If you ask a homeowner who has tried to get a government-certified mortgage modification from a bank, half the time you’ll hear a story of lost paperwork, incompetence, and interminable phone calls to call centers with unhelpful staffers. Recent foreclosure mitigation programs designed by the government are not merely poorly conceived, they are poorly implemented. In discussing principal write-downs, one must take this into account. Who is going to do the writing down? Who will be eligible? What about homes with second mortgages? Most importantly, is there a good database that can match those second mortgages to first mortgages?
The Government Accountability Office has shown, as recently as March of 2011 that there are serious operational problems with the second lien write-down program implemented by Treasury to date. Bluntly speaking, the GAO reports, Fannie doesn’t have the computer systems and quality databases to match second mortgages with first mortgages.
The administration, the banks, and Fannie/Freddie have an impressive track record of operational failure when it comes to implementing mortgage modification programs in the mortgage market. HAMP, the administration’s major housing initiative, bombed not just because of program design, but because of severe operational problems. These kinds of loan modification programs have created bitter mistrust; debtors often send in papers, are given inconsistent instructions, and never hear back on pending loan modifications. Sometimes, debtors will get a loan modification, and after nine months or so of paying on-time, they’ll get a foreclosure notification out the blue. Some of this is because of misaligned incentives in the bank servicing model, but some is a simple lack of operational competence in the form of inadequate record-keeping, staffing and training, and quality assurance.
These same operational competence problems plague the regulatory community. A lack of good data has made it difficult to police programs implemented by banks. The Congressional Oversight Panel came out with a report years ago documenting the glaring absence of a central and complete source of data on foreclosures and mortgages. Regulators must rely on self-reported data by the servicers, or on private foreclosure or mortgage tracking companies.
These operational constraints on both bank and regulator capacity have simply not been addressed. With that in mind, let’s go back to the Government Accountability Report from March of 2011 in which the GAO points out that Fannie and Freddie can’t match first and second liens.
Treasury’s 2MP guidelines specify that in order for a second lien to be modified under 2MP, the corresponding first lien must first have been modified under the HAMP first-lien modification program. Fannie Mae, as the MHA program administrator, has contracted with a mortgage loan data vendor—Lender Processing Services (LPS)—to develop a database that would inform second-lien servicers when the corresponding first lien had been modified under HAMP.
LPS was also the data vendor used by Fannie Mae to process the loan level data reported by servicers for the HAMP first-lien program. Under 2MP, participating servicers agree to provide LPS with information regarding all eligible second liens they serviced. LPS, in turn, provides participating 2MP servicers with data on second liens that have had the borrowers’ corresponding first-lien mortgages modified under the HAMP program. However, the five participating 2MP servicers we spoke with all expressed concerns about the completeness or accuracy of LPS’ data. In particular, they noted that differences in the spelling of addresses—for example, in abbreviations or spacing—could prevent LPS from finding matches between first and second liens.
Additionally, another servicer reported that first-lien data could be incorrectly reported in LPS—for example, in one case, a borrower was incorrectly reported as not in good standing and, subsequently, was reported as canceled from HAMP. This mistake prevented the borrower’s first and second liens from being matched, even though the borrower was in good standing and eligible for 2MP. Treasury has also acknowledged that an inability to identify first- and second-lien matches poses a potential risk to the successful implementation of 2MP.
This of course has bearing because Treasury is putting enormous pressure on FHFA administrator Ed Demarco to write down principal on loans held by the taxpayer (Fannie and Freddie), even when there’s a second lien held by a bank whose value will be increased by the write-down (or when a mortgage insurer’s exposure is reduced by a write-down).
Treasury’s argument is that second liens will have to be written down proportionally when a first lien is written down. As David Dayen points out, “The seconds are supposed to take the full hit before the firsts get touched.” That’s not happening, so even in the best case scenario, this is a straight up taking of property from investors and redistribution to banks and mortgage insurers. Dayen concludes, “Now we get confirmation that it is, in fact, government policy to maintain seconds while writing down firsts, from no less than the US Treasury Department.”
Remember, that’s the best case scenario. But Fannie and Freddie simply can’t match first and second liens. So how can they possibly ensure that second lien holders take a write down when the first lien holders do? I’m guessing that they can’t. And I’m also going to guess that the OCC, which claims to be able to match the liens (though we don’t obviously know if they can), won’t force the issue. I’m told by a prominent investor that it’s not that hard to match these, so the negligence could possibly be intentional. But really, in terms of outcome, the intent is irrelevant. The operational incompetence is basically a way of ensuring that the write-downs of bank owned second liens, inadequate as they are, probably will never happen. It’s just a recipe for cheating.
Interestingly, it seems like who controls the data controls the market. There was a provision in Dodd-Frank mandating that Shaun Donovan’s HUD create a national database of foreclosures and mortgages. I believe that LPS lobbied against its implementation. This is not a surprise. It’s also not surprising that LPS can’t handle the first and second lien matching particularly well. The operational issues, though they aren’t sexy, are a significant constraint on policy-making. Of course, you could just ignore program design and write down first mortgages owned by the taxpayer to benefit big banks. It’s not necessarily the worst policy option. It’s a pretty bad solution, though. And the fact that Treasury is pretending that second liens will be written down at all, when there isn’t the operational competence to even identify what needs to be written down, shows that this is about cheating the taxpayer to help the banks.
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