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Yves Smith: Mortgage service industry makes more money from foreclosures than restructuring debt

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PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I’m Paul Jay, coming to you today from New York City. Yves Smith, the creator of, in a recent blog wrote about foreclosures. And we’ve all been reading about people being foreclosed without any proper documentation or any proof they actually owed any money. But some people are being foreclosed who actually haven’t missed any payments. Here’s what Yves Smith wrote: “a significant number of their clients facing foreclosure has made every single … payment.” She goes on to say, “whether by mistake or design, when a borrower gets caught in the servicer hall of mirrors of compounding fees and charges, there is no way to appeal and pretty much no way out.” Now joining us to talk about this type of foreclosure and the whole service industry in this area is Yves Smith, the creator of Naked Capitalism and author of ECONned: How Unenlightened Self Interest Undermined Democracy and Corrupted Capitalism. Thanks for joining us.

YVES SMITH, WRITER, FINANCIAL ADVISOR: Thanks for letting me be here.

JAY: So talk a bit about this whole mortgage service industry and what role it plays.

SMITH: Well, the mortgage servicing industry is a creation of this new process we have for doing mortgages called securitization. In the old days of banking, the borrower would go to the bank and get the loan, and the loan would remain with the bank. The change that we’ve had, which started in the 1980s and has now become the predominant way that at least first mortgages are done, is that you go to the bank, or you might even go to the mortgage broker, and you will get the loan with them. But instead of keeping the loan, they will sell it. And it usually goes not just directly to one party, but it will often go through a series, typically go through a series of parties, and eventually wind up with investors–it winds up in a little legal box called a trust. Now, that means somebody has to take care of, actually, again, playing some of the role that the bank used to pay of collecting the payments. So they’re the person, they’re the party that gets the payments, they’re the party that credits the payments, and they’re the party that takes the cash from all the different people they’re dealing with and make sure that it goes to the investors in the proper way that the contract’s set up.

JAY: ‘Cause now the people that now own this pool of mortgages aren’t banks that used to have their own credit departments that could go collect the payments. So they’ve got to go hire somebody now to do the collections for them.

SMITH: Well, it’s–in some cases they go that route, but actually, if a borrower gets in trouble, they would then, for example, arrange for the loan to be foreclosed upon. So they would–they’re actually intermediary companies [inaudible] tremendous amount of stuff is–of this is outsourced. So there’s a well-known company called Lender Processing Services that provides a lot of the support to the servicers. The Lender Processing Services would then go hire a foreclosure mill to foreclose. I mean, basically, what the servicer would do at a certain point is say, gee, you’re really behind. And the servicers tend to alert people that they’re behind only very late in the process, where the payments have gotten so large that what’s owed is–the borrowers are often very surprised if it’s because of compounding fees that they’re in that position.

JAY: Let me get clear now. You’ve got a company that collects the payments, the mortgage payments.

SMITH: That’s correct. From the borrowers’ perspective, they’re the company that collects the money.

JAY: And they work for the various banks or whoever owns this pool of mortgages now.

SMITH: Well, they work for the various investors. So the different trusts that the–where the mortgages actually sit, the trusts hire the servicers.

JAY: Right. So why is it in the servicers’ interests to push people closer to foreclosure?

SMITH: Well, some of this is–I think of this as almost being like a doomsday machine, like they have their little imperatives, and the fact that a foreclosure results isn’t something they really care about. You know, their imperative is to keep costs down. Servicers are organized to be very big factories. So all the processes they have are extremely automated. And they have imperatives to maximize fees. Foreclosure happens to be more profitable to them than routine servicing of a loan. So if anything, if somebody gets in trouble, they don’t have any incentive to prevent people from getting in trouble, and in fact they have incentives to get people in trouble. I mean, one of the things that they do, for instance, and this has been repeatedly documented, is that let’s say you have a late fee. Now, sometimes these late fees are not bona fide late fees–the servicer might have applied your payment late. Servicers have also been found to hold payments, sometimes, to make them late.

JAY: So they can–.

SMITH: Then they collect late fees. Correct. So then what happens is–let’s say somebody has–let’s just pick a number. Say it’s $75. The person incurs a late fee. That isn’t going to be charged until the next month. The servicer, unlike a credit card, where you get a statement and say, you owe a late fee, the borrower doesn’t know that they have a late fee. They the next month send in their regular payment. Under both federal law and the agreement that the borrowers sign, his payment, next-month payment, is supposed to go first to the mortgage interest and the mortgage principal. But instead, the servicer will take their fees out first, which makes the second-month payment short and, in theory, late because it wasn’t full.

JAY: So now they can charge another penalty

SMITH: They can charge another penalty, and the way some of them set it up, they might even charge them two fees. Well, then if a borrower has been late twice under the agreement, the investors require them to get something called a broker price opinion, which basically is kind of worthless. But the–you know, some broker will basically drive by the house and write a broker price opinion. Now, those can range anywhere from $50 to as much as $250, depending on–.

JAY: Now, is the service company making money out of that, too?

SMITH: Sometimes those are inflated and they get kickbacks, but let’s just assume that they don’t. We’re just looking at this from the borrower perspective. They’re supposed to charge at $250 to the investor. Many times, they have been found to double dip and also charge the borrower.

JAY: Blaming them for missing two payments [inaudible]

SMITH: Payments, and then–and charging them when it’s only the investor who’s supposed to be paying it, not the borrower. So then suddenly you’ve got more fees, which has, again, not been disclosed to the–. So this whole thing keeps compounding.

JAY: I’m not clear. Why does it become profitable to push them to foreclosure, then?

SMITH: When the borrower goes into the foreclosure process, the servicer is permitted to charge additional administrative fees.

JAY: To the trust.

SMITH: And those come off the top. All the fees to the servicer come off the top. So, the additional work they get compensated for. In addition, when a borrower gets behind on payments–the seriously delinquent–the servicer still has to continue to pay the investors as if the borrower was paying on time. Normally when you have a borrower get in trouble in any other type of lending, the first thing the lender says is, gee, what should I do? Should I liquidate the loan? Should I just, you know, take what I can get? Or is there some way we can restructure the loan? I’m always better taking a half a loaf. If the borrower has enough income, I will be better served by taking less and restructuring the loan. So the investors would actually prefer that the loans be restructured. However, the servicer is continuing to have to advance principal and interest. The servicers don’t get paid for modifying the loans. That’s not part of these agreements. So they have no economic incentive to modify the loans. And the only way for them to recoup the money they keep sending to the servicer if the borrower gets in trouble is through the foreclosure, is by taking the house, so then they can repay themselves and send whatever’s left back to the investor. So all their incentives favor foreclosure. They don’t have any incentives favoring modification.

JAY: But why is it in the interests of a service company like this to foreclose on someone who hasn’t missed a payment?

SMITH: Well, you can say that it’s oftentimes administrative error, but there actually have been documented cases where the servicers would come in and basically make up documentation over and over again, trying to claim that the person was current.

JAY: Person was “current”?

SMITH: They were not behind. This is one of the things that’s very disturbing, to see these banking executives get up and say, we never make a mistake; our foreclosures are all justified. You can look at–there are literally over–academics have been writing about this since 1998, about servicer-driven foreclosures, about how–whether it’s in error and you can’t get it straightened out, or it’s actually something more malicious, where the bank has an incentive to foreclose–.

JAY: To get hold of the property.

SMITH: Well, to get additional fees. It’s to get additional fees. And foreclosure’s a much more profitable activity.

JAY: There was hearings just in the last couple of weeks about this.

SMITH: That’s right.

JAY: So is there any legislation, either in existence or pending, that would deal with this?

SMITH: No, this really hasn’t been addressed. I mean, this whole–one of the problems is it’s like peeling back an onion: the more and more layers of the sort of peeling back, new problems that have been around but haven’t been talked about are being exposed. And the banks have adopted this line that all borrowers are deadbeats. It’s much more complicated. You know, yes, there’s a large number of people who’ve lost their jobs, you know, some of them got in over their heads, some of them had other bad things happen, like, you know, medical bankruptcies, and they really can’t afford their houses. But of the people who are fighting foreclosures, a very significant percentage of them it’s either that they are victims of servicer error and can’t get it straightened out, or that they have actually filed for bankruptcy. And in bankruptcy, everybody who is owed money is supposed to wait until the court sorts it out. They keep trying, the servicers keep trying to take the house, they keep trying to break the bankruptcy stay. And a lot of unsophisticated borrowers–or, rather, unsophisticated lawyers, somebody who might not be familiar, they will make deals with banks, a first deal, the first time the bank tries to do that. That’s very unfavorable and makes it easier for the bank to get the house later on. The abuses are much larger than people recognize.

JAY: And it’s a crazy thing, because the more they foreclose, the more they depreciate the assets of houses they’ve already foreclosed on.

SMITH: Well, that’s–and that’s why we’re having such delays.

JAY: Which is craziness.

SMITH: Well, that’s the other part, that, again, the blame in the media’s being assigned the wrong place. One of the things that now places like The Wall Street Journal are writing about is, now what the average time from when somebody gets seriously in trouble to when they actually are foreclosed upon is 478 days. That’s because the banks don’t want to actually seize the houses until they can sell them. So they have perverse incentives, because they will still have to pay the real estate taxes and maintain the houses. So, on the one hand, they do want to ultimately get the house, but it’s the banks themselves that want to draw out the process in many–and, again, it varies by markets. You know, in a–but in a market where they already have a lot of housing inventory, they really don’t want to take any more houses right now. It’s better for them to keep the borrower in the house, to have the borrower maintain the house, and to have the borrower be on the hook for the real estate taxes.

JAY: And then eventually throw them out.

SMITH: And eventually throw them out, when it’s convenient for them.

JAY: I think the word perverse is the right word. Thanks for joining us.

SMITH: Thank you.

JAY: Thank you for joining us on The Real News Network.

End of Transcript

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Yves Smith has written the popular and trenchant financial blog "Naked Capitalism" since 2006.

Yves has spent more than 25 years in the financial services industry and currently heads Aurora Advisors, a New York-based management consulting firm specializing in corporate finance advisory and financial services. Prior experience includes Goldman Sachs (in corporate finance), McKinsey & Co., and Sumitomo Bank (as head of mergers and acquisitions). Yves has written for publications in the United States and Australia, including The New York Times, The Christian Science Monitor, Slate, The Conference Board Review, Institutional Investor, The Daily Deal and the Australian Financial Review. Yves is a graduate of Harvard College and Harvard Business School.