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The Lack of Consequences for Banks That Fail to Modify Loans

Because servicers in the lending industry can make more money collecting delinquency fees on mortgages than by modifying loans, guess which road they are taking? The New York Times says today that the longer borrowers remain behind on their payments, the more money servicers collect, even after the home goes into foreclosure. That obviously gives servicers little incentive to rework loans on more favorable terms for borrowers facing foreclosure.

“It frustrates me when I see the government looking to the servicer for the solution, because it will never ever happen,” said Margery Golant, a Florida lawyer who defends homeowners against foreclosure and who worked in the law department of a major mortgage company, Ocwen Financial. “I don’t think they’re motivated to do modifications at all. They keep hitting the loan all the way through for junk fees. It’s a license to do whatever they want.”

As I explain in my story today about loan modifications, servicers are also still including waivers that require borrowers to sign some of their legal rights away in order to obtain a loan modification — a practice that lawmakers, including Rep. Barney Frank (D-Mass.), chairman of the House Financial Services Committee, told them to get rid of more than a year ago.

Frank apparently is so fed up with the slow process of loan modifications that he’s now threatening to bring back legislation to allow federal judges to cramdown, or modify, the terms of a mortgage for a borrower in bankruptcy.

At The Atlantic, Daniel Indiviglio points out how little this means:

Democrats have an easy time passing pretty much whatever they want in the House. Not so for the Senate. In fact, when cramdown legislation was offered in the Senate last spring, it failed miserably. Only 45 Senators voted in favor — no where near the 60 necessary. In other words, the Senate would have at least as difficult a time passing cramdowns as passing national health care reform and cap and trade.

But the climate for passing cramdown legislation has changed: now it’s even less likely. Unlike last spring, the economy and housing market are showing signs of stabilization. That should make moderate Senators even more unlikely to change their votes in favor. These days, the Senate has all the power. Frank can threaten all he wants, but unless he knows of some way to sway moderate Senators, those threats may fall on deaf ears.

Frank’s threats aren’t the only ones to carry little weight. As any five-year-old knows, there isn’t much incentive to change your behavior if there aren’t any consequences for bad behavior. Servicers may get summoned to Washington for a public flogging about their lack of progress in modifying loans — but so what? There are no real financial penalties, or retribution, for failing to rework the loans — or for creating non-compliant modification agreements, like the ones with legal waivers. Housing counselors might catch some problems and try to correct them, but they can’t do much about the incentive of junk fees that make foreclosure a more profitable option. So nothing really changes.

The Treasury Department could do more. It could treat servicers as government contractors, spot check contracts and quit paying firms that violate the program’s guidelines. It could levy penalties. It could get serious about cleaning up the sloppiness in its signature foreclosure prevention program. In short, it could do what it hasn’t done, up until now: Make loan modifications a priority.

And there are other options. If real efforts to promote loan modifications don’t pay off, then it’s time to rethink foreclosure strategies. The White House could actually put its clout behind cramdown this time around. It could push innovative rental policies to ease foreclosures. But whatever it does, the lesson here is to apply the fundamentals to any reforms, especially those involving a lending industry that continues to prey on troubled borrowers. If things don’t get done, there should be consequences.

The lack of progress in getting loan modifications completed has highlighted why the failure of cramdown was so disastrous for foreclosure prevention. Cramdown was the veiled threat, the end of the line if lenders didn’t modify loans. Now there’s nothing to deter them, except for the occasional lecture from administration officials or lawmakers. The business of making money from foreclosures just goes on as usual, long after the news cycle ends.

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