WASHINGTON — Federal Reserve Board Gov. Sarah Bloom Raskin said late Friday that the mortgage servicing industry needs to overhaul its practices and be more accountable, delivering the central bank's toughest words to date on the subject.
At a housing conference in Utah, Bloom Raskin dismissed current servicing practices as a "broken system," and called on the industry to change how servicers are compensated, restructure pooling agreements and improve organizational accountability.
"For those in the housing and mortgage fields, making needed changes will not be easy," Bloom Raskin said, according to a copy of her prepared remarks. "In particular, for those in the mortgage servicing industry, it means difficult changes and significant investments to rectify broken systems. … Until these operational problems are addressed once and for all, the foreclosure crisis will continue and the housing sector will languish."
Bloom Raskin said regulators are due to release their review of servicing standards later this month, and what they have found is disturbing. "The preliminary results from this review indicate that widespread weakness exist in the servicing industry," Bloom Raskin said. "The agencies intend to report more specific findings to the public soon, but I can tell you that these deficiencies pose significant risk to mortgage servicing and foreclosure processes, impair the functioning of mortgage markets and diminish overall accountability to homeowners."
For the first time, Bloom Raskin elaborated on just what changes the Fed desires. First, she called on bank holding companies to be more accountable for the actions of their servicing units.
"For those servicers who are subsidiaries or affiliates of a broader parent financial institution, the responsibility for change and further investment absolutely extends up to that parent company, many of which have enjoyed substantial profits while their servicing arms have been run on the cheap," Bloom Raskin said.
She also called for strong corporate governance procedures for servicers that are monitored and enforced enterprisewide to prevent breakdowns.
"Servicers need sound policies and procedures that outline the rules, laws, standards and processes by which internal operations are assessed," Bloom Raskin said. "Senior executives need to emphasize compliance and qualitative measures over short-run cost efficiency, and need to articulate the presence of adequate quality controls and audit processes to identify risks and take timely, corrective actions where needed. Corporate leadership needs to communicate performance expectations that hold all business lines accountable to strong procedural controls."
If errors do occur, Bloom Raskin said servicers must do a better job of reacting swiftly to contain damage to consumers and the market. She also called on regulators to do more to police servicers.
"Regulators now have to be prepared to monitor servicing functions on an ongoing basis to ensure confidence is restored and take enforcement actions, when necessary, to address significant failures," Bloom Raskin said.
She also called attention to the problems in the pricing model. Bloom Raskin agreed with an argument lately from Federal Deposit Insurance Corp. Chairman Sheila Bair that the current model fosters misaligned incentives.
"Costs associated with collections, loss mitigation, foreclosure, the maintenance and disposition of real estate owned properties and so on, are lumpy and can be high," Bloom Raskin said. "The current model is structured with the hope that, over a given period of time, there are enough of the low-touch performing loans to cross-subsidize the high-touch nonperforming ones, so that the overall pool of servicing-fee revenue is sufficient to cover expenses and return a reasonable profit. But if that doesn't happen, servicers are either being paid too much for their efforts or not enough."
Instead, Bloom Raskin said servicers' pay should be closely tied to expenses and reduce the principal agent fee that covers performing and delinquent loans. She suggested servicers could be required to have the capacity for loss mitigation and work with delinquent loans and third parties.
"Contracts could spell out a structure wherein the investor would pay significantly higher and more direct compensation for the more labor-intensive work involved in delinquent loans, though they would need to be careful not to create perverse incentives to encourage such delinquencies," Bloom Raskin said. "Another structural change that would help would be a limit on the extent to which servicers have to advance principal and interest on nonperforming loans. In times of high delinquency, this can put considerable financial strain on servicers, which can lead to negative consequences for consumers trying to work with those stressed servicers."
Bloom Raskin also called for more clarity about loss mitigation standards and systems for auditing purposes.
And finally, Bloom Raskin called for changes to pooling servicing agreements to provide more clarity about what the servicer can and cannot do.
"They should explicitly allow for loan modifications and other nonforeclosure workout actions when they are determined to lead to a smaller loss to the investor than would a foreclosure," she said. "There also needs to be clarity that the servicer is expected to work in the aggregate best interests of the investor, regardless of tranche. And we need to find ways to deal with the problems that arise from the conflicting interests of senior and junior lien interests that can hold up workable alternatives to foreclosure."
Bloom Raskin urged speed to fix the servicing model.
"This isn't easy, and time is of the essence because the drag on our recovery is palpable," she said. "We need the incentives that permit us to re-engineer this sector of the market and build a business model that actually works. … But the government can only do so much, and relevant private-sector actors need to think beyond their bottom line and focus on how their firms' actions are or are not contributing to the economic recovery."
