Fifty Sets of Foreclosure Rules

The mortgage industry has been absorbed in pulling itself back onto its feet for close to four years now. The work that has taken place to sort out what went wrong, to establish blame, and to make restitution where it could be made, is staggering. As a nation and as an industry, it’s clear we can see a light at the end of the tunnel. Historical loan reviews, whether for private investor suits or at the demand of public authorities, are largely defined, and many or most are underway, with some near completion. The economy is showing signs of life. As we near the end of this period of looking back to assess what brought on this collapse, it’s becoming more realistic to envision the day in the near future when the private sector will again have the confidence to lend and to invest in mortgages.

I’m concerned, though, that the light might be just the next train coming toward us. The reason is that we have not seen constructive change in how we lend and borrow. Without major change, it’s going to be Groundhog Day, and that’s why this blog goes by that name. I see little value establishing what happened, if we don’t take from that some important lessons.

Yes, there is Dodd Frank, and maybe someday we’ll be able to pull out of it some parts that are meaningful, and possibly put them in place in a way that makes some difference. But much of what went into that law missed the mark, and won’t make a real difference, even if the industry is able to determine how to implement it.

There is one significant change that would make a lasting difference, and that would mean we won’t be back in the same place in just a couple of years, examining what went wrong this time.

The most sweeping change, and the simplest, would be to establish one foreclosure law for the country.

I know that sounds like an impossible task, but I think it has to happen. Here’s why.

Let’s start with an understanding about mortgage loan servicers. These are, of necessity, very large institutions. The reason is that they are scale businesses. If you are going to service more than a handful of loans, you have to have a servicing system, which is tremendously expensive. You have to have functional leaders with a high degree of expertise, in a number of positions. You have to have capital, to install things like auto-dialers. In other words, you have to be big. To make a living at servicing, you have to service a lot of loans, because the fees you make from one loan aren’t that much. Although these fees represent a lot of money to us, as individuals, one loan or a few thousand loans won’t come close to paying for a servicing center. So, servicers have to be big enough to take on large portfolios.

If you take on large portfolios, you’ll need to take on loans from more than one state. Therein lies the problem. Every state has its own set of foreclosure laws, and they vary vastly from one another. Another fact about foreclosure laws is that they change constantly. To service a large portfolio of loans, a servicer has to have expertise in fifty sets of complex, continually changing foreclosure laws. The complexity alone increases costs which must be passed onto borrowers.

The common solution is to outsource most of the foreclosure process to local and regional law firms, but that doesn’t guarantee that the foreclosures will be done properly. Law firms, including the bulk foreclosure processors, make mistakes too. And servicers are still responsible for getting the foreclosures right. That fact has been explicitly driven home in this financial crisis.

Here’s the reality: no servicer, no matter how big, no matter how much is invested in systems and training, is ever going to be able to even come close to getting every foreclosure right. It’s impossible. In fact, most servicers are going to make a fair number of mistakes, most of which, with any luck, will be insignificant, but some of which could be damaging.

What we need to consider is that this hasn’t changed, and there is no plan for it to change. At the end of this crisis, when all the investor suits are settled and regulatory reviews are final, we will still have servicers trying to manage to fifty sets of foreclosure laws.

When compared to bankruptcy, which is federal law, notice how rarely one reads in the newspaper about borrowers whose bankruptcy was botched, yet how many times borrowers complained that their foreclosures were botched. That’s because it’s not nearly as hard to stay on top of one set of laws as it is to figure out how to implement fifty of them.

Getting one set of foreclosure laws in place would take a lot. The states don’t want it. The reason is that each state wants to be able to set its own agenda to best meet the needs of its constituents. Some states want to be able to evict and foreclose in just a few weeks, to minimize investor losses, and others want the process to take a year or more, so the borrower has every chance to recover. Finding a middle ground would be a challenge, to say the least. But the consequence of not making this fundamental change is that this country will move forward with a stronger economy, people will take out loans again, they will stop paying, and servicers will again have to sort through fifty sets of complex and changing rules, they will get it wrong, and we will be right back where we are now.

I call it Groundhog Day.

And for those of you like our state Attorney General’s office, who think it is simply not a possibility, I’d like to add that just over three years ago nobody would have thought it possible to be doing what this company is doing today—reviewing loans with complete independence, attesting to our results, and working for nearly every issuer in the country, all because this industry is committed to bringing real credibility to the mortgage industry. I think it’s quite doable, as a matter of fact.

I’ll talk about how to implement one set of foreclosure laws in a subsequent blog post. I’d be interested in your comments, in the meantime.