How to Make Money by Screwing Your Customers
The mortgage servicing industry has always been a bit of a black hole. Servicers aren't the folks who make loans, package loans, or invest in loans. Rather, they're the folks who collect payments and handle the routine administrative work after loans have been packaged up and sold off as securities. Basically, they do the gruntwork.
So they had little to do with creating the mortgage crisis of the aughts. However, despite their unglamorous middleman role, they've been one of the chief obstacles to fixing the mortgage crisis over the past few years. The reason is fairly simple: they make more money by screwing borrowers who are in trouble than they do by trying to come up with solutions. David Dayen explains:
In general, servicers are paid through a percentage of the unpaid principal balance on a loan. This creates problems when a borrower gets into trouble and can no longer afford their payments. There are many modifications to help a borrower in such a bind, the most sustainable, successful type being direct reductions of the principal, for obvious reasons. But forgiving principal cuts directly into servicer profits by cutting the unpaid principal balance, so most servicers shy away from it. Moreover, servicers collect structured fees — such as late fees — which make it profitable to put a borrower in default and keep him there. And foreclosures don’t hurt a servicer, because they make back their money owed, along with all fees, in a foreclosure sale, even before the investors for whom they service the loan. The investors take whatever losses result from a foreclosure; the servicer makes out just fine.
So there you have it. Servicers don't like simple principal reduction because that reduces their fees. Conversely, servicers do like it when borrowers get jerked around a lot because that increases their fees. And if it all ends up in foreclosure? That may be too bad for the investors, but servicers make lots of money from foreclosures. The bottom line is simple: servicers do best when distressed borrowers are (a) milked for a while and then (b) foreclosed on.
So naturally, that's what usually happens. The new Consumer Finance Protection Board has recently taken a crack at reforming this obviously absurd situation, but they probably don't have the legal authority to do much about it. However, David suggests that Fannie Mae and Freddie Mac probably do. Unfortunately, they aren't doing anything:
The FHFA/HUD servicer compensation process is showing few signs of life. They announced the initiative two years ago, and released a discussion paper in September 2011, inviting public comment on a couple broadly rendered alternatives, including a “fee for service” model where servicers would get paid a flat rate for performing loans, presumably encouraging them to keep the loans current. As is typical for these regulations, practically all of the public input on the discussion draft came from the mortgage industry. They objected to changing the system before they had new requirements in place, like the 2012 National Mortgage Settlement and the CFPB servicing standards. In addition, they made the usual complaints about undermining the market and increasing costs for borrowers.
Perhaps as a result, basically nothing has been done on servicer compensation since the fall of 2011. Officially, HUD spokesman Brian Sullivan calls the joint project a “work in progress.” An FHFA spokesman told me that “consideration of the servicing compensation issue will continue as FHFA moves forward with the Build portion of the Strategic Plan for the Conservatorships of Fannie Mae and Freddie Mac.” And in a speech last December, FHFA Acting Director Ed DeMarco remarked that they “have already completed a substantial amount of groundwork on this subject,” and that “it remains for me an important part of the work ahead.”
This has long been one of the most frustrating aspects of the mortgage crisis. Everyone understands that the incentives at work in the servicing industry are completely screwy, but no one has both the authority and the political will to change it. It's sort of a nutshell version of our entire political system these days.