Is consumer protection enough to fix housing?

by Christopher Whalen

It is an election year and, no surprise, President Barack Obama is pushing his new Homeowner Bill of Rights that would slow or curb foreclosures when mortgage holders fall behind on their payments.

In February, the progressive Center for American Progress issued a media release lauding the Homeowner Bill of Rights, which stated:

The Homeowner Bill of Rights provides long overdue protections for homeowners from abuses in the servicing of mortgages and is an important step toward reviving a dormant private mortgage finance industry. ‘As we have learned over the past few years, the nation is not well-served by the inconsistent patchwork of standards in place today, which fail to provide the needed support for both homeowners and investors,’ said President Obama. ‘A fair set of rules will allow lenders to be transparent about options and allow borrowers to meet their responsibilities to understand the terms of their commitments.’

Readers of HousingWire will appreciate that many of the laudable sentiments expressed by President Obama with respect to the claimed improvement in the rights of homeowners are more focused on the approaching elections than on true concern about housing. Keep in mind that most homeowners don’t understand how a mortgage loan is priced, funded or serviced. Any discussion of rights is really relative given the borrower is not competent to understand the most significant financial commitment he or she will ever undertake.

The Center for American Progress outlined the proposal’s key elements, which are meant to placate consumers but not really trouble the bankers. President Obama’s Homeowner Bill of Rights requires:

  • Servicers and lenders to offer a much simpler mortgage disclosure form that clearly outlines relevant fees and penalties, so that homeowners will better understand their loan terms
  • Servicers and mortgage investors to develop standards to reduce conflicts of interests that ultimately harm the homeowner
  • Homeowners to be provided with a right of appeal in order to protect them against improper foreclosure

We have written over the past several months about the errors and omissions by the Obama administration when it comes to prosecuting financial fraud on Wall Street. The settlement reached regarding robo-signing, loan-servicing abuses by most of the states and the largest banks is also impacting how servicers will behave in future. But let’s face it, the issue of mortgage servicing has been on the table for years.

In late 2010, my friend Josh Rosner at Graham Fisher & Co. and I helped organize a letter to regulators promoting development of national mortgage servicing standards. We suggested that a servicer engage in loan modifications, including reductions in the payment amount and principal balance, consistent with state law, to address reasonably foreseeable default when a homeowner can make a reasonable payment and it is economically feasible to do so. When existing or future loans are more than 90-days delinquent, federal regulations should mandate that the credit be assigned to a special servicer.

The key point was that the servicer should have the freedom to act in the best interests of the borrower and the investor. More than 100 industry experts and others eventually signed the proposal, which called for a national framework that could be compatible with state law while creating a consistent national standard.

Another implicit point of the letter was that national legislation was not the way to get this done. A national standard for mortgage servicing ought be a collective agreement among the states just like the Uniform Commercial Code. Instead, the Homeowner Bill of Rights is more the functional equivalent of the Uniform Securities Act, which governs the coordination of state securities law and federal regulation, in this case for housing.

The Homeowner Bill of Rights does represent a partial step toward a national standard for originating, selling and servicing loans. The focus on consumers is a natural thing in political terms. But the idea expressed by President Obama that adding another layer of federal regulation over the consumer portion of the mortgage process will fix the secondary mortgage market is silly.

“The devil is in the details,” notes Anthony Sanders of George Mason University.  “Define ‘improper foreclosure.’ Will this just be an eternal stall tactic so we end up like Italy? I applaud the desire to do something, but CAP and related organizations have interests that are not in line with mortgage investors.”

Sanders comment on the lack of any mention of the rights of investors in the Homeowner Bill of Rights and resulting PR buzz from center-left organizations such as CAP is telling. While there were certainly many hundreds of thousands of Americans who suffered the indignity and loss of wrongful foreclosure, these events did not cause the demise of the secondary market for home loans.

So when CAP suggests that the Homeowner Bill of Rights will somehow repair the “dormant private mortgage finance industry,” it is fair to ask how.

The mortgage industry is comprised of a cartel of the four largest banks, which happen to be the largest loan servicers, as well as the owners of most second liens. Federal bank regulations reinforce the cartel structure of the secondary market for loans by allowing large banks to treat servicer and tax balances as core deposits.

This expanded balance sheet enables the large banks to hold equally big portfolios of mortgage servicing rights and also gives the top four banks — JPMorganChase, Bank America, Wells Fargo and Citigroup — a competitive advantage in dealing with the various federal housing agencies in the creation of mortgage-backed securities.

Thus, when a small bank wants to sell a loan into a securitization with a wrap from Fannie Mae or Freddie Mac, it typically sells the loan for as much as half the origination spread or more to one of the large banks.

The big bank then structures the RMBS that issues bonds to investors and retains the mortgage servicing rights. The large banks control the entire process, yet the Homeowner Bill of Rights does nothing to change this situation. Now you know why large banks seem to be more profitable than smaller banks.

Away from the market for conforming loans eligible for a federal guarantee, the situation is little different, with the largest banks dominating the secondary market for private loans — such as it exists today. With the exception of a few showcase deals done by issuers such as Redwood Trust, the market for jumbo mortgages in the U.S. has essentially gone back to the 1950s when banks would “originate to hold” such loans on portfolio.

The failure to address the complete breakdown in the private label, “originate to sell” market for nonconforming loans is one of the glaring omissions of the first term of the Obama administration. But even more than the fact that the Homeowner Bill of Rights is silent on the other pieces of the national servicing puzzle, the key problem with this legislation is that it is likely to further slow the rationalization and stabilization process for home prices in many markets.

In judicial states such as New York, foreclosure backlogs already stretch back years.  Regulation required by the Homeowner Bill of Rights will further increase the time it takes to get property prices above water in many markets.

Nothing in the Homeowner Bill of Rights or the robo-singing settlement with the state attorneys general addresses the core issues at the center of the dysfunction in the world of housing finance. If anything, these new layers of regulatory oversight will simply enable the large banks to continue to drag their feet in terms of resolving the foreclosure backlog, adding years to the time it takes for Americans to see a true economic recovery.

Large banks don’t mind investigations by state AGs, court settlements or other delays in the foreclosure process. These hurdles allow the mega banks to stretch out the time between when a homeowner defaults and the day when the bank becomes the lawful owner of the property and the statistic hits REO in the financial disclosure. It is no small irony that progressive groups such as CAP are perfectly in-sync with the agenda of the largest banks when it comes to pushing for delays in the foreclosure process.

The politics of extend and pretend, after all, make for some very strange bedfellows indeed.

 

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