SPECIAL REPORT: In ancient Greek mythology, Sisyphus was a king who was eternally condemned to roll a boulder up a steep hill, only to have it slip from his hands at the peak and roll down the hill – requiring Sisyphus to start anew from the base of the hill and repeat his exhaustive labor.
Today's mortgage bankers might enjoy a sense of brotherhood with the mythological Sisyphus. In the contemporary setting, the boulder is the housing market and the hill's peak is stabilization. No sooner does it seem that the market's tumult has calmed before a new crisis emerges – requiring the labor of starting all over to push for the elusive goal of stability.
Jean Badciong, chief operating officer at Inlanta Mortgage, headquartered in Waukesha, Wis., puts a great deal of blame on the federal government for repeated promises that supposedly lurk around the proverbial corner.
‘They've been ineffective at putting us back on the right path in a time frame that everyone thought would be acceptable,’ she says. ‘Remember that 2009 was supposed to be the year of recovery; then, 2010 was supposed to be the year of recovery. We're nearly into 2012 – we've skipped 2011 as the year of recovery.’
Why has the road to recovery been full of dangerous detours and ominous roadblocks? The problem, it appears, is two-fold: a combination of problematic borrower behavior and self-inflicted wounds by the mortgage banking industry.
One of the chief arguments made by critics of the mortgage banking industry has been the notion of lenders as villains and borrowers as victims. No less a figure than Elizabeth Warren advocated this scenario. In a posting on the Consumer Financial Protection Bureau's blog in February, Warren painted a picture in which borrowers were portrayed as suckers falling for scams by con artist lenders.
‘The crisis revealed how the financial system permitted lenders to hide the true costs and risks of mortgages and to steer those who trusted them into products they did not understand,’ Warren wrote. ‘While some people profited from this business model, across the country, millions more suffered through foreclosures, crippling debt or bankruptcy. Personal gain for a few came at the expense of all, as risky and complicated mortgage products brought the entire economy to its knees.’
‘The system also permitted some borrowers to take risks that not only hurt themselves, but also hurt their neighbors by driving the value of property higher and then pushing it off a cliff when those borrowers defaulted on their loans,’ Warren added.
However, Warren and like-minded critics overlooked one problem: the mortgage banking industry was itself the victim of miscreant behavior. As early as May 2005, the Federal Bureau of Investigation (FBI) categorized mortgage fraud as an ‘epidemic.’ In summer 2007, the Mortgage Asset Research Institute reported that fraud in residential mortgage originations in 2006 was 30% higher than the 2005 level, with incidents of fraud spread evenly across the country.
But in the aftermath of the recession – with a greater degree of risk mitigation and due diligence implemented by lenders and more law enforcement attention paid to the subject – mortgage fraud failed to abate.
‘The current and continuing depressed housing market will likely remain an attractive environment for mortgage fraud perpetrators, who will continue to seek new methods to circumvent loopholes and gaps in the mortgage lending market,’ said the FBI in its 2010 Mortgage Fraud Report. ‘These methods will likely remain effective in the near term, as the housing market is anticipated to remain stagnant through 2011.’
Within mortgage banking, fraud-detection and -prevention efforts continue at an intense pace.
‘The employment/income fraud index in our 2010 Annual Mortgage Fraud Risk Report rose by nearly 30 percent, which could indicate that 'fraud for property' is on the increase," says Mike Zwerner, senior vice president of Agoura Hills, Calif.-based Interthinx. ‘Our product team has kept a close eye on this insidious trend, and we've focused key development on the area of identifying employment fraud and misrepresentation.’
Just walk away
As the recession intensified, property values plummeted. In turn, many homeowners found themselves stuck in houses that were worth considerably less than what they owed on their mortgages. A housing industry euphemism to describe this situation became commonplace in the vernacular: underwater mortgages.
In view of the bleak financial environment, many homeowners began to run a list of priorities – with homeownership coming out low on the list.
‘If someone is in a home they can no longer afford and they have credit card debt, they will maintain credit card payments and let the house go,’ Dr. Charles R. Geisst, professor of finance at Manhattan College in the Bronx, N.Y. ‘Why? In the case of default, credit card debt has legal recourse to the cardholder's other assets. If a house goes, however, the house is the collateral, and nothing else can be touched.’
Rather than face the burden of paying underwater mortgages or dealing with a potential foreclosure, many homeowners gave themselves a third option by abandoning their property and their mortgages. Thus, another trade euphemism entered the wider language: strategic default.
Within the housing market, many professionals were caught off guard by this action.
‘Negative equity has been one of the main drivers of default for decades,’ observes Frank Pallotta, executive vice president and managing partner at Loan Resource Group, based in Rumson, N.J. ‘Mortgage bankers had not heard a lot about strategic default over the years, because people always had equity in their homes.’
Roy B. Satz, former managing partner at Sterling Investment Solutions and an Irvine, Calif.-based loan modification professional at CPR Home Solutions, believes that homeowners made this decision because they felt there was no alternative path away from their financial dilemma.
‘Property owners contemplating a strategic default are, for the most part, acutely aware that they have a contractual obligation and a moral obligation to pay their mortgages or any other debt,’ he says. ‘However, they look at the financial picture of their money not working for them. Most of them are faced with the reality that they won't ever be made whole and are unable to get ahead of the 'loss situation' they find themselves in. So they weigh the pros and the cons of going into a default situation.’
Reports of strategic default began to grow during 2008 and 2009. By early 2010, the situation became so prevalent that several prominent business and government officials sought to dissuade homeowners from pursuing this option.
The New York Times quoted former Treasury Secretary Henry Paulson in stating, ‘Any homeowner who can afford his mortgage payment but chooses to walk away from an underwater property is simply a speculator – and one who is not honoring his obligation.’ Meanwhile, John Courson, president and CEO of the Mortgage Bankers Association (MBA), used a Wall Street Journal interview to ask, ‘What about the message they will send to their family and their kids and their friends?’
However, playing the moral card did not have much of an effect on today's stressed out society.
‘Strategic default used to be something you would not talk about,’ says Matt Ishiba, president of Birmingham, Mich.-based United Wholesale Mortgage Corp. ‘Now, it is so commonplace that it looks like a business decision. I understand why people did it – sinking money into a house while knowing that you will never get your money back.’
Satz concurs, adding that the failure of the U.S. economy to move swiftly from the recession exacerbated matters.
‘The Obama administration talks about an economic recovery, which, unfortunately, appears to be nothing more than talk to most people,’ he says, ‘coupled with the prospect of the real estate market not bouncing – or even crawling – back anytime soon. Many are of the opinion that it will be years before real estate shows signs of a meaningful and sustainable recovery.’
Complicating matters was a strange distraction created by the MBA. In October 2009, the trade group announced that its Washington, D.C., headquarters was up for sale – it purchased the building in May 2008 for $79 million, but was unable to keep up with its mortgage payments. Courson, in a press statement, stated that continued ownership of the property ‘was economically imprudent and, over the long term, would impair MBA's ability to continue providing [its] members with MBA's full range of services.’ The 10-story property was later sold to CoStar Group Inc. for $41.3 million.
The MBA's short sale, in the face of Courson's advocacy that people with underwater mortgages remain in their properties, held up the trade group to ridicule. The Comedy Central program ‘The Daily Show’ harshly lampooned the MBA's action, and media critics commented tartly on the MBA's perceived hypocrisy.
‘Courson advising homeowners on their moral and financial strategies is like a crocodile telling the neighborhood children they should take a shortcut home through the swamp,’ says Karen DeCoster, a Detroit-based special adviser on economics for the Clare Boothe Luce Policy Institute.
The money trap
Pallotta notes that strategic default currently represents between 18% and 35% of all mortgage defaults, and he is concerned about its impact on the revival of the housing market.
‘Investors are looking at acquiring loan pools,’ he says. ‘The combination of possible strategic default and high unemployment will make investors take a more draconian view of acquiring loan pools.’
Yet Brent T. White, professor of law at the University of Arizona, questions whether strategic default has a negative impact on an already deleterious environment.
‘It's exactly backwards, in fact,’ he says. ‘If more people had strategically defaulted, the housing market would have reached bottom sooner, and the recovery could have started sooner. More strategic defaults could have also been good for the economy, because they could have helped jump-start consumer spending.’Â
However, he adds that the threat of strategic default spreading wider is unrealistic.
‘Most underwater homeowners are still paying their mortgages, and the vast majority of foreclosures continue to be involuntary foreclosures,’ he says. ‘If anything, the financial services industry has learned that most homeowners won't default, even when they are hundreds of thousands of dollars underwater and when, as an economic matter, they plainly should.’Â
White points out that many borrowers who are eager to save their homes have sought loan modifications. However, he dismisses the federal government's effort to encourage loan modifications as a waste of everyone's time.
‘The federal government's loan modification programs have failed, because they have all been voluntary to lenders,’ he says. ‘Lenders are only going to modify a loan if they think that doing so will result in more income to them than foreclosing – and this is rarely the case, because when lenders foreclose, they typically recover much of their loss from the mortgage insurance company.’
Dr. Dan Immergluck, associate professor at the Georgia Institute of Technology and author of ‘Foreclosed: High-Risk Lending, Deregulation and the Undermining of the American Mortgage Market,’ points out that federal incentives to servicers have been too measly to encourage a modernization of their processes and procedures for handling distressed loans.
‘There was nothing in the federal response that required re-engineering [of their operations],’ he says. ‘A thousand dollars here and there will not re-engineer the servicing industry.’
But even if the mortgage servicing industry could have upgraded its operations in record speed, it would still face unprecedented chaos in the housing market.
‘[The industry] certainly had no experience with the size of defaults and the amount of property being returned to them,’ says Dr. Edward Deak, professor of economics at Fairfield University in Fairfield, Conn. ‘This was uncharted territory for the financial services industry across board.’
‘Servicing departments were in no position to handle this crisis,’ says Chris Sorensen, founder of Los Angeles-based Homeownership Education Learning Program. ‘Even outsourcing was a challenge, since they lacked the brain trust capable of setting proper expectations and then inspecting what they expected.’
Sign on 10,000 dotted lines
As the housing market crisis deepened, the volume of foreclosure cases widened dramatically. One case – GMAC Mortgage LLC v. Ann M. Neu – was brought before the circuit court in Palm Beach, Fla., in December 2009. Initially, the case seemed no different from hundreds of near-identical cases taking place at the time. However, this case included a deposition of a GMAC Mortgage official named Jeffrey Stephan, who revealed something a little peculiar: as part of his duties in GMAC Mortgage's foreclosure department, he had signed up to 10,000 foreclosure documents a month for five years.
Stephan's deposition in the case attracted no outside attention. During 2010, however, Stephan was called back several times to provide further depositions in other cases. He repeated his acknowledgement of signing thousands of documents that he did not review. News of Stephan's depositions finally hit the mainstream media in September 2010, and then more reports of similar procedures by the major servicers began to come to light. And yet another euphemism entered the wider language: robo-signing.
Fueled by the news of Stephan's admissions, in September 2010, the attorneys general in California, Connecticut, Illinois and Ohio began respective probes of GMAC Mortgage's servicing practices. By the end of the year, all 50 state attorneys general formed a multistate investigation into mortgage servicing, and federal regulatory agencies and Executive Branch departments joined the probe.
At first, the mortgage banking industry tried to brush off the controversy created by the Stephan admissions. Speaking at the MBA's annual convention, in October 2010, Courson angrily criticized a ‘feeding frenzy’ from outside sources.
‘We've seen facts that are inaccurate,’ he said, ‘and information that's coming out that's unrelated to the issue at hand." Courson added that only a ‘very small minority’ of foreclosed homeowners has been negatively affected by robo-signing. (Within six months of these statements, the MBA announced that Courson was being replaced by David H. Stevens, the former commissioner of the Federal Housing Administration.)
Marx Sterbcow, managing partner with New Orleans-based Sterbcow Law Group LLC, was not surprised by this turn of events.
‘Some major banks and larger servicing companies have been abysmal,’ he says. ‘Some have done things the correct way, but others are completely dysfunctional. I don't want to say which ones, but you see their names in the newspaper every day.’
Erik Patrick, chief technology officer at Foothill Ranch, Calif.-based Quandis, is even more blunt. ‘It is people being lazy,’ he says.
‘The robo-signing scandal has caused further mistrust in an already tarnished arena – not only between property owners and their servicers/banks, but by the judiciary about what servicers are attesting to in their foreclosure petitions,’ comments Satz.
Complicating matters further were reports of foreclosure lawsuits in which servicers were unable to produce legitimate documentation relating to the mortgages. In July, this situation created headlines when New York Supreme Court Justice Arthur M. Schack ordered Irene Dormer, the North American CEO of HSBC, to appear before his court and explain why the company should not be penalized for its handling of the foreclosure case against a Brooklyn homeowner. Schack dismissed the foreclosure as a ‘frivolous motion’ and a ‘waste of judicial resources,’ and noted that HSBC failed to prove that it owned the $475,000 mortgage on the home.
Steve Horne, founder and president of Wingspan Portfolio Advisors, based in Carrollton, Texas, saw this as evidence of changing times. ‘For years and years, servicers operated under presumption of credibility by judges,’ he explained. ‘That has been completely destroyed – now, the servicers have to prove they are not incompetent.’
Horne adds that outsourcing the servicing process has only aggravated the situation. ‘When you own the risk, you service the loan completely differently than if you service someone else's risk,’ he says.
Force of foreclosures
Adding to the servicers' dilemmas was another public relations nightmare: reports of major financial institutions violating the Servicemembers Civil Relief Act (SCRA) in their actions against military personnel and veterans. In February, JPMorgan Chase admitted to overcharging 4,500 military borrowers and wrongfully foreclosing on 18 military families. That same month, Wells Fargo announced it would provide $10 million in refunds to approximately 60,000 military borrowers who were inappropriately charged fees when they sought to refinance their mortgages. Stories of military service members returning from frontline combat to discover their homes were foreclosed percolated throughout the media.
Christopher Coutu, founder and president of the veterans advocacy group AmericanWarrior and a representative in the Connecticut state legislature, does not believe that the financial services institutions are deliberately targeting military personnel. However, he is concerned that the enormity of the ongoing housing crisis is wreaking havoc on the men and women serving their country.
‘It is a symbol of how much confusion there is in the whole mortgage market,’ Coutu says. ‘Loans were transferred to other companies multiple times. Financial companies are dealing with a massive amount of homes instead of looking at each individual situation. More attention needs to be given to military members and their dependents – we need to look harder and make sure SCRA is being enforced.’
But Horne is uncertain if that goal can be achieved. ‘The mega-servicers are not particularly flexible operators,’ he says. ‘They were never built with that in mind.’
And if there weren't enough salt in the wound, the Associated Press and Reuters issued separate investigative reports in July that affirmed robo-signing was still being used, despite promises by the nation's major servicers to halt this practice. This, in turn, resulted in a call from Sen. Robert Menendez, D-N.J., chairman of the U.S. Subcommittee on Housing, Transportation and Community Development, for the public release of information regarding performance by the nation's leading servicers. Menendez stated this was essential, or ‘the public will lack confidence in both the foreclosure review process and results.’
However, not everyone believes servicers are villains.
‘I have been surprised that many of the servicers had as much success as they did,’ says Dr. Anthony B. Sanders, distinguished professor of real estate finance at George Mason University in Fairfax, Va. ‘Certainly, robo-signing and missing chain of title are a problem, but we have never seen anything of this magnitude before. Unfortunately, the housing market has stalled because of the various freezes on foreclosure – and these freezes further contribute to the negative equity problem as house prices sink in various areas of the U.S.’
‘Robo-signing may have been an expeditious way – albeit an irresponsible way – to handle paperwork going through the foreclosure chain,’ observes Scott Stern, CEO of St. Louis-based Lenders One Mortgage Cooperative. ‘But I have not seen evidence of people foreclosed on that should not have been foreclosed on. Clearly, processes and possibly laws were not followed. But the people who were impacted were at least delinquent on loans and, most likely, candidates for foreclosure.’
‘Servicers have undergone a lot of scrutiny over the foreclosure process,’ says Grant Bailey, managing director and head of U.S. residential mortgage-backed securities surveillance at Fitch Ratings. ‘That caused a lot of changes to their procedures – and it also prevented resolution over a lot of distressed properties.’
‘Banks don't particularly enjoy foreclosure,’ adds Dr. Linda Hooks, professor of economics at Washington & Lee University in Lexington, Va. ‘But they are profit-oriented businesses, and that is the proper approach. It may not look good on the surface, but it is the right business approach.’
But the damage was already done. The negative publicity relating to robo-signing and the increased pressure by government officials and the courts put the foreclosure process into a state of slow motion.
In November 2010 – one month after the MBA's Courson dismissed robo-signing as an exaggeration of inept media reporting – foreclosure filings fell 21%, according to data from RealtyTrac. This was the largest month-over-month decrease since the company began publishing its foreclosure data. In July, RealtyTrac reported that foreclosure activity during the first six months of 2011 recorded a 25% decrease from the previous six months and a 29% decrease from the first half of 2010.
‘It would be nice to report that foreclosure activity is dropping as a result of improvements in the economy or the housing market,’ says James J. Saccacio, CEO of the Irvine, Calif.-based RealtyTrac. ‘Unfortunately, with unemployment rates inching back up, consumer confidence weak and home sales and prices continuing to languish, this doesn't appear to be the case. Processing and procedural delays are pushing foreclosures further and further out – we estimate that as many as 1 million foreclosure actions that should have taken place in 2011 will now happen in 2012, or perhaps even later.’
Tomorrow: The final part of this four-part series will present the various strategies being floated as the solutions to reanimate the housing market.