REQUIRED READING: Fifty state attorneys general (AGs) have formed a multistate group, and their investigation into mortgage servicing is well under way, attracting the close attention of servicers of all sizes. Although it is not unprecedented for most of the nation's state AGs to band together in examining mortgage banking – 49 AGs teamed up on the 2006 Ameriquest settlement – the current investigation into servicing, announced late last year, portends the possibility of a major shake-up to industry standards.
The speed and duration of the investigation will be determined by several factors, not least among them the degree of servicer cooperation, legal experts say. Opinions are mixed regarding how accommodating national banks must be to the state AGs' requests for information, which can be quite expansive and far-reaching.
The AGs are looking for detailed loan-level information that explains the reasons for and timing of foreclosures and fees related to foreclosure, says Laurence Platt, a partner in K&L Gates' mortgage banking practice. Nationally chartered banks may successfully argue that state AGs lack visitorial powers, he says. Others suggest that national servicers lost some of that leverage thanks to last year's financial-reform legislation.
"Certainly under Dodd-Frank, the ability of servicers to assert preemption is dramatically limited," says Kathleen C. Engel, a law professor at the Suffolk University School of Law. "And even if they were to assert preemption under the law, pre-Dodd-Frank, I don't think they'd be successful, because the issues of servicing are quite different than the issues that would arise under the National Bank Act."
State-chartered lenders, meanwhile, do not have the luxury of preemption as an argument. They, in turn, might try to narrow the scope of the AGs' requests, Platt says. All the while, servicers are also having to answer to their prudential regulatory agencies, never mind other requests coming in from investors, rating agencies and contractual counterparties. The robo-signing controversy has caused uncertainty among stakeholders, and that uncertainty has spawned a deluge of information requests.
Although it is unclear just how forceful state AGs can be in their demands for information, servicers have largely been cooperative with the requests so far, says Iowa AG Tom Miller, who is helping lead the investigation. As of press time, members of the multistate group's executive committee had met with representatives of the nation's five largest servicers (covering 59% of the market), as well as some investors, he tells SM.
"These were good, thorough meetings, and the lenders are cooperating with our inquiry," Miller says. "We're still in the process of gathering information that will help us understand the extent of the mortgage problems that have emerged."
In prepared testimony before the Senate Banking Committee in November, Miller indicated that the multistate group is interested in issues relating to chain of title and force-placed insurance. Both areas have been hotly contested by consumers in recent years, serving as litigation lightning rods.
One theory holds that because consumers do not appear to have been injured by the incidents of robo-signing, the state AGs are working to ensure the purview of their investigation is broad enough to cover any potential smoking gun. The mortgage industry has maintained all along that none of the now-well-identified procedural errors has resulted in an improper foreclosure. In his testimony, Miller rebutted, "The outrage over robo-signing is about due process, protection of private-property rights and the rule of law."
"They're doing exactly what AGs are supposed to do," says Stuart Saft, a partner at Dewey & LeBoeuf's New York office and chair of the firm's real estate department. "They're investigating wrongdoing in their states and trying to determine if anybody's been injured by the actions that were taken. The question then becomes, how relevant are various things."
Platt believes there is across-the-board recognition that borrowers were not necessarily harmed by robo-signing. "On the other hand, respect for the rule of law in the legal process of foreclosure is important," he says. "So how do you slap the hands of servicers, whose processes may have been sloppy but who didn't wrongfully foreclose on borrowers?"
The holy grail
It is significant that the AGs' investigation finds its backbone in the form of Iowa AG Tom Miller. He was one of the earliest state AGs to home in on servicing and foreclosure issues, having coordinated the State Foreclosure Prevention Working Group in mid-2007. Soon after its formation, the assemblage of 12 state AGs began collecting and analyzing loss mitigation data from the nation's biggest subprime players in an attempt to get a handle on the then-blossoming crisis. Although data reports on loan modifications and repayment plans are now ubiquitous, the first of the working group's five reports was considered unique when it was published in February 2008.
The AGs have been working for years to get servicers to provide data, reform practices voluntarily and modify loans, Platt explains. "All of those issues are still important to them, but the holy grail has been permanent principal reductions, and that's been an elusive goal," he says.
Indications that the state AGs viewed loan writedowns as an important loan modification type first emerged in April 2008, when the working group released its second data report. In that report, the group simply noted that "the majority of servicers are not reporting significant levels of modifications that reduce principal alone." Over time, the tone from the AGs changed considerably. In its January 2010 report, the working group called the failure to write down principal a "glaring flaw"; last August's report – the most recent – recommended outright that servicers "strategically increase their use of principal-reduction modifications to maximize prospects for success."
Debate continues on whether servicers should (or, in the case of securitized loans, even can) reduce principal. Supporters of principal reductions point to research from Amherst Securities, the Federal Reserve Banks and others that suggests writedowns significantly improve a modification's sustainability. Opponents argue that principal reductions amount to an attack on secured lending. Such modifications directly and adversely affect most servicing strips, and opponents always cite moral-hazard concerns.
"It sounds harsh, but the more that people want to give free homes to defaulting borrowers, the more chump-like current borrowers are, and that's just a real big problem," says Platt.
Moreover, Saft says, servicers do not have the authority to reduce principal on loans they do not own. Bank of America executives, explaining that the bank is writing down balances on some Countrywide loans (the result of a separate agreement with a coalition of state AGs) and working with the U.S. Treasury Department and state housing finance agencies on the Hardest Hit Fund programs, positioned the mega-shop as a leader in principal reductions during recent congressional hearings. However, the executives also explained to lawmakers that mortgage-backed securities investors limit the bank's discretion to take certain actions.
Miller declined to address possible remedies, saying the AGs must first define the scope of the problems in mortgage servicing.
Engel says that historical evidence of principal reductions' success in regard to farm loans – combined with the facts that voluntary modifications under HOPE NOW "didn't work" and HAMP is "barely working" – lead her to believe the AGs might be successful in their bids for writedowns.
"So I think for good reason, the state attorneys general are going to be pushing even harder for principal reductions, and I think they're in a good position to be able to get them, because at some point, the servicers and the banks have to recognize that the system, as it stands now, is broken," she says.
Therein lies one of two statements with which all stakeholders appear to agree: The system is broken. Fixed-fee agreements do not lend themselves to high-touch servicing, and the conflicting interests of servicers, investors and other counterparties "is profound," Platt says. In testimony, Miller called fixing the loan modification system "the biggest issue," adding, "There is not currently a coherent loss mitigation system."
Everyone agrees also that correcting the housing market is crucial to the nation's economic recovery, and that it is of national interest for that recovery to happen as soon as possible. The means by which the housing market is ultimately corrected may very well be decided by lawmakers, regulators and the AGs, and that is where the disaccord appears.
Saft says he has no doubt, "because of the numbers involved," that the AGs' investigation will last for a couple of years, but he adds that foreclosure cannot be pent up for that long.
Calling the investigation "an extremely complicated matter" with "a lot of stakeholders," Miller did not offer a possible timeline for the investigation.
"I understand the desire by some to see this investigation conclude quickly, but because we have one chance to address problems that have taken years to get us to this point, we're going to take the time we need to do it right the first time," he says.
