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The Way Out: Banks and Servicers Can Be Forced to Act in the Public Interest

People don’t seem to think that homeowners could get any possible benefit from the fallout of the foreclosure fraud scandal. Nobody’s gone broke betting on the banksters, to be sure, but we’re in a brave new world here. As I’ve pointed out, the title insurance industry and institutional investors are furious at all this, and the only way for the banks to avoid lawsuits which would break them or mass returns of bad mortgages could be to modify the loans to keep them performing.

If this had no precedent, maybe I’d agree that someone will create a TARP II or some other way for the banks to wiggle off the hook. But there actually is precedent. Wells Fargo has been settling with various Attorneys General all over the country, agreeing to mass loan modifications for consumers who bought “Pick-a-Pay” mortgages from them over the past few years. Here’s an article about the most recent settlement:

Wells Fargo Home Mortgage agreed Wednesday to pay New Jersey $3.98 million and 900 residents $67 million in loan modifications over claims subsidiaries deceptively marketed adjustable-rate mortgages.

The agreement ends a state investigation into whether some mortgages sold by Wachovia Corp., Golden West and World Savings violated the Consumer Fraud Act.

Those companies, purchased by Wells Fargo in 2008, sold so-called Pick-a-Payment mortgages by touting their low monthly payment options. But the companies failed to warn borrowers that the minimum payment option often failed to cover the interest on the loan, resulting in an increase in the loan’s principal balance.

As a result, monthly payments rose to amounts not anticipated by borrowers, causing some to lose their homes, according to the Attorney General’s Office.

The loans were sold deceptively, Wells Fargo deduced that it would be easier to modify the loans and pay restitution than to fight it any longer, and they settled. They’ve paid out over $300 million dollars on this, and they’re even forgiving accrued interest and late fees for the borrowers. In addition, they’ve agreed to a variety of conditions, including “adequately staffing telephone hotlines to assist consumers, including Spanish speakers; providing a single point of contact to assist consumers seeking mortgage modifications under the agreement; making decisions on modifications within 30 days of receiving a completed application; establishing a formal appeals process for buyers turned down for a modification; and providing clearer communication to borrowers.”

This model is what I’d like to see in any settlement, as the deceptive practices are essentially the same. We’re already seeing the servicers move toward this approach in the commercial real estate market:

Lenders will shift toward amending mortgages next year instead of extending maturities, leading to increased sales of distressed real estate, according to a survey of almost 900 property professionals.

More than 63 percent of those surveyed said they expect maturing loans to be modified, while 7.1 percent said loans will continue without changes to defer losses, a practice known as “extend and pretend.” About 16 percent of respondents said real estate with maturing loans will be foreclosed on and put on the market, and almost 14 percent said properties will be sold by borrowers, PricewaterhouseCoopers LLP said in a report today.

“‘Extend and pretend’ was the sound bite from a year ago,” Mitch Roschelle, co-chairman of the annual “Emerging Trends in Real Estate” survey, said in a telephone interview. “Now it’s ‘extend and amend.’ There’s less pretending and more focusing on the reality.”

Yesterday, a foreclosure auction in New York was abruptly taken off the market, suggesting problems in CRE similar to the clouded titles in the residential market. And as a result there, modifications are expected.

Nobody should assume it’ll be easy – you still have an economic team in the White House still more mindful of the health of the banks than the health of the population. But in this case, those interests may align. The banks are increasingly running out of options. They have investors, including potentially Fannie and Freddie, who want to send back their fraudulent mortgages to them. They have title insurance companies seeking protection against future losses. They have a 50-state AG investigation. The path of least resistance here could easily benefit consumers.

“Fannie and Freddie have a huge amount of leverage over their servicers, and they haven’t used it thus far,” says Alan White, a law professor at Valparaiso University and expert in mortgage law. “There’s an opportunity for the GSEs and Treasury to go to the servicers and particularly the big four banks and say, ‘You need to do this job and do it properly. Staff up in a serious way, and start showing us some results.'”

Many of the mortgage-title issues will need to be resolved by state governments, which have jurisdiction over real-estate law. State officials like Cordray see an opportunity to force servicers to act in the public interest.

“It would be my desire to have us work on some kind of broader resolution,” Cordray told the Prospect. “Certainly loan servicers, now that it begins to dawn on them the exposure they’ve created for themselves, they need to get more serious about working out loans and loan modifications. To date, they’ve paid lip service and done very little.”

UPDATE: I should add that the National Community Reinvestment Coalition met with the entire Federal Reserve Board of Governors today on precisely this issue. In addition to discussing a temporary foreclosure freeze, the NCRC requested that the Fed, one of the largest holders of mortgage backed securities in the world, uses its power to demand that servicers make principal modifications to keep families in their homes. The servicers often claim they can’t do this out of threats of investor lawsuits. The Fed is a top investor. They can glide this forward.

Just that the Board of Governors took this meeting is encouraging. According to John Taylor, the NCRC’s CEO, “Chairman Bernanke informed us that they have in fact discussed the issue with the major lenders, and that they are meeting with other regulatory agencies to review the problems associated with foreclosures; that they will pursue appropriate remedies relative to document signing and MERS issues. They are taking this very seriously. This is a problem that is not going away.”

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David Dayen

David Dayen