The good news: regulators are pulling back the curtain on the consultants that the big mortgage servicers hired, under orders from the agencies, to review their foreclosure processes.
The bad news: what's been revealed isn't pretty.
Late last month the Federal Reserve Board posted two of the four engagement letters for servicers it regulates and nine project action plans. The Fed was following the Office of the Comptroller of the Currency, which three months earlier had published 12 engagement letters.
The regulators hoped releasing these documents would increase consumer confidence in the foreclosure review process and demonstrate the agencies' commitment to transparency and accountability. The act of disclosing might have had that effect – if the disclosures themselves weren't so troubling.
A big part of the problem is that many of the reviews are being done by Big Four auditing firms. For example, the Fed published an engagement letter between independent consultant Deloitte and JPMorgan Chase to review EMC Mortgage, a servicer the bank inherited from Bear Stearns. Deloitte is also engaged to review JPMorgan’s OCC-regulated mortgage business, including loans it got from the takeover of the failed Washington Mutual. The conflicts of interest here are egregious – in spite of claims by the OCC and Fed that they rejected some auditor-servicer engagements because of conflicts.
A foreclosure review could turn up errors an auditor had made. For example, the independent consultants must develop an estimate of potential liability for charging borrowers illegal or excessive penalties and late fees. If it turns out a bank was charging such improper fees before and during the foreclosure process, it means the auditor missed poor internal controls over the bank’s billing or fraudulent revenue-recognition practices.
The Deloitte partner in charge of the JPMorgan engagement, Ann Kenyon, was a partner on Deloitte's audit of Washington Mutual. So it would not be in her interest for Deloitte’s consultants to turn up any auditing errors the firm made with that mortgage originator, particularly since Deloitte is a defendant in shareholder litigation related to Washington Mutual's collapse. In addition, Deloitte audited Bear Stearns, and is going to trial as a defendant in Bear Stearns investor litigation related, in large part, to EMC. So the consultants wouldn’t have a strong incentive to find any auditing goofs there, either.
If that's not enough conflict to disqualify a firm, I don't know what is.
Even when a company isn't using a onetime auditor as its consultant, the incestuous nature of the Big Four audit firms creates strong disincentives for the one that did get a consulting assignment to dig too deeply.
Consider PricewaterhouseCoopers, which has been hired to do foreclosure reviews for Citigroup, U.S. Bank and SunTrust. What if PwC, in the course of this consulting work, discovers that KPMG made errors auditing Citi, or that Ernst & Young messed up when auditing U.S. Bank or SunTrust? Bringing such findings to light would only increase scrutiny of all of the Big Four, including PwC, because they are all supposed to be following consistent auditing standards and ensuring banks follow the same accounting and disclosure rules.
Likewise, why should Deloitte flag any problems it discovers with PwC’s audit of JPMorgan Chase? Why would Ernst & Young, the consultant to Bank of America, want to ask a lot of questions about PwC’s audit work there? There's nothing to see here, folks. Move along.