on the borrower's total debt burden. Since there is no sense of an overall debt restructuring, the borrower is often left with a mortgage payment that is affordable, but a total debt burden that is not. For example, the Treasury HAMP report shows that the borrowers who received permanent modifications under the Home Affordable Modification Program had their front-end debt-to-income ratio reduced from 45.3 percent to an affordable 31.0 percent, while the median back-end debt-to-income ratio (or total debt burden as a percent of income) was reduced from 79.3 percent before the modification to a still unsustainable 62.5 percent afterwards. The result: a high redefault rate on modifications. For a successful modification, a borrower's total debt burden needs to be completely restructured. Modifications Fail Because They Do Not Address a Borrower's Negative Equity Situation. Consider the 2MP program, the HAMP program which applies to second liens. Essentially this program treats the first and second lien holders pari passu when the borrower's first lien is modified. If there is a rate reduction on the first lien, there is also a rate reduction on the second lien; if there is a principal write-down on the first lien, the second lien also receives a principal write-down. This makes no sense, as the junior lien is by definition subordinate to the first lien, and as such should be written off before the first lien suffers any loss. And if a modification is done outside of HAMP (and there are more non-HAMP or proprietary modifications than there are HAMP modifications) the servicer is not compelled to address second liens at all. The negative equity position of many borrowers would be dramatically improved if the second lien was eliminated or reduced more in line with the seniority of the lien. Indeed, loan modification programs would be markedly more successful if principal reduction were used on the first mortgage and the second lien were eliminated completely. Our research has shown that a principal reduction modification has the highest likelihood of successfully rehabilitating a borrower, and will ultimately result in the lowest redefault rate. Principal Reductions Are Used in Loan Modifications Less Frequently Than They Should Be, Due to Conflicted Servicers. Even with the current pari passu treatment on first and second liens, we believe there are fewer principal reduction modifications on loans owned by private investors than there would be if a related entity of the servicer did not own the second lien. That is, we believe banks are reluctant to take a write-down on a second lien that is paying and current; as a result, they do a first lien modification which is less effective, to the detriment of the borrower/homeowner as well as to the private investors who own the first lien loan. In addition we believe conflicted servicers are counseling borrowers to remain current on their second liens, thereby allowing them to postpone the write down on the second lien, and increasing the likelihood of a pari passu modification. Principal Reductions Are Also Used Less Frequently Due to Distortions in the Compensation Structure. Servicing fees are based on the outstanding principal balance. Thus, when a principal reduction is done, the servicing fee is reduced, as it is based on a lower principal amount. Since it costs more to service delinquent loans than the servicer is receiving in fees, and this is exacerbated by the write down, it adds to the reluctance to do the principal write down. With servicers trying to minimize the write off of second lien holdings and maintain servicing fees, it is no surprise that we see distorted outcomes for borrowers and investors in loans that banks service for private investors. Here is some evidence of the distortion. We can see a marked difference in servicing behavior for first liens owned by banks and those where the first lien is NOT owned by a bank portfolio. According to the OCC/OTS Mortgage Metrics report of Q4 2010, banks did a principal reduction on 17.8 percent of their first lien portfolio loans. These were loans in which they own the first lien, generally own the second lien (if there is one), and modified the first lien to achieve the highest net present value. By contrast, those same financial institutions did a principal reduction on only 1.8 percent of loans owned by private investors and 0 percent of Fannie Mae, Freddie Mac, and Government-guaranteed loans. While there are major obstacles to principal reduction in the case of GSE (Government Sponsored Enterprise) loans or Government-guaranteed loans, there are few obstacles to doing principal reduction on private investor loans. Only a few PSAs (Pooling and Servicing Agreements) prohibit such behavior. And the OCC/OTS Mortgage Metric Report numbers for Q4 2010 were not a fluke; in the immediately preceding calendar quarter Q3 2010, banks did principal reductions on 25.1 percent of their own loans, but on only 0.2 percent of loans owner by private investors. Solution: To Increase the Use of Principal Reductions as a Loan Modification Tool. National servicing standards should require that servicers perform the modification with the highest net present value, which will usually be a principal reduction. Under HAMP, the servicer is required to test the borrower for a modification using both the original HAMP waterfall, as well as the Principal Reduction Alternative, which moves principal reduction to the top of the waterfall. If the Principal Reduction Alternative has the highest net present value, servicers are not obligated to use it. Use of the Principal Reduction Alternative is voluntary, at the discretion of the servicer. HAMP should be amended to require the use of the Principal Reduction Alternative, if it has the highest net present value of the alternatives tested. Consequence of Pari Passu Treatment of First and Second Liens: Higher First Lien Borrowing Costs. We believe a large error was made in opting to treat the first and second liens pari passu for modification purposes. The consequence of this is that first mortgages will become more expensive, as investors realize they are less well protected than their lien priority would indicate. It is very important to realize that under present law and practices, a second mortgage can be added after the fact, without the first lien investor even knowing it. But addition of a second lien significantly increases the probability of default on the first mortgage. However, as presently constructed, if a borrower gets into trouble, the first and second mortgages are treated similarly for modification purposes. Since that raises the risk for the first lien investor, it should also increase the cost of debt for the first lien borrower. (We haven't seen this reflected in pricing yet, as few mortgages have been originated for securitization; most mortgages issued since the pari passu decision were insured either by the GSEs or the U.S. Government.) Solutions To Maintain Lien Priority What can be done about conflicts of interest inherent in an entity servicing a pool of loans and owning the second lien (while the first lien is owned by an outside investor)? There are at least 3 alternative solutions for newly originated mortgages. The first two require congressional consent, while the third would require actions by the bank regulatory authorities. These solutions to the reordering of lien priorities are beyond the scope of national servicing standards. Alternative 1. This solution would contractually require first lien investors to approve any second lien (or alternatively, approve any second lien with a CLTV [(combined loan-to-value, the ratio of the sum of all the liens on the property to the mortgage amount) exceeding a preset level, such as 80 percent]. If the first lien holder does not approve it, yet the borrower still takes out a second lien, the first lien must be paid off immediately (the ``due on sale'' clause is invoked). This may sound harsh, but it really is not. Currently, if a borrower wants to refinance his first lien, the second lien must explicitly agree to resubordinate his lien. The infrastructure to arrange these transactions exists and works smoothly. Prohibition of excessive indebtedness is common in corporate finance. This is done through loan covenants that limit the amount of junior debt that can be issued without the consent of the senior note holders. This alternative may be required to restart the private mortgage markets and would require an amendment to the Garn-St. Germain Depository Institutions Act of 1982. That act prohibits the senior lien holder from invoking the due-on-sale clause if the borrower opts to place a second lien on the property. Alternative 2. Place an outright prohibition on second mortgages where the combined CTLV exceeds a designated level, such as 80 percent, at the time of origination of the second lien. Alternative 3. Establish a rule that a lender cannot service both the first and second liens while owning only the second lien. CONFLICT #2: Affiliate Relationships With Providers of Foreclosure Services. The servicer often owns a share in companies that provides ancillary services during the foreclosure process, and charges above- market rates on such. Entities that provide services during the foreclosure process that are possibly owned by servicers include force- placed insurance providers and property preservation companies. (These companies provide maintenance services as well as property inspection services.) Even when a servicer is not affiliated with the company providing the service, they often mark up the fees considerably. What is the consequence of affiliates of the servicer charging above market fees? Such fees are added to the delinquent amount of the loan, making it much harder for a borrower to become current. Moreover, when a loan is liquidated, the severity on the loan (the percentage of the current loan amount lost in the foreclosure/liquidation process) will be much higher, to the detriment of the investor(s) in that mortgage. It also tends to make servicers less inclined to resolve the loan through a short sale, as fee income that will be earned in the interim (as the loan winds its way through a lengthy foreclosure process) is quite attractive. Problem: Distortion in the Servicing Fee Schedules. We have heard assertions that, since servicers are inadequately paid for servicing delinquent loans, the related fees are a way to make up the difference. It is absolutely the case that servicers are definitely underpaid for servicing delinquent loans. However, they are overpaid for servicing performing loans. Moreover, ex ante (at the inception of the loan), the servicer had agreed to service the loans at the agreed-upon price. It's just that ex post (at the present time), given the amount of delinquent loans that accumulated versus original expectations, their original agreement has turned out to be a bad deal. But in the real world, a deal is a deal! For instance, my own firm Amherst Securities Group can't agree to a consulting contract at a fixed price, then come back and renegotiate because it is more work than we thought it would be. Problem: No Disclosure of Fees. Servicers will tell you that the services they provide are essential, and they would be provided at similar prices by any third party. By owning or having an interest in a wider array of services, the servicers also have more control over the timing and can more closely monitor the quality of the servicers provided. However, neither borrowers nor investors have any way to confirm this. The ancillary fees are not broken out in a form that is transparent to anyone outside. Partial Solution: Make Better Fee Disclosure a Part of National Servicing Standards. The New York State Banking Department, in their Regulations for Servicing Loans (part 419), requires that servicers must maintain a schedule of common fees on its Web site, and must include a ``plain English'' explanation of the fee, and any calculation details. In addition, the servicer should only collect a fee if the amount of that fee is reasonable, and fees should be charged only for services actually rendered and permitted by the loan instruments and applicable law. Attorneys fees charged in connection with a foreclosure action shall not exceed ``reasonable and customary'' fees for that work. At the minimum, this type of language should be adopted for national servicing standards. Force-Placed Insurance Highlights the Conflicts of Interest. The servicer, or an affiliate of the servicer often own a share of a force- placed insurer. This insurance is used to protect the home when the borrower is no longer maintaining his existing policies. Given the conflicts, it is unrealistic to expect a servicer to make an unbiased decision on when to buy this insurance (there is a tendency to buy it without trying to retain the homeowner's policy that was already in place) as well as how to price it (there is a tendency to price too high). There have already been several attempts to address this issue. The New York State requirements explicitly address force-placed insurance (hazard, homeowner's, or flood insurance), and details situations in which it should not be used. A servicer is prohibited from (1) placing insurance on the mortgaged property when the insurer knows or has reason to know the borrower has an effective policy for the insurance; (2) failing to provide written notice to a borrower when taking action to place insurance; and (3) requiring a borrower to maintain insurance exceeding the replacement cost of improvements on the mortgage property. The State Attorneys' General proposed settlement (circulated in March of this year but not yet approved) contains similar provisions governing the placement of force-placed insurance. The servicer must make reasonable efforts to continue or reestablish the existing homeowner's policy if there is a lapse in payment. The servicer must advance the premium if there is no escrow or insufficient escrow. If the servicer cannot maintain the borrower's existing policy, it shall purchase force-placed insurance for a commercially reasonable price. However, the Attorneys' General proposed settlement went one step further than the New York State requirements--it suggested the elimination of the conflict of interest by prohibiting these servicers from placing insurance with a subsidiary or affiliated company or any other company in which the servicer has an ownership interest. Solution: Force-Placed Insurance Conflicts. National Servicing Standards can be used to require servicers to keep existing homeowner's policies in place as long as possible, as both the New York State requirements and the proposed Attorneys' General settlement do. If it is not possible to reestablish the existing homeowner's policy, measures must be included to make sure the pricing of the purchase is reasonable. Moreover, following the lead of the Attorneys' General settlement, national servicing standards should prohibit the placement of force-placed insurance with a subsidiary, affiliated company, or any other company in which the servicer has an ownership interest. Solution: Dealing With Other Ancillary Fees. Under the Attorneys' General proposed settlement, the servicer cannot impose its own mark- ups on any third party fees. Subsidiaries of the servicer (or other entities where the servicer or related entity has an interest in such a third party) are prohibited from collecting third party fees. Moreover, servicers are prohibited from splitting fees, giving or accepting kickbacks or referral fees, or accepting anything of value in relation to third party default or foreclosure-related services. We at Amherst Securities Group agree with these recommendations. These ideas should become a part of a meaningful set of national servicing standards. CONFLICT #3: Conflicts of Interest in the Governance of a Securitization, Including Enforcement of ``Representations and Warranties''. While the enforcement of ``rep and warrants'' (representations and warranties) does not directly affect borrowers, we believe it is a very important topic for investor, and serves to highlight the conflicts between servicers and investors. Violations involving reps and warrants are becoming increasingly common as seen in recent litigation. That is, loans in a securitization often do not conform to the representations made about the characteristics of these loans. For example, a loan may have been represented as an owner-occupied property when in fact it is not; or a borrower lied about income to a degree that should have been picked up in the origination process; etc. Once a rep and warrant violation is discovered, at present the trustee is charged with enforcement [the remedy is generally that the sponsor or originator repurchases that particular loan out of the pool at par (an amount equal to the original balance on the loan less any paid down principal)]. However, the trustee does not have the information to detect the violations, they do not have direct access to the loan files. Moreover, as they have little incentive to detect rep and warrant violations, since the trustee is not compensated for detecting violations and the benefits of doing so actually accrue elsewhere (to the investors). Servicers (who do have the information to identify rep and warrant violations) often have a financial disincentive to do so, as they would be putting the loan back to an affiliated entity. For example, the largest banks often serve as originators, deal sponsors (underwriters) and servicers on securitizations. There is nothing wrong with this, as long as there is a mechanism to allow for enforcement of the reps and warrants. Solution: Properly Enforcing Reps and Warrants. It is critical to have a party that is incented to enforce them, and has both access to the information and enforcement authority. This can best be achieved through an independent third party charged with protecting investor rights, who is paid on an incentive basis. Some current deals nominally have a third party charged with protecting investor rights, but that party is not empowered, does not have access to necessary information (the loan files), and is not paid on an incentive basis. This set of conflicts should be addressed the PSAs (purchase and sale agreements) for new securitizations. National Servicing Standards should direct servicers to make sure that there is an adequate enforcement mechanism for reps and warrants. CONFLICT #4: The Servicing Fee Structure Is Unsuitable to This Environment. There are many situations in which transferring the servicing of a loan on which the borrower is delinquent to a servicer that specializes in loss mitigation would be the best outcome for both borrowers and investors. A number of special servicers have had considerable experience tailoring modifications to the needs of individual borrowers and tend to provide more hand holding to the borrower post-modification than what a major servicer is staffed to provide. Consequently, the redefault rates on modified loans are much lower with specialized servicers who focus on loss mitigation. Servicing transfer issues are made very difficult, as many deals do not provide for adequate servicing fees to encourage such a transfer. We made the point earlier that servicers are compensated too highly for servicing current loans, not highly enough for servicing delinquent loans. If compensation is inadequate, it will be very difficult to convince a special servicer to service the loan. Solution: Revamp the Servicing Fee Structure. There has been a considerable amount of discussion about revamping the structure of servicing fees, to allow for lower fees for performing loans and higher fees for nonperforming loans. The FHFA has organized a number of meetings to discuss these issues, and has outlined the alternatives. If fees were to be altered such that fees for servicing current loans were lowered while fees for servicing delinquent loans were raised, it would allow the special servicer to be adequately compensated for his high- touch efforts. This, in turn, would make it much easier to transfer delinquent loans to servicers who would do a better job at loss mitigation. There has been some concern about the incentive issues that would arise. Given higher servicing fees for servicing nonperforming loans, will servicers be dis-incented to make a proactive phone call when a borrower misses one payment? Will the originator/affiliate be less concerned about the quality of loans they originate? We think there is a very simple solution to this--give the GSEs or private label investors the ability to move the servicing when the higher fees are scheduled to take effect. CONFLICT #5: Transparency for Investors Is Woefully Inadequate. Many of the conflicts are obscured by servicers as a result of the poor reporting they provide on a monthly basis. We believe that with more transparency, many of these conflicts would be more visible and servicers will be less inclined to act against the interests of first lien borrowers and investors. In a private label securitization there is often a large difference between the monthly cash payment the investor expected to receive and what is actually received. Moreover, an investor is unable to delve into the cash flow information further, as he lacks the information on the actions of the servicer that would be necessary to reconcile the cash flows. When I receive the statement from my bank each month, I balance my checkbook, reconciling the differences. Investors want to be able to do exactly this with the cash flows from the securitizations in which they have an interest. There are several culprits:
Insufficient transparency on liquidations. When a loan is liquidated, investors often receive only one number--the recovered amount. Servicers provide no transparency on what the home has been sold for, what advances were made on the loan, what taxes and insurance were, what property maintenance fees were, nor what the costs of getting the borrower out of the house were. A breakdown of these costs/fees would help investors understand severity numbers that were different (often much higher!) than anticipated. It would also allow investors to better compare behavior across servicers, allowing for identification of the most efficient servicers, and exposing the underperformers. Insufficient transparency on servicer advances. A servicer usually advances principal and interest payments on delinquent loans, allowing for a payment to the investor even if the borrower is not paying. These advances are required to be made as long as the servicer deems them to be recoverable. There is often little information on which loans are being advanced on, which makes it very difficult for investors to figure out how much cash they should expect. Insufficient transparency on modifications. Similarly, when a loan is modified, investors often can't tell how that loan has been modified. Has there been an interest rate reduction, a term extension, a principal forbearance, or principal forgiveness? How long will any reduced interest rate be in effect, and how will it reset? Were any delinquent payments forgiven? While some servicers are better than others at reporting this information, investors are often forced to infer (guess!) it from the payments. Insufficient transparency on principal and interest recaptures. When a servicer modifies a loan, the servicer is entitled to recapture the outstanding principal and interest advances. Those amounts, payable to the servicer, have the first claim rights on cash flows of the securitization. Investors often receive less money than anticipated due to these recaptures. There is certainly nothing wrong with servicers recapturing funds they advanced, but investors want to know how much has been recaptured and from which loans. [NOTE: As an aside, we have often heard assertions that servicers have an incentive to speedily move a borrower along in the foreclosure process, as they can recover their advances. That charge has never made any sense to us. By modifying a loan, servicers can recover advances. Moreover, by modifying, the servicer receives bonuses from the U.S. Government from using the Home Affordable Modification Program (HAMP). Finally, the longer the process, the more ancillary fee income is generated for the servicer.] The result of the lack of transparency is that investors can't reconcile the cash flows on the securitization they have invested in. They don't know how much is being advanced, what are the terms of the modifications on the modified loans, and how much of the principal and interest advances the servicer is recapturing when doing the modification. Solution: Transparency. We believe the remittance reports for future securitizations should contain loan-by-loan information, and that loan-by-loan information should be rolled up into a plain English reconciliation. National servicing standards should encourage this transparency. Conclusion In summary, we have discussed five conflicts of interest between servicers and borrowers/investors. They involve the following: 1. Servicers often own junior interests in deals they service, but in which they do not own the first liens 2. The servicer often owns a share in companies which can be billed for ancillary services during the foreclosure process, and charges above market rates on these services 3. There are conflicts of interest in the governance of the securitization, including the enforcement of rep and warrant issues 4. Servicing transfers can be problematic due to a misaligned servicer compensation structure 5. transparency for investors is missing ______ PREPARED STATEMENT OF DAVID H. STEVENS President and Chief Executive Officer, Mortgage Bankers Association May 12, 2011 Introduction Chairman Menendez, Ranking Member DeMint, and Members of the Subcommittee, thank you for the opportunity to testify on behalf of the Mortgage Bankers Association (MBA). \1\ My name is David Stevens, and I am President and CEO of MBA. Immediately prior to assuming this position, I served as Assistant Secretary for Housing at the United States Department of Housing and Urban Development (HUD), and Federal Housing Administration (FHA) Commissioner. --------------------------------------------------------------------------- \1\ The Mortgage Bankers Association (MBA) is the national association representing the real estate finance industry, an industry that employs more than 280,000 people in virtually every community in the country. Headquartered in Washington, DC, the association works to ensure the continued strength of the Nation's residential and commercial real estate markets; to expand homeownership and extend access to affordable housing to all Americans. MBA promotes fair and ethical lending practices and fosters professional excellence among real estate finance employees through a wide range of educational programs and a variety of publications. Its membership of over 2,200 companies includes all elements of real estate finance: mortgage companies, mortgage brokers, commercial banks, thrifts, Wall Street conduits, life insurance companies and others in the mortgage lending field. For additional information, visit MBA's Web site: www.mortgagebankers.org. --------------------------------------------------------------------------- My background prior to joining FHA includes experience as a senior executive in finance, sales, mortgage acquisitions and investments, risk management, and regulatory oversight. I started my professional career with 16 years at World Savings Bank. I later served as Senior Vice President at Freddie Mac and as Executive Vice President at Wells Fargo. Prior to my confirmation as Commissioner of the FHA, I was President and Chief Operating Officer of Long and Foster Companies, the Nation's largest, privately held real estate firm. Thank you for holding this hearing on the important subject of the creation of national servicing standards. I would first like to provide some background information as a preface to my remarks, express support for the need for national standards, highlight what MBA has done so far in examining that need, recommend steps for the process of developing comprehensive servicing standards, and suggest principles for those standards. Background As the housing crisis evolved, industry and policy maker responses evolved along with it. An understanding of these developments and their context is crucial to a full appreciation of the challenges facing the mortgage industry as it works to help borrowers avoid foreclosure and in identifying viable long-term solutions. The ``Great Recession'' was the most severe economic downturn that the U.S. experienced since the Great Depression of the 1930s. It led to the failure or consolidation of many of the country's leading financial institutions, and from January 2008 to February 2010, the U.S. economy lost almost 8.8 million jobs. Government reacted with unprecedented policy initiatives, both in terms of fiscal stimulus and other Government interventions, and monetary stimulus in the form of near zero interest rates and massive purchases of mortgage-backed securities and other assets. The housing and mortgage markets both contributed to and suffered from this crisis. Although not an exclusive list, several factors were at play: excessive housing inventory, lax lending standards that favored nontraditional mortgage products and reduced documentation, the easing of underwriting standards on the part of Fannie Mae and Freddie Mac, passive rating agencies and regulation, homebuyers chasing rapid home price increases, undercapitalized financial institutions, monetary policy that kept interest rates too low for too long, and massive capital flows into the U.S. from countries that refused to allow their currencies to appreciate. According to the Federal Housing Finance Agency (FHFA), home prices nationally decreased a cumulative 11.5 percent during the past 5 years, with much larger cumulative declines of 40 to 50 percent in the States of Arizona, California, Nevada, and Florida, known throughout the crisis as the ``Sand States.'' Household formation rates fell sharply in response to the downturn, with many families combining households and household expenses to save money. And consumers cut spending across the board, as they tried to rebuild savings after the shocks to their wage income and the declines in the stock market and housing values. The residual effects continue today: even though construction of new homes remains near 50-year lows, inventories of unsold homes on the market remain high, with nearly 4 million properties currently listed, and homebuyer demand remains weak. Regardless of which factors caused the recession, we do know that the nature of the crisis changed over time. Initially, rising rates from the Federal Reserve and suddenly tighter regulatory requirements regarding subprime and nontraditional loan products stranded borrowers who had counted on being able to refinance loans in late 2006 and into 2007. As a result, serious delinquency rates on subprime ARM loans (loans 90 days past due) increased by 50 percent in 2006 and then more than doubled through 2007. \2\ Even before their first interest rate reset, these loans failed at unprecedented rates. Subprime ARMs originated from 2005-2007 have performed far worse than any others in recorded data. --------------------------------------------------------------------------- \2\ MBA's National Delinquency Survey. --------------------------------------------------------------------------- Without access to credit for new buyers, home prices in the Sand States markets began to fall dramatically. With investors increasingly questioning loan performance, the private-label MBS market froze in August 2007 and has remained essentially paralyzed ever since. Compounding the problem, lending to prime, jumbo mortgage borrowers effectively stopped. As liquidity fled the system, fewer potential buyers could access credit, and home prices declined further. According to the National Bureau of Economic Research (NBER), the economy officially fell into recession in December 2007. The unemployment rate in January 2008 was 5 percent. Eighteen months later, it would be nearly twice as high, following the near collapse of the financial sector in the fall of 2008. From that point forward, joblessness and loss of income began to drive mortgage delinquencies and foreclosures. Serious delinquency rates on prime fixed-rate loans were at 1.1 percent in the beginning of 2008. By the end of 2009, they approached 5 percent. These loans were traditionally underwritten and well-documented with no structural features that impacted performance. Many borrowers simply could not afford their mortgage payments as they did not have jobs. Important policy initiatives were launched during this time period. Servicers began large-scale efforts to modify subprime and nontraditional loans. Initially, individual servicers and the GSEs undertook these efforts voluntarily, but Government and industry efforts led to standardization of processes through the Home Affordable Modification Program (HAMP). HAMP also benefited proprietary modification programs, which could leverage these standardized processes. Importantly, the HOPE NOW Alliance \3\ estimates that, as of March 2011, almost 3.8 million homeowners have received proprietary modifications since mid-2007. Another 7.2 million borrowers received other home retention workouts, including partial claims and forbearance plans, a key tool supported by the Administration to assist borrowers who are unemployed. \4\ The Treasury Department and HUD also report that borrowers received an additional 670,186 permanent HAMP modifications. \5\ More than 11 million home retention workout options have been provided to consumers in 4 years. This is a significant accomplishment that took significant manpower and coordination in the face of unprecedented turmoil in the mortgage servicing industry and servicers should be recognized for what they have accomplished despite the industry's problems. --------------------------------------------------------------------------- \3\ Established in 2007, HOPE NOW is a voluntary, private sector, industry-led alliance of mortgage servicers, nonprofit HUD-approved housing counselors and other mortgage market participants focused on finding viable alternatives to foreclosure. HOPE NOW's primary focus is a nationwide outreach program that includes (1) over five million letters to noncontact borrowers, (2) regional home ownership preservation outreach events offering struggling homeowners face to face meetings with their mortgage servicer or a counselor, (3) support for the national Homeowner's HOPETM Hotline, 888-995- HOPETM, (4) Directing homeowners to free resources through our Web site at www.HOPENOW.com and (5) Directing borrowers to free resources such as HOPE LoanPortTM, the new web-based portal for submitting loan modification applications. \4\ HOPE NOW, Data Report (March 2011). \5\ March 2011, Making Home Affordable Program Report. --------------------------------------------------------------------------- However, other public policy efforts, such as those designed to delay the foreclosure process, have typically not been effective over the longer term. Frequently, there can be a tradeoff between late-stage delinquencies and foreclosure starts, as new regulatory or statutory requirements delay foreclosure starts one quarter, resulting in a temporary increase in the delinquency ``bucket.'' In most cases, though, foreclosure starts rebounded in subsequent quarters as backlogs were drawn down. In summary, the worst recession in living memory has led to the worst mortgage performance in our lifetime. Servicers have been overwhelmed by national delinquency rates running four to five times higher than what had been typical during the prior 40 years for which MBA has data. In spite of these market circumstances, servicers have worked to help borrowers avoid foreclosure whenever possible. MBA Supports the Concept of National Servicing Standards Presently, servicers face an overwhelming multitude of servicing standards and rules, from Federal laws, such as the Real Estate Settlement Procedures Act, Truth in Lending Act, and the Dodd-Frank Act (just to name a few), to 50 State laws (plus DC), local ordinances, Federal regulations, State regulations, court rulings or requirements, enforcement actions, FHA requirements, Veteran Affair's (VA) requirements, Rural Housing Service (RHS) requirements, Fannie Mae standards, Freddie Mac standards, and contractual obligations, such as the pooling and servicing agreement (PSA). Almost every aspect of the servicer's business is regulated in some fashion, but the rules are not always clear, placing servicers in a position of having to guess as to the requirements. Also, the evolutionary nature of the housing crisis caused significant, near constant changes in these rules. Since the introduction of HAMP, a substantial number of major changes and additions have been made to the program. Many recent judicial challenges to the well-settled law of ownership rights to notes and mortgages have placed the very basis of secured lending at risk by disrupting note holder's and investor's ability to enforce their security interests. Adding to the complexity is the fact that no two servicing standards are alike. Fannie Mae, Freddie Mac, and FHA guidelines may cover the same subjects, but the requirements differ for each. Each of the guidelines addresses foreclosure processes, outlining penalties for not performing specified collection and foreclosure procedures in particular stages of delinquency, foreclosure, or bankruptcy. This results in the need for servicers to create specialized teams for each investor. FHFA has undertaken a project to align certain portions of Fannie Mae's and Freddie Mac's servicing guidelines and create uniform requirements. This is a very positive step and we applaud the effort. State laws also play into the complexity of servicing regulation. Each of the 50 States and the District of Columbia has its own laws governing the foreclosure process and other servicing activities. Some States require judicial foreclosure proceedings while others are nonjudicial foreclosure States. Thus, the servicer must manage the nuances of the laws in the various States through its servicing systems and work processes. MBA supports uniformity among judicial foreclosure laws and nonjudicial foreclosure laws, which have historically been within the domain of the States. As a result of the unprecedented volumes of nonperforming loans during the current cycle, servicers have experienced difficulties in their ability to adjust systems and work processes quickly to meet the ever-changing regulatory environment, including changes to loan modification programs, and the time required to hire and train employees for these new processes. We believe a national servicing standard would be beneficial to streamline and eliminate overlapping requirements. However, a national servicing standard must be truly national in scope and not simply another standard layered atop the already overwhelming number of servicer requirements. In developing servicing standards, we must also pay careful attention to the interdependence of servicing and the impact that changes to the system will have on the economics of mortgage servicing, tax and accounting rules and regulations, and the effect of the new requirements on Basel capital requirements and on the To Be Announced (TBA) market. Servicing does not operate in a vacuum; instead it is part of the broader ecosystem of the mortgage industry. When making changes to the current model we need to be mindful of unforeseen and unintended consequences that could result ultimately in higher costs for consumers and reduced access to credit. MBA's Servicing Initiatives On December 8, 2010, MBA announced the creation of a task force of key industry members to examine and make recommendations for the future of residential mortgage servicing. The Council on Residential Mortgage Servicing for the 21st Century (Council) is being led by MBA's Vice Chairman, Debra W. Still, CMB, the President and Chief Executive Officer of Pulte Mortgage LLC. In announcing the formation of the Council, MBA Chairman Michael Berman, CMB, stated, ``The residential mortgage servicing sector has been operating in a time of unprecedented challenges, presenting us with a unique opportunity to explore potential improvements to business practices, regulations and laws affecting the servicing sector and consumers. As the national trade association representing the real estate finance industry, we will bring together industry experts to take a comprehensive look at the current state and ongoing evolution of residential mortgage servicing and make recommendations for the future.'' The Council convened a 1-day public session on January 19, 2011, in Washington, DC, titled, ``MBA's Summit on Residential Mortgage Servicing for the 21st Century.'' This Summit brought together industry leaders, consumer advocates, economists, academics and policy makers who took a detailed look at the issues that have challenged the industry and started the process of identifying the essential building blocks for the future of servicing. Keynote speakers and panelists at the Summit discussed problems and perceptions from their respective vantage points. Many speakers identified the need for a national servicing standard, the need to change the compensation structure to better incent servicers in the area of dealing with nonperforming loans, and the need for potential changes in laws and regulations related to foreclosures and other facets of servicing. In analyzing the issues that surfaced during the Summit, the Council identified three major areas for further study and development of policy recommendations: Review of existing servicing standards and practices especially in the areas of large volumes of nonperforming loans, foreclosure practices, and loss mitigation practices, including loan modifications. The Council formed a working group to study and make policy recommendations related to a national servicing standard. Evaluation of the legal issues related to the foreclosure process, chain of title and other issues. The Council formed a working group to study and make policy recommendations related to legal issues surfaced during the Summit and any additional statutory or regulatory changes deemed appropriate for servicing in the 21st Century. Analysis of proposed changes in servicer compensation proposed by the FHFA, Ginnie Mae, Fannie Mae, and Freddie Mac. The Council formed a working group to analyze the proposed compensation structure from the vantage of various stakeholders including large and small servicers, depository and nondepository servicers, and portfolio lender/servicers and MBS issuer/servicers. While MBA will continue to release several documents to the public during the next several weeks, today we issued a white paper that will act as an educational tool and provide background information and an environmental scan of the events leading up to the current crisis. The white paper provides information on what a servicer does, how a servicer is compensated, and the perspectives of consumers, regulators, and the legal community with regard to servicer performance in the current crisis and their policy recommendations. It also contains an industry analysis of the criticisms against servicers in order to separate real problems from ``urban myths.'' The last chapter highlights the Council's next steps to set the course for the future of servicing in the 21st century. The ``urban myths'' document summarizes several issues and misperceptions raised by regulators and consumer groups that have crept into the public consciousness during the servicing debate and dialogue. For example, the document dispels beliefs that a servicer's compensation structure is misaligned whereby servicers have higher incentives to foreclose on a delinquent borrower rather than to modify a loan. The final document in the initial wave will be the Council's preliminary views on the four fee proposals currently under consideration by FHFA, Fannie Mae, Freddie Mac, and Ginnie Mae. Since servicers come in different sizes, ownership structures, specialties, etc., each servicer has its own unique motivations or ``hot buttons'' for owning servicing. The Council's analysis will contrast specific attributes of each of the four fee structures against the current fee structure. MBA expects to have a preliminary recommendation with respect to national servicing standards later this year. The Council plans to release in the coming months its preliminary recommendations related to foreclosure laws, chain of title issues, and other legal and regulatory obstacles to the servicer doing its job in dealing effectively with borrowers in default. Additional Industry Efforts In addition to implementing the various loss mitigations programs, including HAMP, the industry has supported many other proconsumer efforts: Free Borrower Counseling: \6\ Many servicers and investors pay HUD-approved counselors to counsel borrowers on options to avoid foreclosure. Housing counseling is also supported through NeighborWorks America and HUD grantees. These counselors are instrumental in helping to educate borrowers about specific program details and to collect documents necessary to complete loss mitigation evaluations. Counseling is free to borrowers. HOPE NOW, of which MBA is a member, supports the Homeowner's HOPETM Hotline, 888-995-HOPETM, which is managed by the nonprofit Homeownership Preservation Foundation, and operates 24 hours a day, 7 days a week in several languages. The hotline connects homeowners to counselors at reputable HUD-certified nonprofit agencies around the country. As of March 2011, there have been more than 5 million consumer calls into the hotline since inception, and it serves as the Nation's ``go-to'' hotline for homeowners at risk. The U.S. Government uses this hotline for their Making Home Affordable program and noted in its December 2010 report that 1.8 million calls have been fielded by the hotline to date, and more than one million borrowers have received housing counseling assistance. --------------------------------------------------------------------------- \6\ MBA's Research Institute for Housing America recently released a study, ``Homeownership Education and Counseling: Do We Know What Works?'' which examined the benefits of prepurchase and postpurchase counseling. http://www.housingamerica.org/Publications/ HomeownershipEducationandCounseling:DoWeKnowWhatWorks.htm HOPE LoanPortTM (HLP): HLP is an independent nonprofit created by HOPE NOW and its members as a data intake facility to improve efficiency and effectiveness of communications among borrowers, counselors, investors and mortgage servicers. HLP was created to help address the frustration among borrowers, policy makers, counselors, and servicers in the document submission process. HOPE LoanPortTM's web-based system allows a uniform intake of an application for a loss mitigation solution though HAMP, all Federal programs and proprietary home retention programs. It allows for all stakeholders to see the same information, in a secure manner, and delivers a completed loan package to the servicer for action. This web-based portal increases accountability, stability and security for submitted information and increases borrower confidence that that their information will be reviewed and will not be lost. Servicer and counselor steering teams, working together have made the decisions on how best to create and improve the HOPE LoanPortTM system. This portal was designed by a core group of nonprofits including NeighborWorks' America and HomeFree-USA, and six industry servicers who shared in this unique and important mission. Recommended Steps in Developing National Servicing Standards Several regulators have recently specified their own distinct standards regarding mortgage servicing, a trend that concerns MBA deeply. The State of New York implemented standards late last year for loans serviced in the State of New York. The Office of the Comptroller of the Currency (OCC) released proposed standards, and has separately issued consent orders to specific banks that impose servicing standards through enforcement action as opposed to the normal Federal rulemaking process. The Federal Reserve and the Office of Thrift Supervision (OTS) have likewise issued consent orders to banks and thrifts that they regulate, which contain prescriptive servicing requirements. Several State attorneys general have proposed a settlement with some larger servicers that would impose restrictive standards as an alternative to civil litigation. Additionally, the SEC and the Bank Regulators are currently attempting to impose servicing standards in the proposed origination rules related to a qualified residential mortgage (QRM) under the Dodd- Frank Act. In order to be considered a QRM and exempt from risk retention requirements, the proposal would require compliance with certain servicing standards. Specifically, the QRM's ``transaction documents'' must obligate the creditor to have servicing policies and procedures to mitigate the risk of default and to take loss mitigation action, such as engaging in loan modifications, when loss mitigation is ``net present value positive.'' The creditor must disclose its default mitigation policies and procedures to the borrower at or prior to closing. Creditors also would be prohibited from transferring QRM servicing unless the transferee abides by ``the same kind of default mitigation as the creditor.'' MBA is extremely concerned with the inclusion of servicing standards in a QRM definition. The QRM exemption was very clearly intended under the Dodd-Frank Act to comprise a set of loan origination standards only. The specific language of the Act directs regulators to define the QRM by taking into consideration ``underwriting and product features that historical loan performance data indicate lower the risk of default.'' Servicing standards are neither ``underwriting'' nor ``product features,'' and while they may bear on the incidence of foreclosure, they have little, if any, bearing on default. Combining origination standards that terminate at loan closing and servicing standards that commence at closing and continue for decades in a single QRM regulation is problematic, as the regulation must address two distinct functions and time frames. Accordingly, MBA strongly believes they have no place in this proposal. Embedding servicing standards within the proposed QRM regulations will have unintended consequences that could actually harm borrowers. Specifying a servicing standard as part of QRM is directly contrary to achieving a national standard, as QRM as proposed would only represent a small share of the market. The proposal requires loss mitigation policies and procedures to be included in transaction documents and disclosed to borrowers prior to closing. Such a requirement codifies the servicer's loss mitigation responsibilities for up to 30 years at the time of origination. While servicers today have loss mitigation policies to address financially distressed borrowers, these policies continue to evolve as regulator's concerns, borrower's needs, loan products, technology, and economic conditions evolve. One need only look at the variety of recent efforts that have emerged during the housing crisis such as HAMP, the Home Affordable Foreclosure Alternatives, FHA HAMP, VA HAMP, and proprietary modifications. A further example is the different set of loss mitigation efforts necessitated by Hurricane Katrina. In both situations, inflexible loss mitigation standards would not have been in the best interest of the public or investors. The QRM proposal is also likely to make servicing illiquid by combining ``static'' loss mitigation provisions in legal contracts and borrower disclosures with the inability to transfer servicing unless the transferee abides by those provisions, even if more borrower- friendly servicing options become available. The proposal also calls for servicers to disclose to investors prior to sale of the MBS the policies and procedures for modifying a QRM first mortgage when the same servicer holds the second mortgage on the property. This adds another level of complexity to the concerns raised above, notwithstanding the irrelevance of these provisions to underwriting, origination, and statutory intent. MBA believes that national servicing standards should start with a full analysis of existing servicer requirements and State laws on foreclosure. The new standards should be promulgated in a process that includes open dialogue with all stakeholders, including Federal regulators, State regulators, consumer advocates, servicers, and investors in mortgages and MBS. MBA welcomes the opportunity to participate and play a constructive role in such a process. Principles for National Servicing Standards MBA believes that one consistent set of standards would be beneficial for servicers and consumers. In developing a national servicing standard, specific principles should to guide decision making. We suggest, at a minimum, the following principles: a. National Servicing Standards Must Be Truly ``National'' Of paramount importance to the industry is that any national servicing standard be truly national and not yet another requirement on top of the myriad existing obligations. Servicers would not have the burden of looking to varying standards created by different entities (e.g., Federal regulators, State laws, Government agencies, etc.). Servicers could reduce staff and third-party experts currently needed to follow, track and comprehend varying standards. Errors would be reduced. Consumers would benefit by reduced complexity and, ideally, easy-to-understand requirements. b. Process Must Be Transparent and Involve Key Stakeholders The process to create national servicing standards must include servicers and investors as these parties must ultimately implement the new standards and the standards will potentially restrict servicing activities and impose additional costs. Although it is likely that the newly authorized Bureau of Consumer Financial Protection (CFPB) will finalize the standards, given its expansive role in consumer protection, industry input must be a crucial part of the process for the standards to be workable. c. Process Must Recognize Existing Requirements As previously indicated, servicers are subject to a multitude of laws, regulations, and requirements. In many cases, remedies already exist for a majority of the perceived problems. In setting national standards, regulators must recognize existing rules and adopt them without change when they have been fully vetted through the rulemaking process. d. Rules Should Allow Flexibility To Deal With Market Changes Rather than prescribe the exact methodology in which servicers must conduct their day-to-day operation, a national servicing standard should describe the ultimate result the Government wishes to achieve. Servicers and investors would be allowed to devise the means to achieve the objective that best suits their business model and capital structure. Moreover, flexibility would allow servicers to address different market conditions and consumer needs. The best example to illustrate the importance of flexibility is by comparing today's borrower's needs, whereby modifications are critical, to borrowers affected by Hurricane Katrina, whereby forbearances were paramount as borrowers awaited hazard insurance and Road Home funds. e. Standards Should Create Uniform and Streamlined Processes Processes that servicers must follow need to be simple and uniform. Markets operate best with certainty, and servicers need straightforward processes that do not differ by product, investor, regulator or State. As stated above, one set of standards will limit errors and litigation risk, and promote customer satisfaction. Simple processes will yield the best results for all consumers and servicers. f. Standards Must Treat Borrowers Fairly/Recognize Borrower Duties MBA strongly believes that borrowers should be treated fairly and with compassion. Customers should obtain respectful service, should have access to the opportunities to retain home ownership for which they qualify, and should understand their options. We also believe that borrowers have duties. These include responding to servicer offers of assistance, contacting the servicer early in the delinquency, and diligence in providing required documents and other fulfillment requirements of loan modification programs. These principles, for both the servicer and the borrower, must be recognized in the development of national servicing standards. g. Standards Must Treat Servicers Fairly National servicing standards should ensure the fair treatment of servicers and recognize the economic realities of the servicing business. Standards must recognize the costs of delinquency and foreclosure, including late fees and other compensatory fees necessary to offset the cost of delinquency. Many of the suggested standards question these charges, yet these fees are necessary to ensure quality customer service, to enable advance payments to bondholders as required, and to provide the loss mitigation products borrowers seek. We urge policy makers, therefore, to balance the needs of borrowers and servicers. Potential Components of National Servicing Standards Regulators, congressional leaders, consumer advocates, and academia have proposed various servicing standards to address perceived problems as well as borrower complaints. These proposals differ significantly, but the goals appear clear: to improve the customer's experience while in the loss mitigation process, to avoid confusion, and to ensure that borrowers are treated fairly and given access to loss mitigation. We agree with these goals. We would like to address several concepts currently under consideration as part of the dialogue concerning various proposed national standards. a. Single Point of Contact Some regulators and consumer advocates are promoting a single point of contact to simplify communications with servicers during the loss mitigation process. MBA supports clear and helpful communication with the borrower. However, a single-point of contact may have unintended consequences, potentially leaving consumers more frustrated and with greater delays. There is no unified definition of ``single point of contact.'' A plain English definition would imply that a single person would be assigned to each borrower and that the borrower would communicate only with this person. This is not feasible in the current environment and would create numerous problems as servicer call volumes fluctuate significantly throughout the day, week, and month. First, a single point of contact eliminates the specialty training necessary to deliver accurate and timely assistance to borrowers, as borrower assistance may range from questions regarding their payment history or escrow processes to complicated modifications such as HAMP or short sales. A single person cannot be expert in each of these highly complex and regulated areas. The result will be delays, miscommunication, and/or errors. Second, given the current environment, it will be impossible to appropriately staff to meet demands as they fluctuate widely. By the sheer reality of the situation, borrowers may be subject to significant delays and response times if limited to one individual. Even if a borrower were able to talk to other knowledgeable servicing team members, we are concerned that said borrower could decline and request a return phone call from the single point of contact. As a result, the borrower will suffer delays and frustration with regard to his or her issues and concerns. Third, a single point of contact raises concerns regarding staff departures, work schedules, business travel, vacations, illness, etc. The reality is a single point of contact can never be truly a single person. In its purest sense, a single point of contact disrupts a servicer's efforts to provide the best service in a specific area of expertise. Borrowers must be willing to communicate with other staff familiar with the borrower's account, and servicers must have the flexibility to structure staff the best way to achieve the principle of superior customer service. b. Dual Track Policy makers and consumer advocates continue to call for the elimination of so-called ``dual tracking.'' Dual tracking occurs when the servicer continues intermediate foreclosure processes while loss mitigation activity is underway. Interim foreclosure processes, such as notices, rights to hearings, and the like are required by State law or the courts and would continue during preliminary loss mitigation efforts to ensure the borrower received due process and to avoid unnecessarily delaying foreclosure should the borrower not qualify. It is important to realize, however, that servicers will not go to foreclosure sale (e.g., the borrower will not lose the house) if the borrower has provided a complete loss mitigation package sufficient to evaluate the borrower for loss mitigation and has provided such information in a reasonable time before the foreclosure sale date. Successful loss mitigation, however, requires diligence and priority on the part of the borrower. Borrowers should submit full application packages as soon as possible and prior to initiation of foreclosure. Servicers should not be expected to stop foreclosure processes, or even a foreclosure sale, if the borrower waits until the last minute to request assistance. Moreover, some courts do not allow a foreclosure sale to be canceled within 7-10 days of the scheduled sale date. The halting of the foreclosure process is difficult due to investor requirements. As noted above, Fannie Mae, Freddie Mac, and FHA all require servicers to meet various foreclosure timelines. Failure to meet these timelines, without a waiver, results in penalties to the servicer. For example, FHA requires that the servicer start foreclosure within 6 months of the date of default. Failure to meet this strict deadline by even one day, without a waiver, means the servicer does not get reimbursed for almost all of its interest costs (e.g., the accumulating arrearage). Moreover, State law often provides that various steps must occur at specific times or costly steps, such as newspaper publication, must be repeated at significant cost to the servicer, foreclosing attorney, Government agencies, and, ultimately, taxpayers with regard to Government programs. Delays have significant monetary impact on the investor and servicer. Delays extend the period of necessary advances a servicer must pay to investors, increase costs to Government agencies due to larger claim filings, result in the loss of equity in the property if market values decline, and allow more time for the property to deteriorate. In addition to merely delaying foreclosure, a pause can result in real hard dollar costs, which today are not fully reimbursed to the servicer or the foreclosing attorneys who incur them. This is not a sustainable model and can result in millions of dollars of unreimbursed costs. A national standard must consider these ``cost'' issues. c. Mandatory Principal Write-Down The issue of mandatory principal write-down continues to be suggested as a means to achieve affordability. While there is no doubt principal write-down promotes affordability, there are other means to achieve the same affordability without the disparate impact on servicers or noteholders. Such options include rate and/or term modifications and principal forbearances. A principal forbearance takes a portion of the principal and sets it aside in calculating a reduced monthly mortgage payment. It is similar to a principal write-down, but appropriately gives a portfolio lender or investor the right to recoup the set aside principal at a later time, such as when the house is sold. FHA, HAMP, and FHA partial claims are principal forbearance programs, and we believe they are effective tools. The concept of mandatory principal write-down--as opposed to principal forbearance--is extremely problematic in secured credit transactions for the many reasons MBA has expressed in previous policy debates regarding Chapter 13 bankruptcies. The same issues surface if servicers are required to accept principal reductions over interest rate or term modifications or principal forbearances in the loss mitigation waterfall: First, the servicer is a mere contractor in the securitization function and thus cannot obligate the note holder or investor to take a permanent loss on the loan. Fannie Mae and Freddie Mac do not accept principal write-downs and FHA and Ginnie Mae do not reimburse for voluntary or mandatory principal write-downs. Servicers, therefore, cannot impose it. Second, with regard to private label securities, the securitization documents must specifically provide for this option or the servicer risks litigation. Most securitization transaction documents do not provide for principal write-downs, and some specifically prohibit principal write-downs. We understand there are differences in views from the various MBS tranche holders. Principal write-downs would benefit senior security holders to the detriment of subordinate holders. However, it is inappropriate to forcibly reallocate winners and losers in contradiction to the contract created to protect against these very default scenarios. Third, note holders and investors must be able to rely on the contractual terms of their mortgage agreements given the secured nature of a mortgage transaction. It is inequitable to mandate that secured note holders or investors to write down principal. Fourth, without statutory changes, mandatory principal write-downs by the servicer could eliminate Government mortgage insurance \7\ and private mortgage insurance \8\ that currently protect servicers/investors against losses. If mandatory principal write-downs were required without a change to agency guidelines/statutes, servicers--not the investors--would be required to absorb the principal loss. This is an inappropriate role of a servicer, who never priced their compensation to accept first dollar loss. However, servicers have been voluntarily writing down principal balances of loans when appropriate and more often on loans they own and will continue to do so. --------------------------------------------------------------------------- \7\ Today, FHA insurance and VA guarantees protect the servicer against principal loss due to foreclosure. However, FHA and VA cannot pay the servicer a claim for principal reductions. Authorizing statutes do not permit it. Conversely, if the loan went to foreclosure, the servicer would have the benefit of the insurance/guarantees and not suffer a principal loss. \8\ Private mortgage insurance is comparable to Government insurance in that it protects lien holders from principal loss in the event of foreclosure. Private mortgage insurance protections will be lost in the amount of the lien strip. In sum, MBA opposes involuntary principal write-down and believes it will inhibit the housing market's recovery. d. Misalignment of Servicer and Investor Incentives Another common theme is that servicer incentives are misaligned with the interests of investors. While servicing compensation may not appropriately compensate the servicer for the multitude of additional requirements imposed on them during this crisis, \9\ we do believe that there are significant incentives within the existing fee structure that encourage appropriate loss mitigation. Fannie Mae, Freddie Mac, and Ginnie Mae ultimately designed their programs and concluded that servicers should not be paid their servicing fee while the loan is delinquent. The theory is that if the servicer is not paid for managing the very expensive default process, they will expend resources to cure the delinquency or otherwise ensure cash flow--ultimately the goal of the investor. This incentive is real for the servicer. --------------------------------------------------------------------------- \9\ Fannie Mae, Freddie Mac, and FHA recognized over a decade ago that servicers could reduce their losses by performing ``extraordinary'' servicing, which involved very complex loss mitigation options. MBA was involved in those discussions, which ultimately resulted in the incentive payments for successful loss mitigation efforts. Unfortunately loss mitigation has become even more complex, with the agencies requiring more and more from servicers and foreclosure attorneys without compensation. This is not appropriate and, thus, we agree that some additional compensation is required. Investor contracts should not impose unlimited cost burdens on servicers. --------------------------------------------------------------------------- The greatest financial incentive supporting modifications over foreclosures for servicers is the reinstatement of servicing income and the servicing asset. A modification immediately reinstates the servicing fee income and retains the servicing asset. Assuming a borrower remains current under the modified terms, the servicer will continue to receive its base monthly servicing fee income (25 basis points for GSE servicing and approximately 44 basis points for Ginnie Mae servicing) over the life of the loan. In contrast, such income ceases during the period of delinquency. In the case of GSE and FHA programs, the servicer never gets reimbursed the servicing fee if the loan goes to foreclosure. In private label securitizations, the servicing fee ultimately is reimbursed to the servicer when the Real Estate Owned (REO) is sold, but the reimbursement is without interest. In summary, foreclosures result in an early termination or, in the case of private label securities, deferment of servicing fee income. Modifications, on the other hand, result in the immediate reinstatement and continuation of such servicing income. Also, the continuation of servicing fee income through a loan modification or other cure provides retention of the servicing asset that is otherwise written off upon foreclosure. Modifications also stop costly advances of principal, interest, tax, insurance and other expenses, such as property preservation costs, and provide for quick reimbursement of these outstanding advances. In the case of private label securities, servicers generally must advance principal and interest from the due date of the first unpaid installment until the property is liquidated through the sale of REO. According to LPS's Mortgage Monitor Report, ``as of February 2011, the average length of time a loan in foreclosure is delinquent was nearly 537 days.'' The average number of days a property remains in REO is in the range of 116-176 days, according to Clear Capital and the Five Star Institute. In many cases, the servicer does not receive full reimbursement for those advances. For example, FHA curtails 60 days of interest advanced and one-third of foreclosure attorney's fees on all foreclosure claims. The GSEs also curtail property preservation expenses and attorney's fees when foreclosure steps must be repeated due to a foreclosure pause. In sum, servicers are incented to modify the loan to reduce the interest costs and capital allocation associated with carrying advances. Conclusion MBA supports reasonable national servicing standards that apply fair practices for borrowers, servicers, and investors alike and that seek to eliminate the patchwork of varying Federal, State, local and investor requirements. However, national servicing standards must be truly national. Creating different State and local requirements would only compound the complexities servicers already face within current market conditions. Servicers must also be included as stakeholders in the development of the standards. It is important to understand why processes are in place to avoid unintended consequences. Existing standards should be given careful consideration before being replaced. Servicer's use and development of successful loss mitigation efforts to date should also be recognized. We recognize that our industry can and must do better. Given the overwhelming nature of the crisis and the ever-changing requirements, servicers have tried to meet competing obligations in a rapidly changing environment, and we believe that national servicing standards can help us accomplish the goal of preventing foreclosures whenever possible. At the same time, in moving toward national servicing standards, policy makers must fully recognize the economics of mortgage servicing and balance laudable public policy goals against business and market realities. Our industry stands ready to play a constructive role in the dialogue about how best to achieve this balance.
PREPARED STATEMENT OF ANTHONY B. SANDERS Professor of Finance, George Mason University School of Management May 12, 2011 Chairman Menendez, Ranking Member DeMint, and distinguished Members of the Subcommittee, thank you for inviting me to testify today. I have been asked to offer opinions on ``The Need for National Mortgage Servicing Standards''. The recent crash of the housing market and the rise of unemployment led to a historic surge in serious delinquencies and requests for loan modifications, short sales, and related transactions. As a result, the residential mortgage servicing industry was overwhelmed. Going forward, it is helpful to recommend changes to both servicing and securitization industries so that they can avoid problems going forward as we attempt to revive the securitization market. Servicing Standards During a December 1, 2010, hearing, Federal Reserve Board Governor Daniel Tarullo stated that ``it seems reasonable at least to consider whether a national set of standards for mortgage servicers may be warranted.'' Although the Government Accounting Office (GAO) has released a report to Congress recommending creation of servicing standards, \1\ I agree with the sentiment but disagree with the process. --------------------------------------------------------------------------- \1\ Government Accountability Office, ``Mortgage Foreclosures: Documentation Problems Reveal Need for Ongoing Regulatory Oversight'', GAO-11-433, May 2011. --------------------------------------------------------------------------- Pooling and Servicing Agreements There already exists pooling and servicing agreements (PSAs). The PSA is a legal document that contains the responsibilities and rights of the servicer, the trustee, and other parties concerning a pool of securitized mortgage loans. If the securitization is public, the documents must be filed with the Securities and Exchange Commission. It has been suggested that PSAs be uniform and I would agree that greater uniformity among PSAs would reduce investor uncertainty. However, rather than having it regulated by the Federal Government, uniformity of PSAs would seem to be a natural evolution demanded by investors in the marketplace. Broader Servicing Guidelines and Standards In December, Christopher Whalen, Nouriel Roubini and others wrote a letter to U.S. financial regulators regarding national loan servicing standards. \2\ I am one of the signers of the letter, but not because I wanted to have national loan servicing standards created by the Federal government. Rather, I wanted to open a discussion for consideration by servicing companies. Many of the items that were discussed were plausible recommendations. --------------------------------------------------------------------------- \2\ ``Open Letter to U.S. Regulators Regarding National Loan Servicing Standards'', Christopher Whalen, et al., December 21, 2010, http://www.rcwhalen.com/pdf/ SecuritizationStandardsLetter_final_122110.pdf. --------------------------------------------------------------------------- The private sector is able to adopt guidelines and standards for loan servicing. For example, the Mortgage Bankers Association (MBA) created a task force of key MBA members to examine and issue recommendations for the future of residential mortgage servicing. While it is tempting to have the Federal Government regulate loan servicing, it will be more effective to have an industry group such as MBA provide guidance. One of the items recommended in the Whalen letter to regulators was: As part of your duties under Section 941 of the Dodd-Frank Act, your agencies must develop new standards for the secondary market in mortgage loans. These standards must promote a sustainable securitization market and, in particular, maintain additional ``skin in the game'' for sellers of loans so the excesses and abuses of the past are not repeated. As part of this effort, you will be defining the criteria for the highest quality residential mortgages, those which do not need risk retention. This new definition for what constitutes a qualified residential mortgage should be the gold standard in all areas of mortgage origination, securitization packaging and servicing, and disclosure. \3\ --------------------------------------------------------------------------- \3\ Ibid. While I agree with the signers that standards could be advantageous to investors and consumers, we need to be careful about the implementation of standards and rules, such as risk retention, which is also an important part of addressing this issue. Ultimately, servicing inadequacies are part of the problem of origination risk, which I address below. Risk Retention and Servicing Dodd-Frank requires that securitizers retain at least 5 percent of the risk in all loans that do not qualify as a Qualified Residential Mortgage (QRM) \4\ and are sold into the securitization market. In theory, 5 percent risk retention would lead securitizers to be more careful in the loan origination, underwriting, and servicing process. --------------------------------------------------------------------------- \4\ A qualified residential mortgage (QRM) is one with a 80% loan to value, full documentation, and more traditional underwriting standards. Generally includes the 30 year fixed-rate mortgage and excludes exotic mortgages such as interest-only mortgages. --------------------------------------------------------------------------- To be sure, 5 percent risk retention would be the simplest approach to implement in order to encourage improved loan origination, underwriting, and servicing. Unfortunately, risk retention also appears to be the least useful approach. First, the house price collapse resulted in house price declines that far exceeded 5 percent; for example, Las Vegas fell 56 percent from peak to trough [see, Figure 1 for the collapse of housing prices]. \5\ --------------------------------------------------------------------------- \5\ Free exchange, ``Recovery Comes to Las Vegas'', The Economist, January 26, 2010, http://www.economist.com/blogs/freeexchange/2010/01/ recovery_comes_las_vegas. --------------------------------------------------------------------------- Second, risk retention does not directly address origination risk or servicing risk. \6\ Representations and warrants (reps and warranties) that are found in Mortgage Loan Purchase Agreements (MLPA) and related documents are supposed to directly address origination risk. The avalanche of loan repurchase requests in the aftermath of the housing collapse makes reps and warranties less viable for nonagency mortgage-backed securities. --------------------------------------------------------------------------- \6\ Origination risk refers to the risk of breaches of underwriting standards, misrepresentations, fraud, poor data quality, and legal breaches. --------------------------------------------------------------------------- Third, the Federal Housing Administration (FHA), Fannie Mae, and Freddie Mac are exempt from risk retention rules. Exempting these players in the mortgage market defeats the spirit of risk retention since a loan originator will be tempted to sell to or be insured by Fannie Mae, Freddie Mac, and the FHA rather than keep the retained risk. All financial entities should be subject to risk retention or none at all. Fourth, given Reg AB (Dodd-Frank 942) and the anticipated transparency of the asset-backed securities markets, the retention rule implies that Qualified Institutional Buyers (QIBs) are not sophisticated enough to understand origination risks and need to be protected beyond greater transparency. QIBs (or ``sophisticated investors'') such as Fannie Mae, Freddie Mac, PIMCO and others do not require the additional security of 5 percent risk retention since they perform substantial due diligence and analysis before purchasing securities. Furthermore, they would have been expected to understand the servicing process and PSAs. Moreover, it is unclear how risk retention will be implemented (e.g., vertical versus horizontal versus ``L'' cuts) and if it is even effective in reducing origination risk. There are more effective alternatives to risk retention: transparency and improved reps and warranties via an origination certificate. Greater Transparency One solution to origination risk is to provide greater transparency to investors. Greater transparency would permit more accurate pricing. Greater transparency potentially reduces the asymmetric information between securitizers and investors. There has already been a movement in the industry toward greater transparency. Prospectuses and Prospectus Supplements for both agency and nonagency mortgage-backed securities provide detailed breakdowns of the underlying loans in terms of critical risk measures such as loan- to-value ratio, loan type, credit score, etc. In 2006, Freddie Mac took loan transparency to a new level by providing a file of loan level information. \7\ The nonagency market (as well as the FHA) could provide similar loan level disclosure. --------------------------------------------------------------------------- \7\ See data reports provided by Freddie Mac and available at: http://www.freddiemac.com/mbs/html/data_files_5bd.html. --------------------------------------------------------------------------- I would prefer that the securitizers provide transparency themselves rather than be forced through regulation. Some investors may prefer having less information disclosed which should result in a higher expected yield compared to fully disclosed loan information. Investors should retain the right to choose how much information that they want disclosed by securitizers. But additional loan disclosure is just one prong to providing a better alternative to retained risk. The other is to enact an ``origination certificate'' approach to reducing securitization risk. Origination Certificate Even though securitizers could release great loan-level information, the market would still be concerned that the information is inaccurate. Furthermore, transparency doesn't address servicing problems. There should be mechanisms to insure that the disclosed information is actually correct and that proper servicing is followed. Andrew Davidson and I proposed a ``securitization certificate'' in our paper ``Securitization After the Fall.'' \8\ In the paper, we write: --------------------------------------------------------------------------- \8\ Andrew Davidson and Anthony B. Sanders, ``Securitization After the Fall'', Second Annual UCI Mid-Winter Symposium on Urban Research, ``Housing After the Fall: Reassessing the Future of the American Dream'', February 2009, http://merage.uci.edu/ResearchAndCenters/CRE/ Resources/Documents/Davidson-Sanders.pdf. We propose a ``securitization certificate'' which would travel with the loan and would be accompanied by appropriate assurances of financial responsibility. The certificate would replace representations and warranties, which travel through the chain of buyers and sellers and are often unenforced or weakened by the successive loan transfers. The certificate would also serve to protect borrowers from fraudulent --------------------------------------------------------------------------- origination practices. The securitization or origination certificate approach has the potential to be effective because it directly addresses origination risk and contains a fraud penalty. \9\ The origination certificate would travel with the loan and would verify that the loan was originated in accordance with law, that the underwriting data was accurate, and that the loan met all required underwriting requirements. This certificate would be backed by a guarantee from the originating firm or other financially responsible firm and would travel with the loan over its life. The seller must provide a means of demonstrating financial responsibility, either via capital or insurance, for the loans to be put into a securitization. There should be a penalty for violations of reps and warrants beyond repurchase obligations and tracking of violations of reps and warrants available to all investors. Furthermore, there could a penalty for violations of the servicing standard adopted by the securitizer. --------------------------------------------------------------------------- \9\ Andrew Davidson and Eknath Belbase, ``Origination Risk in the Mortgage Securitization Process: An Analysis of Alternate Policies'', The Pipeline, Andrew Davidson & Co., 2010. --------------------------------------------------------------------------- It is my opinion that risk retention is ineffective at best in solving underwriting and servicing issues. Increased transparency and loan specific origination certification is a more effective way of preventing future problems. And they are best designed and implemented by the private sector and not the Federal Government. Thank you again for the opportunity to testify. I look forward to your questions.
PREPARED STATEMENT OF RICHARD A. HARPOOTLIAN Attorney, Richard A. Harpootlian P.A. May 12, 2011 Mr. Chairman and Members of the Committee, I thank you for the invitation to speak on behalf of my clients--Captain Jonathon Rowles of the United States Marine Corps and Sergeant George Holloway of the United States Army Reserve. I represent these fine men and women in uniform along with my cocounsel, William Harvey and Graham Newman. As the Committee is aware, our law firms have filed a class action complaint against subsidiaries of JPMorgan Chase alleging systematic violations of rights guaranteed to our men and women in uniform under the Servicemembers Civil Relief Act as it pertains to the financing of real estate. I am pleased to report that after intense negotiations we have reached a settlement with JPMorgan Chase and are currently undertaking the process of informing approximately 6,000 men and women in uniform of their entitlement under the settlement. With this case and settlement serving as a backdrop, I would like to discuss three topics: first, the facts and circumstances leading to the JPMorgan Chase litigation and the pending settlement; second, broader problems in the home finance industry revealed by the litigation; and third, suggestions as to how Congress might address these problems. I. Jonathon Rowles and George Holloway vs. Chase Home Finance, LLC As I noted earlier, the litigation in which I and my cocounsel are representing Captain Rowles, Sergeant Holloway, and approximately 6,000 military men and women stems from violations of the Servicemembers Civil Relief Act pertaining to home finance. The opening words of the Servicemembers Civil Relief Act establish that the purpose of the law is ``to provide for, strengthen, and expedite the national defense through protection extended by this Act to servicemembers of the United States to enable such persons to devote their entire energy to the defense needs of the Nation.'' The venerable nature of these goals is undeniable. But to truly grasp the importance of the Act to our Nation as a whole, one must examine the history of the legislation through the last two centuries. a. History of the Servicemembers Civil Relief Act The roots of the Servicemembers Civil Relief Act lie in the Constitution itself. Article I, Section 8 of the Constitution expressly grants to Congress the authority to build and maintain our Armed Forces in order to guarantee the security of this Nation. With this in mind, as early as the Civil War Congress recognized the need to enact legislation placing certain restrictions on civil actions that would hinder the abilities of an individual soldier or sailor to dedicate all of his efforts to defending this country. In 1917, as the United States became embroiled in World War I, our Government employed the services of Major John Wigmore--then Dean of the Northwestern University Law School and author of the famous treatise Wigmore on Evidence--to draft the first modern version of the SCRA, then known as the ``Soldiers' and Sailors' Civil Relief Act.'' This Act instituted many of the regulations that are central features of the modern law, including a stay of civil actions and a prohibition of foreclosures upon the homes of those on active duty. Major Wigmore's Soldiers' and Sailors' Civil Relief Act expired 6 months after the end of World War I due to a sunset provision included in the law. Thus, in 1940, as conflicts throughout the globe again escalated into World War, Congress reenacted Major Wigmore's bill with some amendments. At the time, Congressman Overton Brooks of Louisiana reiterated the vital role the Act played in preserving the Nation's defense and recognized the concerns the Act was intended to address. This bill springs from the desire of the people of the United States to make sure as far as possible that men in service are not placed at a civil disadvantage during their absence. It springs from the inability of men who are in service to properly manage their normal business affairs while away. It likewise arises from the differences in pay which a soldier receives and what the same man normally earns in civil life. The Soldiers' and Sailors' Civil Relief Act has been in effect since it was reenacted by Congressman Brooks and others in 1940. In April of 2003, as Operation Enduring Freedom in Afghanistan progressed, the 108th Congress styled a complete restatement of the Act. The bill received broad bipartisan support in the House Committee on Veterans' Affairs, boasting as its sponsors then-Chairman Christopher Smith of New Jersey and Ranking Member Lane Evans of Illinois. In its Report to the House, the Committee expressly noted the following: Congress has long recognized that the men and women of our military services should have civil legal protections so they can ``devote their entire energy to the defense needs of the Nation.'' With hundreds of thousands of servicemembers fighting in the war on terrorism and the war in Iraq, many of them mobilized from the reserve components, the Committee believes the Soldiers' and Sailors' Civil Relief Act (SSCRA) should be restated and strengthened to ensure that its protections meet their needs in the 21st century. Among the protections recognized as necessary in modern society were three rights directly implicated in the pending litigation involving my clients: (1) a 6 percent cap of interest chargeable on debts incurred prior to military service; (2) a prohibition of derogatory reports to credit agencies due to eligibility of SCRA protection; and (3) limitations upon the ability to foreclose upon servicemembers' homes. Once favorably reported to the House, the bill gained thirty-nine (39) cosponsors from both parties and was passed by the full House by 425-0. The Senate passed similar legislation with the leadership of Senator Lindsey Graham from my home State of South Carolina and the differences between the two bills were negotiated without need of a conference committee. On December 19, 2003, President George W. Bush signed into law the now-restyled ``Servicemembers Civil Relief Act.'' b. Experiences of Captain Rowles and Sergeant Holloway The litigation in which we are involved began after Jonathon Rowles and his wife, Julia, endured several years of frustration regarding their home mortgage with Chase Home Finance, LLC. Our law firms filed this lawsuit on behalf of Captain Rowles in July of 2011. Over the past several months, we have been contacted by numerous military personnel who have experienced similar denials of SCRA protection from Chase's subsidiaries. Last month, we filed an amended complaint, adding allegations on behalf of Sergeant Holloway. Our research revealed what we believed to be systematic failures in the maintenance of SCRA protections pertaining to three classes of military men and women: (1) those denied the 6 percent maximum interest rate on debts incurred prior to military service; (2) those who received a blighted credit report as the result of their invocation of SCRA protection; and (3) those whose homes were foreclosed upon despite SCRA protection. A review of the basic facts pertaining to each plaintiff is helpful in explaining how these violations came about. In February of 2004, the Jonathon and Julia Rowles entered into a purchase money mortgage with BNC Mortgage, Inc. In May of 2004, Chase Manhattan Mortgage Corporation purchased this loan and, from that point in time, the Rowleses made all payments to Chase. After a year of making payments on this mortgage, Jonathon Rowles executed a United States Marine Corps Reserve contract on August 16, 2005, and received Assignment to Active Duty Orders which became effective on January 22, 2006. Shortly thereafter, Rowles requested in writing that Chase reduce the interest rate on the loan to 6 percent pursuant to the SCRA. In this letter, Rowles specified January 22, 2006, as the date he entered active duty and produced two sets of orders to verify his current status. Again on May 2, 2006, Rowles wrote to Chase to request the 6 percent rate protection under the SCRA. This letter also specified Rowles' active duty date and included additional copies of his orders and a copy of his previous letter. On May 8, 2006, in response to this series of correspondence, Chase requested that Rowles provide ``orders and/or an enlistment agreement showing the date of original call to duty.'' Again Rowles sent faxes to Chase customer service representatives that included handwritten cover sheets explaining his active duty orders as well as copies of his letters of April 14 and May 2. In a letter dated July 27, 2006--seven months after Rowles received his active duty orders--Chase informed Rowles that because he had qualified for the protection of the SCRA, the company had adjusted the interest rate on the loan to 6 percent effective with his May 1, 2006, payment. However, Chase failed to apply the statutory interest rate to the loan until August 17, 2006, which was the date of the first statement received by Rowles that reflected the 6 percent rate. The July 27 letter also informed Rowles that his ``loan is protected against late fees, adverse credit reporting, and default activities. These protections will remain in effect for 90 days following your return from active duty.'' Though Rowles' SCRA protection had been in place for less than 4 months, Chase mailed Rowles a letter on December 1, 2007, which it characterized as a ``required quarterly verification.'' The letter included a form which Rowles was instructed to complete and sign in order to continue to receive the protection of the SCRA. Rowles duly completed the form and returned the letter to Chase. Chase sent additional verification letters on December 17, 2008, March 25, June 22, and December 29 of 2009, and March 22, 2010. In addition to the periodic verification letters, no fewer than four times per year since July of 2006, Rowles has had to call various Chase customer service representatives after being verbally informed or receiving documentation indicating that the interest rate on the loan was going to be adjusted above 6 percent if he failed to do so. In March of 2008, Rowles was forced to request that his commanding officer at Training Squadron Eighty-Six in Pensacola, Florida, write to Chase on his behalf in order to confirm that he was in fact an active duty Marine. In a letter dated January 16, 2007, Chase again informed Rowles that he had qualified for the protection of the SCRA and that the company had accordingly extended the adjustment on the 6 percent interest rate effective February 1, 2007. On April 2, 2008, Chase informed Rowles in writing that the company was ``in receipt'' of his ``request for relief'' under the SCRA and that he should allow three to four weeks for review of the request. A subsequent letter dated April 25, 2008, again informed him that his rate adjustment would be extended effective October 1, 2008. From the time that Chase applied the 6 percent interest rate to the loan until April 2009, Chase would send loan statements to the Rowles family indicating the interest rate charged on their loan was, in fact, substantially above 6 percent. On information and belief, during this time Chase would use various formulas and accounting methods to reconcile the higher stated interest rates while effectively only charging Rowles at 6 percent. This pattern of conduct by Chase caused Rowles to spend considerable time communicating with Chase via telephone, e-mail, and written correspondence. This time included leave from his unit which was spent traveling to meet with Chase representatives in an effort to preserve his 6 percent interest rate under the SCRA and to prevent Chase from taking threatened actions which are unlawful under the SCRA. Finally, in June of 2010, Chase denied Rowles electronic access to his account. Thereafter Rowles brought this suit. The circumstances giving rise to Sergeant Holloway's allegations are much more brief, but gave rise to an injury perhaps worse than that of Captain Rowles and his family. On March 30, 2000, Holloway purchased a house located in Fountain Inn, South Carolina. At the time of the purchase, Plaintiff Holloway was not on active duty. The purchase was financed by NVR Mortgage Finance, but the loan was thereafter transferred to Chase for servicing. In 2008, Chase initiated foreclosure proceedings against Holloway's home which resulted in a foreclosure sale on May 4, 2009. Holloway was serving on active duty at the time of the sale. Today Sergeant Holloway is serving with the Army Reserve in the Afghanistan theater. His mail is addressed to his parents' home. c. Details of the Proposed JPMorgan Chase Settlement After Captain Rowles brought to light the potential systematic failure of internal SCRA procedures at JPMorgan Chase, Chase began an extensive internal review to determine the extent of the mistakes made. That review, combined with the efforts of Captain Rowles and Sergeant Holloway, has resulted in a settlement that was reached after several months of intense negotiations that were supervised by a retired Federal judge. While this settlement is awaiting final approval of the District Court--the hearing of which has been scheduled for November 15, 2011-- the details of the proposal have been made public. In sum, Captain Rowles, Sergeant Holloway, and Chase have agreed to a benefits package amounting to $48 million of relief to the military men and women who were denied SCRA benefits. This figure amounts to an estimated six times the actual damages suffered by the class members, including refunds of overcharges, full remediation of damage to credit, and remediation of all foreclosure actions. To its credit, JPMorgan Chase has begun instituting many of these reforms even prior to the final approval of the settlement. Chase has also asked Captain Rowles to serve as an informal advisor to several of its senior officers, providing the company with a ``boots on the ground'' perspective of how its policies affect our men and women in the military. II. Systematic Problems Revealed by the Rowles Litigation The immediate effect of SCRA violations on our military men and women are obvious. Unlawful foreclosures force families from their homes. Derogatory reports to credit agencies damage the ability of our soldiers and sailors to enter into future financial agreement. Excessive charges of interest demand monies which are not owed. Perhaps more damaging than these immediate effects, however, is the financial stress endured by military families while their loved ones serve on active duty. As the stories of Captain Rowles and Sergeant Holloway show, the spouses, parents, and children of our military men and women are those that inevitably bear the brunt of SCRA violations. While her husband was deployed to Korea, Julia Rowles was forced to negotiate with Chase representatives while caring for a small child and pregnant with another. While he was serving in a war zone, George Holloway was powerless to protect his home as foreclosure crept closer. I began this written testimony by referring to the stated policy of the SCRA: ``to enable [servicemembers] to devote their entire energy to the defense needs of the Nation.'' Violations such as those suffered by our clients directly defeat this purpose. While on active duty, our soldiers have limited time to so much as contact their families. Sadly, it appears that over the past few years several thousand men and women like Captain Rowles and Sergeant Holloway were forced to spend what personal time they did have on the phone with banking officials seeking an explanation why their families were being overcharged interest or why their home was being foreclosed. Obviously companies like JPMorgan Chase need to do more to ensure that their internal procedures are refined to ensure that all servicemembers entitled to SCRA protection enjoy those rights. As Chase has shown with the settlement terms now pending in Federal court, it has made the affirmative decision to lead the way in the financial industry in crafting more reliable SCRA policies and procedures. But based on my experience in this case over the past year, I believe there are measures that Congress can take to produce an atmosphere in which SCRA violations are greatly reduced. Below are three problem areas that can be addressed. a. Lack of reliable information regarding servicemember status As Captain Rowles' situation demonstrates, one of the primary problems with SCRA protection is that it can be difficult for the financial companies to determine when the ``active duty'' status of servicemen ends. As a result, account managers resort to calling the families of men and women in the military to obtain some sort of verification as to whether the borrower in question is, or is not, still ``active duty.'' This repeated contact, however, violates the very spirit of the SCRA. b. Lack of JAG manpower sufficient to protect civil rights Many of the SCRA-protected individuals with whom I have spoken have emphasized two things: first, the staff at their bases or posts do an excellent job of educating them on their SCRA rights; but second, once a problem arose with their home mortgages, insufficient staff existed to help these servicemen negotiate resolutions with the various home finance companies. Our clients and those servicemen I have spoken to all speak very highly of the JAG services that they receive. However, these attorneys are often heavily burdened with other tasks associated with their duty and do not have the ability to dedicate sufficient time to SCRA problems. c. Lack of incentives to adjust mortgages that can be saved After my testimony before the House Veterans' Affairs Committee in February, I received phone calls from hundreds of service men and women about problems they were experiencing with their mortgage. Some of these folks were entitled to SCRA benefits and some were not. But during my many conversations I noticed a disturbing trend of borrowers who had become no more than a handful of months delinquent on their loans only to be threatened with foreclosure. There appears to be an atmosphere within the home finance market that incentivizes foreclosures and discourages modifications. Numerous servicemen I spoke with offered to increase their payments over a period of 6 months or less to become current on their loans. As a matter of routine, however, the financial institutions replied that these men and women immediately pay the balance of the loan--an option that is impossible for almost every American--or face accelerated collections or even foreclosure. Within the State of South Carolina, this problem has reached epidemic proportions. In fact, on May 9, 2011, our State Supreme Court Chief Justice entered an administrative order dramatically altering the means by which foreclosures are litigated in this State. Now, before any foreclosure proceedings can proceed, a financial institution must certify: (a) that the Mortgagor has been served with a notice of the Mortgagor's right to foreclosure intervention for the purpose of seeking a resolution of the foreclosure action by loan modification or other means of loss mitigation; (b) that the Mortgagee, or its designated agent, has received and examined all documents and records required to be submitted by the Mortgagor to evaluate eligibility for foreclosure intervention; (c) that the Mortgagor has been afforded a full and fair opportunity to submit any other information or data pertaining to the Mortgagor's loan or personal circumstances for consideration by the Mortgagee; (d) that after completion of the foreclosure intervention process, the Mortgagor does not qualify for loan modification or other means of loss mitigation, in accordance with any standards, rules or guidelines applicable to the mortgage loan, and the parties have been unable to reach any other agreement concerning the foreclosure process; and (e) that notice of the denial of loan modification or other means of loss mitigation has been served on the Mortgagor by mailing such notice to all known addresses of the Mortgagor; provided, that such notice shall also state that the Mortgagor has 30 days from the date of mailing of notice of denial of relief to file and serve an answer or other response to the Mortgagee's summons and complaint. A copy of this order has been attached to my testimony for your review (See, Exhibit A). III. Suggestions for More Diligent Enforcement of SCRA The systematic failure of SCRA protections in the Rowles litigation is evidence that the enforcement provisions of the SCRA deserve reconsideration. In our review of the law and its application over the last 6 months, we believe that there are three areas Congress may improve to strengthen the SCRA in hopes of preventing such failures in the future. a. Cooperation between the Department of Defense and financial institutions As noted above, much of the strain suffered by Jonathon and Julia Rowles was the result of continuous contact from JPMorgan Chase officials seeking written verification that Captain Rowles was still on active duty and thus entitled to SCRA protection. There is no provision of the SCRA that permits a financial institution to demand such verification and the Rowles believe that Chase was overly aggressive in pursuing it. At the same time, however, JPMorgan Chase and other financial institutions undoubtedly wish to protect themselves from the potential of fraud, namely a servicemember continuing to receive SCRA benefits long after he or she has been deactivated. A solution for this quandary could be found in the creation of a liaison office within the Department of Defense designed to work with financial institutions to certify when servicemembers are--or are not-- on active duty. Such an office would provide the financial institutions with the information needed to determine whether to apply SCRA protections while relieving the servicemembers and their families from the burden of continuously updating their status. b. Stronger emphasis on legal support for servicemembers Every single class member with whom I have spoken has noted his or her gratitude for the assistance they have received from JAG officers. However, it appears that JAG is often unable to render remedial SCRA support to servicemen that experience problems with their home loans. This could be due to several reasons. Obviously lack of manpower hinders any ability to respond to this type of situation. But also, JAG officers may not be licensed to practice in the civilian courts in which their fellow soldiers are experiencing difficulty. For example, a JAG officer assigned to Fort Jackson, South Carolina may receive an SCRA question from a solider about to lose his home to foreclosure in California. It would be highly unusual for that South Carolina-based officer to be licensed to appear on behalf of the soldier in the State of California to contest the foreclosure. Even if the officer was licensed to do so, transporting him or her across the country for this one event may not be practical. In my opinion, Congress should examine two possibilities that may alleviate this situation. First, determine whether JAG possesses sufficient manpower to adequately address remedial needs of servicemen who need to assert their SCRA protections. Second, examine partnership efforts that can be formulated between JAG and State bar associations who would be, I am sure, willing to offer pro bono services to the military in order to help enforce SCRA rights. c. Incentivize mortgage modification and discourage foreclosure Congress should reexamine the incentives in place that either encourage, or discourage, loan modifications. As I noted above, many servicemen have offered to accelerate their loan payments over a series of months in order to become current on their obligations to the various financial institutions. Yet they report what seems to be a disturbing trend of preferring foreclosure and/or collections to preserving the terms of a loan. Federal insurance of mortgages may contribute to this reverse incentive. While the specifics of mortgage finance are not my professional specialty, it appears that the guaranteed payment financial institutions receive from entities such as FHA may be encouraging foreclosure rather than loan modification. While I in no way suggest that such programs be terminated, I do think that considering modifications to these programs that would incentivize loan modification could alleviate many of the problems that servicemembers are now facing with their mortgages. Consideration of several prerequisites to foreclosure as instituted by the South Carolina Chief Justice (see, Exhibit A) may serve as a useful starting point. Conclusion I would again like to thank the Committee for the opportunity to speak on behalf of our clients and on behalf of the thousands of servicemen and servicewomen who have fallen victim to SCRA violations in the last several years. As the SCRA recognizes, its protections are essential to our national defense. It is my hope that Congress will take all steps necessary to ensure the continuing vitality of this law.
RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN MENENDEZ FROM DIANE E. THOMPSON Q.1. In your testimony, you provide a stunning array of specific examples of homeowners who have had terrible experiences with mortgage servicers' actions, most of them illegal. In your experience, how widespread are each of the homeowner abuses you describe? A.1. The abuses I catalogued in my May 12, 2011, testimony are widespread. Every day, I hear examples of similar abuses. Attorneys representing homeowners anywhere in the country have similar experiences to relate. Last December, in an attempt to quantify the scale of servicer abuses, the National Association of Consumer Advocates, in conjunction with NCLC, conducted a survey of attorneys representing homeowners in foreclosure. That survey found that almost 99 percent of the respondents were representing a homeowner who had been placed into foreclosure while awaiting a loan modification, almost 90 percent of the attorneys surveyed were representing a homeowner who had been placed into foreclosure despite making payments as agreed, 87 percent of the attorneys were representing clients who had been placed into foreclosure due to a servicer's improper failure to accept payments, over 50 percent reported representing homeowners who had been placed into foreclosure as a result of forceplaced insurance alone, with similar figures reported for the impact of illegal fees and the misapplication of payments. These figures suggest that all of these abuses are common. My testimony provides illustrative examples of several different kinds of abuses: the improper solicitation of a waiver of some or all of a homeowner's legal rights; servicers' failure to honor their agreements with homeowners, whether permanent or temporary modifications or short-term payment plans; the failure to timely convert a loan modification to a permanent modification; foreclosing on homeowners who are either awaiting a loan modification review or are in a temporary or permanent loan modification; misapplication of payments, improper assessment of fees, and abuse of suspense accounts; and a failure to offer homeowners a loan modification that would have benefited the investor. In my experience, all of these abuses are so commonplace as to be unremarkable were they not so appalling. Q.2. Ms. Goodman, Senior Managing Director of Amherst Securities, stated in her testimony that mortgage servicers should be required to offer borrowers the loan modification that has the highest net present value for the investor, not just any modification that has a higher net present value than foreclosure. Do you agree with that? A.2. We agree with Ms. Goodman's proposal that servicers be required to offer a loan modification with a principal reduction where a loan modification with a principal reduction offers a greater return to investors than a modification without a principal reduction. The failure to make the HAMP Principal Reduction Alternative mandatory where the principal reduction offers a greater net present value to investors than a conventional HAMP modification is illogical and harms both borrowers and investors. We would oppose any requirement that the servicer be required to offer borrowers only the loan modification that has the highest net present value for investors in all circumstances. There are many circumstances in which the loan modification that is most responsive to the homeowners' needs may not be the one that returns the highest NPV to investors. Indeed, such a rule might impede settlement of litigation and interfere with judicial oversight of foreclosure mediation. Moreover, we are not sure that such a rule would in all cases serve the interests of investors. We are unsure the extent to which the NPV test accurately measures the value of an increase in the sustainability of a loan modification. Recent data from the OCC-OTS Mortgage Metrics Report supports our experience that providing deep payment cuts, reducing principal significantly, and otherwise structuring loan modifications to ensure long term affordability results in improved outcomes and lowered redefault rates. Unless the redefault rate used in the NPV test dynamically takes into account the offered terms of the loan modification, the NPV test will likely understate the positive return to investors from a loan modification that provides for greater sustainability. ------ RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN MENENDEZ FROM LAURIE F. GOODMAN Q.1. Can you suggest any methods of doing principal reductions for homeowners that would avoid moral hazard? Please explain how moral hazard would be avoided. A.1. We have to stop thinking of borrowers making moral choices, and start thinking of borrowers as making economic choices. Once we recognize that they are making an economic choice, we can design an incentive structure where borrowers who need the principal reduction to stay in their home are able to obtain it, while those that don't need the principal reduction are not envious of those who received it. Here are a few possibilities:
Make it clear that if the borrower accepts a principal write-down, there is a well established set of costs. These costs could include either (1) a shared appreciation feature, in which the borrower shares any future appreciation with the lender; or (2) a Federal tax levy of 50 percent on any future appreciation on the property. The tax levy is the conceptual equivalent of a shared appreciation mortgage, except the borrower share the upside with the Government. We believe a tax would be easier to implement on a broad scale than a shared appreciation feature. If the borrower accepts a modification, there is an appropriate ``ding'' to one's credit rating. To discourage ``economic defaulters'' who can easily afford their home, lenders will pursue deficiency judgments to the extent possible. Let's look at the impact of these actions. A borrower at a 150 percent loan-to-value ratio would have been apt to default. By giving the borrower a principal reduction to say, 115 percent LTV, the borrower is able to stay in his home. A shared appreciation mortgage would be acceptable to the borrower, as that is the only way he can afford to continue to own and live in the home. A borrower with a 120 percent LTV, who is paying his mortgage, wonders if he, too, should go delinquent in order to obtain a principal reduction. By making the costs of the principal reduction explicit (a shared appreciation mortgage, a ding to a borrower's credit rating), the borrower at 120 LTV would make the rationale decision not too default. He would look at the deal his neighbor received, and decide that he wouldn't take a principal reduction on these terms. That is, in order to receive a principal reduction from 120 LTV to 115 LTV, the borrower would have to share his appreciation with either the lender or the Government--too large a cost for the limited benefit. Again, the best way to combat the moral hazard issue is to think about a set of economic frictions designed such that the borrower who can afford to pay continues to do so, and the underwater borrower who cannot afford to pay his mortgage is entitled to a principal reduction (assuming the modification is NPV positive). ------ RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN MENENDEZ FROM DAVID H. STEVENS Q.1. Ms. Goodman, Senior Managing Director of Amherst Securities, stated in her testimony that mortgage servicers should be required to offer borrowers the loan modification that has the highest net present value for the investor, not just any modification that has a higher net present value than foreclosure. Do you agree with that? A.1. Ms. Goodman indicated in her testimony that servicers should be required to perform principal write-downs on HAMP modifications if they present the highest net present value [NPV]. She suggested this would mandate principal write-downs over other loss mitigation options. MBA does not support mandatory principal write-downs. The proposal would require bondholders and lien holders, not merely servicers, to accept principal write-downs. As evidenced by the lack of significant principal reductions by portfolio lenders and Government agencies, there is not a uniform view that principal write-downs are the most economical response for lien holders. Rate and term modifications and principal forbearance modifications offer the borrower the same affordability during his or her period of hardship, as a principal reduction, but without the permanent impairment to the mortgage asset for the lien holder. As a result, a borrower who ``must'' receive a principal reduction to remain in the home in addition to the same affordable payment through other means (such a principal forbearance) is a strategic defaulter. Strategic defaults should be discouraged, not encouraged. The NPV does not test whether a policy, such as principal reduction, will result in greater numbers of defaults, thus greater overall losses to lien holders. If there is a high level of debt forgiveness created by this standard, it is going to increase default frequency associated with high LTV loans. This in turn impacts the NPV assumption, predicting a higher default rate on high LTV loans, thus perpetuating (or self- fulfilling) the appearance that principal reductions are the necessary and best outcome. MBA along with many others believe that principal write-downs will cause more delinquencies and ultimately increase the severity of losses. The proposal does not offer indemnification from risk for a servicer who performs a principal reduction on behalf of a trust. HAMP safe harbor may not be sufficient protection to alleviate such risk. A mandate to write down would be a taking and could subject the servicer to litigation risk. Some PSAs prohibit principal reduction. We do not believe Ms. Goodman's proposal should or will change the ultimate authority of the transaction documents over HAMP. In general, efforts could be made to discourage strategic defaults by reversing the exemption to the discharge of indebtedness tax rules for principal residences created by the Mortgage Forgiveness Debt Relief Act of 2007. Prior to this Act, an individual would be subject to ordinary income taxes on the amount of mortgage debt discharged or written down, unless the person was insolvent. With the current exemption to this rule for principal residences, borrowers benefit even more from a principal reduction than a principal forbearance--despite the forbearance achieving an ``affordable payment'' for the borrower. This greater the incentive of a principal write-down, the greater the impact on default rates--a critical factor that drives the outcome of the NPV calculation. As previously stated, if Congress wishes to discourage strategic defaults, it could reinstate the discharge of indebtedness rules for principal residences. Individuals would be taxed on the amount of discharged debt to the extent he or she was solvent. The change would start to equalize the incentives between principal write-downs and principal forbearances by reducing the strategic default incentive. ------ RESPONSES TO WRITTEN QUESTIONS OF CHAIRMAN MENENDEZ FROM ANTHONY B. SANDERS Q.1. Ms. Goodman, Senior Managing Director of Amherst Securities, stated in her testimony that mortgage servicers should be required to offer borrowers the loan modification that has the highest net present value for the investor, not just any modification that has a higher net present value than foreclosure. Do you agree with that? A.1. No Response provided.