Felix Salmon reports on a conversation with departing assistant Treasury Secretary Michael Barr on newly-commenced reviews of the practices of bank servicers.
Barr’s patter might sound convincing to the uninformed. An “11-agency, 8-week review of servicer practices, with hundreds of investigators crawling all over the banks”! Promises to hold miscreants accountable! Banks required to fix what’s broken!
Felix was skeptical, noting that the reviews were effectively a “physician, heal thyself” approach to a part of the banking business that has proven to be unable to change behavior. But how many mortgage mod programs have the Bush and Obama administrations put into place, which each time led to embarrassingly inadequate results? Here, one can easily imagine more fundamental change might be warranted. Yet in the blogger meeting with Treasury last August, when pressed about the lousy results of HAMP, Geithner took pains to point out that Treasury had little authority over servicers. So how, pray tell, can they force changes in behavior?
And as we saw in the House Financial Services committee hearings on mortgage documentation issues last week, it took persistent grilling by Maxine Waters to establish that regulators aren’t even imposing fines or sanctions for known problems in this arena, which strongly suggests they aren’t even willing to use the powers they do have.
In addition, as Felix pointed out, if the exams were to uncover issues that might pose systems risk, the Treasury is certain to reason to minimize them. Its prime directive has been to defend the idea that the banking system is sound, no matter how compelling the evidence otherwise. It is too deeply committed to this course of action to change course now.
But Felix was far too charitable in his appraisal. He treat Barr as a dedicated public servant, which by implication, unwittingly gives the Treasury and other regulators a pass if their intentions appear genuine. But terrorists, um, freedom fighters are also nothing if not sincere. In my very limited interactions with Treasury staff, they seem at a minimum to be victims of what Willem Buiter has called “cognitive regulatory capture“. Sincerity is of little moment if you are operating from a badly skewed world view.
The evidence to the contrary is compelling. This “review” is clearly a Potemkin exercise, yet another stress test-type charade, in which the facade of a serious investigation is used to sell the message that all is well in the banking industry.
Why are these exams obviously a a whitewash? A somewhat more detailed discussion of the process and progress to date of the so-called Foreclosure Task Force took place at the Financial Servicer Oversight Council meetings today. Michael Barr gave an update, and the critical part comes at 6:10 of the session, where he discusses the areas the review will cover:
Loss mitigation (which might be more correctly called “how did those servicers game HAMP?”)
Barr indicated the investigations had been underway since the fall, with the field work on the foreclosure process investigation to be completed by year end, with a report due in late January. So this is evidently the eight-week, servicer-focused exercise Barr discussed with Salmon. Other investigations are “ongoing”. Barr did indicate that the foreclosure process reviews found “widespread, and in our judgement, inexcusable breakdown in basic controls in the foreclosure process”.
Sounds like they are on the case, no? Then why does it appear likely that this investigation will downplay any serious misconduct? Consider:
1. Inadequate staffing and inadequate time. In my day job as a management consultant, I’ve done quite a lot of what is called fieldwork, as in digging in the bowels of client operations and teasing information out of (often not cooperative) executives, staff, clients, analysts, even competitors, so I have a keen appreciation of how long this sort of inquiry takes if done properly (and unlike most consultants, I have a reputation for getting to the bottom of things in short order). While regulators might in other cases be able to build upon past exams, this angle of investigation is new, so they are starting largely, if not entirely, from scratch.
The ambitious claims for this undertaking, as contrasted with the compressed time frame is a direct repeat of the US and European versions of the bank stress test charades, in which so few bodies were thrown at the problem as to make clear that they were cosmetic exercises.
In the original stress tests, we had 200 regulators stretched across 19 TARP banks over a roughly two month period. Here, on the first task (which is the major but not exclusive focus) we have “hundreds” over, say, fourteen servicers plus foreclosure mills, MERS and Lender Processing Servicers, and hopefully also the trustees and their custodians. Recall the leg work is to be completed by year end. This period includes Thanksgiving and the Christmas-New Year period. Not only will there be fewer working days as a result, but key staff are certain to be taking holiday, plus managerial staff will also be distracted by year-end tasks (strategic reviews, closing out certain activities for financial accounting purposes).
Let’s look at an obvious way in which this foreclosure process exam will fall short. It is pretty clear from the various statements by regulators thus far that no one is taking an issue raised increasingly by borrowers’ attorneys (including those who testified before the Senate Banking Committee and House Financial Services Committee hearings this week), namely, that a high percentage of foreclosures (estimates run at over 50%) are the result of servicer errors and illegal application of payments, quickly result in compounding fees and charges which can quickly put an otherwise viable borrower on a tight budget into default.
The reason so few cases are contested on this basis is it is very difficult to get the bank to disgorge its reports of how it came up with its fees and charges. Even when the borrower gets the report, it takes a fair bit of painstaking analysis to determine which if any extra charges were legitimate and how payments were misapplied (both the securitization agreement and Federal law require payments to be applied first to principal and interest, and only then to fees and charges, but servicers do the reverse, which assures that regular monthly payments will come up short one a mystery fee is assessed). To look at this seriously, the best way would be for the task force to contact borrowers’ counsels, collect and analyze a large sample to see if their charges had merit, and then ascertain how to investigate servicers more systematically to see if these claims had any merit and implement the in-depth review. There is no way this could have been accomplished in the eight weeks allotted to the “fieldwork” phase of the foreclosure process review.
Let’s look at another area where staffing is certain to be too low, on the putback issue. We’ve pointed out why these cases are so difficult: the legal threshold for establishing liability is high. It isn’t simply that the originators and sponsors misrepresented loan quality; you need to show the misrepresentation was material and that it is why you as investor suffered losses. The fact that we now have broadly measured unemployment at 17% and housing prices down 25% to 45% is probably sufficient to explain a lot of defaults, so investors have a major hurdle to surpass in proving that their losses were due specifically to misrepresentation, as opposed to other causes.
The process for arguing these cases historically has been on a loan-by-loan basis, which is time-consuming and costly. Even if the task force uses a comparatively small sample, it will still need to replicate the onerous process the litigants would go through for its results to have any integrity.
2. The regulators appear not know what they are doing. Get a load of this comment via Felix from Barr:
Barr told me that they’re doing file reviews which take between five and eight hours to go through a single loan file: this is hard, detailed work, and at the end of it all there will be a real understanding of what needs to be done—something necessary, if not sufficient, to finally resolve this mess.
Securitization professionals tell me that someone who was competent would not be capable of spending five, much the less eight hours on a loan file. This is proof that they are so clueless that they don’t have the foggiest idea of what is germane.
One might argue that the file reviews are taking so long because Treasury is also contacting borrowers. I find that unlikely given the language (“file review”) plus the difficulty of finding borrowers and getting cooperation, the compressed time frame, and the mechanics of doing large scale interviews (the herding cats process of drafting and getting input and sign off on the questions, determining who to interview, and documenting interviews means that each hour of interview time requires 3-4 hours total time, and note this is for a comparatively flexible fact gathering/conversational format, as opposed to the more rigid survey type of interview).
3. The regulators are not talking to people who know where the dead bodies might lie. The community of people with securitization expertise who are independent, meaning not in the employ of banks and senior enough to have perspective is surprisingly small and tight-knit. Some are open critics while others adopt a more studiedly neutral posture. I have been told that none have been engaged in or even quizzed about this exercise.
Similarly, RMBS investors are at risk due to the difficulties banks have experienced in forecloses. They are an important constituency and there is very good reason to think they are similarly being held at a remove. Again, the lawyers involved in securitization litigation (another small fraternity) that I am in contact with indicate that they are not aware of any outreach by the Foreclosure Task Force (I’m sure word would spread quickly if any such effort were underway; investors would be all over a prospective ally like a cheap suit).
4. These regulators have history of siding with financial services industry interests. Treasury has served as a cheerleader of banks. The OCC is even worse, and might as well be a branch of the American Bankers Association. The Fed’s failing are somewhat different; since the Greenspan era, it has not taken regulation seriously (even the OCC was tougher about trying to use its authority under the Home Ownership and Equity Protection Act to rein in the worst subprime abuses) and it is very much of a “blame the borrower” mindset. HUD, which is also part of this investigation, has been downplaying bank misbehavior. In early November, after “robo signing” had entered the lexicon, its secretary Shaun Donovan claimed,
…we have not found any evidence at this point of systemic issues in the underlying legal or other documents that have been reviewed.
That looks more like a failure to look very hard than reason to believe nothing is amiss.
If the Administration were serious about getting to the bottom of this mess, it would be using a very different process, one with far heavier involvement of independent individuals with real expertise.
5. The process is not transparent. If the objective really were to get to the bottom of questionable behavior in mortgage-land, the process would be far more open, with a clear statement of issues to be addressed and general remarks about process. Weirdly, the Obama Administration seems to want to have its cake and eat it too. It wants credit for having been pro-active on this front, yet seem at the same time trying hard to keep this operation as invisible as possible. When I tried to ascertain how long the Foreclosure Task Force had been at work for instance, I searched the Treasury web site (both “foreclosure task force” and foreclosure + “task force”) and could not find the usual press release announcing its formation. The state attorney generals investigating foreclosure improprieties appear to be aware of it; Tom Miller of Iowa commented favorably in his Senate Financial Services committee testimony on the cooperation he had gotten from Treasury, specifically Michael Barr. So why such a low public profile on such a hot topic?
From what I can infer, this exam is part of a broader effort by something called the Financial Fraud Task Force. Yet when I put that string in Google News, it has been so low profile as to have garnered a grand total of four stories in a Google News search. A decent announcement would generate more fanfare than that. In fact, it appears it was being noised about in early November (Andrew Leonard of Salon mentioned it then), it was not officially established until November 17. (Update/correction per Marcy Wheeler of FireDogLake: the fraud task force was established in 2009, but despite the grand language associated with its formation, it appears to have rested largely moribund, given its apparent inaction until now. The lack of any footprint in the media suggests that this is its first meaningful initiative, and that in turn does not appear to have been presented in any public forum prior to the FSOC hearings I can find save a mention-in-passing by Andrew Leonard early in November, the NPR interview that Salmon highlighted, and the Salmon/Barr chat. The near invisible profile does appear to be by design. Back to the earlier post).
This is precisely the same tactic the American Securitization Forum used when it released its remarkably unconvincing white paper on the conveyance of mortgage loans the same day of the Senate hearings. The intent, as with the ASF, is to create the impression at the same time meaningful probes are on that the supervising adults really do have matters in hand, and therefore there is no reason for the public to worry its head about these matters.
A saying I heard in Venezuela is, “A politician is someone who gets in front of a mob and calls it a parade.” The cynic in me wonders whether the impetus for this task force was the announcement of the 50 state attorney general investigation into the foreclosure mess. Thus, Treasury’s seeming generosity and cooperativeness may result from their desire to influence, moderate, and if necessary, end run the attorney generals’ investigation.