Mortgage Servicing… The Winds Have Shifted, the Pendulum is About to Swing
Early in 2010, while speaking in Park City, Utah at the American Bar Associationâ€™s Conference on Consumer Financial Services, I cautioned the two hundred plus attorneys from financial institutions and mortgage servicers all over the country that were in the audience, that the proverbial pendulum was being allowed to go too far in their direction.
Overall, I said that if mortgage servicers continued to treat Americaâ€™s homeowners in financial distress as a result of the economic downturn, as â€śirresponsible borrowers,â€ť essentially forcing them through the collections and foreclosure machine with inadequate systems related to loss mitigation, ultimately the people would push back en masse.Â And that the further that pendulum was allowed to go in one direction, the hard the push back towards the other side would be.
The recent passage of Californiaâ€™s Homeowner Bill of Rights (53-25, 25-13) is the most conclusive example that what I spoke of at that conference in 2010, has come to pass.Â The financial services industry lobbied heavily against the passage of Californiaâ€™s pro-homeowner legislation, just as was the case each of the last three years, but this year were unable to prevent its passage.Â And itâ€™s worth noting that this yearâ€™s legislative proposals were far more draconian than past proposals.
The fact of the matter is that beginning on January 1, 2013, foreclosing in California will be far more problematic for servicers than has been the case to-date.Â The new laws essentially codify the servicing standards found in the $25 billion National Mortgage Settlement, but beyond such aspects as the prohibition on dual tracking and â€śrobo-signing,â€ť Californiaâ€™s new laws provide for a private right of action and provision for attorneysâ€™ fees in specific instances, in addition to several violations that come with significant statutory fines.
That component, more so than any other, threatens the mortgage servicing status quo.Â If servicers fail to recognize this as being a substantive change in the business environment, and as a result, continue as if little or nothing has changed, they will find that their costs, litigation risk and foreclosure timelines all increase significantly in 2013 and beyond.
What weâ€™re experiencing is the cumulative impact of the last six years of increasing numbers of foreclosures.Â According to a â€śPublic Policy Discussion Paper,â€ť written by two of economists at the Federal Reserve Bank of Boston and titled, â€śShifting Confidence in Homeownership: The Great Recession,â€ťÂ those with no direct negative experience in terms of the housing market did not experience a change in their attitude towards buying a home.
Or, another way of saying it might be that information alone is not changing attitudes, but actual experience is.Â And the aggregate number of American homeowners directly and negatively affected by the housing and foreclosure crisis is closing in on the 20 percent mark.Â Once we reach the 20 percent level, it could very well be that the Pareto Principle, which is also known as â€śthe law of the vital fewâ€ť or the 80-20 rule will come into play and that 20 percent directly affected will have an inordinate impact on the remaining 80 percent.
The day Californiaâ€™s new laws were signed by Governor Brown, I told an executive at one of the largest servicers that my guess would be that 15 states would be considering adopting similar laws in 2013, but the very next day the headlines proved me wrong, saying that there are 25 states considering the adoption of such laws.Â According to the Wall Street Journal and Nonprofit Quarterly, respectively.
â€śNationwide, 25 states have bills contemplating changes to various laws governing the foreclosure process, according to the National Conference of State Legislatures.â€ť
â€śThe National Conference of State Legislatures is reporting that half of the states in the U.S. are considering changes to laws regulating the steps that lenders must take before foreclosing.â€ť
Opposition by banks and the mortgage industry has continued to revolve around the idea that the costs of new laws will be borne by tomorrowâ€™s borrowers, but even in California, a state with historically bank-friendly mortgage regulations, this time around, that argument utterly failed to win the day.
The simple fact is that the forecasts related to foreclosures for the next 2-3 years are based largely on a continuation of existing trends, and that alone should cause servicers great concern.
Beginning during the fall of 2010, and continuing through 2011 and into 2012, the number of foreclosures was suppressed by such factors as the negotiations between state attorneys general and the five largest servicers, a variety of state laws and pending court decisions, and the operational issues faced by servicers struggling to contend with the unprecedented volume of defaulting loans.
In May and June of this year, however, foreclosure starts are rising, and all indications point to a continuation of that trend, but regardless of percentages, the aggregate number of foreclosure filings nationwide for the first half of 2012, which RealtyTracâ€™s mid-year report shows at 1,045,801 total properties, should be enough reason not to bet on us having reached any sort of bottom.
In addition, state budget deficits in 2012-2014, and increasing city bankruptcies, both point to a need to reduce state spending from coast-to-coast in the years ahead, and that invariably means that jobs will be lost and foreclosures will rise in key states as a result.Â Three California cities have already filed for bankruptcy protection, and eight more cities in California have notified the municipal bond market that they are facing significant financial hardships and uncertainty.
Although the press has downplayed the foreclosure crisis as being the root cause of the fiscal problems faced by municipalities, itâ€™s indisputable that along with such factors as rich retiree benefit plans, and other public employee union related costs, tax revenues have plummeted essentially everywhereâ€¦ and that comes as a direct result of foreclosures and structural unemployment.
Other factors, including HELOCs with fully amortized payments, increasing numbers of strategic defaults, and the ongoing impact of the credit crisis sure to drive an increasing number of underwater mortgages, along with other demographic and global realities, all point to a level of foreclosures in at least the next three years certain to be deserving of the â€ścrisisâ€ť moniker.
While foreclosures will continue at crisis levels for the foreseeable future, the climate for foreclosing has changed.Â The direction of the political winds has shifted, and legislation in the years ahead should be assumed to favor consumers more than it will the banking and mortgage servicing industries.Â Recent legislative developments in California, Massachusetts, Oregon and New York should be sufficient to support this assertion, but in addition, even conservative states like Arizona are starting to look at adopting more in the way of consumer-friendly foreclosure laws.
Already, in California servicers are certain to feel the impact of the private right of action created by the new Homeowners Bill of Rights.Â And as the parade of banking scandals and continuous flood of stories in the press that tell of servicer behaviors widely seen as being objectionable, continues to erode whatever trust in financial institutions exists among American consumers, more will turn to the courts for relief.
The costs to financial institutions associated with this erosion in consumer trust is most assuredly reaching well into the billions, and thatâ€™s no secret to the banking industry.Â Reputational Institute, an organization that scores the reputations of banks and others on a 100-point scale, and says that everyone should score above 70, shows none of the major banking institutions broke the 70-point mark this year.
Many banks are reportedly looking to hire new ad agencies in response to their reputational losses, and no doubt there are plenty of consultants saying that itâ€™s not too late for banks to regain whatâ€™s been lost.
That may be true, few things are truly irrevocable, but that doesnâ€™t mean that weâ€™re not about to witness hundreds of millions of ad dollars wasted on campaigns wholly incapable of repairing the damage thatâ€™s been done as far as more than 25 million Americans are concerned.Â The simple fact is that whatâ€™s transpired to-date isnâ€™t going to be reversed with an ad campaignâ€¦ any kind of ad campaignâ€¦ and to think otherwise is delusional.
(BOAâ€™s dismal response to its recent mailing of 60,000 mailers offering principal reduction is but one example of what lost trust means to banks and servicers.)
Regardless, the salient point is that it should be considered undeniable that banks and servicers foreclosing going forward will be operating in a far less forgiving legislative and judicial climate than they have in the past.Â To survive in the new environment, at a minimum, will require compliance with new servicer standards, but to thrive going forward will require much moreâ€¦ it will require a change in orientation.
An orientation towards collectionsâ€¦
When a homeowner defaults on his or her mortgage, what happens?Â Theyâ€™re sent to into the collections machine.Â That machine has been around for a long time in this countryâ€¦ itâ€™s an established and mature industryâ€¦ itâ€™s quite largeâ€¦ and itâ€™s proven itself to be entirely inadequate for dealing with many of todayâ€™s homeowners at risk of foreclosure.
Until now, the costs of this obvious inadequacy have been largely seen as unavoidable, but increasingly, servicers are going to come to understand that these costs, like the default rates and loss ratios of today, are cumulative and therefore much greater than previously imagined.
In the more litigious environment of 2013 and beyond, made possible by the California Homeowner Bill of Rights, among other factors, servicers are going to find that the propensity for a homeowner to file a lawsuit is directly linked to the level of trust that exists between homeowner and servicer.
In simple terms, if you believe that the entity on the other side of the table is capable of nefarious acts in opposition to your interests, then the likelihood of you being dissatisfied with the process/negotiations, and the chances that you will turn to the courts for resolution are both quite high.Â For this not to be the case, you must believe that your servicerâ€™s orientation is not to â€ścollect and foreclose,â€ť but rather is to resolve favorably for all parties, if at all possible.
What happens when a commercial borrower defaults on his or her loan?Â Is a commercial borrower sent to collections as are individual homeowners?Â No, commercial borrowers that stop making payments are sent to their â€śrelationship managers.â€ťÂ Itâ€™s a very different orientation.
The presumption when a commercial borrower defaults on a loan is that something is wrong and needs to be resolved or restructured.Â The presumption when an individual homeowner defaults, is that he or she is at least potentially an â€śirresponsible borrower,â€ť who has not properly managed his or her finances in some way, or perhaps that he or she has endured a hardship from which it is unlikely that he or she will recover.
And thereâ€™s good reason for this to be the caseâ€¦ up until our current crisis, it was for the most part true.Â In todayâ€™s economy, however, it is not the case.Â The reasons for the vast majority of todayâ€™s defaults by homeowners are not all that different from the causes of defaults by todayâ€™s commercial borrowers. In 2011, conclusions drawn by TransUnionâ€™s â€śLife After Foreclosure Study,â€ť showed the perspectives of the lending industry havenâ€™t all been correctâ€¦
â€śThe study did not find any strong evidence supporting the widely accepted “excess liquidity theory,” which suggests consumers who stopped paying their mortgage loans during the recent recession had an increased cash flow in the short term, and therefore could repay other debts. In fact, consumers in the foreclosure process performed similarly, if not better, on certain accounts when they opened them further in the foreclosure process.
This recession was unique in that certain consumers who defaulted on mortgages would otherwise be good credit risks. It appears their actions were driven more by difficult economic circumstances than by any inherent inability to manage debt,” said Ezra Becker, vice president of research and consulting in TransUnion’s financial services business unit.”
At this point it should be relatively easy to accept that todayâ€™s foreclosure crisis and economic conditions are unprecedented and therefore have no historical road map.Â In such times of instability, the better path is often one not previously traveled, and therefore difficult for the existing management team to see, much less embrace.
Unquestionably, changing the orientation of those in a mature industry such as collections wonâ€™t be easy, however, continuation of the status quo should be seen as having a predictable outcome, and one far from optimal in what is a changed regulatory and business climate.
Trust.Â Once you lose it, you just donâ€™t regain it naturally.
Going forward itâ€™s going to be critical that, at the very least, servicers are not entirely mistrusted by their borrowers and that not only means being compliant with new standards, but it also means addressing in some way, perceptions and the misconceptions about loan modifications that have been allowed to spread among homeowners over the last three years.
In the absence of any substantive communication by either the government or servicers to address these types of issues, homeowners and others, some of whom make their living by perpetuating misinformation, have created a myriad of urban myths about servicers and the loan modification process.Â A little clarity and information would go a long way in terms of how homeowners perceive whatâ€™s gone on over last three years, and to completely ignore the subject is to ensure years of misperceptions and mistrust among homeowners.
Probable servicer responses to new climateâ€¦
If history is any sort of guide, it seems likely that servicers and most notably the GSEs will respond to the new laws and climate, as they have in similar situations, by foreclosing judicially, even in non-judicial statesâ€¦ with predictable results.Â In shortâ€¦ alone it is not an answer.
For one thing, state AGs will not take kindly to the obvious circumvention of mandatory state mediation programs, and if consumer complaints persist are likely to respond by making the state mediation apply to the judicial process as well.Â And for another, state judges are more likely to demand that servicers prove standing and a valid chain of title, which evidently is problematic for servicers in many instances.Â (And, God forbid we ever get to the point of arguing notes endorsed in blank and UCC-3 vs. UCC-9, and weâ€™re going to be at this for a long time to come.)
Another probable response is the continuation of the same lobbying strategy that weâ€™ve seen to-date, even though the recent experience with the California legislature should be a fairly strong indication that more of the same is unlikely to produce a different result.
However, ineffectiveness of the financial lobbyâ€™s chosen messaging is actually a best case scenario type of outcome.Â What is more likely is that a continuation of the same scare tactics that threaten higher costs for future borrowers will have the opposite of the intended effect, leading state governments to take more onerous action than might otherwise be the case.
In California, for example, continued lobbying by the mortgage industry after the Bill of Rights passed the state legislature led Californiaâ€™s Attorney General to ask the governor to sign the legislation immediately, instead of in October, as would have otherwise been the case.
We are probably already in another recessionâ€¦
The fact is that the foreclosure crisis has caused much more harm than weâ€™ve been led to believe, or been able to discern.Â What allowed for this delay in our recognition of the situation was primarily the economic stimulus bill passed into law after President Obama was inaugurated in 2009.
That bill provided roughly $500 billion for the states, and while it wasnâ€™t enough to provide for any real stimulus to our economy, it did fill the holes in state budgets for a full three years.Â As 2012 began, however, only $6 billion remained, and with the federal government now seemingly unwilling to provide further state aid, and in fact may reduce the amounts allocated to the states, we are sure to be entering a period of austerity at the state level.
According to a recent report published by the State Budget Crisis Task Force, an independent group led by former Federal Reserve Chairman Paul Volker and New York Lieutenant Gov. Richard Ravitchâ€¦
â€śIn California, Illinois, New Jersey, New York, Texas and Virginia â€” the six states the report focused on â€” pension liabilities are underfunded by more than $385 billion, and retiree health benefit promises by more than $500 billion.â€ť
The simple fact of the matter, also according to the report, is that between 2008 and 2010, state tax revenue declined by more than 12%, more than any decline in any previous recession.Â And according to Pete Peterson, the secretary of commerce under President Richard Nixon and a contributor to the task force, the impact of a federal deficit reduction on states would be catastrophic.
â€śFederal aid accounts for one-third of a stateâ€™s budget. So if the federal government decided to cut state grants by 10%, bigger states such as California and New York would lose more than $6 billion annually.â€ť
Spending cuts are already accompanying tax increases and there should be no question as to the effect such measures will have on state GDPsâ€¦ they will fall as a result of reduced spending and higher taxesâ€¦ and on unemploymentâ€¦ it will rise as spending at the state level is reduced.Â Foreclosures, especially when other factors are considered, can only increase in such an environment.
According to New York Lieutenant Gov. Richard Ravitch, factors such as, â€śrising Medicaid costs, expected federal budget cuts, underfunded pensions, volatile tax revenue and encumbering laws will prevent states from developing a sustainable budget unless significant changes are made.â€ťÂ
Further, the Lt. Governor was quoted by MarketWatch as followsâ€¦
â€śâ€¦ social service programs have already felt the impact of the increasing (state budget) gaps because more than 650,000 state employees have been laid off since 2008.â€ť
While it is unclear just how long we will be able to kick the can here, or how long the EU will be able to continue doing the same, it should be clear that we are not solving problems as much as we are delaying their recognition.Â But where the rubber meets the road, is likely to be at the state level, for it is reductions in state spending that cause people to acutely feel economic pain.
History doesnâ€™t repeat itself, but it often rhymes.Â Mark Twain
During the 1930s, a similar dynamic was in play, and by 1934, there were 28 states with some type of foreclosure moratoria in place, and five additional states in which foreclosing was markedly more difficult.
A white paper written by David Wheelock, assistant vice president and economist at the Federal Reserve Bank of St. Louis, titled: â€śChanging the Rules: State Mortgage Foreclosure Moratoria During the Great Depression,â€ť offers us a view of how things changed at the state level by 1933-34, roughly five years into the decadeâ€™s economic downturn.
â€śThe first attempts to reduce foreclosures during the Great Depression focused on encouraging lenders and borrowers to renegotiate loan terms through mediation boards and other voluntary arrangements. However, the clamor for compulsory foreclosure moratoria grew louder as the Depression worsened and the number of foreclosures rose.
On February 8, 1933, Iowa became the first state to enact a moratorium on mortgage foreclosures. Over the subsequent 18 months, a total of 27 states enacted legislation to limit or halt foreclosures.â€ť
Many of the states enacting foreclosure moratoria by 1934 were farm states, but not all by any means.Â The list of states with moratoria in place by 1934 includes: Arizona, Arkansas, California, Delaware, Idaho, Illinois, Iowa, Kansas, Louisiana, Michigan, Minnesota, Mississippi, Montana, Nebraska, New Hampshire, New York, North Carolina, North Dakota, Ohio, Oklahoma, Oregon, Pennsylvania, South Carolina, South Dakota, Texas, Vermont and Wisconsin.
In point of fact, during the 1930s, in addition to states passing foreclosure moratoria, many states also enhanced borrower redemption rights, limited deficiency judgments, and/or made other changes to their laws to favor borrowers.
In some states the length of the redemption period was left for the courts to decide. Â For example, in Kansas, â€śthe period for redemption on real estate may be extended for such additional time as the court shall deem it just and equitableâ€ť (Central Housing Committee,1936, p. A-10).
Other state laws governing redemption were more specific.Â In North Dakota, for example, legislation specified that, â€śThe period within which a mortgagor or judgment debtor may redeem from a mortgage foreclosure or execution sale of real estate is extended for a period of two yearsâ€ť(Central Housing Committee, 1936, p. A-21).
As to deficiency judgments, different state legislatures had different solutions.Â For example, Idaho passed a law in 1933 specifying, â€śno deficiency judgment may be entered in any amount greater than the difference between the mortgage indebtedness, plus the cost of foreclosure and sale and the reasonable value of the propertyâ€ť (Central Housing Committee, 1936, p. A-7).Â And most states, including Idaho, chose to leave the determination of â€śfair or reasonable valueâ€ť to the discretion of a local appraisal board or court.
In addition, there were several state legislatures that placed new limits on the length of time that a lender could pursue a deficiency judgment after a foreclosure sale. Â In both Iowa and Ohio, for example, legislation was enacted that limited the time period for collecting deficiency judgments to two years after a foreclosure sale (Skilton, 1944, p. 130).
Some state legislatures chose to abolish the right to seek deficiency judgments completely. In Montana, for example, a 1935 statute stated that, â€śDeficiency judgments are abolished in all actions for foreclosure of mortgages for balance of purchase price of real propertyâ€ť (Central Housing Committee, 1936,p. A-16).
And some states went even further by imposing a moratorium on ALL debts, not just mortgage debt.Â Louisiana, for example, adopted a debt moratorium in July of 1934, which was followed by the state legislature amending the legislation in order to authorize a state debt commissioner to â€śsuspend all laws relating to the collection ofÂ fundamentally all types of debts in existence at the time of the passage of the actâ€ť (Skilton, 1944,pp. 83-84).
Conclusions drawn from our past experience with widespread foreclosuresâ€¦
Unfortunately, housing data, such as state-level data on the percentage of homes carrying a mortgage, are not available for the 1930s, so it is difficult to ascertain empirically what drove states to pass foreclosure moratoria, or enact other borrower protections.Â Itâ€™s possible, for example, that states with a higher percentage of owner-occupied homes would mean greater consumer demand for a statewide foreclosure moratorium, but drawing such conclusions are largely irrelevant to the more important lessons from the period.
What is relevant is that as the number of foreclosures rose during the 1930s, the pressure by homeowners and farmers on state legislatures became so great that many were compelled to act, and that same type of public pressure is mounting today.Â It is a safe assumption that as austerity measures increase, the pain felt by the people of the given state will become more acute, and pressure on the stateâ€™s legislature to do more to prevent foreclosures will once again become impossible to ignore.
Just as would be the case today, back then it was understood that laws preventing foreclosures, or those that impose longer periods for redemption, would likely also increase future borrowing costs and security requirements.Â According to a 1936 federal government reportâ€¦
â€śStatutes which provide a lengthy, expensive, complicated or otherwise burdensome foreclosure procedure, or which interpose a long period of redemption before title and possession to the mortgaged property can be obtained, have a tendency to increase interest rates and security requirements throughout the jurisdiction, since prospective lenders naturally take into account the procedure available for realizing the debt out of the security when determining the conditions on which they will be willing to make loans. (Central Housing Committee,1936)â€ť
However, the same report noted that in 1933-34, many states chose to disregard the potential for such future impacts to borrowing because they believed thatâ€¦
â€śâ€¦ unrestricted foreclosure of farm and home mortgages under the circumstances prevailing at the time would have deprived large numbers of persons of essential shelter and protection, and would have left them without the necessary means for earning a living.Â Such wholesale evictions might have seriously endangered basic interests of societyâ€ť (Central Housing Committee, 1936, p. 2).
So, it is clear that by 1933-34, it had become widely understood that the societal costs of allowing the ongoing widespread foreclosures would exceed any costs of reduced loan supply and higher interest rates that could result in future years.
Further, because it was understood that a high number of foreclosures in an area reduced property values and therefore caused still more foreclosures, it was also argued that even lenders realized an advantage as a result of foreclosure moratoria, because such limits on foreclosures halted the downward spiral in property values, thus benefiting lenders as a whole.
The Winds Have Shifted, the Pendulum is About to Swing…
The day Governor Brown signed California’s Homeowner Bill of Rights, even CongresswomanÂ Nancy Pelosi, sensing the change in the wind’s direction, joined the group at the signing and was quick to issue a statement praising those involved…
â€śAs one of the hardest-hit states, California has borne the brunt of our national foreclosure crisis. From small communities in the central valley to the stateâ€™s largest cities, the foreclosure crisis has left behind blighted neighborhoods and shattered communities. But with todayâ€™s action, many California families who in good faith are trying to avoid foreclosure will now have the right to be treated with fairness and dignity by mortgage servicers.
â€śThe California Homeownersâ€™ Bill of Rights makes mortgage servicers accountable and gives homeowners the right to sue in state court. No longer will homeowners face the threat from mortgage servicers of losing their homes as they try to negotiate a reasonable mortgage modification. And with the single-point-of-contact requirement in the bill, no longer will mortgage servicers have the ability to give homeowners the run-around.
â€śI applaud Governor Brown, Speaker PĂ©rez, and Senator Steinberg for their bold leadership in ensuring victory for homeowners; and I congratulate Attorney General Harris, whose ceaseless efforts to protect Californians against abuses by some in the mortgage servicing industry was instrumental in achieving fair compensation for our state in the multi-state mortgage settlement.â€ť
# # #
In closing, there are but two quotes that come to mind…
â€śAll great changes are preceded by chaos.â€ť – Deepak Chopra
â€śA year from now you will wish you had started today.â€ť – Karen Lamb
P.S. And look for my detailed breakdown of California’s Homeowner Bill of Rights later this week.