One of the more amusing moments of yesterday’s House Financial Services Committee hearings on foreclosure fraud was when the representatives for the loan servicers were asked why they were subsidiaries of the large financial institutions. The link between the servicers and the big banks, mainly caused by a series of mergers, leads to all kinds of conflicts of interest, because it inevitably pairs them up with the originator or trustee of the loan. The servicers had no real answer to this question. Finally, the Wells Fargo representative claimed that it was for “customer convenience,” because some customers had their mortgage and their checking accounts at the same bank.
Everyone’s jaw dropped in the hearing room.
Now Miller is out with a letter (I’ve placed it below), signed by all the top leaders of the House Financial Services Committee, that seriously ratchets up the demands on the Financial Stability Oversight Council. Among other things, it asks the FSOC to use its authority under Dodd-Frank to force the large financial institutions to divest from the loan servicers.
There is no apparent advantage in having financial companies that securitized mortgages also act as trustees or servicers, and there is an obvious conflict of interest. The uncertainty about the extent of the risk to our nation’s financial stability posed by the mortgage irregularities is largely the result of the control of critical information by financial companies at risk of insolvency from potential legal liability to mortgage investors and others. The control of critical information by financial companies with a possible motive to conceal systemic risks is incompatible with the intent of the Dodd-Frank Act, and is a grave threat to our nation’s financial stability.
In addition, the letter, signed by 11 members, including House Judiciary Committee chair John Conyers, Financial Services Committee chair Barney Frank and top members of the Financial Services Committee Maxine Waters, Luis Gutierrez and Stephen Lynch, also asks that the stress tests being held by the Federal Reserve include provisions for scenarios where the big banks must take back bad mortgages due to breaches of the pooling and servicing agreements (PSAs). They ask that the FSOC get a random sample of collateral loan files from the major servicers, so they can check it for the note, the deed of trust, and all supporting documents showing proper conveyance and recording. They want the Council to look at the servicing of mortgages where the servicer is affiliated with the firm that holds a second lien. The belief here is that the servicer is intentionally avoiding any modifications on those loans so their parent company doesn’t have to write down the second lien.
I talked with Rep. Miller late yesterday about the letter, and his views of where the foreclosure crisis is headed. A lightly edited transcript follows.
Q: So you really stepped it up a notch in this letter.
Rep. Miller: That was my intention.
Q: Was it designed to get the attention of the FSOC, or is this what you feel needs to be done?
Rep. Miller: It’s what needs to be done. The idea behind Dodd-Frank, and the lesson of the financial crisis is that we need to identify specific risks early, and not have those frantic weekends like we did in 2008. We have to make sure the systemic risks are not concealed from us.
It’s striking how similar this whole discussion is to what we had two years before the financial crisis about how significant the issue is. We’re hearing from the industry, from people involved in the securitization business that the problems are overblown, isolated, and technical in nature. We’re hearing from others that the problems are pervasive, cannot easily be cured, and perhaps not at all. I mean this may require hundreds of billions of dollars in buybacks. That’s more than the banks hold in capital.
Q: Do you think the FSOC will take your advice here? Do you get any indication that they see it as a systemic risk?
Rep. Miller: I simply do not know. The Congressional Oversight Panel called for stress tests to take into account potential liabilities from mortgage put-backs. A few days later the Fed said they were doing stress tests, and there was not word one about liability issues. It seems apparent that there’s a systemic risk here. I can’t imagine how they could do a stress test without looking at all the potential liabilities.
A: There was that extraordinary moment in the hearing when you were questioning Adam Levitin, and he said that the regulators don’t want to fix the foreclosure crisis because it would show that the banks are insolvent. Can they ignore this forever?
Rep. Miller: The letter, and the contents of the letter, would certainly make that difficult. I do not place a high priority on protecting the solvency of the banks if they are insolvent. Protecting bank solvency has been a goal for Treasury that I do not share. It has prevented them from doing anything about foreclosure crisis which is killing the economy. Millions of people are losing their homes. Millions more, pretty much everyone, are seeing the value in their home decline, which for most Americans is the bulk of their net worth. This is a huge burden on families.
Q: I noticed you were keen to call for things that don’t require Congressional approval. (Yesterday, Rep. Jim McDermott introduced a cramdown bill that would allow bankruptcy judges to modify mortgages, but that has little chance of passing Congress.)
Rep. Miller: I shifted into that pose much earlier this year. I wrote an article for the New Republic in February about starting an HOLC.
HAMP provides the authority to buy assets, which includes mortgages. I proposed they buy mortgages from pools. Because I didn’t think that companies with an interest in securitized mortgages would want to sell them at market value, but at the value on books, I proposed they use eminent domain. It was a distraction at the time from cramdown, which was what everyone wanted, but in many ways it provided a much broader authority to deal with the problem.
During the Depression, the HOLC turned a slight profit by the time it ended in 1951. They bought mortgages at a low price from failed banks. This was before safety and soundness regulation, so the banks were happy then to sell mortgages and get them off the books. The current eminent domain authority might extend to buying mortgages, so you wouldn’t have to come to Congress. Or maybe state and local governments could buy them, and we’ll buy it from them. Especially the hardest hit states may be willing.
Q: How big do you think this problem goes?
Rep. Miller: I’ve been apoplectic about this problem for years. Housing starts are at 1/3 of natural demand. There are maybe 10 million units in shadow inventory or on the market. At natural demand you’re going to sell 1.4/1.5 million units, and starts are at about 0.5 million. That’s an enormous employer of blue-collar Americans. We all knew we were going to have a correction. But the failure to get this under control has made it much worse, and there’s no end in sight. We all believe that, at some point, twenty-somethings will move out of their parent’s basement. Eventually people will start buying new housing, and we’ll have to replace obsolete housing. But the lack of new residential construction is an enormous burden on economy. The huge pent-up demand should become part of a virtuous cycle. But it’s not going to do it with the foreclosure crisis.
Q: I hear all the time that somehow Congress is going to be able to swoop in and fix this, do you think that can even happen legally?
Rep. Miller: I don’t. Professor Levitin’s proposal was my original idea for bankruptcy reform in 2007 (Levitin has proposed a global settlement, where servicers are removed from the process, and homeowners who can pay get principal reductions, with a quieting of title on securitized properties, and a restructuring of bank balance sheets to absorb the attendant loss). It quickly became apparent that it was preferable. We may eventually get to that point if the document problem becomes bad enough.
I don’t think we can do anything about the document problem from Congress, because the provisions of the PSAs apply. There’s a Constitutional issue there as well.
Q: And most of this is governed by state courts. You said to Ezra Klein that we have resolution authority, and we may get a chance to use it. Do you still believe that?
Rep. Miller: There is no possibility of another bailout. Not any possibility Congress will come riding to the rescue. Even if the alternative is an economic cataclysm. This may ultimately give us the opportunity to see how resolution authority works.
I’ve known Adam Levitin since the beginning of the cramdown debate. He has two possibilities, either one of which may result in insolvency for the banks. One, the investor suits, and from what I’ve seen, there’s a lot of merit to the claims for put-backs. The failure of documentation was pervasive, and the pooling and servicing agreements are very clear to the consequences, that banks would have to buy them back at face value. And the liability would exceed capitalization. Two, if we did what Levitin proposed, reduce principal and quiet title in a special process, the problem from the banks’ perspective is that would also push them over to bankruptcy.
Q: Do you get the sense that Republicans are paying attention to this issue at all? What will they do with it in the majority?
Rep. Miller: Blame borrowers. Or, I’m sure they’re going to find some way to argue that it’s all government’s fault, liberals’ fault. I’m sure they’re scrambling. They probably have a full team at AEI and Cato working on that now. They’ll have some experts with a complete explanation come January.
Q: So this letter is going out tomorrow?
Rep. Miller: We’re going out tomorrow on it. We have a good number of people on the letter, and important people, Rep. Frank, Waters, Gutierrez, Conyers. We’ll all be in the minority soon, but this raises the profile of the issue, that’s one of the things you can do in the minority. You can call attention to things.
The full letter follows.
Members of the Financial Stability Oversight Committee
c/o Secretary Geithner, Chairman of the FSOC
1500 Pennsylvania Avenue NW
Washington DC, 20220
In light of the recent report from the Congressional Oversight Panel regarding mortgage irregularities, we are writing to support the panel’s call for a new round of stress tests to examine stability issues arising from residential mortgages held in securitized pools. Stability issues that have not been included in previous stress tests include liabilities for breaches of representations and warranties in Pooling and Servicing Agreements, liabilities arising from systemic mortgage documentation irregularities, and conflict of interests for servicers affiliated with firms that hold significant portfolios of second liens. We urge the council to recommend that its members conduct specific, thorough reviews of the potential effects of these issues on the risk profiles of the institutions they regulate and also that the Federal Reserve incorporate these potential liabilities into the new round of stress tests it announced earlier this week. We urge that the Financial Stability Oversight Council consider, in light of those stress tests, requiring that some financial companies divest affiliates involved in servicing securitized mortgages.
First, we urge that the members of the Council examine a representative sample of collateral loan files of each major servicer to determine if the files contain all the documents required by contract or by law, including the note; mortgage, deed of trust or equivalent document; and all documents evidencing or constituting the necessary assignment, delivery and recording of those documents. The Council should determine if the documents satisfy contractual representations and warranties in the pooling and servicing agreement or other governing instrument for the mortgages in question, and if not, any potential liability that may result. The collateral loan files examined should be selected at random, not by the servicers.
Questions about the documentation of securitized mortgages have received much recent attention. The financial institutions involved in securitization, including sponsors, trustees and servicers, have said publicly that any problems are isolated, technical in nature and easily cured. Others contend that the problems are pervasive, incapable of cure, and may ultimately require financial institutions involved in the securitization of residential mortgages to repurchase at face value hundreds of billions of dollars of mortgages, many of which are now non-performing. Many of the financial companies with potential liability to repurchase those mortgages are on any list of systemically significant firms.
Second, we urge the Council to examine the servicing of first mortgages by servicers that hold second liens or are affiliated with firms that hold second liens. The largest servicers hold almost half a trillion dollars in second liens, which are valued for accounting purposes at approximately 85 percent of face value. Those servicers, also systemically significant firms, assert that the second liens are performing, as are the first mortgages on the same property, and thus the second liens are accurately valued. The servicers contend that any interest the servicers may hold in second liens has not affected their servicing of securitized first mortgages. Others contend that there is an indefensible conflict of interest for servicers of securitized first mortgages to hold second liens on the same property, that servicers have acted contrary to the interest of the beneficial owners of first mortgages to avoid accounting losses on second liens, and that servicers face significant unrealized losses on those second liens.
An important purpose of the Dodd-Frank Act is to identify risks to the financial system as early as possible, so that regulators can take corrective action or minimize the disruption to the financial system that results from the insolvency of systemically significant financial companies. It is also a purpose of the Act to make risk to our nation’s financial system transparent in order to restore the confidence of the American people in the financial system and in their government. It would serve those purposes to examine these issues and make the result of that examination public.
Finally, we urge that the Council consider use the authority under the Dodd-Frank Act to require that financial companies divest affiliates or other holdings involved in servicing securitized mortgages. There is no apparent advantage in having financial companies that securitized mortgages also act as trustees or servicers, and there is an obvious conflict of interest. The uncertainty about the extent of the risk to our nation’s financial stability posed by the mortgage irregularities is largely the result of the control of critical information by financial companies at risk of insolvency from potential legal liability to mortgage investors and others. The control of critical information by financial companies with a possible motive to conceal systemic risks is incompatible with the intent of the Dodd-Frank Act, and is a grave threat to our nation’s financial stability.
Thank you for your attention to this matter.
Andre Carson (IN)
Stephen Lynch (MA)
Joe Baca (CA)
Jackie Speier (CA)
Danny K. Davis (IL)
Laura Richardson (CA)
Barney Frank (MA)
John Conyers (MI)
Luis Gutierrez (IL)
Maxine Waters (CA)