Frannie’s juristic parasites

By Felix Salmon
August 30, 2010
the kind of money which attracts a lot of interest:

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Everybody knows that the biggest winners from default and foreclosure are always the lawyers. But did you know that default fees on foreclosed properties alone are now being racked up at a rate of $2 billion a year? That’s the kind of money which attracts a lot of interest:

In the past five years, many of the default industry’s largest law firms have leveraged their mushrooming volume — courtesy of their status with the GSEs — into private equity investments, not to mention a large cash payday for their firm’s partners. Unlike many other areas of law, foreclosure processing typically involves a significant amount of paper pushing, and many law firms have set up operating subsidiaries to their legal operations to manage this aspect of their businesses. It’s these paper-pushing subsidiaries that have been purchased by private equity and hedge fund investors in recent years, looking to find a profitable investment during the economic downturn.

The interesting thing about this market is that it has sprung up in the shadow of Fannie and Freddie, which are being very strict about what is and isn’t allowed in this market:

Beyond determining the legal fee schedule for much of the multi-billion dollar default services market, the GSEs also largely determine who gets their own foreclosure work. Both Fannie and Freddie maintain networks of law firms called “designated counsel” or “approved counsel” in key states marked with significant foreclosure volume — and they either strongly suggest or require that any servicers managing a Fannie or Freddie loan in foreclosure refer any needed legal work to their approved legal counsel.

Each state will have numerous designated counsel — sometimes as many as five law firms — but in practice, attorneys say, two to three firms end up with the lion’s share of each state’s foreclosure work. In states hit hard by the housing downturn and foreclosure surge, like Florida, the amount of work can be substantial…

Freddie Mac sent out a memorandum last week to its designated counsel stating that its law firms could not agree to a blanket cut in foreclosure and bankruptcy fees involving Freddie Mac loans without the GSE’s approval first…

“It won’t be long until we have a federally-regulated foreclosure industry, where Congress sets allowable fees,” opined one of the attorneys I spoke with.

I can see the attraction, from Frannie’s point of view, of keeping the foreclosure business in a small number of foreclosure mills which behave in a predictable and affordable manner. If they’re going to do that, however, they should have strict oversight over those law firms, some of which look very sleazy indeed. Federal regulation, in this context, doesn’t look like such a bad thing at all. Because you can be quite sure that those private equity and hedge fund investors have no particular interest in being scrupulously fair when foreclosing on a delinquent borrower.

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