by Sheila Bair
On November 5, 2010, I sent a letter to Ben strongly urging caution in approving dividend increases:
Given the continued205 uncertainty in the markets in which these institutions operate, we do not believe it is the right time to allow transactions that will weaken their capital and liquidity positions. The highly publicized mortgage foreclosure process flaws provide an example of how quickly material issues can arise in these institutions and how they are still exposed to the poor decisions made in the years leading up to the crisis.
I sent a similar letter206 to John Walsh, asking the OCC not to approve banks’ dividends to their parent companies without first consulting with the FDIC. Once the money was at the holding company, I knew there would be pressure to let it pay it out to shareholders. In my letter to Ben, I pointed to research conducted by the Boston Federal Reserve Bank showing that regulators had been slow to curb dividend payments before the crisis, with $80 billion being paid out before and during the crisis. “[O]nce the level of dividends increases,” I argued, “it is difficult to scale back.”
The OCC and Fed agreed to consult with us on dividend payments. They also invited us to participate in their reviews of the fourteen largest mortgage servicers, twelve of which were regulated by the OCC. I reluctantly agreed. I was conflicted as to what our strategy should be. I didn’t want us tainted by the foreclosure mess. The banks we regulated hadn’t done those things. On the other hand, if we participated, we could perhaps push the OCC and Fed to take more aggressive action in correcting problems than they might otherwise be inclined to. There were reputational risks for us. If the OCC and Fed came out with weak orders, notwithstanding our advocacy, they would still expect us to sign on. Throughout the crisis, I had been frustrated by our lack of leverage in forcing more meaningful action to address the housing crisis. Here again, I had the same problem. Our only direct “hook” with those fourteen servicers was the fact that we were the primary regulator of GMAC’s insured bank, Ally. Ally did not service loans, but it did originate conventional mortgages and contracted with GMAC Residential (regulated by the Fed) to service them. If not satisfied that GMAC Residential had taken appropriate corrective action, we could order Ally to stop doing business with it.
Notwithstanding my concerns, I decided that we should participate in the exams. Almost immediately, the disagreements began. We thought the OCC was being too narrow in how it was defining the scope of the exams—focusing only on the question of whether the borrower had been seriously delinquent before the foreclosure proceeded. Even if a borrower was seriously delinquent, the servicer still had to comply with the legal requirements associated with foreclosure. In particular, it needed to show that it held good title, which could be a challenge in some cases because the ownership of securitized mortgages changed hands many times. There were also many reported instances where servicers had charged borrowers inappropriate fees, then classified the mortgages as delinquent when the borrower refused to pay. Finally, and most important, we wanted to make sure that loan modification applications had been appropriately reviewed. Our ongoing review of the loan files of loss-share acquirers was revealing significant error rates in loan mod denials. Specifically, of the institutions we looked at, a number of borrowers had been denied a modification even though they had been entitled to one. In these instances the modified loan would have had greater value than a foreclosure. Yet the mod had been turned down.
The Fed was much more receptive and aligned with our thinking, again thanks to the efforts of Dan Tarullo. The disagreements came to a head207 during a December 1 hearing before the Senate Banking Committee on mortgage-servicing problems. All of the bank regulators, as well as the Treasury Department, were asked to testify. I did not want to testify at the hearing. We weren’t perfect, but in this case, we had had nothing to do with the regulatory lapses that had led to the robo-signing scandal. If I testified, I feared, the FDIC would be lumped in with the OCC. But Dodd was insistent that I be there because he felt I would be more open about servicing problems and more proactive in pushing for action to address them.
Congressional hearings are a time-consuming process. It is a lot of work to write the testimony and prepare for all the questions that can come up. I had so much else on my plate in those final months of my tenure, I resented having to deal with this hearing. The night before my appearance before the committee, the staff and I were working late in my large conference room on preparation, and I just lost it. In the middle of the session, I stood up and said, “I DO NOT WANT TO TESTIFY AT THIS HEARING.” I stomped out of the room, went into my office, slammed a few doors and drawers, took a deep breath, and counted to ten. Then I went back to the staff, sat down, and finished the prep. The staff just picked up and continued as if nothing had happened.
During the hearing, Dan and I were straightforward about the kinds of problems our examiners were seeing; Dan was even more pointed than I. “While quite preliminary208,” he told the committee, “the banking agencies’ findings from the supervisory review suggest significant weaknesses in risk-management, quality control, audit, and compliance practices as underlying factors contributing to the problems associated with mortgage servicing and foreclosure documentation. We have also found shortcomings in staff training, coordination among loan modification and foreclosure staff, and management and oversight of third-party service providers, including legal services.” He continued, “The servicing industry overall has not been up to the challenge of handling the large volumes of distressed mortgages. The banking agencies have been focused for some time on the problems related to modifying mortgage loans and the large number of consumer complaints by homeowners seeking loan modifications. It has now become evident that significant parts of the servicing industry also failed to handle foreclosures properly.”
I watched Walsh stiffen as Dan testified. His testimony, in contrast, tried to minimize the issues as process-oriented and make it sound as though few, if any, borrowers had really been hurt. It was one thing for the FDIC to call out the national banks the OCC regulated; people expected that from us. It was quite another for the Fed to do so. Dan’s testimony threw a monkey wrench into OCC’s strategy of downplaying the problems.
The OCC’s retaliation was swift. The day after the hearing209, I heard from my examiners that the OCC no longer wanted us or the Fed participating in the servicing reviews because it was upset about our testimony. Several days later, our examiners were notified by the OCC that it would not be sharing their written exam findings with us or the Fed until December 23 and that it intended to begin discussions with the banks no later than January 3 to present those findings. I protested in a December 17 email to Walsh. “This will give us210 only one week over the holidays to review your findings and provide comments,” I wrote. “Given holiday schedules and the fact that I, my board, and many of our senior officials will be out of the office that week, this ‘offer’ of information sharing is really no help at all.” I demanded a briefing for the FDIC board and a copy of the OCC examiners’ written reports.
Walsh responded211 with a token description of the OCC’s findings that essentially recounted everything that we already knew—that policies, training, staffing, and so on were all “deficient.” I fired back angrily, “I’m sorry but we cannot engage in a process in which our access to information has been delayed and impeded and in which we have had no meaningful input into decision making. . . . If that is all that is coming out of this, why in the world is it taking so long?”
Tarullo weighed in with similar concerns, and Walsh finally relented on allowing more time for interagency consultation.
As we began discussions over examination findings and what remedial action to require of the banks, the Treasury Department and HUD had initiated a parallel process to try to negotiate a global settlement among the major servicers and the various federal agencies that had enforcement responsibilities over servicing as well as the state attorneys general.
The idea—which I had advo
cated212—was to negotiate an agreement among the major servicers and major enforcement agencies that would require the banks to significantly increase their servicing resources and loan workouts and provide redress to those harmed by wrongful foreclosures. In return, they would receive litigation relief from the state AGs and borrowers who were made whole. I viewed that type of agreement as crucial to the housing market recovery. Servicers needed to restructure loans when it made economic sense to do so. Because of the servicers’ deficiencies, far too many loans were going to foreclosure when it would have been less costly to modify them. But we also needed a functioning foreclosure market. If the borrower was just in too big a house, we needed a process to move the property back onto the market. As numerous studies have documented213, effective servicing can dramatically reduce mortgage losses and aid in the housing recovery. Ineffective servicing will cause unnecessary losses and delays. Because of skewed economic incentives and lack of adequate staffing, defective servicing had impeded our housing recovery. Now, because of all the servicing errors, the banks had opened themselves up to endless litigation that would further impede the clearing of the housing market.
As I stated in a January speech to the Mortgage Bankers Association:
If we are214 to successfully respond to today’s foreclosure crisis, all parties involved must recognize some important principles. Loss mitigation is not just a socially desirable practice to preserve homeownership where possible. It is wholly consistent with safe and sound banking and has macroeconomic consequences. Fair dealing with borrowers and adherence to the law are not optional. They must be viewed as mandatory if our servicing and foreclosure process is to function in the interest of all parties concerned.
I went on to call for a major global settlement, noting that while industry would resist the financial costs of such a settlement, “this would be215 short-sighted. The fact is, every time servicers have delayed needed changes to minimize their short-term costs, they have seen a deepening of the crisis that has cost them—and the rest of us—even more.”
I had been pushing for the FSOC to take a leadership role in resolving the foreclosure crisis. The growing backlog of foreclosed properties, combined with escalating litigation from servicer errors, presented a systemic risk, I thought, to both the financial sector and the broader economic recovery. A number of influential members216 of Congress, including Democratic Senator Jack Reed of Rhode Island, also called for the FSOC to exercise leadership. Tim scheduled a couple of discussions on servicing errors before the FSOC, including, at our request, a briefing from the FHA on the problems it had unearthed in their own reviews of servicers. But other than scheduling a few meetings, no one was showing any initiative. Some staff working groups had been set up and they were meeting frequently, but nothing was getting done. The Fed was also concerned about the inertia and had requested that Tim convene another meeting of principals. I decided to present a specific proposal to Tim for FSOC consideration. He would at least have to respond to our proposal, and even if he didn’t like it, it would put pressure on him to come up with something on his own.
On February 7217, I sent Tim an email suggesting a two-pronged approach to a global settlement with an estimated cost of $20 billion in cash outlays for the five major servicers. The first prong was to set up an independent claims commission for foreclosures occurring after January 1, 2008. The servicers would pay a nominal, standard amount for pure processing errors in exchange for the borrowers’ waiver of claims. We estimated that a $1,000 payment for each mortgage would cost the servicers $3.3 billion. For borrowers who had suffered financial harm, i.e., those who had been wrongfully denied a loan modification, the independent commission would determine the appropriate amount of compensation. We roughly estimated wrongful foreclosures at 4 percent with an average award of $50,000 each, costing about $6.6 billion.
The second prong was what we called the “super mod.” The idea was for the servicers to make a onetime, blanket offer to seriously delinquent home owners to write down their principal balance to below market value. A borrower could either complete a short sale at that reduced amount or try to resume mortgage payments at the reduced level. However, borrowers who redefaulted on their mortgage would have to contractually commit to relinquishing the property, ameliorating the need to initiate foreclosure. If at any point the house was sold, the borrower would have to give up any gain on the sale above the written down principal.
The super mod was designed to shock the market and create incentives for delinquent borrowers to sell their houses or start their mortgage payments again. Since the loan restructuring was based on a home’s market value, not the borrower’s income, all that the understaffed servicers needed was a current appraisal to make the offer. Moreover, since most of the seriously delinquent loans were virtually certain to land in foreclosure absent a modification, our super mod would save both lenders and mortgage investors money. Selling the house outside the foreclosure process, or letting the borrower stay with a reduced payment, would be significantly cheaper than liquidating the property in an increasingly lengthy, expensive foreclosure process. Thus the super mod would not cost the banks money, and we would not give them credit for writing the loans down. Instead, we proposed requiring incentive payments to investors and relocation and counseling expenses for borrowers that would total another $10 billion in cash outlays.
I told Tim that I wanted the opportunity to present those ideas at the next FSOC meeting. He never responded. The next thing I knew, Tim had asked Elizabeth Warren and her colleagues at the nascent consumer bureau to develop a proposal. Elizabeth and her team wanted to require the servicers to write down $25 billion in principal balances. That amount was cleverly based on the amount of money they estimated the servicers should have spent on servicing since 2007 but hadn’t. But Tim was clearly trying to play us off each other. I asked Elizabeth to come to my office so that we could discuss our differences in approach. We had different perspectives, but we had a good working relationship and I think could have converged on a position. But we never got the chance. A few days later, a story broke on the front page of The Wall Street Journal that Elizabeth was pushing for $25 billion in relief from the big servicers.
All hell broke loose. The Republicans jumped all over her, accusing her of overstepping her authority. They charged that it was inappropriate for her to be involved in the global settlement discussions because the CFPB was not yet a functioning agency. (Dodd-Frank had given it a start-up date of July 1, 2011.) I couldn’t believe it. Tim had invited her to the meetings, and he had asked her to give him a proposal. But he didn’t do anything to defend her once the barrage started. Then, with Tim’s blessing, the OCC, DOJ, and state AGs agreed to limit the global settlement discussions to the enforcement agencies (DOJ, HUD, and the AGs) and exclude the regulatory agencies, which, of course, took the FDIC and the CFPB—led by us troublemaking women—out of it.
The state AGs, led by Iowa’s Tom Miller, also did not object to letting the OCC oversee the “lookback” process to make sure borrowers who suffered financial harm from wrongful foreclosures were compensated. That completely undermined our efforts to set up some type of independent remediation commission. The OCC argued against our proposal, saying that we would compensate only those who came forward to complain. Walsh argued that the OCC would require the banks to look at all the foreclosure files and require compensation for all victims, not just those who came forward. But of course, the OCC, not an independent commission, would be defining the scope of the lookback and determining whether compensation was required.
I do not understand why the state AGs acquiesced in that, as it played right into the hands of the OCC and the big banks. The only thing I can think of is that Tom Miller had his hands full trying to build consensus within his own ranks on the wisdom of a global settlement. Unlike the FDIC, the OCC did not want to put pressure on its big banks to come to the table and agree to something reasonable. The strategy suited the OCC well. I think
it felt that the global settlement was worth doing if the big banks would have to make only token concessions. Otherwise, their attitude was that the big banks, with their deep pockets, could litigate the issues forever. We, on the other hand, as a deposit insurer, didn’t want to take any chances that the litigation could get out of hand. We wanted it settled and resolved, and we were willing to put pressure on the banks to get there. That was shortsighted thinking on the OCC’s part, as uncertainties about litigation exposure continue to weigh heavily on bank stocks. Ironically, I think that some of the banks would probably have been willing to make greater concessions. Based on my conversations with GMAC, Wells, and BofA, I believe they were willing to do much more to facilitate principal write-downs, but the OCC never pushed in that direction. There are decades of bad blood between the OCC and the state AGs. I seriously doubt that the OCC wanted the state AGs to succeed.
Our efforts to secure meaningful changes through the examination process were similarly stymied by the OCC’s leadership, who seemed more interested in protecting the banks than regulating them. Unbelievably, the OCC would not even agree to require specifically that the banks provide the name and contact information of the individual who would serve as the borrower’s single point of contact (SPOC). We thought an SPOC was essential to improving staff resources and accountability at the major servicers. Regulators had been inundated with complaints from borrowers about servicers losing their paperwork and putting them on hold forever when they called trying to reach a live person. We had also all heard numerous horror stories about when borrowers had been in the process of getting a loan modification from one division at the servicer while another division was sending them foreclosure papers. By requiring the servicers to have a single individual with both the authority and responsibility to handle a borrower’s case from beginning to end, we would force the servicers to hire more staff as well as improve the quality of service. A single employee would be accountable for the proper handling of each loan, as opposed to the disorganized, uncoordinated process that many of the servicers were using.