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Bankers Should Take Personal Responsibility for the Foreclosure Mess

A Solution to Rebuild Confidence in the Housing Market

SOURCE: AP/Damian Dovarganes

Thousands of people wait in line at the Los Angeles Convention Center for free mortgage help in downtown Los Angeles on September 30, 2010.

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Responsible policymakers face a dilemma in how to respond to the revelations that employees of some major banks have been “robo-signing” affidavits used in foreclosure actions. The banks deserve serious condemnation for routinely making misrepresentations (the less polite term is “lies”) in what they filed with the judges. As a law professor who has taught professional ethics, I know that even one knowing misstatement to a judge can result in a lawyer losing his or her bar license. Making thousands of such misstatements is far worse.

Yet simply blasting the banks and stopping all foreclosure actions can bring gridlock to the housing market, reducing sales and lowering the market price for nonforeclosed homeowners. The New York Times described one Florida real estate broker who has had half of his pending home sales halted by concerns about improper foreclosure documentation. The same story described how new families are eager to buy the houses where previous owners couldn’t pay the mortgage but cannot purchase them due to the halts on foreclosures. The temptation for righteous indignation and the pleasure of blasting the banks could cause this uncertainty to spread farther into the housing market, further endangering the economic recovery.

Here is one idea to resolve this dilemma. It holds banks accountable while also creating a path back to restoring certainty in the housing market. The idea starts with a senior corporate officer at a bank personally certifying that his or her bank has checked its internal processes and found those practices to be sound. The Sarbanes-Oxley Act requires this sort of certification by chief financial officers and other top corporate officials when they submit their public financial statements. Markets were skeptical about public companies’ financial statements after the Enron and Worldcom scandals. The solution was certification based on personal responsibility—the senior corporate official puts his or her name on the line. In practice, that means that the official insists on stringent scrutiny by people working on the books because no official wants to sign until he or she is confident that the statements are accurate.

Some major banking institutions—including GMAC, Chase, and Bank of America—have admitted that there are significant problems in the statements they have made to judges about foreclosures. Others, including Wells Fargo and Citibank, have informed the press that they do not have those problems. But regulators, the markets, and the public don’t know how much confidence to put in the reassuring statements. Many judges and others are skeptical of general statements that things are OK in light of the problems already uncovered. There are thus calls for generalized halts to foreclosure sales, which could lead to a great deal of uncertainty about when housing markets will function well again.

Certification by senior bank officers will hold those officers accountable for the sorts of misstatements that some banks have made to the courts. The bank and senior banker would be essentially making a stronger set of “reps and warranties” about the banks’ systems. If a senior officer is not willing to sign, then the regulators and the public have good reason to remain skeptical. If and when the senior officer does sign, the officer and the bank are taking responsibility—something many feel has not happened enough since the financial crisis began.

The certification can also bring increased certainty back to a portion of the housing market—the portion covered by that bank’s activities. More banks will sign over time, and this will create a path forward to leaving this portion of the mortgage mess behind us.

There are some implementation issues and possible objections that come with the basic idea of the certification. First, the actual implementation of the certification could be achieved in various ways. Bank regulators or state attorneys general could negotiate the certification as part of a supervisory or enforcement action, or Congress could pass a law requiring the certification as it did in Sarbanes-Oxley. Those owning mortgages (including Fannie Mae and Freddie Mac) might negotiate for certifications, or a bank might even decide to certify unilaterally and set forth specified forfeitures or other consequences for any violations.

Second, the scope of the certification can vary based on what a senior bank official has the basis for promising. A bank may have done enough double-checking to be confident that robo-signing has not occurred, for instance, but may not have double-checked its entire range of operations to make sure that other problems do not exist, such as possible problems in the title of some prior foreclosures. The point here is that banks can gradually expand the scope of certifications over time as they scrub their systems, steadily increasing the portion of the housing market where judges and the public have this renewed basis for confidence.

Third, a broad foreclosure moratorium should not be embraced because of a perception that it will help housing prices. I share the view of many housing economists that most local housing markets won’t be ready for long-term recovery until the large, current backlog of distressed properties is sold. Estimates of the time to clear out this “shadow inventory” range from a year to considerably longer. And an important point, which was the subject of a Federal Reserve conference in September, is that a strikingly large portion of foreclosures happen for vacant properties, where no family remains in the house. These vacant properties are blights on a neighborhood. A long foreclosure moratorium makes it far harder to clean up these properties and get them into new families’ hands.

The dilemma for policymakers has been how to choose between inaction and overheated words that could likely harm the housing market. Personal responsibility and certification would allow us to hold banks and bankers accountable while creating a path to renewal for the housing market.

Peter Swire was special assistant to the president for economic policy until this August, working extensively on housing issues. He has returned to his positions as Professor of Law at the Ohio State University and Senior Fellow at the Center for American Progress.

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