Mortgage Servicers: Getting Away With The Perfect Crime?

National Memo, Mon, 11/28/2011 - 12:40pm —

Matt Stoller

Without prosecutions, there’s nothing keeping fraud from becoming a standard business practice.

In 2004, the FBI warned Congress of an “epidemic of mortgage fraud,” of unscrupulous operators taking advantage of a booming real estate market. Less than two years later, an accounting scandal at Fannie Mae tipped us off that something was very wrong at the highest levels of corporate America.

Of course, we all know what happened next. Crime invaded the center of our banking system. Wall Street CEOs were signing on to SEC documents knowing they contained material misstatements. The New York Fed, riddled with conflicts of interest, shoveled money to large banks and tried to hide it under the veil of central bank independence. Even Tim Geithner noted that Lehman had “air in the marks” in its valuations of asset-backed securities, as the bankruptcy examiner’s report showed that accounting manipulation to disguise the condition of the balance sheet was a routine management tool at the bank. There’s a reason Charles Ferguson got an Academy Award for his work on the documentary Inside Job.

And yet, no handcuffs. The big news on prosecutions in the traditionally high-powered Southern District of New York are convictions for relatively petty insider trading that are unrelated to the collapse of the economy. The criminal charges could have been filed in the 1980s. U.S. Attorney Preet Bharara has brought minor civil suits against banks, but nothing significant, and no criminal indictments for the Ponzi scheme of the last four years.

And what happens when this kind of fraud goes unprosecuted? It continues, even today. The same banks that ran the corrupt home mortgage securitization chain are now committing rampant fraud in the foreclosure crisis. Here’s New Orleans Bankruptcy Judge Elizabeth Magner discussing problems at Lender Processing Services, the company that handles 80 percent of foreclosures on behalf of large banks (emphasis added):

In Jones v. Wells Fargo, this Court discovered that a highly automated software package owned by LPS and identified as MSP administered loans for servicers and note holders but was programed to apply payments contrary to the terms of the notes and mortgages.

The bad behavior is so rampant that banks think nothing of a contractor programming fraud into the software. This is shocking behavior and has led to untold numbers of foreclosures, as well as the theft of huge sums of money from mortgage-backed securities investors.

Here’s how the fraud works: Mortgage loan notes are very clear on the schedule of how payments are to be applied. First, the money goes to interest, then principal, then all other fees. That means that investors get paid first and servicers, who collect late fees for themselves, get paid either when they collect the late fee from the debtor or from the liquidation of the foreclosure. And fees are supposed to be capitalized into the overall mortgage amount. If you are late one month, it isn’t supposed to push you into being late on all subsequent months.

The software, however, prioritizes servicer fees above the contractually required interest and principal to investors. This isn’t a one-off; it’s programmed. It’s the very definition of a conspiracy! Who knows how many people paid late and then were pushed into a spiral of fees that led into a foreclosure? It’s the perfect crime, and many of the victims had paid every single mortgage payment.

A lack of criminal prosecutions means that unethical business practices like this one drive out ethical business practices. After all, why should a bank hire an ethical default servicer that charges a high price for its product when it can pay nothing to one that simply extracts from investors and homeowners?

The joke that is the U.S. Attorney network has become very old and very stale. And unfortunately, because of Attorney General Eric Holder, that joke is on us.

Matt Stoller is a Fellow at the Roosevelt Institute and former Senior Policy Advisor to Congressman Alan Grayson. The Roosevelt Institute is a non-profit organization devoted to carrying forward the legacy and values of Franklin and Eleanor Roosevelt.