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Mortgage Servicers Are Hugely Conflicted

Posted by Larry Doyle on July 23, 2010 12:57 PM |

Information is everything. Those who control the information have immense power. The allegiances of those in control of the info obviously have an enormous impact on how the information is processed and dispensed. The potential for conflicts of interest are significant. Standard business fare, correct? Have these conflicts played out on Wall Street? All too often. How so?

I have repeatedly highlighted the conflicts within our financial regulatory structure. We also know that the credit rating agencies have been enormously conflicted. Anywhere else? Let’s enter the world of mortgage servicing, …..

What Does Mortgage Servicing Rights – MSR Mean?
A contractual agreement where the right, or rights, to service an existing mortgage are sold by the original lender to another party who specializes in the various functions of servicing mortgages. Common rights included are the right to collect mortgage payments monthly, set aside taxes and insurance premiums in escrow, and forward interest and principle to the mortgage lender.

Seems like a fairly simple business, correct? Who are the largest mortgage servicers? No surprise that the largest servicers just so happen to be the largest mortgage originators, those being Wells Fargo, JP Morgan Chase, and Bank of America. Where is the conflict? The servicers not only manage the cash flows from mortgages for their parents but they also manage the cash flows from the mortgages that are backing a wide array of securitized, structured transactions. As such, the servicers are positioned to protect the interests of investors to make sure that principal and interest payments are made on the transaction. Where is the conflict? Let’s navigate.

What happens when investors question the integrity or lack thereof of mortgages that have been underwritten by a bank that then packaged the loan into a securitized transaction? What’s that, you say, you want the layman’s version? What happens when a bank or related entity fraudulently underwrites and conveys a loan into a deal? Shouldn’t the servicer unearth that loan and put it back to the bank which underwrote it in the first place? In theory, one would think the servicer should do that. In practice, do they? In the current environment in which a LOT of mortgages were poorly, if not fraudulently, underwritten this issue presents a major conflict for the servicers and a potential MAJOR liability and loss for the banks.

Bloomberg recently highlighted this issue in writing, Fannie Subpoena to Show 30B (that’s billion, boys and girls!!) Bad Mortgages, Rosner Says

Fannie Mae’s and Freddie mac’s  regulator may identify as much as $30 billion of debt included in mortgage bonds that the companies can force sellers to repurchase, according to Joshua Rosner, an analyst who in 2007 predicted the collapse in the market for the securities.

The Federal Housing Finance Agency this month said it issued 64 subpoenas seeking loan files and other documents related to so-called non-agency mortgage securities bought by the two government-supported companies. The U.S. is trying to determine whether misrepresentations might require issuers to repurchase debt, producing funds from firms that may include Wall Street’s largest banks to help repay taxpayer money.

If the large Wall Street banks are forced to repurchase fraudulently underwritten mortgages won’t this simply be a refiltration process of taxpayer funds. Yes, I believe it will be. However, what about the servicers. Where are they in this process? Aren’t they compelled to perform and protect investors in the deals? One would think. But who eats the losses on the poorly and fraudulently underwritten loans? The servicers’ parents, those being the banks. Bloomberg offers,

Mortgage servicers have hindered investors’ efforts to get debt repurchased by denying them access to loan files, citing a right to do so if they don’t own at least 25 percent of the deals, said Bill Frey, head of Greenwich, Connecticut-based securities firm Greenwich Financial Services LLC.

“The subpoenas will hopefully stop the silliness,” Frey, who sued Bank of America’s Countrywide unit in 2008 over its servicing practices, said in a telephone interview.

Standard fare? Perhaps, but when you are talking about billions of dollars in losses, the conflicts are certainly not standard. Regrettably in the oligopoly currently operating on Wall Street, the conflicts embedded in mortgage servicing are truly accentuated.  

LD 

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  • Ron

    Do not forget that the servicers are also conflicted in terms of modifying mortgages.

  • fred

    LD,

    Your at ground zero, stay on this one.

    Barrons this weekend…FDIC has no $, plans to sell mortgage backed securities with Fed guarantee, that would otherwise sell for between .10-.50 cents on the dollar,(Hmmm wonder who the servicers are), to raise necessary funding rather than go thru Congress as otherwise required by law.

    Do you think book values for financial cos. are overstated?
    The only way earnings and cash flows can cover understated losses is if they remain buried as “held to maturity assets” and then, as if by magic find themselves onto the gov’ts balance sheet.

    Barron’s again…Aflacs a buy because they can hold investments until they mature at 100 cents on the dollar rather than marking them to market. Do they really think underwriting issues will just simply disappear if held to maturity? ONLY THEIR SERVICERS WILL KNOW FOR SURE!

    • fred

      Berkowitz over at FAIRX, a very savvy investor, has begun building a position in MBIA @ 1/2 X book value proving that there is a market out there for distressed securities but it’s not at par.

      Why not just take the hit and let the market value these securities…shareholders have taken the hit, MBIA went from 60 to 7, (SEC where are you), why not bondholders. Since the crisis is past, if you believe the experts, let’s stop sticking our kids and grandkids with the financial mistakes made by a “select” few.

  • LD

    Fred,

    The fact is although the powers that be would like to present the crisis as having passed, the fact that the Fed is talking about the need for more stimulus is a clear indication that that the economy and markets remain very challenged to stand on their own.

    The big banks are winning real big under the current rules and regs so I do not expect to see substantial changes to these rules of the road anytime soon.

    The next interesting debate will likely be as a result of the FASB and IASB (International Accounting Standards Board) and IFRS (International Financial reporting Standards) convening to discuss fair value accounting.

    See more here,

    http://www.fasb.org/cs/ContentServer?c=FASBContent_C&pagename=FASB/FASBContent_C/NewsPage&cid=1176156961430

  • fred

    LD,

    the fact remains, unless you have “mark to market” accounting of securities, you don’t have true transparency.

    the flipside, buyers will not step in, even for a real bargain, until pricing stabilty is perceived to have been established.

    As for non financial corporations and purchase price accounting, I’m reminded of the classic scene between Matt and Robin over at Bunker Hill Community, “Goodwill Hunting”.

  • Maybe if Fannie and Ginnie just stopped purchasing mortgages being sold to them by MERS, they’d be in better shape. As it is, with MERS involved in the chain, they’re only legally being sold the MORTGAGE and not the NOTE.

    Additionally, both Fannie and Ginnie have been purchasing mortgages that are most likely going to end up with significant service related issues/claims due to the $108M C-wide/BAHLS FTC enforcement action. Last I heard, the class was projected to be somewhere in the 200k range.

    Not only is Fannie and Ginnie purchasing these tainted mortgages but they are FORECLOSING on them. That is ultimately going to come back and bite them IF the enforcement action notices ever reach the foreclosed borrower.






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