Overview – The Mortgage and Foreclosure Crisis History
In the post-war period from 1946 to mid- 2007, the American mortgage, secured by a home, was widely considered one of the safest investments in the world. The crisis in home foreclosures, triggered by the simultaneous meltdown of the subprime mortgage market and collapse of the housing bubble, put many American families and communities, as well as the nation and the world’s economy under extreme duress. It led to an almost instant freezing of credit markets, mass insolvency of the world’s largest lenders, and was the catalyst for the deepest, longest economic downturn in America since the Great Depression.
Spike in Foreclosures and “Robo-Signing”
The American mortgage was one of the safest investments because the rate for failed mortgages was so low. Historically, the failure rate has been less than 1%; indeed, between 1997 and 2006, only 0.4 percent of all mortgages fell into the foreclosure process.[i]
Yet, as foreclosures spiked, many borrowers believed lenders cut corners in foreclosing on their homes. Press reports indicated lenders were submitting falsified documents, under a process that broadly came to be described as “robo-signing,” (generally understood to mean the signing of legal, foreclosure related documents without review to confirm stated “facts.” It is important to note that because foreclosures in California are largely administrative rather than judicial, “robo-signing” has not been a California problem) in foreclosure proceedings.
These growing complaints drew the attention of federal and state authorities. In October 2010, the National Association of Attorneys General (AGs) announced a bipartisan, multistate investigation by 50 state Attorneys General, and targeted select state bank and mortgage regulators. The investigation focused on whether individual mortgage servicers improperly submitted affidavits or other documents in support of foreclosures, but grew to cover other aspects of lending and foreclosure practices as well. This process resulted in the “National Mortgage Settlement,” discussed below.
In April 2011, the federal Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System, and the Office of Thrift Supervision, after investigating these allegations, issued final enforcement orders against the nation’s 14 largest mortgage lenders and servicers, compelling them to correct their foreclosure procedures. This federal enforcement action was directed at Ally Bank/GMAC, Aurora Bank, Bank of America, Citigroup, EverBank, HSBC, JPMorgan Chase, MetLife, OneWest, PNC, Sovereign Bank, SunTrust, US Bank, and Wells Fargo. These servicers handle about two-thirds of American mortgages.[ii] The federal report said of the lenders and servicers, “The reviews found critical weaknesses in servicers’ foreclosure governance processes, foreclosure document preparation processes, and oversight and monitoring of third-party vendors, including foreclosure attorneys. While it is important to note that findings varied across institutions, the weaknesses at each servicer, individually or collectively, resulted in unsafe and unsound practices and violations of applicable federal and state law and requirements.”[iii]
The National Mortgage Settlement
After approximately a year and a half of investigations and ten months of negotiation, the nation’s five largest mortgage servicers agreed to individual settlements that, collectively, amount to a $25 billion settlement with a coalition of state attorneys general and federal agencies [the U.S. Department of Justice (DOJ) and the U.S. Department of Housing and Urban Development (HUD)]. The sweeping settlement addresses past mortgage loan servicing and foreclosure abuses and fraud, provides substantial financial relief to borrowers harmed by bank fraud, and establishes significant new homeowner protections for the future. The joint state-federal group announced the agreement with the nation's five largest servicers: Ally/GMAC, Bank of America, JPMorgan Chase, Citigroup, and Wells Fargo. Together, these five banks service nearly 60 percent of the nation’s mortgages,[iv] and this is the largest joint state-federal settlement in history.
The settlement funds are allocated as follows:[v]
- Servicers commit a minimum of $17 billion directly to borrowers through a series of national homeowner relief effort options, including principal reduction. Servicers will likely provide up to an estimated $32 billion in direct homeowner relief.
- Servicers commit $3 billion to an underwater mortgage refinancing program.
- Servicers pay $5 billion to the states and federal government ($4.25 billion to the states and $750 million to the federal government).
Although the financial sums of the settlement are significant, this brief will focus more on the terms reshaping mortgage loan servicing and foreclosure procedures.
Mortgage Servicing Reforms
An important part of the settlement terms is the comprehensive effort to regulate mortgage loan servicing and foreclosure procedures. According to the AGs, “The new standards will prevent mortgage servicers from engaging in “robo-signing” and other improper foreclosure practices. The standards will require banks to offer loss mitigation alternatives to borrowers before pursuing foreclosure. They also increase the transparency of the loss mitigation process, impose time lines to respond to borrowers, and restrict the unfair practice of “dual tracking,” where foreclosure is initiated despite the borrower’s engagement in a loss mitigation process.[vi]
According to the summary from the AGs, specific new standards for mortgage loan servicing and foreclosure procedures include:
- Information in foreclosure affidavits must be personally reviewed and based on competent evidence.
- Holders of loans and their legal standing to foreclose must be documented and disclosed to borrowers.
- Borrowers must be sent a pre-foreclosure notice that will include a summary of loss mitigation options offered, an account summary, description of facts supporting the lender’s right to foreclose, and a notice that the borrower may request a copy of the loan note and the identity of the investor holding the loan.
- Borrowers must be thoroughly evaluated for all available loss mitigation options before foreclosure referral, and banks must act on loss mitigation applications before referring loans to foreclosure; i.e. “dual tracking” will be restricted.
- Denials of loss mitigation relief must be automatically reviewed, with a right to appeal for borrowers.
- Banks must implement procedures to ensure accuracy of accounts and default fees, including regular audits, detailed monthly billing statements and enhanced billing dispute rights for borrowers.
- Banks are required to adopt procedures to oversee foreclosure firms, trustees and other agents.
- Banks will have specific loss mitigation obligations, including customer outreach and communications, time lines to respond to loss mitigation applications, and e-portals for borrowers to keep informed of loan modification status.
- Banks are required to designate an employee as a continuing single point of contact to assist borrowers seeking loss mitigation assistance.
- Military personnel who are covered by the Service members Civil Relief Act (SCRA) will have enhanced protections.
- Banks must maintain adequate trained staff to handle the demand for loss mitigation relief.
- Application and qualification information for proprietary loan modifications must be publicly available.
- Servicers are required to expedite and facilitate short sales of distressed properties.
- Restrictions are imposed on default fees, late fees, third-party fees, and force-placed insurance.[vii]
Attorney General’s Legislative Agenda
On February 29, California’s Attorney General, Kamala Harris (D), joined by the legislature’s Democratic leadership, announced her 11-bill legislative package, called “The California Homeowner Bill of Rights,”[viii] to ostensibly conform to the terms of the National Mortgage Settlement.” Six of the bills were introduced in the Assembly, and five in the Senate, with all five Senate bills mirroring five of the six Assembly bills. Four of the bills[ix] dealing directly with the foreclosure processes were set for hearing in the respective Assembly and Senate Banking Committees for the week of April 16-20. However, as Members of the respective committees began to understand the sweeping scope of the AG’s legislative package, it become clear the bills could not pass the stacked, Democratic policy committees, and they were summarily pulled from the committees’ hearings, without being heard.
The failure of the legislature’s policy committee to hear the foreclosure bills was a direct result of the bills themselves. Bills written significantly beyond the terms of the settlement confronted committee legislators; bills that could potentially lead to unknown, and unwanted consequences. The legislation’s deviations from the settlement are too numerous to list in this short brief, but suffice to say the legislature’s Democratic leadership was compelled to rescue these bills by using another legislative process. The leadership of the two houses, contrary to rules requiring only bills the respective houses are unable to concur in amendments to be eligible for conference committee, sent this subject matter to a conference committee. It remains to be seen, having by-passed the normal, public legislative process, whether the subject matter will have the same public input as they would have under the regular process that was bypassed when the four bills were pulled from their hearings. Time will tell if the final product of the conference committee improves the foreclosure process or makes matters worse.
California and the nation’s housing and mortgage markets have changed considerably since the subprime mortgage meltdown and bursting of the housing bubble. State and national laws and regulatory regimes governing mortgage lending and other financial transactions have also changed, significantly. At the federal level, the sweeping Dodd-Frank Act was enacted, creating a new federal agency, the Consumer Financial Protection Bureau (CFPB), with unprecedented oversight powers. The CFPB will be responsible for implementing and enforcing compliance with laws regulating most consumer financial products and services, including home mortgages and the settlement[x]. CFPB is currently promulgating mortgage regulations; it is not known yet if California’s efforts will conflict, complement or even conform to the CFPB regulations. Other federal regulatory actions, taken before the creation of the CFPB, have considerably expanded federal power over the nation’s mortgage markets, powers that had previously been left largely to the individual states.
Regardless of this significant increase of federal power over mortgage lending, the states have not yielded the regulatory field to the federal government. As noted above, the first National Mortgage Settlement between the states’ Attorneys General and five large lenders has been reached. On the heels of this settlement, the Attorneys General indicate they plan to initiate a second round of settlement talks with remaining nine lenders and servicers that reached agreements last year with the Office of the Comptroller of the Currency (OCC) on their foreclosure practices.[xi]
Yet, even as state and federal officials continue their efforts to expand regulatory oversight of mortgage lending, the foreclosures resulting from the recession are declining and housing values have seemingly hit bottom and are slowly recovering in many locations.[xii] Despite this seemingly new stability in California’s housing and mortgage markets, they remain fragile and at risk.[xiii]
State legislators should be mindful that their efforts to protect borrowers from potential abuses by lenders need to provide consistent, transparent standards between the national settlement, and federal and state laws. Deviations in state law that increase cost or increase risk to lenders will, invariably, constrain the availability of mortgages to Californians, or increase their costs of borrowing, for a traditionally expensive housing market. Targeted legislation that narrowly reflects the negotiated national settlement, where there are gaps, would be more prudent than leveraging this historic failure in the American housing and mortgage market to greatly expand state power over private markets.
Despite the unprecedented turmoil in the housing market, home ownership remains a valued and valuable American tradition. This issue demands careful and deliberate study. A zealous regulatory climate, one that aggressively exceeds the nationally negotiated settlement, could prompt some lenders to abandon the California real estate market. We need to make sure we do not regulate new mortgages out of existence.
[vii] https://d9klfgibkcquc.cloudfront.net/National_Settlement_Executive_Summary.pdf p.3
[ix] AB 1602 (Eng), AB 2425 (Mitchell), SB 1470 (Leno) and SB 1471 (DeSaulnier)
[xiii] Finance Bulletin, California Department of Finance, April 2012
For more information on this report or other Banking & Financial Institutions issues, contact Tim Conaghan, Senate Republican Office of Policy at 916/651-1501.