Mortage servicers’ perverse incentives

By Felix Salmon
July 30, 2009
wondered whether banks' seeming inability to effectively modify mortgages was a function of "greed on the part of the banks — that while they pay lip service to the idea of modifying mortgages, they actually make more money by being recalcitrant and obstructive and unhelpful."

It turns out that the answer is yes, it is -- and the NYT's Peter Goodman has chapter and verse:

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Last month, I wondered whether banks’ seeming inability to effectively modify mortgages was a function of “greed on the part of the banks — that while they pay lip service to the idea of modifying mortgages, they actually make more money by being recalcitrant and obstructive and unhelpful.”

It turns out that the answer is yes, it is — and the NYT’s Peter Goodman has chapter and verse:

Many mortgage companies are reluctant to give strapped homeowners a break because the companies collect lucrative fees on delinquent loans.

Even when borrowers stop paying, mortgage companies that service the loans collect fees out of the proceeds when homes are ultimately sold in foreclosure. So the longer borrowers remain delinquent, the greater the opportunities for these mortgage companies to extract revenue — fees for insurance, appraisals, title searches and legal services.

In a sidebar, Goodman examines the case of a mortgage servicer, Countrywide, which refused to let Alfred Crawford sell his house for $620,000 in settlement of mortgage debts exceeding $800,000. The latest offer on the house is now just $465,000, and still no short-sale is being allowed.

In the meantime, Countrywide is paying itself lots of fees — fees which will ultimately come out of the pockets of the investors who bought the mortgage-backed bonds which Crawford’s loan was bundled into. The minute that Countrywide allows the house to be sold, that fee income dries up.

Countrywide’s official response is hilarious:

David Sunlin, Bank of America’s senior vice president in foreclosures and real estate management, acknowledged that Mr. Crawford’s applications for short sales had suffered from “a number of communication issues,” but he said that the bank had acted in good faith.

“We have to protect our investors’ interests,” he said. “We have reputational risks involved.”

A bank spokesman, Dan Frahm, said Bank of America owned a second mortgage on the property with a balance of $85,000 and stood to “take the full losses on it,” so it is at risk of loss along with the investors who own the first mortgage.

Countrywide clearly isn’t protecting its investors here: in fact, it’s gouging them for fees. And the second lien is a sideshow: that’s going to zero whether the house sells for $620,000, for $465,000, or for even less.

It’s not going to be easy to solve this problem. And I particularly feel for Mr Crawford, who moved out of his house two years ago, but who, it turns out, could simply have lived there rent-free for the past two years instead, while the process dragged on. Why should the servicers be the only people benefitting from all this inefficiency?

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Comments
24 comments so far

Passing of time will solve this problem, and it’s sad for any homeowner in that status. However…how’s about paying the flipping mortgage? Is that such a nasty problem that must be addressed ? Yes circumstances do change, but good Lord this isn’t a constitutional right (like habeas corpus or free assembly).

Yes, the banks were foolish in lending. Yes, the servicers likely have an incentive to take the least resistant path. And YES, it takes two to tango: I sign my name on the document, I darn well better support what I say i have in the bank and current income. Not everyone will be helped, and not everyone is deserving of help. There are some mortgages that just never should have been, and somewhere the free ride just had to end.

Charging fees on 90+ delinquent loans is like bailing the Titanic with small buckets: these loans are behind and payments are, in most cases, not being made at all. Just because the servicer charges the fee does not precisely imply future collection. And, this all presumes anything is left in foreclosure to start.

Servicing the 90+ delinquent loans is an expensive proposition. Servicers would be best served, and the homeowner as well, to sell delinquent loans to a 3rd party investor willing to pay $0.25 on the guesstimate that an investor can modify the terms such that the owner can pay & stay, and that investor ultimately recoups capital + return on the capital. Most large servicers just are not equipped to handle the deluge of problem loans, and likely they never were.

Posted by Griff | Report as abusive

Additional thought: regional housing markets need to reach clearing levels, which can never happen to it’s fullest effect if the mortgage modification issue continues to allow banks, servicers, real estate lawyers / agents, prior owners kick the can down the road to reach some “virtuous conclusion”.

The rightful conclusion must be, going forward, is that new buyers can & will emerge, so that local housing MSAs will reach a rightful clearing level that balances (so to speak) the interests of sellers / buyers. Except perhaps for all those foolish condo towers in Miami or south beach….thats just idiotic.

Posted by Griff | Report as abusive

Countrywide IP’s should be banned from this blog.

The passing of time will solve this problem, mr. industry shill — for the people of America, but not for you. The passing of time will see house prices creep back to the centuries-long average of 3x income, whether you like it or not. The passing of time will see Countrywide lose more and more money on the nominal value of this dump of a loan.

As to paying the mortgage – If Countrywide had obeyed the 3 C’s of sound underwriting, this wouldn’t be a problem in the first place. But then, of course, Countrywide would have watched their fees for origination dry up. Also, I’ll bet that Countrywide hasn’t paid the local or state property taxes nor have they paid for upkeep on the property.

“good Lord this isn’t a constitutional right”

Actually, it is. This is a free market. Businesses have the right to fail as a result of their own bad decisions. That’s the definition of capitalism. Countrywide made a bad decision, and SHOULD be forced to suffer the pain of it.

Never forget the potential of the back of the invisible hand of the market.

Posted by Unsympathetic | Report as abusive

You need to read between the lines. The “investors” that they are protecting are the BofA stock investors, not the investors in the MBS that hold this mortgage. Conflict of interest, anyone?

Posted by Careful1 | Report as abusive

I have ZERO affiliation with Countrywide or any originating entity. But since you called I shall answer: having spent the last 10-11 years analyzing RMBS cashflows for agency & non-agency securities alike, I did absorb some things along the way from an investment perspective. That included both deal-level and loan-level analysis.

Making a broad distinction that “every” delinquent loan must be saved is just fool-hardy. Countrywide lent foolishly and the Mozilo’s of the lending world are no more. This is fact. And the constitutional right I speak of is owning a friggin home.

Posted by Griff | Report as abusive

@Griff, why are you bringing up the “constitutional right of owning a home”? The post talks about the problems with selling the home, not buying it. The would-be seller obviously cannot make the payments, and seemingly wanted to do what was best for all parties. The issue is not should people be let out of mortgages, but are banks preventing reasonable settlements of loans gone bad?

The example given here highlights the shortsightedness of the lenders, even disregarding their questionable ethics. Yeah, they may make a few bucks in fees, but eventually the house gets sold at a lower price, and not only do they get less back (I don’t understand that trade), but they have now enabled the further devaluation of homes in that area, which has spread like a virus beyond neighborhoods and state lines. Deflating home values are about the worst thing that can happen to the mortgage industry (unless you are a bankruptcy lawyer).

Posted by KenG | Report as abusive

Geithner and Obama refused to nationalize the banks when they had failed and instead decided the best thing to do with these blood suckers was to give them more blood.

Posted by miguel | Report as abusive

Griff – Which part of “Countrywide, which refused to let Alfred Crawford sell his house for $620,000 in settlement of mortgage debts exceeding $800,000″ didn’t you understand? This isn’t about saving the loan or his constitutional right to own a house. He doesn’t want the fricking house, hasn’t lived there in two years, and they won’t let him sell it for what it’s worth.

You really need to start reading these articles rather than repeating the same stale bunkum you were fed by the people you trust. This is a lot more complicated than you’ve been led to believe.

Griff, this process is no more writ in stone than your recalitrance to seeing that this is a ‘pursuit of happiness’ issue.

Predators are predators, in this case they are enabled by the laws, and we’re all paying the price while the lenders giggle all the way to the deposit windows.

Posted by mdh | Report as abusive

My dream is now realized…this posting is about me somehow. Good lord…I come here to learn / understand / see what’s being written, pro & con.

In the sidebar article, as noted this now-unfortunate owner tried to sell his home. Did each separate buyer actually qualify under newer, tightened underwriting standards ?? That is a detail which goes missing. We only know that an offer was made…yet BAC/Countrywide refused to sell. I would not defend the servicer’s practice…a short sale should have been completed.

Take anecdotal evidence, extrapolate to entire industry. rinse & repeat

Posted by Griff | Report as abusive

Griff,

people have a problem here because we are trying to talk about “what the bank should do when a borrower cannot make his payments”, and you show up and say “make the payments!”, followed by a bunch of gobbledygook. That hardly seems helpful. And then, when pressed, you conjure a miraculous defense for the bank (“Did each separate buyer actually qualify under newer, tightened underwriting standards?”) that the bank itself didn’t offer (it just said “a number of communication issues”)

I suspect we all thought it was reasonable to infer, when the $620,000 offer was mentioned, that it was a legitimate offer, and not one by a buyer who would mysteriously not pass a credit check, or be wanted by the FBI for money laundering, or be an illegal alien, or whatever other hypothetical reason you want to conjure up here.

Posted by Whispers | Report as abusive

Griff, you’re okay with me. That said, I think you are wrong on the merits here. This situation cries out for government intervention to reach a more optimal outcome.

That said, personally I am all in favor of this. There is a vacant REO in a great location next to my apartment that almost certainly suffers from the disease described here. The longer it stays vacant, the more likely I can afford it eventually.

Griff, nice lather.

Posted by mdh | Report as abusive

“Just because the servicer charges the fee does not precisely imply future collection. And, this all presumes anything is left in foreclosure to start.”

Not to join the anti-Griff horde, but I just want to point out that in a foreclosure, those fees are gonna come off the top. I’m auditing foreclosures as we speak, and generally fees from the servicer or the substitute trustee are going to have priority over putting money against repaying the note. In a refinancing, those fees are lumped into the principal of the new loan the debtor takes out, and in a short sale, the bank is going to be able to skim those fees ahead of putting the money towards paying off the note. In the shocking and rare event that the debtor wins the lottery and comes up with the cash to cure default without refinancing, he’s paying those fees up front in order to cure default.

And unless the house literally burns down or is otherwise more trashed than it was at the time the loan was taken out, you’re still getting enough of the principal back to cover those fees (excepting truly insane levels of fees). The only things with higher priority are court/registration fees (<1% sale value) and substitute trustee’s fees (capped to <5% in many states).

The only way the servicer doesn’t get these charged fees is (1) it voluntarily waives them, (2) the foreclosure goes for <20% of the loan principal, or (3) the fees are so outrageous that a court official overturns them.

It is, however, true that if a servicer buys the property itself at foreclosure, it may be for an amount which ultimately loses it money. But it’s still pocketing those fees ahead of paying out shareholders.

Posted by ZachPruckowski | Report as abusive

Pity the banks!

I closed on a 30 year loan in March with B of A at 4 3/8% fixed after paying 1.25 points. As one might imagine, that was securitized and sold to Fannie Mae, as are almost all mortgages now.

Really, 4 3/8% fixed for 30 years? There is no way a private lender can play that game. The long run inflation worries are too great. So we end up with this weird Statist arrangement where the government owns all the (new) mortgages. Meanwhile the banks must try to make their money on fees rather that than the old borrow short, lend long business that they have been in since time began.

What a mess! Will government ever stop dominating the mortgage market?

Posted by Dan | Report as abusive

Isn’t there a divergence of interests between the Lender and the Servicer? I still believe that the lender could believe that Loan Modifications are a temporary fix on the road to eventual default. Such a situation is not a good method to clear a bubble.

However, the Servicers could well base their decisions on where and how they can get the highest fees, which is why a govt subsidy to them was supposed to help. But maybe, just maybe, in a downturn of this magnitude, lenders are worried that there’s more on the downside to go, and that they’d rather clear that downside sooner rather than later, and the servicers are following that view.

Again, Loan Modifications are a good idea under normal market conditions, but, during Deflation, it doesn’t make that much sense to me. Better to allow the market to clear and help people who need it with money for housing, rather than subsidizing only the purchase of a house. There are too many distortions at work for an easy fix here. Maybe I’m making no sense.

I don’t agree that loan modifications are a good idea under most circumstances. Aside from the few (and, yes, they are relatively few) instances of outright fraud the buyer has not lived up to their end of a contract they signed. Period. The bank is within their rights to do whatever they want. It may be “not nice” but since when is anyone obligated to be “nice?” The whole goal of modifications is to prop up housing prices by reducing foreclosures. While I understand the alleged benefits of perpetuating the housing price fantasy that caused this whole mess to begin with, artificially propping up prices is not the best solution in the long term.
I am REALLY no fan of bankers, and having bought a house last year I stand to lose big on this market “correction” like a lot of other people. But for as long as I’ve been alive the rule has been “don’t pay your mortgage -> lose your house” Why is it different now?
As for banks screwing MBS investors, well, let’s just say they deserve each other.

Posted by Rockfish | Report as abusive

From Yves Smith:

http://www.nakedcapitalism.com/2008/10/n ew-mortgage-recuse-proposal-to-kick.html

“Listen to this article. Powered by Odiogo.com
Before we debate the merits (more accurately, the lack thereof) of the latest trial balloon of a plan being floated to rescue overextended mortgage borrowers, we need to consider a few not sufficiently discussed facts:

1. The problem is that banks are not making loan modifications as they did in the past( NB DON ). That is turn is due to securitization In the old days, including in the nasty (in the Southwest and Texas) housing bear market of the early 1990s, it was standard practice for banks to modify mortgages ( NB DON ). That was not charity on the part of the bank but a cold-blooded economic calculation, that in the majority of cases, it would take a lower loss by changing mortgage terms than by foreclosing.( NB DON )

80% of mortgages are now securitized, however, and the servicers do not do mods in the vast majority of cases, despite over a year of tough talk, pressure, and various half-baked programs (Hope Now Alliance as the poster child).Why? Our belief is the big reason is the most obvious: servicers get pretty well compensated for foreclosing, but cannot charge (much if any) for the work of doing a mod. Servicers are also set up like factories, with highly standardized procedures. They are not set up to do anything on a one-to-one basis, lack knowledge of the borrower (no doc and low doc mortgages mean the initial files are skimpy, and I am told they are often a mess) and have no experience in assessing borrower ability to pay (ie, they never were in the credit-extension business). To top that off, many servicers have lousy relationships with their borrowers, and so borrowers would probably not be as forthcoming as they would need to be to work out a fair and viable deal (the borrower would assume anything could and would be used against them).”

What I’m arguing is that in most conditions, as in the not too distant past, Loan Modifications can work for both sides. Instead of Securitization, though, I’m arguing that this bubble situation and deflation doesn’t allow that possibility in most cases. It’s just a different take.

It’s miller time and the digression of my posts, and mine only, merit a beverage or three. I’ll shut it up, but echo in full the comments from mr libertarian.

Posted by Griff | Report as abusive

Is anyone else out there thinking to themselves: gee, this is sort of like an Agatha Christie mystery. Who dunit (killed the homeowner)? First, we thought it was the banks, but that was too vague. Next we thought it was the owners of the MBS who wouldn’t let the servicers modify the loans. Then–switcheroo–it turns out to be the servicers, in secret alliance with their bank-lovers who are bleeding the homeowner at the expense of the MBS holder.

Is anyone else pissed off that the nation, the financial services industry, the financial media and our elected hacks are all bouncing around idiotically on this issue??

Posted by Kelli K | Report as abusive

I’m paying 7.5% on a 30 year fixed. We do qualify for a loan modification but BOA/countrywide refuses to do it. $22,400/yr. in interest payments! We deduct it from our taxes and delay paying our local taxes. Isn’t it great for everyone how a bailed out bank is screwing us?

The plan was to refinance once my wife and I both had jobs. Now only one of us is working.

Markets are human inventions subject to human regulation. If spreading misery to prop up bank and investor profits is the holy word of the “market” then it’s time for a change.

Posted by Frank | Report as abusive

Interesting, but old, old news. This has been going on for years – long before most folks knew what a subprime loan was. It was common practice when I left the industry in 1986, and the folks who run the show certainly haven’t become any less greedy or immoral in that time…

Posted by jjcomet | Report as abusive

I love how people like Griff act like this is a normal situation where it should be obvious that people who take out loans should pay them. Under normal circumstances, people who find themselves in financial trouble could SELL their homes. Not so today. My partner and I had to move so that he could keep his job and we\’ve have been unable to sell our condo, so we\’ve been paying for a condo and an apartment for nearly a year. We paid $145k for the condo and put 20% down, so we hardly got into a situation where we were in way over our heads, yet it is not reasonable for anyone to pay for 2 homes indefinitely. The house has been listed for $124 and still no one even interested. So, please, spare me the personal responsibility BS.

Posted by selrencon | Report as abusive

Keep functioning ,terrific job!

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