Officials of both the Mortgage Bankers Association (MBA) and the Federal Deposit Insurance Corporation (FDIC) told Congress Thursday that resolution of the problems that have plagued the mortgage servicing industry through the housing and foreclosure crises must be resolved before the housing market can fully recover.

Mark Pearce, Director of FDIC's Division of Depositor and Consumer Protection and David H. Stevens, President and CEO of MBA testified to a joint hearing of the House Subcommittees on Financial Institutions and Consumer Credit and Oversight and Investigations Committee on Financial Services on "Mortgage Servicing: An Examination of the Role of Federal Regulators in Settlement Negotiations and the Future of Mortgage Servicing Standards."

Pearce told that committees that, while earlier actions of the primary federal regulators to issue enforcement orders against the largest mortgage servicers should, if correctly implemented, put servicers on the path to working effectively to resolve defaults going forward, this review did not look at errors in the past.  These past practices used by servicers in modifying loans and in processing foreclosures have given rise to a multitude of actual and potential claims in litigation, clouding the status of recent foreclosures and title transfers.  The market anxiety surrounding servicer performance is dampening expectations about the housing market's recovery and is discouraging the return of private capital to the mortgage market.

Pearce said that, while FDIC is not the primary federal regulator for those large servicers responsible for most of the servicing and foreclosure deficiencies, they have worked to address problems with mortgage servicing operations.

Following the "robo-signing" revelations last fall and the subsequent reviews by regulators, servicers signed consent orders which require them to retain independent, third party consultants to review past foreclosure actions and report the reviews back to the regulators.  These reviews, Pearce said, must be independent and comprehensive in order to identify errors and provide meaningful remedies to borrowers harmed through those errors. 

Servicing problems continue to present significant operational and litigation risks.  There are currently 90,000 homeowners involved in actions to forestall foreclosure.  In addition, FDIC is tracking:

• 67 pending class-action suits in 23 states challenging foreclosures related to robo-signing, defective assignments, the MERS system or misapplication of payments;
• 57 class action cases in 25 states alleging improprieties in processing loan modifications under the Home Affordable Modification Program (HAMP);
• 24 class actions in 18 states alleging misconduct under non-HAMP modification programs
• 21 investor suits in 12 states alleging foreclosure and securitization misconduct related to originator action;
• Three suits brought by three Attorney's General against two major lenders with more such suits expected.

These legal actions and the anxiety surrounding them as well as ongoing servicing and foreclosure problems will continue to hinder the recovery of the housing and mortgage markets Pearce said.  Loans in foreclosure are taking longer and longer to process, more than doubling between the end of 2007 and 2010 while the pace of loan modifications has declined.  "Coupled with the impact of the market uncertainty regarding the impact of allegations of past errors, this current shadow inventory of non-performing loans in the foreclosure process hinders the clearing of the housing market."

Improving servicing, Pearce said, will take both market reforms and regulatory reforms and the incentive structure of mortgage securitizations must also be addressed.  While HUD has begun to rethink compensation for mortgage servicers they must keep in mind the implication of changes on small or community bank servicers who have not been guilty of the shortcomings of large bank servicers.

Pearce said that the experience of FDIC suggests that there are certain common-sense practices that should be incorporated into servicing and securitizations:

• Servicers should have the authority and be granted appropriate incentives to mitigate losses on residential mortgages, address reasonably foreseeable defaults and do what is necessary to maximize net present values of mortgages to benefit all investors not just a particular class of investors.
• Servicers must be required to disclose any ownership interests and have a pre-defined process to address subordinate liens they hold on properties that also secure loans in pools they service.
• Servicers must establish a single point of contact for borrowers for purposes related to collection, loss mitigation, and foreclosure in a manner that ensures timely, effective, and efficient communication.
• Servicers must provide sufficient staffing to manage loss mitigation, collateral management, collections, and foreclosures to comply with state and federal laws and provide adequate training to that stuff.
• Servicers must maintain sufficient document control to ensure foreclosure proceedings that comply with relevant laws.

Over the last few years the servicing system has "ill-served all parties involved - borrowers, lenders, neighborhoods, and investors," Pearce said, "and has impaired the health and recovery of the housing and mortgage markets.  Addressing the problems that have been uncovered is critical to reducing the risk of a wider disruption to the foreclosure process, a larger cloud of uncertainty over the ownership rights and obligations of mortgage borrowers and investors, and further significant claims against firms central to the mortgage markets."

Stevens agreed that the mortgage servicing system "admittedly failed a great number of consumers during the recent foreclosure crisis."  There was, he said, a perfect storm when the global economy collapsed, the subprime market failed, unemployment and loan defaults soared and "It is clear that the real estate finance industry as a whole was unprepared to handle these unprecedented events -- and that mistakes were made."

Today, Stevens said, trust is lacking at every level of the industry.  "There is a lack of trust between borrowers and servicers. There is a lack of trust between servicers, regulators, the state AGs and the courts to find a joint solution as to how to equitably handle borrowers facing foreclosure. And there is a lack of trust between investors, underwriters, and credit rating agencies to restore private capital to the mortgage market in a meaningful way. Without trust, the housing industry goes nowhere.  And by trust, I mean the ability of policymakers, borrowers and the industry at large to have faith in the products and services we provide, and how those loans will be serviced.  We must do better moving forward. "

MBA believes that consolidated national servicing standards are necessary to stimulate much of the needed reform of the system.  Stevens referenced his past experience when, as FHA Commissioner, he was able to achieve reform of that agency and said he believes the environment now exists to reach similar agreement among regulators and stakeholders regarding servicing standards.  Such a national standard would streamline and eliminate many overlapping requirements, he said, and provide clarity for everyone involved, but it is critical that the regulators act in coordination to develop a standard that applies to the entire industry  "rather than each piling on requirement after requirement."

Developing such a standard should involve a complete analysis of existing requirements for servicers and state laws regarding foreclosures and all stakeholders must be involved in an open dialogue.   "Servicing does not exist in a vacuum, Stevens said.  "Instead, it is part of a broader inter-dependent and inter-connected 'ecosystem' that involves all the varied elements of the mortgage industry.  The housing market remains fragile.  Therefore, when considering changes to the current model, policy makers must be mindful of unforeseen and unintended consequences that could ultimately result in higher housing costs for consumers and reduced access to credit.