Sarah Bloom Raskin: Problems in the mortgage servicing industry
Remarks by Ms Sarah Bloom Raskin, Member of the Board of Governors of the Federal
Reserve System, at the National Consumer Law Center's Consumer Rights Litigation
conference, Boston, Massachusetts, 12 November 2010.
* * *
Good afternoon. I would like to thank the National Consumer Law Center (NCLC) for inviting
me to speak here at the Consumer Rights Litigation Conference. I'm particularly pleased to
share my thoughts with you in my first public speech since joining the Federal Reserve Board
of Governors last month.
These are challenging times for policymakers because they are profoundly challenging times
for millions of Americans. Many families have suffered significant declines in their net worth
over the past several years, especially as the value of their homes and other assets has
plummeted. Many households have faced job losses or large reductions in the number of
hours worked, events that have reduced family income and well-being. Retirees are feeling
heightened anxiety as companies and local and state governments debate measures to
restrict retiree pensions. The ability of households to borrow has also shrunk as underwriting
standards have tightened, placing more weight on existing debt obligations of consumers.
For households trying to navigate these difficulties, the work that many of you do to directly
help consumers deal with the legal dimensions of their financial lives is of great importance. I
commend you for your ongoing and persistent contributions to stabilizing family and
community life in our country.
One aspect of the financial crisis that touches directly on your work is foreclosure. As you
well know - and in fact you were among the first to predict the problem - millions of
homeowners have gone through foreclosure in recent years; many more will go through it in
the near future; and countless others are struggling to keep their payments current even as
the housing market and the overall economy make it hard to do so.
The number of foreclosures initiated on residential properties has soared from about one
million in 2006, the year that house prices peaked, to 2.8 million last year. There were
1.2 million foreclosure filings in just the first half of this year. In addition, right now nearly five
million loans are somewhere in the foreclosure process, or are 90 days or more past due and
hence at serious risk for a foreclosure filing.
Our projections remain very grim for the foreseeable future: All told, we expect about two and
one-quarter million foreclosure filings this year and again next year, and about two million
more in 2012. While these numbers are down from their peak in 2009, they remain extremely
high by historical standards and represent a trauma in the lives of millions of people affected.
The most recent alarming development in the foreclosure process that has caught public
attention involves improper activities by mortgage servicers. But let's remember that, for
years, housing counselors and advocates nationwide have documented patterns of
fraudulent and abusive mortgage servicing practices. Current attention is focused on
socalled "robo-signers," individuals who appear to have attested to the validity of documents in
a number of foreclosure filings so large as to suggest that something may be amiss in the
recording process. This development is troubling on its own, but it also shines a harsh
spotlight on other longstanding procedural flaws in mortgage servicing.
Many may view these procedural flaws as trivial, technical, or inconsequential, but I consider
them to be part of a deeper, systemic problem and am gravely concerned. During my time as
Commissioner of Financial Regulation for the State of Maryland, I encountered a Pandora's
Box of predatory tactics that included:

the padding of fees, such as late fees, broker-price opinions, inspection fees,
attorney's fees, and other fees;

the strategic misapplication of payments so that the homeowner's payments for
principal and interest due on the loan were improperly applied to the servicer's fees,
sometimes improperly causing the loan to be considered to be in default; and

the inappropriate assessment of force-placed insurance, with premiums of two to
four times the cost of standard homeowners' insurance, which in turn caused
servicers to collect these premiums before applying the payments to principal and
interest, precipitating foreclosure.
Theoretically, it is possible that the robo-signer controversy may turn out to be a short-term
technical problem that can be addressed through additional verifications and, when
necessary, re-processing of critical documents. Nevertheless, I believe that serious and
sustained reform is needed to address the larger problems in mortgage servicing.
The mortgage servicing industry as we know it is a relatively recent invention, and,
undoubtedly, it has never before been tested in a national housing crisis of this magnitude.
As the continuing surge in foreclosures suggests, mortgage servicers simply are not doing
enough to provide sustainable alternatives to foreclosure. This may be due to the fact that
the vast bulk of loan servicing today is done by large servicers, which are either subsidiaries
of depository institutions, affiliates of depository institutions, or independent companies
focused primarily or exclusively on loan servicing.
Before securitization became commonplace, it was much more likely for a mortgage to be
serviced by the same entity that had originated the loan. This simple approach ensured that
lenders knew immediately if a homeowner was having payment problems, and could take
action to mitigate possible losses. A fair bit of this kind of "portfolio servicing" still takes place,
but as the residential real estate market shifted from an originate-to-hold model to an
originate-to-distribute model, an industry of independent third-party entities emerged to
service the loans on behalf of the securitization trusts. These trusts, as a requirement for
their tax-preferred status, were supposed to be passive, with the management of individual
loans left to the servicer. These servicing arrangements are now commonplace in the
industry: In fact, the system has matured rapidly and experienced considerable consolidation
over the past twenty years.
The benefits to consolidation include significant economies of scale in the collection and
disbursal of routine payments. But the kind of time-consuming, involved work that is now
needed in the loss mitigation area was not contemplated at anything like this kind of scale,
and the payment structures between the servicers and investors may not always be sufficient
to support large-scale loan workout activity. Unfortunately, as we are seeing now, there are
also dramatically significant drawbacks to this model. Third-party servicers earn money
through annual servicing fees, a myriad of other fees, and on float interest, and they
maximize profits by keeping their costs down, streamlining processes wherever possible, and
by buying servicing rights on pools of loans that they hope will require little hands-on work.
Again, for routine payment processing this all leads to economies of scale, and the industry
has consolidated significantly in recent years as a result.
But the services needed in the current housing crisis are not one-size-fits-all. Loan servicers
likely never anticipated the drastic need for the kind of time-consuming, detailed work that is
now required in the loss mitigation area, and the payment structures between the servicers
and investors are not sufficient to support large-scale loan workout activity. As it turns out,
the structural incentives that influence servicer actions, especially when they are servicing
loans for a third party, now run counter to the interests of homeowners and investors.
While an investor's financial interests are tied more or less directly to the performance of a
loan, the interests of a third-party servicer are tied to it only indirectly, at best. The servicer
makes money, to oversimplify a bit, by maximizing fees earned and minimizing expenses
while performing the actions spelled out in its contract with the investor.
In the case, for instance, of a homeowner struggling to make payments, a foreclosure almost
always costs the investor money, but may actually earn money for the servicer in the form of
fees. Proactive measures to avoid foreclosure and minimize cost to the investor, on the other
hand, may be good for the homeowner, but involve costs that could very well lead to a net
loss to the servicer. In the case of a temporary forbearance for a homeowner, for example,
the investor and homeowner both could win - if the forbearance allows the homeowner to get
back on their feet and avoid foreclosure - but the servicer could well lose money. In the case
of a permanent modification, the investor and homeowner could both be considerably better
off relative to foreclosure, but the servicer could again lose money.
Why might a servicer lose money in an instance that could be win-win for the borrower and
investor? It's because of the amount of work needed, the structure for reimbursing costs to
the servicer, and other costs incurred by the servicer on delinquent, but not yet foreclosed
upon, borrowers. Loss mitigation options, such as forbearance and loan modification, require
individualized case work. Thus, the servicer needs to invest in additional resources, including
trained personnel who can deal with often complex one-off transactions. In the case of a
private-label security, many of the costs of this work may not be reimbursed by the trust.
Other costs result from even temporary forbearance, such as the servicer's requirement, in
most cases, to advance principal and interest to the investor every month, even though it has
not received payment from the borrower. Even in the case of a servicer who has every best
intention of doing "the right thing," the bottom-line incentives are largely misaligned with
everyone else involved in the transaction, and most certainly the homeowners themselves.
We don't know yet what the end results will be for homeowners. But the best third-party
servicers would have to be diligent and willing to absorb relative losses when the standard
business model for the industry would seem to put a thumb on the scale in favor of
foreclosure. The most urgent needs of the servicing world today require a sufficient number
of personnel with the adequate mix of training, tools, and judgment to deal with problem
loans on a large scale - in other words, activities with few economies of scale. The skill set of
personnel hired and trained for routine work - efficiency and accuracy in following rules, and
little discretion in decisionmaking - is likely a poor match for loss mitigation activities that
require constant creativity and case-by-case judgment. Therefore, simply transferring work
from one part of a company to another does not achieve much without significant
investments in training and retraining. Servicers have been publicly pledging for several
years to increase their servicing capacity, and many have. Unfortunately, there is plenty of
evidence to suggest that many servicers' workforces lack the knowledge and capacity to deal
with the immensity of the mortgage crisis.
In order to do their jobs well servicers need strong internal procedures and controls. Recent
events suggest that servicers may be lacking in this regard, to the detriment of consumers,
and, quite possibly, to the detriment of the investors to whom they are contractually obligated
to maximize revenue. I recognize that many servicers have stepped up and diligently tried to
improve their work; I applaud and encourage them. However, lingering problems remain and
I suspect that these may be due to deferred maintenance and investment on a significant
scale. In boom times, servicers had the luxury of building out relatively lean systems that
efficiently processed the more routine aspects of the business, but they do not appear to
have planned for the infrastructure that would be needed during a serious down cycle. As
you know, consumers hold the losing end of this stick.
More seriously, recurring issues that have dogged some elements of the servicing industry
go beyond misaligned incentives to simple bad business practices. One recurring problem
that has triggered litigation involves the servicer's handling of fees. When a servicer does not
properly carry out its primary duty of collecting and appropriately allocating mortgage
payments, it can cost homeowners money and, in the most extreme cases, cause a
homeowner to be pushed into premature default. Some servicers obtain unwarranted or
unauthorized fees from borrowers after engaging in unfair collection practices, or through
other conduct that causes borrower default, such as misapplied payments, padded costs,
erroneous charges, late fees, and so on.
Too many accounts of shoddy operating procedures - lost paperwork, slow response times,
and sloppy recordkeeping - cast a dark shadow on this part of the industry that links
mortgage borrowers and lenders. The broad grant of delegated authority that servicers enjoy
under pooling and servicing agreements (PSAs), combined with an effective lack of choice
on the part of consumers, creates an environment ripe for abuse. Moreover, the inability of
some servicers to maintain complete and accurate records, and to transfer servicing rights
cleanly, causes additional uncertainties and vulnerabilities.
The impact of poor business practices can linger on even after the foreclosure sale. In
managing foreclosed properties in lenders' inventories, servicers may be motivated by
timeliness measures in PSAs to induce the former homeowner or bona fide tenant to vacate
before they are legally required to do so, sometimes under the threat of eviction. Once the
properties are vacant, servicers exercise great discretion in deciding whether or not to repair
foreclosed property based on the likelihood that the servicer's advances are recoverable
from the sale proceeds. With real estate owned (REO) inventories projected to reach one
million by the end of 2010, servicer actions will heavily influence the effectiveness of
neighborhood stabilization efforts at a time of persistent decline in home values and in fragile
markets already weakened by a glut of vacant and abandoned properties, particularly in
lowwealth communities.
Finally, we face a cluster of problems surrounding loan modification. Servicers' significant
concerns about the U.S. Treasury's Home Affordable Modification Program (HAMP) are
wellknown. That said, we do not know enough about how well servicers are complying with the
requirements of that program, or whether all of the HAMP modifications that should be made
are indeed being made. Many servicers, in fact, currently report that the bulk of their loan
modifications are being done outside of HAMP. Again, we do not know enough about what
those modifications look like or how they are being structured.
Prior to HAMP, many servicers were creating modifications that themselves were
problematic. For example, high percentages of the pre-HAMP modifications provided no
payment relief to borrowers and, not surprisingly, then exhibited high re-default rates.
Servicers may not be doing everything they can do to ensure that loss mitigation activities,
including HAMP and non-HAMP modifications, are responsible and sustainable and subject
to strong internal controls.
So the problems that have been grabbing headlines in recent weeks are neither new nor
amenable to quick fixes. While there may be some specific practices - "robo-signing" among
them - that are possible to isolate and eliminate, chronic, uncured problems continue to
plague this industry. There is a long track record of actions and cases brought by attorneys
general, which some of you in this room have no doubt litigated, demonstrating the harm
done to consumers by sloppy or unscrupulous practices. Because consumers cannot choose
to hire or fire their servicers (other than by paying off the loan), the industry lacks the level of
market discipline imposed in other industries by the working of consumer choice. For this
reason, if servicers do not actively maintain adequate and trained staff and do not establish
and heed internal controls, if investors do not monitor their servicers' behavior, if regulators
do not conduct meaningful examinations, if courts do not stand guard against unfair
practices, both substantive and procedural, then it will be much less likely that a
wellfunctioning housing market will reemerge from this crisis. Because the very structure of the
loan servicing industry as it currently operates inevitably leads to misaligned incentives and a
propensity to defer costly investments, a more significant re-thinking of the basic business
model must also be undertaken if we are to avoid repeating prior mistakes.
I realize that I'm painting a rather gloomy picture. But be assured that I do believe that we
can make real progress on the ground through coordinated public and private action. Let me
conclude by talking a little bit about what the Federal Reserve and others are doing to
address these issues.
Although foreclosure practices have traditionally been - and rightfully should remain - a
domain of the states, the Federal Reserve has been expanding its expertise in working with
the industry - first, in a review of non-bank subsidiaries in conjunction with other state and
federal regulators, and, currently, with a review of loan modification practices by certain
servicers. As the current servicing issues began to emerge more clearly, the Federal
Reserve and other federal banking agencies initiated an in-depth review of practices at the
largest mortgage servicing operations. The review focuses on foreclosure practices
generally, but with a concentration on the breakdowns that seem to have led to inaccurate
affidavits and other questionable legal documents being used in the foreclosure process.
When the interagency review is completed, we will have more information about the extent
and significance of these very troubling practices, as well as an understanding of what must
be done to prevent them in the future. We have also solicited information and input from
other knowledgeable sources, including NCLC, to help us better direct our actions to detect
possible systematic problems at specific servicers or within the industry at large.
Preliminarily, we have directed certain firms to complete thorough self-assessments of the
policies and procedures they use for determining whether to foreclose on a residential
mortgage loan, and, in those cases where foreclosure is authorized, an examination of the
processes they used to comply with relevant federal and state laws. We have directed these
firms not just to address their stated policies and procedures, but to assess how they actually
work in practice. At the same time, examiners from the banking agencies will be on-site to
review individual loan files, evaluate controls over the selection and management of
thirdparty service providers, and carefully test the assertions that the institutions make in their
self-assessments. Institutions will be directed to correct any deficiencies that they discover in
their self-assessments or that come to light in the on-site examination process.
As a general matter, the Federal Reserve reviews the compliance procedures of the banking
organizations that we supervise as part of the examination process. However, federal
examiners typically are not experts in the application of each state's laws, especially in an
area as complex as mortgage foreclosure procedures. So, federal examiners need to
coordinate with their state examiner counterparts who should have a stronger understanding
of their state foreclosure laws. For federally chartered institutions, the Federal Reserve
requires that the banks we supervise have adequate compliance risk management programs
that are being followed.
Given the potential ramifications for consumers, the housing market, and the economy as a
whole, I believe it's fair to say that every relevant arm of the federal government is taking the
underlying dynamics of the mortgage foreclosure crisis very seriously. I also hold out hope
that the multi-state work engaged in by the 50 state attorneys general will prove to be a
vehicle for resolving the underlying problems. The coordination and expertise at the state
level in these matters is an essential corrective. To the extent that legal settlements are
structured in such a way as to generate a broader underlying reform of servicing processes,
it will be more likely that we can assure consumers that they will not encounter other
mortgage harms moving forward.
The complex challenges faced by the loan servicing industry right now are emblematic of the
problems that emerge in any industry when incentives are fundamentally misaligned, and
when the race for short-term profit overwhelms sustainable, long-term goals and practices.
Responsible parties within the industry are no doubt already scrambling to fix some of the
problems that have surfaced. However, because so much is riding on getting these systems
right, and because consumers have such little measure of individual choice or recourse,
reliance on pledges from market participants will not be enough. Many of you have been
doing your part for years to point out problems in the industry and to give consumers some
protection and redress when wronged. The public sector too is stepping up its efforts to
monitor firms' actions and systems. Until a better business model is developed that
eliminates the business incentives that can potentially harm consumers, there will be a need
for close regulatory scrutiny of these issues and for appropriate enforcement action that
addresses them.
Thank you.