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

and trigger other supervisory reviews and limitations, and restrict the ability of institutions to expand. the agencies also have the authority to assess cmps on individuals who are responsible for violations, to issue cease and desist orders on responsible individuals, or, if the statutory criteria are met, to remove them from banking. in addition, we may make referrals to law enforcement agencies, or require institutions to file suspicious activity reports, as appropriate. although the examinations are not yet fully completed, based on what we have already learned, the federal reserve expects to use many or all of these tools through the course of our review of foreclosure and other mortgage matters. in particular, the federal reserve has already emphasized to the industry and to institutions we supervise the importance of addressing identified weaknesses in risk - management, quality control, audit, and compliance practices. the problems that are evident to date raise significant reputation and legal risk for the major mortgage servicers. these weaknesses require immediate remedial action. they will also affect the rating assigned by federal reserve supervisors to management of bank holding companies, even where the servicing activity was in a banking subsidiary of a holding company. in addition, the federal banking agencies expect that employees are adequately trained and have sufficient resources to appropriately review the facts and circumstances of files when preparing documents, and that legal processes are fully and properly followed. banking organizations also must ensure quality control for third - party service providers, including legal services. with respect to future supervisory practice more generally, two points for increased emphasis are already apparent. first, this episode has underscored the importance of our using the new authority given the federal reserve in the dodd - frank wall street reform and consumer protection act to send our examiners into non - bank affiliates of large bank holding companies, including those in large institutions that have become bank holding companies only in the last couple of years. second, our experience suggests that the utility of examining and validating internal control processes within firms may extend beyond improvements to the specific processes subject to the exam. we have found that problems in foreclosure practices do not seem as pervasive in institutions in which we had previously examined other internal control processes, found shortcomings, and insisted on corrective action. while we would not draw strong conclusions from such a limited experience, it seems possible that a firm may improve its general approach to control processes once it has been required to remedy problems in discrete areas. if this relationship is borne out, it could be a significant advance