Mortgage Foreclosures: Documentation Problems Reveal Need for Ongoing Regulatory Oversight
Published: 2011-05-12T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: This testimony discusses our work on mortgage servicing issues. With record numbers of borrowers in default and delinquent on their loans, mortgage servicers--entities that manage home mortgage loans--are initiating large numbers of foreclosures throughout the country. As of December 2010, an estimated 4.6 percent of the about 50 million first-lien mortgages outstanding were in foreclosure--an increase of more than 370 percent since the first quarter of 2006, when 1 percent were in foreclosure. Beginning in September 2010, several servicers announced that they were halting or reviewing their foreclosure proceedings throughout the country after allegations that the documents accompanying judicial foreclosures may have been inappropriately signed or notarized. The servicers subsequently resumed some foreclosure actions after reviewing their processes and procedures. However, following these allegations, some homeowners challenged the validity of foreclosure proceedings against them. Questions about whether documents for loans that were sold and packaged into mortgage-backed securities were properly handled prompted additional challenges. This statement focuses on (1) the extent to which federal laws address mortgage servicers' foreclosure procedures and federal agencies' authority to oversee servicers' activities and the extent of past oversight; (2) federal agencies' current oversight activities and future oversight plans; and (3) the potential impact of foreclosure documentation issues on homeowners, servicers, regulators, and investors in mortgage-backed securities. It is based on the report we issued on May 2, 2011, on foreclosure documentation problems that Congress requested.
section_title: What GAO Found
paragraphs: In summary, until the problems with foreclosure documentation came to light, federal regulatory oversight of mortgage servicers had been limited, because regulators regarded servicers' activities as low risk for banking safety and soundness. However, regulators' recent examinations revealed that servicers generally failed to prepare required documentation properly and lacked effective supervision and controls over foreclosure processes. Moreover, 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 risks these entities present to the financial system and create problems for the communities in which foreclosures occur. As a result, we recommended in our report that the financial regulators take various actions, including (1) developing and coordinating plans for ongoing oversight of servicers, (2) including foreclosure practices as part of any national servicing standards that are created, and (3) assessing the risks of improper documentation for mortgage loan transfers. The regulators generally agreed with or did not comment on our recommendations, and some are taking actions to address them.

section_title: Letter
paragraphs: Thank you for the opportunity to discuss our work on mortgage servicing  issues. With record numbers of borrowers in default and delinquent on  their loans, mortgage servicers—entities that manage home mortgage  loans—are initiating large numbers of foreclosures throughout the  country. As of December 2010, an estimated 4.6 percent of the about 50  million first-lien mortgages outstanding were in foreclosure—an increase  of more than 370 percent since the first quarter of 2006, when 1 percent  were in foreclosure. Beginning in September 2010, several servicers  announced that they were halting or reviewing their foreclosure  proceedings throughout the country after allegations that the documents  accompanying judicial foreclosures may have been inappropriately signed  or notarized. The servicers subsequently resumed some foreclosure  actions after reviewing their processes and procedures. However,  following these allegations, some homeowners challenged the validity of  foreclosure proceedings against them. Questions about whether  documents for loans that were sold and packaged into mortgage-backed  securities were properly handled prompted additional challenges.
My statement today focuses on (1) the extent to which federal laws  address mortgage servicers’ foreclosure procedures and federal agencies’  authority to oversee servicers’ activities and the extent of past oversight;  (2) federal agencies’ current oversight activities and future oversight plans;  and (3) the potential impact of foreclosure documentation issues on  homeowners, servicers, regulators, and investors in mortgage-backed  securities. It is based on the report we issued on May 2, 2011, on  foreclosure documentation problems that Chairman Menendez, Senator  Franken, and Ranking Members Conyers, Gutierrez, and Capuano  requested.
To conduct the work for our report, we reviewed relevant federal laws,  regulations, examination guidance, and other agency documents. We also  reviewed relevant literature, examples of reported court cases involving  these issues, congressional testimonies, and other relevant publicly  available documentation. In addition, we examined agency documentation  on current oversight activities, such as an examination worksheet,  checklists, and supervisory letters summarizing examination findings. We  conducted interviews with representatives of federal agencies, including  the Bureau of Consumer Financial Protection (CFPB), Federal Deposit  Insurance Corporation (FDIC), Board of Governors of the Federal Reserve  System (Federal Reserve), Office of the Comptroller of the Currency  (OCC), and Office of Thrift Supervision (OTS). We also interviewed legal  experts and representatives of the mortgage industry, investor groups, and  consumer advocacy groups. We conducted the work for the report from  October 2010 through April 2011 in accordance with generally accepted  government auditing standards.
In summary, until the problems with foreclosure documentation came to  light, federal regulatory oversight of mortgage servicers had been limited,  because regulators regarded servicers’ activities as low risk for banking  safety and soundness. However, regulators’ recent examinations revealed  that servicers generally failed to prepare required documentation properly  and lacked effective supervision and controls over foreclosure processes.  Moreover, 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 risks these entities  present to the financial system and create problems for the communities  in which foreclosures occur. As a result, we recommended in our report  that the financial regulators take various actions, including    developing and coordinating plans for ongoing oversight of servicers,  including foreclosure practices as part of any national servicing standards  that are created, and   assessing the risks of improper documentation for mortgage loan  transfers.
The regulators generally agreed with or did not comment on our  recommendations, and some are taking actions to address them.
subsections: section_title: Background
paragraphs: The origination, securitization, and servicing of mortgage loans involve  multiple entities. In recent years, originating lenders generally have sold or  assigned their interest in loans to other financial institutions to securitize  the mortgages. Through securitization, the purchasers of these mortgages  then package them into pools and issue securities for which the mortgages  serve as collateral. These mortgage-backed securities (MBS) pay interest  and principal to their investors, such as other financial institutions,  pension funds, or mutual funds. After an originator sells its loans, another  entity is usually appointed as the servicer. Servicing duties can involve  sending borrowers monthly account statements, answering customer  service inquiries, collecting mortgage payments, maintaining escrow  accounts for taxes and insurance, and forwarding payments to the  mortgage owners. If a borrower becomes delinquent on loan payments,  servicers also initiate and conduct a foreclosure in order to obtain the  proceeds from the sale of the property on behalf of the owner of the loan.  Any legal action such as foreclosure that a servicer takes generally may be  brought in the name and on behalf of the securitization trust, which is the  legal owner of record of the mortgage loans.
Several federal agencies share responsibility for regulating activities of the  banking industry that relate to the originating and servicing of mortgage  loans (see table 1). Upon assumption of its full authorities on July 21, 2011,  CFPB also will have authority to regulate mortgage servicers with respect  to federal consumer financial law. Other agencies also oversee certain  aspects of U.S. mortgage markets but do not have supervisory authority  over mortgage servicers.
section_title: Federal Laws Generally Do Not Address the Foreclosure Process, and Past Federal Oversight of Foreclosure Activities Has Been Limited and Fragmented
paragraphs: Because state laws primarily govern foreclosure, federal laws related to  mortgage lending focus on protecting consumers at mortgage origination  and during the life of a loan but not necessarily during foreclosure. Federal  consumer protection laws, such as the Truth in Lending Act (TILA) and  the Real Estate Settlement Procedures Act of 1974 (RESPA), address some  aspects of servicers’ interactions with borrowers. For example, these laws  require servicers to provide certain notifications and disclosures to  borrowers or respond to certain written requests for information within  specified times, but they do not include specific requirements for servicers  to follow when executing a foreclosure. According to Federal Reserve  officials, in addition to federal bankruptcy laws, federal laws that address  foreclosure processing specifically are the Protecting Tenants at  Foreclosure Act of 2009, which protects certain tenants from immediate  eviction by new owners who acquire residential property through  foreclosure, and the Servicemembers Civil Relief Act, which restricts  foreclosure of properties owned by active duty members of the military.
Banking regulators oversee most entities that conduct mortgage servicing,  but their oversight of foreclosure activities generally has been limited. As  part of their mission to ensure the safety and soundness of these  institutions, the regulators have the authority to review any aspect of their  activities, including mortgage servicing and compliance with applicable  state laws. However, the extent to which regulators have reviewed the  foreclosure activities of banks or banking subsidiaries that perform  mortgage servicing has been limited because these practices generally  were not considered as posing a high risk to safety and soundness.  According to OCC and Federal Reserve staff, they conduct risk-based  examinations that focus on areas of greatest risk to their institutions’  financial positions, as well as some other areas of potential concern, such  as consumer complaints. Servicers generally manage loans that other  entities own or hold, and are not exposed to significant losses if these  loans become delinquent. Because regulators generally determined that  the safety and soundness risks from mortgage servicing were low, they  have not regularly examined servicers’ foreclosure practices on a loan- level basis.
Oversight also has been fragmented, and not all servicers have been  overseen by federal banking regulators. At the federal level, multiple  agencies—including OCC, the Federal Reserve, OTS, and FDIC—have  regulatory responsibility for most of the institutions that conduct  mortgage servicing, but until recently, some nonbank institutions have not  had a primary federal or state regulator. Many federally regulated bank  holding companies that have insured depository subsidiaries, such as  national or state-chartered banks, may have nonbank subsidiaries such as  mortgage finance companies. Under the Bank Holding Company Act of  1956, as amended, the Federal Reserve has jurisdiction over such bank  holding companies and their nonbank subsidiaries that are not regulated  by another functional regulator. Until recently the Federal Reserve  generally had not included the nonbank subsidiaries in its examination  activity because their activities were not considered to pose material risks  to the bank holding companies. In some cases, nonbank entities that  service mortgage loans are not affiliated with financial institutions at all,  and therefore were not subject to oversight by one of the federal banking  regulators. In our 2009 report on how the U.S. financial regulatory system  had not kept pace with the major developments in recent decades, we  noted that the varying levels or lack of oversight for nonbank institutions  that originated mortgages created problems for consumers or posed risks  to regulated institutions.
section_title: While Federal Regulators Conducted Reviews in Response to Reported Problems, Future Oversight and Servicing Standards Have Yet to Be Determined
paragraphs: In response to disclosed problems with foreclosure documentation,  banking regulators conducted coordinated on-site reviews of foreclosure  processes at 14 mortgage servicers. Generally, these examinations  revealed severe deficiencies in the preparation of foreclosure  documentation and with the oversight of internal foreclosure processes  and the activities of external third-party vendors. Examiners generally  found in the files they reviewed that borrowers were seriously delinquent  on the payments on their loans and that the servicers had the documents  necessary to demonstrate their authority to foreclose. However, examiners  or internal servicer reviews of foreclosure loan files identified a limited  number of cases in which foreclosures should not have proceeded even  though the borrower was seriously delinquent. These cases include  foreclosure proceedings against a borrower who had received a loan  modification or against military service members on active duty, in  violation of the Servicemembers Civil Relief Act.
As a result of these reviews, the regulators issued enforcement actions  requiring servicers to improve foreclosure practices. Regulators plan to  assess compliance but have not fully developed plans for the extent of  future oversight. According to the regulators’ report on their coordinated  review, they help ensure that servicers take corrective actions and fully  implement enforcement orders. While regulatory staff recognized that  additional oversight of foreclosure activities would likely be necessary in  the future, as of April 2011 they had not determined what changes would  be made to guidance or to the extent and frequency of examinations.  Moreover, regulators with whom we spoke expressed uncertainty about  how their organizations would interact and share responsibility with the  newly created CFPB regarding oversight of mortgage servicing activities.  According to regulatory staff and the staff setting up CFPB, the agencies  intend to coordinate oversight of mortgage servicing activities as CFPB  assumes its authorities in the coming months. CFPB staff added that  supervision of mortgage servicing will be a priority for the new agency.  However, as of April 2011 CFPB’s oversight plans had not been finalized.  As we stated in our report, fragmentation among the various entities  responsible for overseeing mortgage servicers heightens the importance of  coordinating plans for future oversight. Until such plans are developed,  the potential for continued fragmentation and gaps in oversight remains.
In our report, we recommend that the regulators and CFPB develop and  coordinate plans for ongoing oversight and establish clear goals, roles, and  timelines for overseeing mortgage servicers under their respective  jurisdiction. In written comments on the report, the agencies generally  agreed with our recommendation and said that they would continue to  oversee servicers’ foreclosure processes. In addition, CFPB noted that it  has already been engaged in discussions with various federal agencies to  coordinate oversight responsibilities.
As part of addressing the problems associated with mortgage servicing,  including those relating to customer service, loan modifications, and other  issues, various market participants and federal agencies have begun  calling for the creation of national servicing standards, but the extent to  which any final standards would address foreclosure documentation and  processing is unclear. A December 2010 letter from a group of academics,  industry association representatives, and others to the financial regulators  noted that such standards are needed to ensure appropriate servicing for  all loans, including in MBS issuances and those held in portfolios of the  originating institution or by other owners. This letter outlined various  areas that such standards could address, including those requirements that  servicers attest that foreclosure processes comply with applicable laws  and pursue loan modifications whenever economically feasible.
Similarly, some regulators have stated their support of national servicing  standards. For example, OCC has developed draft standards, and in his  February 2011 testimony, the Acting Comptroller of the Currency  expressed support for such standards, noting that they should provide the  same safeguards for all consumers and should apply uniformly to all  servicers. He further stated that standards should require servicers to  have strong foreclosure governance processes that ensure compliance  with all legal standards and documentation requirements and establish  effective oversight of third-party vendors. A member of the Board of  Governors of the Federal Reserve System testified that consideration of  national standards for mortgage servicers was warranted, and FDIC’s  Chairman urged servicers and federal and state regulators in a recent  speech to create national servicing standards. Most of the regulators with  whom we spoke indicated that national servicing standards could be  beneficial. For example, staff from one of the regulators said that the  standards would create clear expectations for all servicers, including  nonbank entities not overseen by the banking regulators, and would help  establish consistency across the servicing industry. The regulators’ report  on the coordinated review also states that such standards would help  promote accountability and ways of appropriately dealing with consumers  and strengthen the housing finance market.
Although various agencies have begun discussing the development of  national servicing standards, the content of such standards and how they  would be implemented is yet to be determined. According to CFPB staff,  whatever the outcome of the interagency negotiations, CFPB will have  substantial rulemaking authority over servicing and under the Dodd-Frank  Act is required to issue certain rules on servicing by January 2013. We  reported that problems involving financial institutions and consumers  could increase when activities are not subject to consistent oversight and  regulatory expectations. Including specific expectations regarding  foreclosure practices in any standards that are developed could help  ensure more uniform practices and oversight in this area. To help ensure  strong and robust oversight of all mortgage servicers, we recommended  that the banking regulators and CFPB include standards for foreclosure  practices if national servicing standards are created.
In written comments on our report, the agencies generally agreed with this  recommendation, and most provided additional details about the ongoing  interagency efforts to develop servicing standards. For example, OCC  noted that ongoing efforts to develop national servicing standards are  intended to include provisions covering both foreclosure abeyance and  foreclosure governance. OCC added that the standards, although still a  work in progress, will emphasize communication with the borrower and  compliance with legal requirements, documentation, vendor management,  and other controls. The Federal Reserve commented that the intent of the  interagency effort was to address the problems found in the servicing  industry, including in foreclosure processing, and coordinate the efforts of  the multiple regulatory agencies to ensure that consumers will be treated  properly and consistently. FDIC noted that the agency successfully  proposed the inclusion of loan servicing standards in the proposed rules to  implement the securitization risk retention requirements of the Dodd- Frank Act. FDIC also noted that any servicing standards should align  incentives between servicers and investors and ensure that appropriate  loss mitigation activities are considered when borrowers experience  financial difficulties. CFPB said it has effective authority to adopt national  mortgage servicing rules for all mortgage servicers, including those for  which CFPB does not have supervisory authority. Finally, Treasury said it  has been closely engaged with the interagency group reviewing errors in  mortgage servicing and that it supports national servicing standards that  align incentives and provide clarity and consistency to borrowers and  investors for their treatment by servicers.
section_title: While Documentation Problems Likely Will Result in Delays in the Foreclosure Process, the Impact on Financial Institutions and Others Is Less Clear
paragraphs: To date, a key impact of the problems relating to affidavits and  notarization of mortgage foreclosure documents appears to be delays in  the rate at which foreclosures proceed. Despite these initial delays, some  regulatory officials, legal academics, and industry officials we interviewed  indicated that foreclosure documentation issues were correctable. Once  servicers have revised their processes and corrected documentation  errors, most delayed foreclosures in states that require court action likely  will proceed.
The implications for borrowers could be mixed, but delays in the  foreclosure process could exacerbate the impacts of vacant properties and  affect recovery of housing prices. Borrowers whose mortgage loans are in  default may benefit from the delays if the additional time allows them to  obtain income that allows them to bring mortgage payments current, cure  the default, or work out loan modifications. However, according to legal  services attorneys we interviewed, these delays leave borrowers unsure  about how long they could remain in their homes. And borrowers still  might be subject to new foreclosure proceedings if banks assembled the  necessary paperwork and resubmitted the cases. Communities could  experience negative impacts from delayed foreclosures as more properties  might become vacant. We reported that neighborhood and community  problems stemming from vacancies include heightened crime, blight, and  declining property values, and increased costs to local governments for  policing and securing properties. Delays in the foreclosures process,  although temporary, could exacerbate these problems. Various market  observers and regulators indicated that the delays could negatively affect  the recovery of U.S. housing prices in the long term. According to one  rating agency’s analysis, market recovery could be delayed as servicers  work through the backlog of homes in foreclosure. Regulators also  reported that delays could be an impediment for communities working to  stabilize local neighborhoods and housing markets, and could lead to  extended periods of depressed home prices.
Impacts on servicers, trusts, and investors because of loan transfer  documentation problems were unclear. Some academics and others have  argued that the way that mortgage loans were transferred in connection  with some MBS issuances could affect servicers’ ability to complete  foreclosures and create financial liabilities for other entities, such as those  involved in creating securities. According to these academics, a servicer  may not be able to prove its right to foreclose on a property if the trust on  whose behalf it is servicing the loan is not specifically named in the loan  transfer documentation. In addition, we note in our report that  stakeholders we interviewed said that investors in the MBS issuance may  press legal claims against the creators of the trusts or force  reimbursements, or repurchases. Conversely, other market participants  argue that mortgages were pooled into securities using standard industry  practices that were sufficient to create legal ownership on behalf of MBS  trusts. According to these participants, the practices that were typically  used to transfer loans into private label MBS trusts comply with the  Uniform Commercial Code, which generally has been adopted in every  state. As a result, they argue that the transfers were legally sufficient to  establish the trusts’ ownership. Although some courts may have addressed  transfer practices in certain contexts, the impact of the problems likely  will remain uncertain until courts issue definitive, controlling decisions. In  the near term, industry observers and regulators noted that these cases  and other weaknesses in foreclosure processes could lead to increased  litigation and servicing costs for servicers, more foreclosure delays, and  investor claims.
Although tasked with overseeing the financial safety and soundness of  institutions under their jurisdiction, the banking regulators have not fully  assessed the extent to which MBS loan transfer problems could affect  their institutions financially. According to staff at one of the regulators, as  part of the coordinated review, examiners did not always verify that loan  files included accurate documentation of all previous note and mortgage  transfers—leaving open the possibility that transfer problems exist in the  files they reviewed. The enforcement orders resulting from the  coordinated review require servicers to retain an independent firm to  assess these risks. Regulators will more frequently monitor these servicers  until they have corrected the identified weaknesses; however, the  regulators have not definitively determined how transfer problems might  financially affect other institutions they regulate, including any of the  institutions involved in the creation of private label MBS. With almost $1.3  trillion in private label securities outstanding as of the end of 2010, the  institutions and the overall financial system could face significant risks.
To reduce the likelihood that problems with transfer documentation could  pose a risk to the financial system, we recommended that the banking  regulators assess the risks of potential litigation or repurchases due to  improper mortgage loan transfer documentation on institutions under  their jurisdiction and require that the institutions act to mitigate the risks,  if warranted. Completing the risk assessments and fully ensuring that  regulated institutions proactively address the risks could reduce the  potential threat to the soundness of these institutions, the deposit  insurance fund, and the overall financial system. In written comments on a  draft of our report, the regulators generally agreed with or did not  comment on this recommendation. For example, FDIC strongly supported  this recommendation and noted its particular interest in protecting the  deposit insurance fund. In addition, the Federal Reserve said that it has  conducted a detailed evaluation of the risk of potential litigation or  repurchases to the financial institutions it supervises and will continue to  monitor these issues.
Chairman Menendez, Ranking Member DeMint, and members of the  subcommittee, this completes my prepared statement. I would be happy to  respond to any questions you may have at this time.
section_title: Contacts and Staff Acknowledgments
paragraphs: If you or your staff have any questions about matters discussed in this  testimony, please contact A. Nicole Clowers at (202) 512-4010 or  clowersa@gao.gov. Other key contributors to this testimony include Cody  Goebel (Assistant Director), Beth Garcia, Jill Naamane, and Linda Rego.
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