What Mortgage Settlement Lacks in Substance, It Makes Up in Execution

A practical, well-executed plan, even one with disappointingly modest goals, will deliver more than an overly ambitious plan, easily subverted, that, in hindsight probably had no hope of ever succeeding.

When a judge approved the state attorneys general settlement with five mortgage servicers on April 5, the consent decrees issued by federal bank regulators mandating foreclosure reviews at 14 servicers – including the five in the multistate settlement – were already a year old.

The settlement focuses primarily on helping distressed borrowers still in their homes. At least $17 billion of the $25 billion in relief advertised is earmarked for principal reductions and loan modifications. Three billion dollars is for refinancing "underwater" homeowners. Only $1.5 billion will go to homeowners hurt by a foreclosure finalized between Jan. 1, 2008 and Dec. 31, 2011.

The banking regulators’ review process covers borrowers subject to a foreclosure action on a primary home between Jan. 1, 2009 and Dec. 31, 2010. A completed foreclosure and loss of property is not required. The 14 mortgage servicers' potential liability to borrowers under the consent decrees is unlimited and, so far, unknown.

The foreclosure reviews are a "look back" at the past. No one hates admitting and paying for mistakes more than banks. The "independent consultants" selected by the banks in November, after more than six months of contract negotiations, haven't calculated any final damage numbers yet. It wasn't until June of this year that, 15 months after the consent orders were signed, regulators finally issued a "financial remediation framework" prepared by the consultants.

Rest assured the consultants are getting paid, even if borrowers are not. PricewaterhouseCoopers will bill more than $1 billion for four of the 14 ordered reviews, according to my sources. I think banks will spend at least $5 billion in total on consultants just to find out how much they'll owe.

The mortgage settlement monitor left the gate quickly after his appointment, publishing a preliminary report in August, only four months after the settlement was approved. Joseph Smith's team will send an annual report to the court, then a final report in 2016. The foreclosure review under the consent orders has issued two interim reports, in November 2011 and June 2012, but the regulators do not announce in advance when they'll update the public next. The next update may not occur until all the work is done.

The mortgage settlement monitor's interim report cited $10.6 billion of consumer relief activities reported by the banks. Those amounts have not been not audited or confirmed by Smith or his team. The mortgage settlement does, however, provide an incentive to the banks to pay consumers quickly. For each dollar relief of provided since March 1, a servicer gets credit against its settlement commitments. There's an additional 25% credit for any first or second lien principal reductions or credited refinancing activities in the first 12 months and a penalty of at least 125% of any unmet commitment amount if the servicer doesn't hit its total target within three years.

The consent decrees, on the other hand, have no financial incentive for the banks to compensate harmed borrowers quickly. Other than having to pay consultants to go through the motions, there's every incentive to stall on payments. I'm pessimistic that borrowers will see any meaningful compensation under these orders.

The two mortgage harm make-good efforts are organized quite differently. The Office of the Comptroller of the Currency and the Federal Reserve balked at the idea of directly hiring consultants to evaluate liability to borrowers. Regulators told me it was too difficult and would take too long to negotiate the contracts, even though almost all of the firms selected already act as approved vendors to the government for audits, consulting and financial crisis related initiatives like TARP. Under the consent orders, therefore, the banks selected their own "independent consultants" and pay them directly. Regulators were supposed to ensure the consultants' independence and strongly monitor their activities. Instead, the OCC and Fed have been hands-off, allowing independence issues to persist and potentially collusive communications between consultants to continue.

Settlement monitor Smith hired his consultants directly, as the settlement agreement required. Two months after Smith started on the job, BDO was selected to be the project manager. Five additional consulting firms were hired and are paid by Smith, not the banks, to monitor and report on compliance progress at each servicer.

I'm confident that the AG settlement monitoring activities will, at least, be tightly controlled by Smith, even if not more financially beneficial for harmed borrowers than what was hoped for under the foreclosure reviews. The OCC and Fed have abdicated responsibility for the "free" foreclosure reviews to the banks and their consultants. The borrowers will probably get what they paid for: zip, zero, nada.

There are some overly optimistic parts of Smith's first report. It seems impossible to me that banks can successfully implement system changes needed to comply with 304 actionable servicing standards by Oct. 2. Perhaps that's why Smith designed the monitoring activities to check compliance on an incremental basis rather than all at once. Judging from testimony in some mortgage foreclosure lawsuits, I fear servicer systems and processes are still broken. Banks are betting Smith's monitors won't catch them in the act of conducting business as usual.

Francine McKenna writes the blog re: The Auditors, about the Big Four accounting firms. She worked in consulting, professional services, accounting and financial management for more than 25 years.