The first real test of the $25 billion mortgage settlement comes Tuesday, when the nation's largest servicers must reveal their progress.
That's the deadline for the five companies — Ally, Bank of America, Citigroup, JPMorgan Chase and Wells Fargo — to certify that they are complying with 304 servicing standards, everything from loss-mitigation practices to adequate training to proper communication with customers.
"Every indication I have from all five servicers is they will be ready to perform each and every one of the servicing standards on Oct. 2nd," says Joe Smith, the former bank regulator hired to oversee implementation of the settlement's terms. "Each of the firms, to a varying level of severity, is going through a really extensive quality control process with regard to each of the standards."
Forty-nine states and the federal government struck a deal with the biggest servicers back in February that was designed to clean up the business and reimburse borrowers harmed during the foreclosure crisis. Smith, 62, was hired to ensure the servicers fulfill the settlement's mandates.
The first official report from the Office of Mortgage Settlement Oversight isn't due until a year after the settlement was finalized, or April 2013. But Smith didn't want to wait that long, so he released a preliminary progress report in late August and then gave a speech in his hometown of Raleigh, N.C., this month.
The settlement's next big test comes in November, when the five firms must detail how much relief has been provided to customers in each of the 49 states. (Oklahoma is the only state that did not join the settlement.) "I think the November report will be very interesting," Smith told me in an interview. "There was a lot of work in progress when we gave our [preliminary] report, so we will see how much came to fruition."
In particular Smith expects the November reports to show more principal is being forgiven on troubled mortgages.
For his August report, the servicers voluntarily estimated how much they had helped borrowers. The top-line figure: nearly 138,000 customers got $10.6 billion in relief, or $76,615 each. But the biggest chunk of that, by far, was $8.7 billion in short sales.
Only 12,500 borrowers got roughly $1.1 billion in principal forgiveness, which is the type of relief the settlement values most. But Smith says principal reductions were likely underestimated in August because the settlement requires borrowers to make three, on-time payments under the new mortgage before a servicer may count it.
The claims the servicers make in the November reports will be subject to two levels of review. The first will be done by groups of people employed by the servicers. These teams of 30 to 50 people, called independent review groups, will verify how much relief is being provided and confirm a company's compliance with the 304 servicing standards.
A handful of independent firms hired by Smith will then verify the work of these internal review groups. "We will do additional work and analysis to satisfy ourselves that this [internal] review was rigorous enough, that we can trust it," he says. "If we need more, I can ask for more."
The settlement gave Smith a slew of metrics to use to judge compliance plus the ability to create three "wild-card" metrics. If one of those is needed, he says it'll likely be used to address a problem at a specific bank rather than applied broadly.
"If I make a wild card up, it doesn't necessarily have to apply to all five of them," he says. "It would apply to somebody where I thought there was a problem.
"It gives me a reason to go back and talk with them about what I am hearing that may not be covered by the existing metrics and say, 'Look, here is what your complaints say. Here's what I hear from the field. I can add a metric if I have to. Do I have to?' "
The 304 servicing standards fall into seven categories, all of which Smith says are important.
"Each one of those contributed to a situation that, frankly, undermined the trust and confidence in the financial system. So to me they are relatively equal," he says. "The settlement was designed to remediate a specific series of alleged abuses."
Smith boils down what went wrong by saying banks were "overwhelmed, understaffed, undertrained, improperly mechanized and using third parties in a way that was inappropriate."
These companies "are massive enterprises," he says.
Too massive to manage properly?
"I think that remains to be seen. The people I meet are very capable people. And I think they have immense resources," Smith says. "I am hopeful it's going to work out."
That's how Smith sees much of what's happening in the mortgage business today. Optimistic but not yet convinced.
For instance, I asked him whether he thinks the banks "get it" — whether they are chastened by what happened in the mortgage meltdown and committed to avoiding a repeat.
"Talk to me in a year. We'll see," Smith says. "They are all serious about the process, very serious about compliance. I don't think there will be a failure because of an intention not to comply. That's my guess, but we'll see."
Smith endorses the move to wring bad actors and bad practices out of the mortgage business, but says the price may be less credit at a higher cost.
"The thing the policymakers need to be discussing is the cost of compliance with a necessarily more rigorous mortgage regulatory system," he says. "I am not saying it's wrong to have those costs. But I think the banks are going to reduce the number of loans that they are making and reduce the number of counterparties from whom they buy loans. The level of competition in the marketplace overall" will decrease.
"There is a chance," Smith says, "that the cost of this will reduce competition in the marketplace, and we don't know how that will affect the availability and cost of credit in the future."
Smith figures the standards will be loosened, eventually.
"I think the standards we've got are effective to address the abuses we've had in the past," he says. "I am not entirely convinced all of them will be needed going forward and can't be streamlined over time. But it's not the time to streamline yet. Let's get them in place and see what works and what doesn't."