WORD ON THE STREET: The recently identified deficiencies in the preparation and handling of legal documents to carry out foreclosures are unacceptable. While those deficiencies undoubtedly reflect strains on a system that is operating beyond capacity and was never designed to handle the volume of nonperforming loans that we are seeing today, they also represent a breakdown in corporate internal controls and the integrity of mortgage servicing and foreclosure processing. Servicers and others within the industry may have attempted to expand the resources available to deliver appropriate loss mitigation services, including timely and accurate foreclosure processing, but in some instances, those efforts have been inadequate.
Since this latest set of difficulties was identified, I have had a team of managers and staff from the Federal Housing Finance Agency (FHFA) working closely with government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac to gauge the full scope of the foreclosure processing problem and to move forward on foreclosures where appropriate. Our goals are twofold: to ensure that foreclosure processing is done in accordance with the servicer contract and applicable laws, and to protect taxpayers from further losses on defaulted mortgages. Moving forward on foreclosures where appropriate limits taxpayer losses and contributes to the ultimate recovery of the domestic housing markets. Of course, before any foreclosure is completed, we expect servicers to exhaust all alternatives.
Today, Fannie Mae and Freddie Mac own or guarantee 30 million mortgages; of those, more than 1.3 million are more than 90 days seriously delinquent. As I have reported to the committee on prior occasions, the GSEs have sought to minimize losses on delinquent mortgages by offering distressed borrowers loan modifications, repayment plans or forbearance. These loss mitigation techniques reduce the GSEs' losses on delinquent mortgages and help homeowners retain their homes. Servicers of GSE mortgages know that these loss mitigation options are the first response to a homeowner who falls behind on their mortgage payments.
Yet, for some delinquent borrowers, their mortgage payments are simply not affordable due to unemployment or other hardship and a loan modification is not a workable solution. In other cases, homeowners have decided not to continue payment on their mortgages, perhaps because of the decline in value of their house or because personal circumstances have changed their desire or ability to retain their home. For these cases, the GSEs offer foreclosure alternatives in the form of short sales and deeds-in-lieu of foreclosure. Such foreclosure alternatives generally are better for the homeowner, the neighborhood and the GSE. Despite these options for a graceful exit from a home, foreclosure remains the final and necessary option in many cases.
The sheer volume of delinquent homeowners has put intense pressure on servicers, including their loan workout efforts and their foreclosure processes. Other hearings and studies have analyzed how and why this has happened. One of our challenges today is to identify the full scope and implications of foreclosure processing problems and to improve the integrity of the foreclosure process at servicers and related parties that are failing to perform to required standards.
As conservator of the GSEs, the FHFA expects all companies servicing GSE mortgages to fulfill their contractual responsibilities, which include compliance with both the GSEs' seller/servicer guides and applicable law. We expect the same of other parties as well, including law firms working on foreclosure processing of GSE loans. Finally, to reinforce the duties undertaken by servicers, the GSEs have indicated that they may pursue remedies for contractual violations.
The role of the servicer
When a GSE purchases a mortgage from an originating lender, it contracts with that lender or another bank or financial institution to service the loan. The servicer is the main communication point for the borrower, accepting all payments and crediting the borrower's account.
When homeowners get behind in payments, the servicer is expected to work with the delinquent borrower to set up a repayment plan, modify the loan or, if foreclosure alternatives are not viable, begin foreclosure proceedings. Although the GSEs hold the actual promissory notes through document custodians who maintain these records separate from the servicers, Fannie Mae and Freddie Mac do not themselves accept or process payments or move to modify or foreclose.
For their work, the servicers get paid by the GSEs, and, under the terms of their contracts, each servicer is obligated to follow the procedures established by the GSE, including compliance with all appropriate laws. The GSEs also provide policy guidelines to their seller/servicers. A servicer is contractually bound to comply with this guidance; however, the GSEs do not review loan files for each and every mortgage they guarantee or purchase. Instead, the GSEs rely on a representation and warranty (rep and warrant) model under which the loan originator and loan servicer commit that the loan origination and servicing complies with the GSE's seller/servicer guide. Under the terms of the servicer contracts, the GSEs can require the servicer to pay damages if the servicer does not follow the seller/servicer guidelines or force the servicer to buy back the loan if the loan fails to meet the GSEs' eligibility guidelines.
The majority of GSE loans are serviced by a few very large banks. However, there are hundreds of servicers that hold contracts with each GSE; many are relatively small institutions. Each servicer typically works on behalf of many investors, including trustees for private-label securities, and must follow the procedures and processes set forth in each investor contract. We are working with other government agencies to review foreclosure servicing practices and operations, and where we find firms with operational deficiencies, these must be remedied.
Attorneys specializing in foreclosure processing
In order to complete foreclosures, particularly in judicial foreclosure states, servicers often contract with law firms from the GSEs' approved attorney networks. (For servicers of one GSE, this is required; for the other, it is optional to use the approved network.) These law firms have been evaluated by the GSEs before being added to that GSE's attorney network. By adding a firm to its network, the GSE has concluded the firm has sufficient capacity and expertise to assist a servicer in need of foreclosure processing services. Recently, the capacity of some of these law firms has also been strained by the volume of foreclosures and the burden on the court systems. In light of the processing problems we are discussing today, it is evident that both GSEs must take steps to improve their selection and oversight of the attorneys in their networks.
State processes and timelines
Foreclosure proceedings and requirements are established at the state level. Almost half of the states have a judicial foreclosure process that relies on the court system. By contrast, foreclosures in nonjudicial states are managed according to state and local laws but are handled outside of the court system.
Both systems have protections for homeowners, and to a large extent, the essential paperwork and documentation elements are the same across all states, although particular requirements vary from jurisdiction to jurisdiction. In judicial foreclosure states, individual judges may set specific requirements within their courtrooms that are in addition to, or differ from, terms established by other judges in that state. Servicers and law firms involved in processing foreclosures must be aware of and responsive to such particular requirements.
Both judicial and nonjudicial states are experiencing growing numbers of foreclosures, which are contributing to long delays between a borrower's default and the completion of an associated foreclosure.
Currently, the time from start to completion of a foreclosure for GSE loans in nonjudicial states typically takes six months to a year. In judicial foreclosure states, it takes even longer – often six months longer than in nonjudicial states, and in certain judicial states, the difference is even greater. Bear in mind, these foreclosure periods begin after the loan becomes seriously delinquent – typically about four months.
Some reasonable delays in the foreclosure process have been expected, appropriately so over the past two years, as new loss mitigation programs, such as loan modifications, have been introduced. These programs have often been accompanied by temporary foreclosure moratoria so that homeowners in the foreclosure process could be assessed for a modification. Servicers are obligated to follow GSE guidelines, including evaluating homeowners for eligibility for the various foreclosure mitigation programs I described earlier.
While the FHFA remains committed to ensuring borrowers are presented with foreclosure alternatives, it is important to remember that the FHFA has a legal obligation as conservator to preserve and conserve the GSEs' assets. As I have said before, this means minimizing losses on delinquent mortgages. Clearly, foreclosure alternatives, including loan modifications, can reduce losses relative to foreclosure and benefit homeowners and neighborhoods, adding some measure of stability to local housing markets.
But when these alternatives do not work, timely and accurate foreclosure processing is critical for minimizing taxpayer losses. The direct effect on taxpayers is thus: When a GSE-guaranteed mortgage is four months delinquent, the GSE removes the mortgage from the mortgage-backed security in which it was funded, paying off the security investors at par. The delinquent mortgage then goes on the balance sheet of the GSE, funded with debt issued by the GSE – debt supported by the Treasury Department's senior preferred stock purchase agreement. While awaiting foreclosure (or some foreclosure alternative), that loan is generating no revenue, because the borrower has stopped paying, but the GSE must keep paying interest on the debt supporting the mortgage. The cost of the delay is why it is critical to FHFA's responsibilities as conservator to ensure timely processing of foreclosure actions – the cost is ultimately borne by the taxpayer.
When a homeowner falls behind on their mortgage payments, servicers operate on a single track, working through loss mitigation options with the homeowner, typically beginning with the Home Affordable Modification Program and followed by other loan modification programs or other foreclosure alternatives. When all loss mitigation alternatives have been exhausted, servicers are expected to initiate the foreclosure process. Furthermore, the GSEs have instructed servicers to suspend foreclosure processing when loss mitigation activities reach certain milestones. At times, simultaneous actions are necessary because of the long time frames of the foreclosure process and because borrowers are not always responsive to foreclosure alternative offers.
While the GSEs have established foreclosure time limits in their seller/servicer guides, no servicers have been penalized in recent years for exceeding those limits, largely because state and local legal requirements, loan modification efforts, the unprecedented volume, and various foreclosure moratoria have greatly contributed to delays. During this year, the FHFA has been working with each GSE to improve servicers' adherence to these timelines, and to apply penalties where justified, but the recent set of issues have further complicated that effort.
Deficiencies in the foreclosure process, including problems with affidavits, notaries and improper practices, appear to be the result of inadequate resources for and oversight of servicing operations. The pressure from high volumes of foreclosures working through the system has surfaced fault lines in the foreclosure process that remain the responsibility of management at these companies to identify and fix.
All of us – regulators, lawmakers, investors and the general public – want answers to the questions raised by this most recent breakdown in our housing finance market, and we want them now. Much work is under way to assess the characteristics, extent and location of these problems, and conclusions must await the completion of this work. Regulatory agencies, including the FHFA, are carrying out important examination activities that will better inform the issue. Thus, identification of further actions or regulatory responses must await the results of these examinations and evaluation of the information developed.
Edward J. DeMarco is the acting director of the Federal Housing Finance Agency. This article, which was not prepared exclusively for MortgageOrb.com, is adapted from testimony that DeMarco delivered before the House Judiciary Committee on Dec. 2, 2010. To view DeMarco's complete testimony, click here (pdf).
