daniel k tarullo : problems in mortgage servicing testimony by mr daniel k tarullo, member of the board of governors of the federal reserve system, before the committee on banking, housing, and urban affairs, us senate, washington dc, 1 december 2010. * * * mr. chairman, ranking member shelby, and other members of the committee, thank you for your invitation to this morning ’ s hearing on problems in mortgage servicing. in the first portion of my testimony, i will explain our current understanding of the nature and extent of the deficiencies in mortgage documentation that have been so apparent in the robosigning misconduct, as well as what the banking agencies are doing in support of a broader interagency effort to develop a full picture of these problems. i also want to address the issue of so - called put backs of mortgage - backed securities ( mbs ) to mortgage originators or securitization sponsors. though only indirectly related to robo - signing and associated servicing flaws, financial exposure resulting from put backs could be more significant for some institutions than that from documentation flaws. in the second portion of my testimony, i will turn to the question of appropriate policy responses – with respect to specific regulated financial institutions, to supervisory practices more generally, and to the structural problems we have observed in the mortgage servicing industry, including the discouragingly sluggish pace of mortgage modifications. this last point is a matter of concern not only because of its significance for the millions of american families who are unable to maintain their mortgage payments on homes that have lost considerable value in recent years, but also because of the importance from a macroeconomic perspective of realizing as quickly and efficiently as possible a clearing of housing prices, which would help create the conditions for a market recovery. mortgage documentation and other servicing issues foreclosure is a legal process initiated to terminate a borrower ’ s interest in a property and is permitted only when the borrower has defaulted on the debt obligation for a specified period. the process allows the lender to sell the property and use the proceeds to satisfy the borrower ’ s unpaid debt to the extent it is secured by the property. foreclosure requirements are generally established by state laws and each state has its own statutes, rules, and court decisions pertaining to foreclosures. some 23 states, known as judicial foreclosure states, require foreclosures to be reviewed and approved by a court. nonjudicial foreclosure states

by u. s. residents abroad and by foreigners in the united states are enormous, both in absolute terms and as shares of gdp. ( see figure 1. ) last year, for example, u. s. liabilities to foreigners totaled more than $ 20 trillion, exceeding 140 percent of u. s. gdp. at the same time, u. s. claims on foreigners totaled $ 17. 5 trillion, roughly 130 percent of u. s. gdp. even the net liability position of the united states is sizeable, $ 2. 5 trillion or more than 17 percent of gdp. this net position as a share of gdp has remained fairly constant in recent years, while gross claims and liabilities have both been growing steadily. second, within these enormous gross positions is a great variety of types of claims and liabilities, including many forms of direct investment, equity securities, and debt instruments. 1 ( see figure 2. ) the composition of u. s. liabilities is quite different than the composition of u. s. claims on the rest of the world. for example, more than two - thirds of u. s. liabilities are in the form of debt instruments, while over half of u. s. claims are in equity securities and direct investment. some call this the “ venture capitalist ” nature of the u. s. external position : u. s. investments abroad tend to be concentrated in relatively risky equity instruments, but liabilities of the united states tend to be in low - volatility debt instruments. third, the different asset classes tend to have different rates of return for both capital gains and income. ( see figure 3. ) the return on equity securities ( both claims and liabilities ), for instance, is mainly from capital gains, while the return on debt instruments and direct investment is primarily from income. for debt and equity securities, the income return and the rate of capital gain on u. s. claims are roughly the same as those on u. s. liabilities. this is not true, however, for direct investment : the income return on direct investment by the united states in other countries is more than twice as high as the income return foreigners receive on their direct investment in the united states. taking into account the differences in returns and the differences in the composition of assets, the total return on u. s. claims turns we include bonds, loans, and deposits with debt instruments. out to be about 2 percentage points per year higher than the