Posted on Tuesday, November 2, 2010
October 27, 2010
Good morning Chairman Kaufman and members of the panel. Thank you for the
invitation to discuss the Making Home Affordable program and other efforts to respond
to the millions of foreclosures that have devastated families, destroyed neighborhoods,
and triggered a global financial crisis.
I serve as Senior Policy Counsel at the Center for Responsible Lending (CRL), a
nonprofit, non-partisan research and policy organization dedicated to protecting
homeownership and family wealth by working to eliminate abusive financial practices.
CRL is an affiliate of Self-Help, a nonprofit community development financial
institution. For thirty years, Self-Help has focused on creating asset building
opportunities for low-income and minority families, primarily through financing safe,
affordable home loans. In total, Self-Help has provided over $5.6 billion of financing to
64,000 low-wealth families, small businesses and nonprofit organizations in North
Carolina and across America. Currently, Self-Help is grappling with many of the same
issues encountered by other lenders, including servicer capacity limitations and
homeowners who face serious economic challenges. Our testimony today is informed by
I. Introduction and Summary
Almost four years ago, our organization released a report warning that the reckless and
abusive lending practices of the previous two decades would lead to approximately 2
million subprime foreclosures. At the time, our report was denounced by the mortgage
industry as absurdly pessimistic. Sadly, the opposite was true. The system was even
more larded with risk than we had understood, and the damage has been far worse,
spreading from the subprime to the prime sectors, catalyzing a housing-lead recession,
and triggering historic levels of unemployment. Since we issued the report, there have
already been more than 2.5 million homes lost, and Wall Street analysts recently
predicted there could be as many as 11 million more foreclosures filed.1
The foreclosure crisis has had catastrophic consequences for families and communities,
especially communities of color. Millions of homeowners are in dire straits due to
abusive mortgage originations, incompetent and predatory mortgage practices, ineffective
government oversight, and a complex securitization system that lacks accountability all
the way up and down the chain. Ultimately, the fate of these homeowners impacts all of
us. Foreclosures bring down home values across the board, and devastate communities
and municipal budgets. Even worse, since historically the housing sector has led the way
out of economic downturns, weakness in the housing sector will likely slow or derail
economic recovery and hamper efforts to create jobs and reduce unemployment.
Things did not need to be this bad. If the Bush Administration had moved quickly back
in 2007, or if the Obama Administration and Congress had acted more forcefully in early
2009, we could have significantly limited the breadth and depth of the foreclosure crisis.
Instead, seemingly hamstrung by concerns about bank capitalization levels and “moral
hazard,” the government put forth a series of initiatives that relied on voluntary actions
from servicers in return for targeted monetary incentives. In evaluating how well this
approach has worked, the facts speak for themselves.
In this testimony, we have been asked to focus on the performance of the Home
Affordable Modification Program (HAMP), to compare HAMP modifications with
proprietary ones, and to suggest ways to improve HAMP and other programs to prevent
foreclosure. We have also been asked to comment on the foreclosure process issues that
have recently made headlines and the recent calls for a broader foreclosure moratorium.
In our view, HAMP’s performance has been disappointing, given initial hopes for its
performance and given that it still remains the only significant government response to
the crisis. On the positive side, HAMP has provided approximately a half million
families with a second chance at homeownership, which is a very significant number of
people. HAMP also may have helped standardize the industry approach to modifications
and increase the number of modifications reducing the borrower’s monthly payments; the
apparent sustainability of proprietary modifications has increased significantly since
At the same time, HAMP has fallen far short of its initial goals for helping individual
homeowners and has remained well behind the curve of additional foreclosures. Worse,
many families encounter an incompetent or even predatory mortgage servicing system
once they apply to the program, experiencing delays or denials that are inconsistent with
the promise of the program guidelines. Hundreds of thousands of people who received
trial modifications during HAMP’s initial phase have ended up in a worse financial
situation as a result of their participation in the program if they do not get converted to a
permanent modification; during the trial period, they are reported as delinquent to the
credit bureaus and late fees and interest continue to accumulate, resulting in large
arrearages due at the end of the trial modification. There are also troubling questions
about what will happen to families’ modifications when the interest rates on their new
loans begin to reset in five years. The continued insistence by Treasury officials that
HAMP is working has contributed to deep cynicism in those who have interacted with
participants.3 The credibility of the program has been further undermined because it has
not been transparent and has not created adequate enforcement mechanisms.
HAMP would have been much more successful if the government had implemented other
measures, such as changes to the bankruptcy code, to provide a “stick” to complement the
HAMP “carrot” and to give homeowners an alternative to relying on servicers who act in
their own interest first. Instead, the system is still entirely at the mercy of those servicers,
who frequently have not acted in the best interest of either investors or homeowners, and
who have demonstrated a complete disregard for the legal requirements of the foreclosure
process. It is also evident that the servicing industry, despite being aware of the
oncoming wave of foreclosures for several years now, has failed to develop the capacity
and quality control systems to ensure the integrity of the process.
It is also disturbing that the vast majority of modifications continue to be made outside of
HAMP. As of August of this year, only 470,000 permanent modifications were made
through HAMP, compared to 3.2 million proprietary modifications.4 Servicers routinely
ask borrowers to waive their right to a HAMP modification.5 Sometimes, servicers
transfer their accounts to other entities that are not bound by the HAMP contract with
Treasury. While we do not know all the reasons why this happens, some possibilities are:
(1) servicers profit more from the proprietary modifications because the HAMP
incentives are insufficient to overcome other financial incentives; (2) the design of the
HAMP program does not fit the majority of borrowers; (3) servicers do not want to fill
out the detailed reports required by HAMP; or (4) servicers wish to avoid oversight.
Whatever the reason, the lack of transparency about proprietary modifications makes it
very difficult to compare them with HAMP modifications or to analyze their ultimate
suitability for borrowers.
Along with their failure to adhere to HAMP guidelines, servicers also are engaging in
shoddy, abusive, and even illegal practices related to the foreclosure process itself. The
recent media revelations about “robo-signing” highlight just one of the many ways in
which servicers or their contractors elevate profits over customer service or duties to their
clients, the investors. Other abuses include misapplying payments, force-placing
insurance improperly, disregarding requirements to evaluate homeowners for nonforeclosure
options, and fabricating documents related to the mortgage’s ownership or
While we agree that the housing market is not likely to recover fully until foreclosures
level off and the swollen REO inventory is absorbed, recovery is unlikely until
participants regain confidence in the process. One key reason that buyers have become
skittish about REO purchases is that they believe the title to the home may not be good.
To get the market working again, buyers need assurances that the foreclosures are legal
and not vulnerable to challenge. Having banks claim to “fix” thousands of mortgages
within a couple of weeks without more information is unlikely to restore public
confidence in the system.
In our view, a temporary pause in pursuing foreclosures during which defined, objective,
and transparent measures are taken to ensure the integrity of the system is the best way to
stabilize the market. Otherwise, continued uncertainty will continue to damage the
Today, we urge everyone concerned about the stability of the housing market and the
sustainability of our economic recovery to address the foreclosure problem head-on with
every tool available. Congress, the Administration, banking regulators, federal and state
law enforcement officials, and state legislatures have many ways to ensure that servicers
are accountable for producing the results that will best serve investors, homeowners, and
the market as a whole. It is time to take the gloves off.
Recommendations for Congress
?? Change the bankruptcy code to permit modifications of mortgages on principal
?? Mandate loss mitigation prior to foreclosure.
?? Level the playing field in court by funding legal assistance for homeowners.
?? Ensure that homeowners receiving mortgage debt forgiveness or modifications do
not find their new financial security undermined by a burdensome tax bill.
Recommendations for Federal Agencies
?? The federal prudential banking regulators should immediately focus on the
servicing operations of their supervisees.
?? The Consumer Financial Protection Bureau should make regulating servicers one
of its first priorities.
?? Fannie Mae and Freddie Mac should serve as models to the industry.
?? HUD, VA, and other government housing programs should enforce their servicing
rules, especially those related to mandatory loss mitigation.
Recommendations for States
?? State legislatures should mandate loss mitigation prior to foreclosure.
?? States should exercise their supervisory and enforcement authority over servicers
doing business in their jurisdiction.
If nothing else, we have learned that HAMP cannot remain the principal response to the
problem. Moreover, changes to HAMP are likely to push even more modifications
outside of HAMP, so it is important to have a comprehensive approach. However,
despite our disappointment with HAMP, it is still the only significant federal response to
the foreclosure crisis and has a developed infrastructure, and we therefore support
improving it as much as possible. The following recommendations will help optimize
?? Aggressively enforce HAMP guidelines through serious penalties and sanctions
?? Create an independent, formal appeals process for homeowners.
?? Evaluate all borrowers for HAMP, 2MP, and HAFA or other sustainable
proprietary solutions before proceeding with foreclosure.
?? To ensure that loan modifications are sustainable, require servicers to reduce
principal whenever the alternative waterfall yields a positive net present value
(NPV) or at least to disclose the positive NPV to investors, require servicers to
reduce principal on second liens proportional to any reduction of principal undertaken
with respect to the first lien, and require servicers to reduce principal appropriately
when the underlying mortgage exhibits predatory characteristics.
?? Increase the mandatory forbearance period for unemployed homeowners to six
months and reinstitute the counting of unemployment benefits as income.
?? Mandate automatic conversions of successful trial modifications and reimburse
homeowners who pay their trial modifications but are not converted for any
interest and fees paid during that period.
?? Make the NPV model transparent and available to homeowners and the public as
required by the Dodd-Frank Act.
?? Require servicers to provide the homeowner with the relevant written documentation
any time a modification is denied due to investor restrictions.
?? Share loan-level data with the public to ensure that everyone has access to the
most complete source of data on foreclosure prevention.
?? Transfer servicing duties to companies that don’t have conflicts of interest.
?? Permit homeowners who experience additional hardship to be eligible for a new
HAMP review and modification.
?? Mandate an additional 30 days after HAMP denial to apply for Hardest Hit
Program monies and HAMP reconsideration if the HHP application is approved.
?? Clarify existing guidelines to streamline the process and carry out the intention of
II. Background: The foreclosure crisis has impacted tens of millions of people
directly or through spillover effects, with a particularly severe impact on minority
communities, and mortgage servicers have routinely engaged in careless, predatory
and illegal practices.
A. The foreclosure crisis impacts millions of people, both directly and
through spillover effects.
With one in seven borrowers delinquent on their mortgage or already in foreclosure7 and
nearly one in four mortgages underwater,8 continued weakness in the housing sector is
already impairing economic recovery and hampering efforts to create jobs and reduce
unemployment. According to industry analysts, the total number of foreclosures by the
time this crisis abates could be anywhere between 8 and 13 million.9 A recent study by
CRL estimated that 2.5 million foreclosure sales were completed between 2007 and 2009
while another 5.7 million borrowers are at imminent risk of foreclosure.10
Beyond the impact of the foreclosures on the families losing their homes, foreclosure
“spillover” costs to neighbors and communities are massive. Tens of millions of
households where the owners have paid their mortgages on time every month are
suffering a decrease in their property values that amounts to hundreds of billions of
dollars in lost wealth just because they are located near a property in foreclosure.
Depending upon the geography and time period, the estimated impact of each foreclosure
ranges from 0.6 percent to 1.6 percent in lost value to nearby homes. CRL estimates that
the foreclosures projected to occur between 2009 and 2012 will result in $1.86 trillion in
lost wealth, which represents an average loss of over $20,000 for each of the 91.5 million
houses affected.11 These losses are on top of the overall loss in property value due to
overall housing price declines.12
Furthermore, since African-American and Latino borrowers have disproportionately been
impacted by foreclosures, these spillover costs will disproportionately be borne by
communities of color. CRL has estimated that African-American and Latino
communities will lose over $360 billion dollars in wealth as a result of this spillover cost.
In addition, foreclosures cost states and localities enormous sums of money in lost tax
revenue and increased costs for fire, police, and other services because vacant homes
attract crime, arson, and squatters. As property values decline further, more foreclosures
occur, which only drives values down still more. The Urban Institute estimates that a
single foreclosure results in an average of $19,229 in direct costs to the local
The crisis also severely impacts tenants in rental housing. According to the National
Low-Income Housing Coalition, a fifth of single-family (1-4 unit) properties in
foreclosure were rental properties and as many as 40 percent of families affected by
foreclosure are tenants.14 While tenants now have some legal protection against
immediate eviction,15 most of them will ultimately be forced to leave their homes.16
Furthermore, a great deal of housing stock is now owned by the banks rather than by new
owners. Banks are not in the business of renting homes and are not well suited to carry
out the duties required of a landlord.
Compounding the problem of renters losing homes to foreclosures is the impact that the
crisis has on other sources of affordable housing. A policy brief from the Joint Center for
Housing Studies reports that dramatic changes at Freddie Mac and Fannie Mae and
coincident changes in credit markets have disrupted and increased the cost of funding for
the continued development of multi-family (5+ units) properties, despite the fact that
underwriting and performance has fared better in this segment than in single-family
housing.17 As a result, even though a general over-supply of single-family housing
persists, the deficit in the long-term supply of affordable rental housing is at risk of
B. Toxic loan products lie at the heart of the mortgage meltdown.
In response to the foreclosure crisis, many in the mortgage industry have evaded
responsibility and fended off government efforts to intervene by blaming homeowners for
mortgage failures, saying that lower-income borrowers were not ready for
homeownership or that government homeownership policies dictated the writing of risky
loans.19 This argument is both insulting and wrong. Empirical research shows that the
elevated risk of foreclosure was an inherent feature of the defective nonprime and exotic
loan products that produced this crisis, and that these same borrowers could easily have
qualified for far less risky mortgages that complied with all relevant government policies
A number of studies demonstrate that loan performance and loan quality are strongly
related. For example, Vertical Capital Solutions found that the least risky loans20
significantly outperformed riskier mortgages during every year that was studied (2002-
2008), regardless of the prevailing economic conditions and in every one of the top 25
metropolitan statistical areas.21 That study also confirmed that loan originators frequently
steered customers to loans with higher interest rates than the rates for which they
qualified and loans loaded with risky features, and that 30 percent of the borrowers in the
sample (which included all types of loans and borrowers) could have qualified for a safer
loan. The Wall Street Journal commissioned a similar study that found 61 percent of
subprime loans originated in 2006 “went to people with credit scores high enough to
often qualify for conventional [i.e., prime] loans with far better terms.”22
Even applicants who did not qualify for prime loans could have received sustainable,
thirty-year, fixed-rate subprime loans for—at most—half to eight tenths of a percent
above the initial rate on the risky ARM loans they were given.23
CRL’s own research has demonstrated that common subprime loans with terms such as
adjustable rates with steep built-in payment increases and lengthy and expensive
prepayment penalties presented an elevated risk of foreclosure even after accounting for
differences in borrowers’ credit scores.24 A complementary 2008 study from the
University of North Carolina at Chapel Hill supports the conclusion that risk was inherent
in the structure of the loans themselves.25 In this study, the authors found a cumulative
default rate for recent borrowers with subprime loans to be more than three times that of
comparable borrowers with lower-rate loans. Furthermore, the authors found that
adjustable interest rates, prepayment penalties, and mortgages sold by brokers were all
associated with higher loan defaults. In fact, when risky features were layered into the
same loan, the resulting risk of default for a subprime borrower was four to five times
higher than for a comparable borrower with the lower- and fixed-rate mortgage from a
Finally, CRL conducted a more targeted study to focus on the cost differences between
loans originated by independent mortgage brokers and those originated by retail lenders.
In that study, we found that for subprime borrowers, broker-originated loans were
consistently far more expensive than retail-originated loans, with additional interest
payments ranging from $17,000 to $43,000 per $100,000 borrowed over the scheduled
life of the loan. 26 Even in the first four years of a mortgage, a typical subprime borrower
who used a broker paid $5,222 more than a borrower with similar creditworthiness who
received a loan directly from a lender.27 The data overwhelmingly supports that
irresponsible lending and toxic loan products lie at the heart of the crisis.
C. Minority families and communities of color bear a disproportionate
burden of the foreclosure crisis.
It is well documented that African-American and Latino families disproportionately
received the most expensive and dangerous types of loans during the heyday of the
subprime market.28 New CRL research released this summer shows that, not
surprisingly, minorities are now disproportionately experiencing foreclosure.
In June, our report entitled “Foreclosures by Race and Ethnicity: The Demographics of a
Crisis” shows that African-Americans and Latinos have experienced completed
foreclosures at much higher rates than whites, even after controlling for income.29 While
an estimated 56% involved a white family, when looking at rates within racial and ethnic
groups, nearly 8% of both African-Americans and Latinos have already lost a home,
compared to 4.5% of white borrowers. We estimate that, among homeowners in 2006,
17% of Latino and 11% of African-American homeowners have lost or are at imminent
risk of losing their home, compared with 7% of non-Hispanic white homeowners. The
losses extend beyond families who lose their home: From 2009 to 2012, those living near
a foreclosed property in African American and Latino communities will have seen their
home values drop more than $350 billion.
Another CRL report issued in August, “Dreams Deferred: Impacts and Characteristics of
the California Foreclosure Crisis,” shows that more than half of all foreclosures in that
state involved Latinos and African Americans.30 Contrary to the popular narrative, most
homes lost were not sprawling "McMansions," but rather modest properties that typically
were valued significantly below area median values when the home loan was made.
The impact of this crisis on families and communities of color is devastating.
Homeownership is the primary source of family wealth in this country, and people often
tap home equity to start a new business, pay for higher education and secure a
comfortable retirement. In addition, home equity provides a financial cushion against
unexpected financial hardships, such as job loss, divorce or medical expenses. Perhaps
most important, homeownership is the primary means by which wealth is transferred
from one generation to the next, which enables the younger generation to advance further
than the previous one. Minority families already have much lower levels of wealth than
white families, and therefore this crisis is not only threatening the financial stability and
mobility of individual families, but it is also exacerbating an already enormous wealth
gap between whites and communities of color.31
D. Unemployment is exacerbating the crisis but didn't cause it.
High unemployment did not cause the foreclosure crisis, but because of the crash of the
housing market, unemployment is now far more likely to trigger mortgage default than in
the past, largely due to widespread negative equity. In past recessions, homeownership
served as a buffer against income interruptions because homeowners facing
unemployment could sell their homes or tap into their home equity to tide them over.
Today, selling homes is difficult to impossible in many markets, and even when sales
take place, the seller sees no net proceeds from the sale. Figure 1 below shows that
during previous periods of very high unemployment, foreclosure numbers remained
essentially flat. Delinquency levels did rise somewhat, but they rose far less than they
have risen during the recent crisis.32 Other research confirms that the risk of default due
to unemployment rises mainly in situations where homeowners are underwater on their
And why are so many homeowners underwater? It is because the glut of toxic mortgages
contributed to inflating the housing bubble and then led to the bursting of the bubble,
followed by a self-reinforcing downward spiral of home prices.
Figure 1: Historical relationship of unemployment and foreclosure rate
Sources: MBA National Delinquency Survey, Bureau of Labor Statistics.
E. Foreclosures continue to outstrip loan modifications.
Despite both HAMP and proprietary modifications, the number of homeowners in need
of assistance continues to overwhelm the number of borrowers who have received a
permanent loan modification by ten to one. About 4.6 million mortgages are in foreclosure or 90 days or more delinquent as of June
30.34 New foreclosure starts were over 225,000 per month in July and August, having
fallen below 200,000 in each of the previous three months. There were roughly 33,000
permanent HAMP modifications in August and 116,000 proprietary modifications.35
According to the State Foreclosure Prevention Working Group, more than 60% of
homeowners with serious delinquent loans are still not involved in any loss mitigation
F. Recent legal developments have revealed pervasive abuses in the
mortgage servicing industry.
For at least a decade, community-based organizations, housing counselors and advocates
nationwide have documented a pattern of shoddy, abusive and illegal practices by
mortgage servicers whose staff are trained for collection activities rather than loss
mitigation, whose infrastructure cannot handle the volume and intensity of demand, and
whose business records are a mess.37
The most egregious of these abuses include:
?? misapplication of borrower payments, which results in inappropriate and
unauthorized late fees and other charges, as well as misuse of borrower funds
improperly placed in “suspense” accounts to create income for servicers.
?? force-placing very expensive hazard insurance and charging the borrower’s
account when the borrower’s hazard insurance has not lapsed, often driving an
otherwise current borrower into delinquency and even foreclosure.
?? charging unlawful default- and delinquency-related fees for property monitoring
and broker price opinions.
?? failing or refusing to provide payoff quotations to borrowers, preventing
refinancings and short sales.
?? improperly managing borrower accounts for real estate tax and insurance escrows,
including failure to timely disburse payments for insurance and taxes, causing
cancellation and then improper force-placing of insurance as well as tax
delinquencies and tax sales.
?? abuses in the default and delinquency process, including failing to properly send
notices of default, prematurely initiating foreclosures during right to cure periods
and immediately following transfer from another servicer and without proper
notices to borrowers, initiating foreclosure when borrower is not in default or
when borrower has cured the default by paying the required amount, and failing to
adhere to loss mitigation requirements of investors.
These practices have become so ingrained in the servicing culture that they are now
endemic in the industry. The harm to which borrowers have been subjected as a result of
these abuses cannot be overstated. Numerous homeowners are burdened with
unsupported and inflated mortgage balances and have been subjected to unnecessary
defaults and wrongful foreclosures even when they are not delinquent. Countless
families have been removed from their homes despite the absence of a valid claim that
their mortgage was in arrears.
In addition, perverse financial incentives in pooling and servicing contracts illustrate why
servicers press forward with foreclosures when other solutions are more advantageous to
both homeowner and investor. For example, servicers are entitled to charge and collect a
variety of fees after the homeowner goes into default and can recover the full amount of
those fees off the top of the foreclosure proceeds.
In recent weeks, legal proceedings have uncovered the servicing industry’s stunning
disregard of basic due process requirements.38 Numerous servicers have engaged in
widespread fraud in pursuing foreclosures through the courts and, in non-judicial
foreclosure states, through power of sale clauses. Depositions of employees from a broad
range of lenders, servicers and law firms have confirmed what many homeowners’
advocates have long known: Fraud and deception is rampant in the servicing industry and
has culminated in the unjustified and sometimes criminal seizing of family homes. It is
becoming more and more apparent that servicers falsify court documents not just to save
time and money, but because they simply have not kept the accurate records of
ownership, payments and escrow accounts that would enable them to proceed legally.
The public is also now learning what foreclosure defense attorneys have asserted for
years: the ownership of potentially millions of mortgages is in question due to
"innovations" and short-cuts designed to speed the mortgage securitization process.
The illegal practices of servicers during the foreclosure process are not simply a technical
problem. Due process when taking private property is a cornerstone of our legal system,
and case after case reveals that this is not just a question of dotting the I’s and crossing
the T’s, but of unnecessary and even wrongful foreclosures. The rules that the banks
have broken in their rush to foreclose are designed to give people a fair chance to save
III. It is time for a comprehensive approach to foreclosure prevention that uses
all the tools in the toolbox.
A. Congress can pass legislation that would meaningfully realign
incentives among servicers, investors, and homeowners.
1. Change the bankruptcy code to permit modifications of
mortgages on principal residences.
Our country’s well established system for handling problems related to consumer debt is
bankruptcy court. The availability of this remedy is so crucial for both creditors and
debtors that the Framers established it in the Constitution, and the first bankruptcy
legislation passed in 1800. Today, bankruptcy judges restructure debt for corporations
and individuals alike.
Shockingly, however, when it comes to the family home -- the primary asset for most
people in our country -- these experienced judges are powerless: current law makes a
mortgage on a primary residence the only debt that bankruptcy courts are not permitted to
modify in Chapter 13 payment plans. Owners of vacation homes, commercial real estate
and yachts can have their mortgage modified in bankruptcy court (and the peddlers of
predatory mortgages such as New Century or over-leveraged investment banks like
Lehman Bros. can have all their debt restructured) but an individual homeowner is left
Addressing this legal anomaly would solve almost in one fell swoop a range of problems
that have beset efforts to combat foreclosures. First and foremost, bankruptcy does not
leave foreclosure prevention to the voluntary efforts of servicers. Instead, a trusted third
party can examine documents, review accounting records, and ensure that both the
mortgagor and mortgagee are putting all their cards on the table. Moreover, the
homeowner is the one who controls when this remedy is sought, rather than the servicer.
Second, in bankruptcy, the judge can reduce the level of the mortgage to the current
market value of the property. This stripdown (some call it cramdown), or principal
reduction, can help put homeowners in a position to begin to accumulate equity on their
home again, thereby shielding them against future income shocks and increasing their
incentive to make regular mortgage payments.
Third, a bankruptcy judge has the power to deal with the full debt picture of the
homeowner, including any junior liens on the family home and other consumer debt such
as medical bills, credit cards, or student loans. Second liens have proven to be one of the
most vexing problems facing many foreclosure prevention efforts, and high consumer
debt can threaten the sustainability of any mortgage modification made in a vacuum.39
Fourth, bankruptcy addresses “moral hazard” objections, meaning the concern that people
will want relief even when they don't need or deserve it. Filing a Chapter 13 claim is an
onerous process that a person would rarely undertake lightly. Any relief from debt comes
at a substantial cost to the homeowner -- including marring the homeowner’s credit report
for years to come and subjecting the homeowner’s personal finances to strict court
Fifth, the availability of this remedy would in large part be the very reason why it would
not need to be used very often. Once mortgages were being restructured regularly in
bankruptcy court, a "template" would emerge as it has with other debts, and servicers
would know what they could expect in court, making it much more likely that servicers
would modify the mortgages themselves to avoid being under the control of the court.
Similarly, the fact that a homeowner had the power to seek bankruptcy would serve as the
now-missing stick to the financial incentive carrots provided by other foreclosure
Permitting judges to modify mortgages on principal residences, which carries zero cost to
the U.S. taxpayer, could potentially help more than a million families stuck in bad loans
keep their homes.40 As foreclosures continue to worsen, more and more analysts and
interested parties are realizing the many benefits this legislation could have.41 Recently,
the Federal Reserve Bank of Cleveland published an analysis of using bankruptcy courts
to address the farm foreclosure crisis of the 1980s, concluding that using bankruptcy to
address that crisis did not have a negative impact on availability or cost of credit.42
2. Mandate loss mitigation prior to foreclosure.
Congress has the power to require that all servicers, industry-wide, must engage in loss
mitigation, and that the failure to do so is a defense to foreclosure. For many servicers,
only a legal requirement will cause them to build the systemic safeguards necessary to
ensure that such evaluations occur.
In the Senate, a bill introduced by Senator Jack Reed (S. 1431) would address this
problem. Similar legislation was introduced in the House of Representatives by
Representative Maxine Waters (HR 3451), but the Waters bill needs to be extended to
cover existing loans.
3. Level the playing field in court by funding legal assistance for
All banks and servicers are represented by attorneys, but most homeowners in default or
foreclosure cannot afford an attorney. Housing counselors can help people with their
mortgages, but only attorneys can contest foreclosures in court. Programs offering free
legal assistance can play an integral role in foreclosure prevention, including:
?? identifying violations of mortgage lending laws and laws related to the
?? assisting with loan modification applications and the modification process.
?? advising homeowners on existing bankruptcy options.
?? helping homeowners seek alternatives to foreclosure.
?? defending tenants who are being forced out following foreclosure.
?? educating homeowners and tenants about the foreclosure process and legal rights.
Recognizing the importance of borrower representation, the Dodd-Frank Act authorized
$35 million to establish a Foreclosure Legal Assistance Program through HUD that
would direct funding to legal assistance programs in the 125 hardest hit metropolitan
areas. Unfortunately, that money has not yet been appropriated.
As the foreclosure crisis continues unabated, other funding for foreclosure legal
assistance is drying up. State-administered Interest on Lawyer Trust Account (IOLTA)
revenue, a major source of funding for legal aid programs, has declined 75 percent due to
interest rate decreases. State budget crises have forced the slashing of legislative
appropriations that fund legal aid. Another major private source of funding for antiforeclosure
work, a grant program run by the Institute for Foreclosure Legal Assistance
(IFLA), has already made the last grants it can make under current funding and will end
Without additional funding, the attorneys who have developed expertise in this area may
well lose their jobs, and legal aid groups will not be able to keep pace with the spike in
foreclosure-related needs. Already, legal aid programs turn away hundreds of cases. For
these reasons, it is crucial to fund the $35 million Foreclosure Legal Assistance Program
authorized by the Dodd-Frank Act.
Congress also should instruct Treasury to permit States participating in the Hardest Hit
Program to use that funding for legal assistance when appropriate as part of their overall
plan. On the advice of outside counsel, Treasury permits the use of funding for housing
counselors, but not for attorneys. This is a perverse result, especially given the unique
role that attorneys play in foreclosure prevention.
4. Ensure that homeowners receiving mortgage debt forgiveness
or modifications do not find their new financial security undermined
by a burdensome tax bill.
Even principal forgiveness or the most carefully structured loan modifications can be
seriously undermined if struggling homeowners must treat the forgiven mortgage debt as
taxable income. Solving this tax problem has been flagged as a priority by the IRS’s
Office of the National Taxpayer Advocate.44
When lenders forgive any mortgage debt, whether in the context of a short sale, a deedin-
lieu-of-foreclosure, foreclosure, or principal reduction in a loan modification, that
amount of forgiven debt is considered income to the homeowner and tax must therefore
be paid on it unless the homeowner qualifies for some kind of exclusion to that tax. In
2007, Congress passed the Mortgage Forgiveness Debt Relief Act of 2007 to prevent
adverse tax consequences to homeowners in trouble. After passage of this bill, most
policymakers considered the problem to have been solved.
Unfortunately, many homeowners are not covered by that legislation because they took
cash out of their home during a refinancing to make home repairs, pay for the
refinancing, or consolidate other debt.45 Moreover, even those homeowners already fully
covered by the Mortgage Forgiveness Debt Relief Act often fail to take advantage of this
exclusion because it is complicated and they do not understand the need to do so to avoid
owing additional taxes. 46The National Taxpayer Advocate reports that in 2007, less than
one percent of electronic filers eligible for the exclusion claimed it.47 If the definition of
qualified mortgage debt is expanded, the IRS can take steps through its tax forms to
simplify the process for taxpayers claiming the mortgage debt exclusion.
Finally, while the sunset date on this legislation was already extended through 2012, it
needs to be extended further, and preferably made permanent, since this particular part of
the tax code was originally aimed at corporate deals (where the vast majority of the
related tax revenues are generated) rather than at individual consumer debt issues.
B. Federal agencies have significant authority to help fight foreclosures.
There are a number of agencies with authority to help fight foreclosures. In a later
section, we will provide extensive recommendations for improvements that Treasury can
make to HAMP. In this section, we provide other suggestions.
1. The federal prudential banking regulators should immediately
focus on the servicing operations of their supervisees.
Federal supervisory banking regulators should use their examination authority and
supervisory authority to focus on the servicing operations of their supervisees, with a
focus on the legality and propriety of accounting inaccuracies, inappropriate fees and
charges, failure to comply with loss mitigation requirements, and other problems
identified in this testimony.
2. The Consumer Financial Protection Bureau should make
regulating servicers one of its first priorities.
The Consumer Financial Protection Bureau (CFPB) already has concurrent supervision
authority with federal banking regulators over large banks to examine them for
compliance and to assess risks to consumers and markets.48 Since some of the largest
banks are also large servicers, the CFPB and the relevant federal prudential regulators
should immediately begin to exercise this supervisory function by closely examining
servicers for compliance with all relevant laws and regulations as well as adherence to the
provisions of contracts with investors and government agencies such as FHA and VA.
As of July 2011, the CFPB will acquire rule-making authority to prevent abusive, unfair,
deceptive and harmful acts and practices and to ensure fair and equal access to products
and services that promote financial stability and asset-building on a market-wide basis. It
will also have strong enforcement tools, and the States will have concurrent authority to
enforce the rules against violators in their jurisdictions. The CFPB should quickly move
to regulate the servicing industry to prevent the abuses of the past.
3. Fannie Mae and Freddie Mac should serve as models to the
Fannie Mae and Freddie Mac (the GSEs), now in conservatorship and supported by
taxpayers, should serve as a model for how to prevent unnecessary foreclosures. While it
has been a GSE priority to ensure that foreclosures proceed in a timely way, it is
important that the desire to avoid delay does not prevent their servicers and attorneys
from scrupulously adhering to all laws and guidelines, particularly those regarding loss
mitigation reviews. In addition, the GSEs should consider reducing principal on loans
when a modification with principal reduction as a positive net present value, rather than
having a blanket policy against all principal reductions.
4. HUD, VA, and other government housing programs should
enforce their servicing rules, especially those related to mandatory
FHA, VA, and other government-insured housing finance programs should ensure that
their servicers are conducting the required loss mitigation reviews and following all
relevant laws and guidelines. In a recent press conference, HUD Secretary Shaun
Donovan admitted that an internal HUD investigation indicated that FHA servicers were
not always conducting the loss mitigation reviews required by FHA. In addition to
recommending that HUD terminate contracts with servicers that are not adhering to the
provisions of those contracts, we recommend that HUD release public information
concerning the loss mitigation track records of its servicers.
C. State foreclosure laws provide an opportunity for States to prevent
servicing abuses and save homes.
1. State legislatures should mandate loss mitigation prior to
While states have been hit hard by the current crisis as foreclosures drain resources from
already-strapped budgets, states are also in a strong position to prevent foreclosures.
Although mandatory loss mitigation standards exist in many parts of the market now,
lack of enforcement has diminished their impact, and they are not industry-wide. By
exercising their control over the foreclosure process, states can require that servicers
assess whether foreclosure is in the financial interest of the investor before proceeding to
foreclosure. A mandatory loss mitigation standard will function as a low-cost, highimpact
foreclosure prevention tool that ensures foreclosure is a last resort.49
Like the NPV test required by HAMP, a mandatory loss mitigation standard would
require that servicers weigh the investor’s cost of foreclosure against the investor’s
anticipated cash flow from future modified mortgage payments.50 By mandating this
additional step, states can impose uniform standards, which promote fairness and
transparency, across all mortgage servicers and financial institutions, regardless of their
charter or affiliation.
While ideally states would require servicers to perform a loss mitigation analysis prior to
filing for foreclosure, existing laws have incorporated elements of a mandatory loss
mitigation standard at various stages of the foreclosure process. There are four ways in
which a loss mitigation component has been integrated into state foreclosure laws, either
implicitly or explicitly: (1) as a pre-condition to foreclosure filing; (2) as part of a
foreclosure mediation program; (3) as a pre-condition to foreclosure sale; and (4) as the
basis for a challenge post-foreclosure sale.
This range of approaches demonstrates the extent to which a loss mitigation standard can
be adapted to any foreclosure process. Because not all foreclosures are preventable, the
implementation of this standard will not limit the right of creditors to foreclose on a
property where appropriate, but would ensure that the foreclosure sale is a last resort,
after all other foreclosure prevention strategies have been considered.
The HAMP qualification process has repeatedly been criticized for its lack of
transparency by both borrowers and their advocates. In fact, no mechanism currently
exists to provide borrowers with a standardized and meaningful explanation of the
reasons they are denied a modification. Without a standardized modification denial
process with possibility of appeal, borrowers are unable to know whether their
modification application was denied based on accurate information. States can promote
transparency and accountability by combining a mandatory loss mitigation standard with
basic disclosures of the inputs used in the NPV calculation and the results of the
calculation, which can be contested by appeal.
To be most effective, a flexible mandatory loss mitigation standard should be combined
?? a requirement that the foreclosing party provide homeowners with a loss
mitigation application in tandem with any pre-foreclosure notice or preforeclosure
?? a requirement that the foreclosing party submit an affidavit disclosing the specific
basis for the denial of a loan modification, including the inputs and outputs of any
loss mitigation calculations;
?? a defense to foreclosure (or equivalent right in non-judicial foreclosure states)
based on failure of the foreclosing party to engage in a good faith review of
foreclosure alternatives; and
?? public enforcement mechanisms to safeguard against systemic abuses.
?? states with a mediation program or considering creating one could use the
program as an appeal process when an adverse loss mitigation determination is
Finally, state authority to regulate and license mortgage servicers provides another
avenue through which States can promote servicer accountability and incorporate
mandatory loss mitigation.52
2. States should exercise their supervisory and enforcement
authority over servicers doing business in their jurisdiction.
Where state banking agencies have examination and enforcement authority over servicers
operating in their jurisdiction, they, too, should focus on the legality, propriety, and
accuracy of accounting, inappropriate or unnecessary fees and charges, failure to comply
with loss mitigation requirements, and other problems identified in this testimony.
The recently announced investigation by the state attorneys general should encompass
these same matters, as well as the mortgage ownership and “robo-signing” problems.
IV. To fight foreclosures effectively, the Treasury Department should make a
number of important changes to the HAMP program.
A. Although HAMP has had some accomplishments, its overall
performance has failed to live up to expectations and has not significantly
changed the trajectory of the foreclosure crisis.
The Making Home Affordable program was launched about a year and a half ago. It has
two components. One component is the HARP program, which is a refinancing program
for homeowners with GSE mortgages and which we will not address in this testimony.53
The other component -- and the one that has drawn far more public attention -- is the
HAMP program, which provides incentives for participating servicers to make loan
modifications when the net NPV of the modification is greater than that of foreclosure.
As of September, approximately 470,000 homeowners had received and were still active
in a permanent modification.54
While saving almost a half million homes is a significant accomplishment, it falls far
short of the original estimate that HAMP would assist 3-4 million borrowers.55 The
number of new trial modifications has dropped significantly since HAMP changed its
guidelines to require up-front underwriting of the modifications, and the number of
conversions to permanent modifications is also declining, with fewer than 28,000
permanent modifications made in September. Given that trajectory, it seems unlikely that
the total number of permanent modifications by the end of 2012 will exceed one
Also, the efforts have come at a significant cost. Almost 700,000 homeowners who
received trial modifications have seen their modifications cancelled, and many of those
have ended up in a worse financial situation as a result of their participation: during the
trial period, not only did they make payments on a home that they might ultimately lose,
but they also were reported as delinquent to the credit bureaus and they continued to
accumulate late fees, interest, and attorneys fees, resulting in large arrearages due at the
end of the trial modification.
Perhaps even more important is the widespread negative experience that so many
homeowners and their advocates have had with the program. For a whole range of
reasons ranging from lack of capacity to conflicts of interest, mortgage servicers in many
cases fail to provide many homeowners with a HAMP review that is timely, accurate, and
adheres to HAMP guidelines. Stories abound of servicers who have had stunningly bad
experiences with the program.
For example, Ms. L., a Latina homeowner in California, first applied for a HAMP
modification in April 2009. In August 2009, SunTrust finally approved Ms. L. for a
three-month HAMP trial plan with payments of $1,000 per month beginning in
September 2009. Despite the fact that Ms. L. was making every payment under the plan,
SunTrust caused a Notice of Default to be recorded against her home in November 2009.
Ms. L found a nonprofit attorney, who first contacted SunTrust in January 2010 and was
told Ms. L. had been denied a HAMP modification because of insufficient income.
However, the income information SunTrust stated was in Ms. L's file was inaccurate. Her
attorney requested reconsideration on that basis and provided the correct income
information. SunTrust said it would reconsider the denial. SunTrust said the modification
may have been rejected because of SunTrust’s overstatement of insurance costs and
requested proof of insurance and updated financial documents from Ms. L., which the
attorney provided. SunTrust said its initial calculations showed that Ms. L. was eligible
for HAMP, and that the foreclosure sale of her home had been “put on hold.” Ms. L
continued to make her payments every month. Nevertheless, in April, Ms. L.’s son
returned home to find a Notice of Trustee Sale posted on the client’s door.
From the perspective of nonprofit attorneys and housing counselors, Ms. L's story is a
very typical interaction with the HAMP program. This experience is especially
astonishing given that most borrowers who have an attorney or housing counselor
submitted all their financial information at the front end of their modification, rather than
obtaining a so-called “stated-income” modification. Subsequently, it has become clear
that, prior to the new HAMP requirement of pre-trial modification underwriting, even
when a fully documented package was submitted, the servicer did not use this
information and just made a trial modification on a stated income basis. This results in
far more reevaluations than would have otherwise have been necessary, both slowing the
rate of conversation and raising the rate of program dropouts.
However, given the way HAMP was created and implemented, many of these problems
are no surprise. First, the program repeatedly raised public expectations that were then
dashed when programs were not already operational. This pattern began at the inception
of the program, when HAMP was announced to the public well before its infrastructure
was in place. Servicers were quickly overwhelmed by requests when they were not yet
prepared to qualify people for the program, thereby causing many homeowners to be very
disappointed early on. Despite this initial bad experience with a lag between public
announcement and rollout, Treasury continued to make every subsequent program
change the same way. Rather than inform the servicers and wait for them to be ready
before informing the public, Treasury's routine was to release the broad outline of a new
initiative or guideline change and then have an implementation date months away.
Second, the Administration did not make its foreclosure prevention program a priority on
its own agenda. For example, Treasury did not appoint the permanent head of the Office
of Homeownership Preservation until about six months after the program had been
launched. Key leadership in HAMP's early days came from Bush Administration
holdovers, who were knowledgeable about the issues but not part of the inner circle of
Third, because program changes were occurring on a rolling basis, servicers had to
engage in continual retooling of the already strained systems with which they were
working. Servicers already were scrambling to staff up their loan modification
operations, often hiring staff with very little if any experience to do a job that is normally
done by experienced underwriters. With continual changes to the program, the difficult
challenge of training these staff became virtually impossible.
Fourth, and perhaps most important, the HAMP program originally was intended to be
only one part of the foreclosure prevention program, with the other part being a reform to
the bankruptcy code that would have allowed judges to modify mortgages on principal
residences. When the bankruptcy reform failed to pass Congress, HAMP became an
entirely voluntary system. As a result, any change to HAMP policy always had to be
evaluated as to whether it would either deter servicers from signing up or cause them to
withdraw from the program. In other words, not only did the HAMP carrot lack the
bankruptcy stick with respect to individual borrowers, but it has had to pull punches with
respect to overall program design to ensure continued participation.
Finally, as has become crystal clear to even the casual observer, the servicing system
remains in complete disarray for a variety of reasons, including that the system's capacity
is too strained to function correctly; the existence of crosscutting financial incentives that
cause servicers and their contractors to act in their own best interest rather than in the best
interest of either investors or homeowners; and the fact that the system may simply be too
big to ever be manageable.
B. Recommendations to make HAMP fairer and more effective.
1. Aggressively enforce HAMP guidelines through serious penalties
and sanctions for noncompliance.
Over its year and a half of operations, Treasury has improved the HAMP program in a
number of ways in response to concerns expressed by homeowners, advocates, and
servicers. Unfortunately, servicers do not always comply with all the HAMP guidelines.
Although we are told that errors are corrected when they are found during the Freddie
Mac compliance process, the continuous flow of HAMP horror stories from advocates
and the press illustrates that many guidelines are being evaded or ignored.
We recommend that Treasury develop a clear, impartial system of penalties and sanctions
for failure to comply with HAMP guidelines. Some HAMP guidelines are more crucial
than others (see, for example, the section below on foreclosure stops), and violation of
those guidelines should result in stiffer penalties. In addition, Treaury should release full
information on the compliance records of each servicer, along with the number of
corrective actions that have been taken, and develop a system for logging and
investigating complaints from advocates about noncompliance with HAMP guidelines.
2. Create an independent, formal appeals process for homeowners
who believe their HAMP denial was incorrect or who cannot get an
answer from their servicer.
When a borrower is rejected for a HAMP modification, that borrower should have access
to an independent appeals process where someone who does not work for the servicer can
review and evaluate the situation. The existing HAMP escalation procedures are
extremely inadequate. (Freddie Mac does conduct compliance reviews and will require a
servicer to fix any errors it finds, but this process cannot be triggered by request of an
individual homeowner.) Since HAMP changed its procedures in January 2010 to require
that servicers send letters with reasons for denial, and even more so as HAMP
implements the directive contained in the Dodd-Frank Act that servicers disclosure the
inputs used to make those decisions, homeowners have increased access to information
about their denial, but they still have no way to make a change if that information
indicates their denial to be in error.
We recommend that the Treasury establish an Office of the Homeowner Advocate to
serve an appeals and ombudsman role within the program, along the lines of the National
Taxpayer Advocate. Senator Al Franken and several co-sponsors drafted an amendment
to Senate legislation that would have established such an office; although the amendment
passed the Senate floor with bipartisan support, the underlying legislation failed so it was
never enacted.57 For states or localities that have foreclosure mediation programs, those
programs could also be used to handle this type of appeal.
3. Review all borrowers for HAMP, 2MP, and HAFA eligibility or
other sustainable proprietary solutions before proceeding with
Prior to June 2010, servicers routinely pursued HAMP evaluations and foreclosures
simultaneously. Homeowners trapped in those parallel tracks received a confusing mix
of communications, including calls and letters concerning evaluation for a modification,
and other formal notifications warning of an impending foreclosure sale. These mixed
messages contributed to the failure of some borrowers to send in all their documentation,
the early re-default of many trial modifications, and the difficulty servicers have reaching
Although HAMP guidelines prohibited the actual foreclosure sale from taking place prior
to a HAMP evaluation, sales were taking place anyway because the foreclosure
proceedings are handled by outside law firms and communications between servicers and
foreclosure attorneys regarding HAMP are extremely minimal.58 Adding insult to injury,
when continuing the foreclosure process during HAMP evaluation servicers’ lawyers
were billing thousands of dollars in attorneys fees that the homeowners were then
expected to pay.
With Supplemental Directive 10-02, Treasury directed that for all new applicants,
servicers were supposed to complete the HAMP review prior to referring the case to
foreclosure. However, except for the very small group of borrowers whose trial
modifications were fully verified,59 borrowers whose foreclosures had already begun
would remain in the foreclosure process even if their HAMP evaluation had not been
Not surprisingly, despite Supp. Dir. 10-02, advocates are still routinely seeing
homeowners placed into the foreclosure process even when they have not yet had their
HAMP review. In some cases, this is because the homeowner did not qualify for the
“foreclosure stop”; in other cases, servicers simply are not complying with the guidelines;
in still other cases, the rules are ambiguous. For example, while servicers may not refer a
case to a foreclosure attorney before the review, in a non-judicial state, it may not be
clear that the foreclosure cannot actually be filed.
Foreclosures and foreclosure sales prior to HAMP evaluation are perhaps the biggest
reason for the public’s loss of confidence in the program. We recommend that when a
borrower applies for HAMP,60 the servicer should stop all foreclosure referrals, filings, or
any actions to advance any goal other than HAMP review. As noted in Recommendation
#1 above, when a servicer is found to proceed with a foreclosure prior to evaluation, strict
penalties should ensue swiftly.
4. To ensure that loan modifications are sustainable, require
servicers to reduce principal whenever the alternative waterfall yields
a positive NPV or at least to disclose the positive NPV to investors,
require servicers to reduce principal on second liens proportional to any
reduction of principal undertaken with respect to the first lien, and
require servicers to reduce principal appropriately when the underlying
mortgage exhibits predatory characteristics.
Millions of Americans now owe more on their mortgages than their homes are worth.
While the overall number of mortgages underwater is estimated to be almost one in
four,61 this ratio is far higher for homeowners who are having trouble affording their
mortgage, and the average HAMP borrower owes $1.14 for ever $1.00 the house is
worth.62 Homeowners who are underwater have no cushion to absorb future financial
shocks, and they have fewer incentives to sacrifice to stay in the home or to make
ongoing investments in maintenance.63 For these homeowners, even the reduction of
monthly payments to an affordable level does not fully solve the problem. As a result, a
homeowner’s equity position has emerged as a key predictor of loan modification
redefault, more so than unemployment or other factors.64
Many stakeholders believe that principal reduction is ultimately the only way to help the
housing market reach equilibrium and begin to recover.65 However, even as loan
modification activity has ramped up in the overall market, principal reduction has
remained relatively rare. One context in which it occurs is in portfolio loans with no
second liens, which suggests that banks understand the usefulness of principal reduction
but that for securitized loans, there is a conflict of interest between the banks that own the
second liens (and who also own the servicers) and the investors who do not want to agree
to a write-down on the first lien unless the second lienholder does the same.
In recognition of these realities, HAMP has initiated two programs: the "alternative
waterfall" principal reduction program, and 2MP, the second lien program.
Unfortunately, although HAMP offers generous financial incentives to cover the writedown,
HAMP does not require servicers to engage in principal reduction even when it's
in the best interests of the investor.66
Since the alternative waterfall program just began this month, we do not yet know how it
will work. It is likely that the only way principal reduction is ever going to happen on a
widespread basis is if it is required. Similarly, although 2MP has existed for over a year
and although all four major banks have signed up, it is unclear why that program has only
been used 21 times to date.67 For this reason, HAMP should either require the writedowns
or require the servicers to disclose the results of the positive NPV calculations to
Finally, HAMP should provide a commensurate reduction in principal for loans that
exhibit predatory characteristics, such as 2/28s, 3/27s, and non-traditional loans such as
interest-only or negatively amortizing loans not underwritten to the fully indexed rate or
fully amortizing payment.
5. Increase the mandatory forbearance period for