Foreclosure reforms may be coming to a head

Getting banks, investors and borrowers together to work out a solution that benefits them all is the most promising idea to emerge since the housing market first crashed.

We are now in the fifth year of a housing crisis in which more than 3 million Americans have lost their homes to foreclosure, with millions more still at risk.

Every initiative — government or private — to stem the tide of misery has fallen leagues short in the face of continued economic gloom and the intransigence of lenders.

So it's an odd moment to be identifying glimmers of optimism that solutions to the crisis might finally be emerging. Yet that may be the case.

Over the next few weeks, several initiatives aimed at reforming the foreclosure process, holding mortgage lenders and services accountable for their past abuses, and creating more effective mortgage workouts are coming to a head.

First, some context. The complexity of the foreclosure crisis stems from the process of bundling hundreds of thousands of mortgage loans into securities and selling them to investors.

Typically, banks and other lenders retained almost no financial interest in the mortgages they originated, other than the duty to service them — collect payments and pursue delinquent borrowers, say — for which they received a fee.

Several drawbacks to that system emerged when the housing economy crashed. Because the loans weren't going to stay on their books, the lenders hadn't been too careful about whom they lent to and on what terms.

Ownership of the repackaged loans was dispersed among investors, so it's hard to know even today who the owners are or whether their ownership is properly documented. This has led to further abuses, such as the infamous "robo-signing" outbreak, in which institutions trying to foreclose on mortgages have submitted forged documents attesting to their legal right to do so.

Perhaps the biggest problem is that although the servicers, which include huge banks such as Bank of America and Wells Fargo, are burdened with the responsibility to renegotiate mortgages to keep borrowers out of foreclosure, their authority to do so on behalf of investors is murky.

As a result, though the investor, the borrower and the economy in general benefit if a home is kept out of foreclosure, even if that means its owner makes lower payments than were required by the original mortgage, the servicing banks are leery of renegotiating too aggressively.

The most closely followed remedial effort involves the 50 state attorneys general under the leadership of Iowa Atty. Gen. Tom Miller.

Last March, the group produced a 27-page proposal for foreclosure reforms that drew fire from some consumer advocates for being too lenient — its provisions include mandates that banks comply with state law in dealing with borrowers, as if that's a novel concept — and from business interests for putting too much pressure on banks to reduce principal balances for homeowners having trouble keeping up payments on homes with values that have fallen below the mortgage balance.

But Miller's group is under pressure to issue a final proposal around Labor Day. The longer the settlement talks drag on, some observers say, the harder it becomes to keep all the participants on board.

Indeed, a key attorney general who has been skeptical of Miller's approach is pursuing his own line.

New York's Eric T. Schneiderman recently took a promising step by filing to intervene in the proposed legal settlement between Bank of America, which acquired mortgage king Countrywide Financial, and Bank of New York, which managed 530 investment trusts that bought packages of Countrywide mortgages. Schneiderman wants to block the settlement unless it's improved.

The settlement calls for BofA to pay investors in the trusts $8.5 billion and to commit to an improved mortgage servicing and modification process, including giving "individualized attention" to high-risk borrowers aimed at helping them stay in their homes.

Among the deal's flaws, according to Schneiderman's motion, is that the payment is too low and the settlement indemnifies Bank of New York against further claims for fraud in its handling of the trusts. Schneiderman says the bank, which he contends is guilty of numerous violations of state law, had a conflict of interest in cutting a deal that let itself off the hook. (The New York state judge overseeing the BofA settlement talks with Bank of New York hasn't yet ruled on Schneiderman's motion.) Several investors have also objected that the two banks made the settlement privately and secretly.

Despite its shortcomings, the proposal settlement does provide a possible framework for solving the foreclosure crisis by giving all parties something they want: Borrowers get efforts at loan modifications from their banks, in return for which the banks and investors would get the borrowers' acknowledgment that they're owed the money. Fewer foreclosures, more loan modifications and an end to robo-signing — in the housing world, that's nirvana.

Schneiderman has some pretty heavy artillery to bring to the battlefield.

Most of the trusts subject to the proposed settlement fall under the jurisdiction of New York law (the rest come under the law of Delaware, whose attorney general, Beau Biden, is working with Schneiderman). As my colleagues Nathaniel Popper and Alejandro Lazo reported last month, the standard for fraud claims under New York law is less stringent than under federal law.

A third driver of solutions to the foreclosure crisis is investigations by individual states into foreclosure abuses. California, where nearly 800,000 homes have been lost to foreclosure since 2006, according to the property information service DataQuick, and tens of thousands more might fall in the next year, is ground zero of the foreclosure crisis.

Atty. Gen. Kamala Harris has been playing both sides of the fence; she has met with Schneiderman to discuss cooperating in his investigation of securitization fraud, but is also watching the 50-state effort to see if it produces "accountability and results" for California borrowers. Read that as: a cash settlement commensurate with the pain caused to Californians by foreclosure abuses, and real reform. The louder that states like California threaten investigations, the more inclined banks may be to agree to reform.

It's still unclear how each of these initiatives will influence the others, or indeed if any of them will result in relief for strapped and defrauded homeowners. Bankers have been perfectly candid about their power to draw out the legal process indefinitely if they choose: Bank of New York has defended its proposed $8.5-billion settlement with Bank of America in court by warning that the alternative is "litigation …over the course of several years."

It warns that there might be legal questions over whether Bank of America, which acquired Countrywide in 2008, could be forced to cover judgments against the latter. Without BofA's deep pockets, it's hinted, there won't be money for anyone.

The one incontrovertible fact about the foreclosure crisis is that voluntary loan modification efforts, whether they're conducted under the sponsorship of the government's Home Affordable Modification Program or the mortgage industry, haven't helped more than a handful of affected borrowers.

Bringing the banks, investors and borrowers to the same table to work out a solution that benefits them all is the most promising idea to emerge since the housing market first crashed. Why has it taken so long to get there?

Mortgage Lending News