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How Sheila Bair Would Fix the Foreclosure Crisis

Mortgage servicers should be compensated differently and provide a single point of contact for troubled borrowers, for a start.

At a summit today, FDIC Chairman Sheila Bair outlined some of the problems with mortgage servicing today and how they should be addressed. "FDIC-insured institutions have recognized more than half a trillion dollars in losses thus far, and they're not finished yet," she noted. Some of her suggestions would impact mortgage servicing technology.

"Throughout the mortgage crisis, from the earliest days of the subprime credit problem to the current robo-signing controversy, the most persistent adversary has been inertia in the servicing and foreclosure practices applied to problem loans," she said.

One problem with the system is the way servicers are paid, Bair said. "Paying servicers a low fixed-fee structure based on volume may be sufficient to ensure that payments are processed and accounts are settled during good times, when most mortgages are performing," she said. "But it does not provide sufficient incentives to effectively manage large volumes of problem loans during a period of market distress." This compensation structure drove automation, cost cutting and consolidation in the servicing industry in the years leading up to the crisis, which further complicated the ability to responsibly manage distressed loans.

Bair offered a few specific requirements that would help the mortgage industry offer more modifications and fewer foreclosures.

First, she would like servicers to provide a single point of contact to assist troubled borrowers throughout the loss-mitigation and foreclosure process. To prevent costly miscommunication, this person -- "and it does need to be a real person," Bair said -- must be well trained and adequately compensated, have access to all relevant information and be authorized to put a hold on any foreclosure proceeding.

Second, servicers must commit to adequate staffing and training for effective loss mitigation. "There is no question that the fee structure currently in place for most servicers provides insufficient resources for effective loss mitigation and has led servicers to cut corners in their legal and administrative processes," she said.

Third, to expedite the loan modification process, loan-modification offers should be "greatly simplified" in exchange for waivers of claims, Bair said.

In addition, the second-lien problem needs to be addressed, Bair said. "Throughout the mortgage crisis, the competing interests of first and second lien holders have been a source of conflict for servicers," she said. "Early in the crisis, many servicers were unwilling to modify first mortgages unless second-liens were written down or extinguished. More recently, investors in first mortgages have complained that they were accepting losses without meaningful participation of second lien holders," even where both loans were being serviced by the same company.

Borrowers should have the right to appeal any adverse denial of a loan modification request to an independent party who has the proper information to conduct an immediate review and the power to correct erroneous determinations, Bair said.

Weak practices associated with title documentation must also cease, she said. "This means that banks and other servicers must: foreclose in their own names instead of allowing MERS to foreclose; and provide complete chain of title and note transfer history in the notice of default."

Bair favors eliminating incentive payments to law firms for speedy foreclosures, as well as the use of lost-note affidavits, except where the servicer has made good faith efforts to obtain the note.

She also would like to see a foreclosure claims commission, modeled on the BP or 9/11 claims commissions, set up and funded by servicers to address complaints of homeowners who have wrongly suffered foreclosure through servicer errors.

Bair also noted that the FDIC is working with other agencies to develop Dodd-Frank standards for risk retention across several asset classes, including requirements for low-risk "Qualifying Residential Mortgages," or QRMs, that will be exempt from risk retention. These rules, Bair said, will allow the FDIC to establish a gold standard for securitization to encourage high-quality mortgages that are sustainable for the long term.

The definition of a QRM could require servicing agreements that, among other things: provide for the legal authority and require financial incentives for servicers to take actions that maximize the value of the entire mortgage pool rather than the claims of any one class of investors, including modifying loans where default is reasonably foreseeable; require disclosure in cases where the servicer manages both the first and second mortgages, and establish a pre-defined process to address conflicts between these positions; restrict the commingling of mortgagors' payments with its own assets; require an independent master servicer to provide oversight and resolve disputes regarding the servicers' actions; and cap servicer principal and interest advances and provide for a means other than foreclosure for servicers to be repaid.

Bair said the Dodd-Frank risk-retention rules should also create securitization standards that will align incentives in the securitization process. "Unless we follow through and address servicing incentives and standards in our implementation of the Dodd-Frank reforms, we will have missed an historic opportunity to restore investor confidence, restart a constructive securitization market, and create long-term stability in our mortgage markets," she said.

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