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Foreclosures Pay – How to Reverse the Incentives

Simply put, the problem with the housing market right now, not the problem for investors or banks but the problem for the people living in the homes, is that it has become more lucrative for many servicers to foreclose on the property than to work out a modification. That changes all of the incentives around housing, and makes fraud attractive. That the system was swamped with calls for modifications after pushing people into loans that they couldn’t afford when they recast makes fraud all the more attractive. Foreclosure pays in particular for servicers who don’t also own the loan: for them, they’d rather pay a foreclosure mill a flat rate to process the homes rather than pay more staff to do person-to-person modifications and all the things that go with that: verification of income, negotiation, etc. This happens to be, in most cases, the mega-servicers who are owned by the big banks.

And foreclosure not only pays for servicers, it really pays off for the foreclosure mill law firms, who can process this stuff at a rapid pace and, until the revelations, get judgments with virtually no opposition. And lo and behold, Wall Street private equity firms are behind the foreclosure mills in some cases. The lawsuit on behalf of homeowners claims that Great Hill Partners, a private equity firm, has benefited from what the lawsuit calls an illegal fee-splitting arrangement between Prommis Solutions and several of the busiest foreclosure law firms it controls. Great Hills is the biggest stakeholder in Prommis, a company that acts as a middleman between mortgage servicers and law firms. A lawyer for Prommis rejected that claim, and officials of Great Hill Partners did not respond to inquiries. But a review of public filings, company news releases and other public statements shows that several private equity firms or entities they control have stakes in the business operations of some of the busiest foreclosure law firms in New York, California, Connecticut, Florida, Georgia and Texas. Cue the line about Wall Street sticking its blood funnel into anything that makes money. Prommis Solutions adds nothing of value but is just a go-between for the servicers and the foreclosure mills. They just skim off the top. And their profit margins are likely pretty low, and so they encourage cost-cutting measures:

Tom Miller, the Iowa attorney general who is heading up the task force investigating questionable document practices, said he was not aware that private equity firms had acquired some foreclosure-related operations. While there is no law against such purchases, Mr. Miller said the issue could prove significant because it expanded the possibilities of where and how the foreclosure system failed.

“If this is happening, this is something we are concerned about and would want to find out more about it,” Mr. Miller said in a telephone interview.

Miller, incidentally, is heading up the 50-state AG investigation into foreclosure practices.

This isn’t a new problem. It’s been the standard practice of at least some of the industry since 2007, if not sooner. Somewhere along the line, servicers figured out they could make more money on foreclosure than modification. And they decided to bend the rule of law to make that process even more lucrative.

We can do something about this. Foreclosures need to go back to their traditional position – as a last resort when all other options have been exhausted. This is a short-sighted run at profits by the servicers, with very damaging long-term effects for the economy. Government has a responsibility, if they want to promote the general welfare as well as economic growth, to end this rush to judgment in the foreclosure process. All they would be doing is enforcing current law. There are mandatory loss mitigation standards in many parts of the market, like FHA loans, which the servicers are simply ignoring. John Taylor of the NCRC puts it best:

EK: The property-value issue doesn’t get enough attention, I think. But in a new paper, Third Way argues it cuts in the other direction: Removing foreclosures from the equation makes it easier for people to strategically default, as they won’t get kicked out. That will lead to more defaults and thus lower property values.

JT: Bring me a live body. Where are these people waiting to jump into foreclosure? People are in foreclosure because they have no choice. There isn’t a group waiting to pounce on the foreclosure process […]

We’re not out of the woods with this economy. We’re deep in the jungle. We’re still looking at twice as many foreclosures as we’ve already experienced, and if unemployment gets worse, those numbers will go higher. Unless this situation gets managed, properly, we’re going to continue to have foreclosures dragging down our economy. Things may be going well on Wall Street, but it’s really not going well on Main Street. If people think we’ve gotten through this, they’re really misguided.

This is beyond just the robo-signing and the paperwork. This is a continuing continuum of bad practices and fraudulent lending that got us into this situation. And yes, some of those institutions that did the worst of it are gone, but other institutions have purchased them — and that means they purchased their responsibilities, too. These homeowners were thinking that the bank wouldn’t be making them a loan if they couldn’t pay it back. They were told interest rates were going down, that they could do this, and they believed it. The responsibility began with the lenders, and it still lies with them. Dodd-Frank actually had to legislate that you can’t make a loan to anyone who doesn’t have the ability to pay. The fact that we had to legislate that tells you how far our financial-services sector fell.

And the only real way out of this is with a mass modification program.

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David Dayen

David Dayen