Rorty Bomb website reports:
What Do Servicers Do? A Case Study in Bad Design and Worse Incentives
Servicers in a mortgage-backed security have two businesses. The first is transaction processing. This means taking in your mortgage money on one end and walking it over to the crazy tranches and payment waterfalls on the other end. This is clean, efficient, largely automated, requires little discretion and works very well, and implicit in it is that it is most profitable when you can harness economies of scale.
It’s considered a “passive entity” in fact, so there are no taxes applied in this passthrough mechanism. If servicers went “active”, say by looking for mortgage notes not in the trust 90 days after the fact or mortgage notes that are not in the trust that have defaulted, which is what they’d likely have to do to get out of this foreclosure fraud crisis, they’d face very severe tax penalties.
Their other business is to handle default situations. In addition to the fixed fee they get for servicing each individual mortgage they get paid from default fees like late charges. They get to retain most, if not all, of these fees.
So right away they have an incentive to not find ways to negotiate to get a mortgage to a good state. They also have a strong incentive to keep a steady stream of fees and charges going to their books rather than to investors. So anything that puts servicers in charge of negotiating mortgages, say the Obama’s administration’s HAMP program, is designed to fail.
Because even without bad incentives, doing good work on modification is costly, time consuming, requires individual expertise and experience and doesn’t benefit from automation or economies of scale. Which is to say it is the opposite structure of their normal business.
And there are additional worries. Many of the servicers work for the largest four banks – Wells Fargo, Bank of America, Citi, and JP Morgan – and these four banks have large exposures to junior liens. These are second or third mortgages or home equity lines of credit that would have to be wiped out before the first mortgage can be modified. The four banks have almost half a trillion dollars worth of these exposures and, from the stress test, are valuing them at something like 85 cents on the dollar. Keeping a homeowner struggling to pay the second lien would be more worthwhile to these middlemen banks than getting him or her into a solid first lien to the benefit of the bond investor.
So keep these in mind as you read about the servicers here. There have been worries that they, as a designed institution, were simply not qualified for this job going back a decade. They have massive conflicts with the investors they are supposed to be working for. They profit when homeowners collapse and lose money when they are brought up to a normal payment schedule (made current). And if the instruments don’t have the notes necessary to bring standing to carry out the foreclosures they have to take a massive tax hit in order to take the note into the trust. And regulation to handle this isn’t in place.
No Regulator
Because for all the talks of regulatory burden, there is no current federal government agency that regulates the servicers. Not the Federal Reserve. Not the Treasury. This is what happens when the financial industry writes the deregulation. Instead you have a patchwork of state regulators and attorney generals. Notice how President Obama has nobody to turn to and tell the press that “So and So is on the case.” In theory the OCC regulates servicers if they are part of a bank or a thrift. This must fall to the new regulatory counsel and the Consumer Financial Protection Bureau to investigate, where it will properly belong.
What Do Servicers Do? A Case Study in Bad Design and Worse Incentives
Servicers in a mortgage-backed security have two businesses. The first is transaction processing. This means taking in your mortgage money on one end and walking it over to the crazy tranches and payment waterfalls on the other end. This is clean, efficient, largely automated, requires little discretion and works very well, and implicit in it is that it is most profitable when you can harness economies of scale.
It’s considered a “passive entity” in fact, so there are no taxes applied in this passthrough mechanism. If servicers went “active”, say by looking for mortgage notes not in the trust 90 days after the fact or mortgage notes that are not in the trust that have defaulted, which is what they’d likely have to do to get out of this foreclosure fraud crisis, they’d face very severe tax penalties.
Their other business is to handle default situations. In addition to the fixed fee they get for servicing each individual mortgage they get paid from default fees like late charges. They get to retain most, if not all, of these fees.
So right away they have an incentive to not find ways to negotiate to get a mortgage to a good state. They also have a strong incentive to keep a steady stream of fees and charges going to their books rather than to investors. So anything that puts servicers in charge of negotiating mortgages, say the Obama’s administration’s HAMP program, is designed to fail.
Because even without bad incentives, doing good work on modification is costly, time consuming, requires individual expertise and experience and doesn’t benefit from automation or economies of scale. Which is to say it is the opposite structure of their normal business.
And there are additional worries. Many of the servicers work for the largest four banks – Wells Fargo, Bank of America, Citi, and JP Morgan – and these four banks have large exposures to junior liens. These are second or third mortgages or home equity lines of credit that would have to be wiped out before the first mortgage can be modified. The four banks have almost half a trillion dollars worth of these exposures and, from the stress test, are valuing them at something like 85 cents on the dollar. Keeping a homeowner struggling to pay the second lien would be more worthwhile to these middlemen banks than getting him or her into a solid first lien to the benefit of the bond investor.
So keep these in mind as you read about the servicers here. There have been worries that they, as a designed institution, were simply not qualified for this job going back a decade. They have massive conflicts with the investors they are supposed to be working for. They profit when homeowners collapse and lose money when they are brought up to a normal payment schedule (made current). And if the instruments don’t have the notes necessary to bring standing to carry out the foreclosures they have to take a massive tax hit in order to take the note into the trust. And regulation to handle this isn’t in place.
No Regulator
Because for all the talks of regulatory burden, there is no current federal government agency that regulates the servicers. Not the Federal Reserve. Not the Treasury. This is what happens when the financial industry writes the deregulation. Instead you have a patchwork of state regulators and attorney generals. Notice how President Obama has nobody to turn to and tell the press that “So and So is on the case.” In theory the OCC regulates servicers if they are part of a bank or a thrift. This must fall to the new regulatory counsel and the Consumer Financial Protection Bureau to investigate, where it will properly belong.
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