How Federal Regulators May Standardize Foreclosures

WASHINGTON — Though regulators have so far been vague about what kinds of national servicing standards they hope Congress will enact next year, momentum appears to be growing behind the concept.

Whether it succeeds will depend largely on how ambitious the plan is, including whether lawmakers and regulators try to craft standards that would preempt local foreclosure laws.

Even if they do not go that far, however, observers said opportunities exist to set minimum servicing standards that would govern documentation of delinquent loans, loan modification efforts and borrower outreach.

The ideas are still nascent, but many lawmakers appear willing to support some type of standard.

"There needs to be legislation," said outgoing House Financial Services Committee Chairman Barney Frank in a brief interview this month. "We have to come up with a situation where there is one entity responsible for any mortgage and any individual who invests in a mortgage has to know that that's there. … I think it will require legislation to clean this up, going forward, to prevent the recurrence of" a foreclosure mess.

The idea was first raised at a Dec. 1 hearing by Federal Reserve Board Gov. Dan Tarullo, who said regulatory agencies' review of servicers had turned up significant problems. A key issue was servicers' difficulties in complying with the various state standards governing foreclosures.

"In light of the range of problems already encountered and the prospect of further changes in the industry, … it seems reasonable at least to consider whether a national set of standards for mortgage servicers may be warranted," Tarullo said at the hearing.

Though Tarullo was vague on what he wants nationalized, such standards could include the timing of a servicer's notice to a delinquent borrower of how many days until foreclosure is allowed under the servicer contract, responsiveness to customers, how a foreclosure should be done and how a servicer should operate during a foreclosure. At the hearing, both outgoing Senate Banking Committee Chairman Chris Dodd and his expected successor, Sen. Tim Johnson, said they were interested in the idea, and they asked regulators to submit draft legislation.

Other regulators also agree that federal standards are needed.

"The volume that the servicers have to handle now has taken us to the point where having a clean set of uniform standards would be a desirable thing," said a regulator who spoke on condition of anonymity. "It's obvious that there were types of internal controls breakdowns, there was a failure to react to the consequences of the volume and there was insufficient diligence over third parties. Those are areas where you could develop standards to direct servicers to do particular things."

Though regulators could write new rules for banks' loan servicers, the agencies would clearly prefer that lawmakers craft a set of rules that would apply across the financial services industry.

Cliff Rossi, an executive-in-residence at the University of Maryland's Center for Financial Policy, said that, at the very least, policymakers could standardize loan platforms, loan documentation and loan modification procedures. "Trying to bring standardization to this process … is one way to ensure there is a minimum level of performance by these servicers," he said. "While there are general guidelines, they are so unspecific that if you go to a B of A, JPMorgan or Wells Fargo you are going to see quite a bit of variation."

Regulators have general guidelines for servicing and loan modifications but no detailed rules. The Treasury Department has a more stringent set of guidelines for its Home Affordable Modification Program, but because the program is voluntary, their impact is limited. Ironically, Rossi said, Hamp may discourage Congress from seeking to write a national standard, given the program's poor performance.

"The Hamp program might make it argue it's less effective," Rossi said. "The percentage of modifications hasn't been what anyone expected so that, as an example [of] a government program, [it] hasn't met with stellar performance."

L. Richard Fischer, a partner in the Morrison & Foerster law firm, agreed that foreclosure documentation requirements and overall procedures for handling delinquent loans would be helpful.

"One could argue it's fairly simple," Fischer said. "The federal government is already looking at making" the Real Estate Settlement Procedures Act "and the Truth in Lending Act consistent, so I don't think defining the standards is the difficult part."

Regulators could also seek to require that servicers stop dual-tracking foreclosures with modifications. Acting Comptroller of the Currency John Walsh has already asked servicers to stop such tactics, but he only has oversight of servicers owned by national banks.

"What they are really talking about is best practices, mainly not having a dual track where you [are] seeing who can come up with the fastest resolution," said Stephen Ornstein, a partner at SNR Denton, who said regulators would be better off setting best practices than pushing for legislation.

The biggest unknown is how effective standards could be without also preempting state and local laws that govern foreclosures. Many observers said any new standard would have to preempt state laws to be effective.

"The problem servicers are grappling [with] is 50 different state laws on foreclosures and 50 different laws on loss mitigation, and if they just add another federal standard on state standards, it's just going to make it worse," said Laurence Platt, a partner at K&L Gates. "It sounds nice. Everyone would like to have a national standard, but if it's a uniform standard as an overlay, not a last-word national standard, then it only makes it worse."

Any attempt to preempt state laws is a political minefield and sure to provoke a fight with state regulators and attorneys general.

"You can separate out servicing standards and best practices and get to greater consistency on federal standards, and we would welcome working with our federal counterparts on that," said John Ryan, an executive vice president of the Conference of State Bank Supervisors. "But I don't think that [supports] the need for a national foreclosure law, and I strongly believe you need to maintain the local connection of foreclosure."

Tom Miller, the Iowa attorney general, agreed.

"If they're talking about sort of a minimum federal standard, that's something that might work and be helpful," he said in a recent interview. "But if they're talking about preempting the states, I don't think that's a good idea. A foreclosure action is something very local and something that the states have traditionally controlled. It's very much a local transaction and should continue to be a fundamental state responsibility to control state litigation. I don't think that there should be a federal standard that preempts state law." Miller said conflicting state laws is not an issue. (For a longer question-and-answer session with him, see page 8.)

"Foreclosing is something that the servicers do right now and do successfully," Miller said. "Despite the problems banks have created on foreclosures, there's been a lot of them. The rules in the 50 states are really quite similar. And when [state regulation is] done in so many areas, with regard to food and with regard to insurance to some extent — it's part of interstate commerce, and it's done successfully in so many different areas."

But many industry representatives disagree, arguing that differing standards were a key cause of servicing problems.

"If Congress is concerned about us making mistakes and treating people differently, then they could set one set of rules," said Jordan Dorchuck, an executive vice president and chief legal officer at American Home Mortgage Servicing. "Just conceptually, any time you have different rules to do the same thing you are increasing the opportunity for mistakes and the opportunity for things to go awry, but you could prevent that if you had one set of rules."

Even if regulators push for a preemptive standard, however, many questions remain unanswered. For example, only 23 states have a judicial foreclosure process. Would a new standard require all states to have such a process?

"The harder part of mandating a uniform federal law is the question of, do you supplant the existing local laws that are divided between judicial and nonjudicial process?", said Gerald Alt, the president of Logs Network. "If you created a standard saying every state has to be judicial, you have half the states with no experience of doing a judicial foreclosure."

But if policymakers do not get past such problems, some argue, big servicing issues will persist.

"The feds seem unwilling to grapple with the fact that there are materially inconsistent state laws that are extending the time to foreclosures," said Platt, the K&L Gates partner. "Unless they synchronize those with a federal standard, my son could start and end college before a foreclosure could end."