Federal regulators and eight of the nation’s largest mortgage servicing companies announced yesterday that they completed settlements over mortgage fraud allegations such as “robosigning” that helped bring about and continue to exacerbate the housing crisis. The federal settlements came weeks after state attorneys general, led by Thomas Miller of Iowa, divulged settlement terms with mortgage servicing companies in state fraud and consumer lending practice investigations that were nearing completion. The settlement terms at both state and federal level focus heavily on changes in servicers’ internal procedures along with potential fines.
The question, though, is which settlement terms will prevail. Previously, federal regulation of servicers pre-empted similar state regulation under national banking laws, raising the specter that a federal settlement focused on servicer practices could preempt efforts in the state settlement to change servicer practices. Admittedly, this is an open question, but the risk of preemption could leave state attorneys general with effectively one option: Focus on fines.
The current penalty figure in the state settlement terms stands at around $20 billion, but that assumes that states would also get procedural changes and consumer protections that carry equal, if not greater, value. Take them away and the penalty figure could shoot much higher to make up the difference.
The timing of the federal settlement has led some observers to wonder if servicers were looking to pre-empt the state attorney general, or AG, settlement with a federal settlement given the Office of the Comptroller of the Currency’s historically aggressive stance on pre-empting state banking regulation. Bank of America Corp. and Citi group Inc. signed their settlements, for example, just one day (March 29, 2011) after the banks responded to the state AGs with their own terms.
As one would expect, both federal regulators at the Office of the Comptroller of the Currency, which regulates some of the nation’s largest banks, and the state AGs led by Iowa AG Thomas Miller insist that the federal consent orders won’t affect state efforts. Miller released a statement yesterday stating that federal regulators’ “actions will not impact our investigation of the nation’s largest servicers and pursuit of a joint settlement,” and that, “Today’s actions by the OCC will not limit our pursuit of remedies and reforms.” While the investigation may continue, if AGs cannot guarantee that any procedures they write into their settlement will hold up, fines may be their only option.
All three settlement documents are, to borrow Iowa Attorney General Thomas Miller’s term, “disappointing.” The AGs’ terms do not go far enough. The terms address robosigning, Mortgage Electronic Registration Systems, or MERS (a system that lenders and servicers used to transfer mortgages without recording them with state governments), independent monitoring, reduction in loan principal, and so on, but the provisions are too weak or lack “teeth” for enforcement.
The servicers’ counterproposal on March 28, 2011, is worse, ignoring the issues above completely and stating over and over that “servicers will implement processes reasonably designed to ensure” what amounted to little more than compliance with existing law. Case in point: Each borrower is entitled to a so-called “single point of content” at the servicer—one contact to interface with the homeowner to avoid the repeated phone calls, lost documents, and lack of follow through that have characterized mortgage modifications to this point. Yet under the bank’s proposed terms the single point of contact can be more than one person. Georgetown University law professor Adam Levitin has provided a more detailed critique of the banks’ counterproposal.
The servicers’ settlements with federal regulators is only marginally better. There is no mention of penalties, and the servicers’ repeated focus on “processes” is replaced by the terms “policies and procedures” and “internal controls,” nearly all of which presumably should already be in place. While the AG settlement required oversight by a third party monitor appointed by the AGs and the new Consumer Financial Protection Bureau, the federal regulators permit the servicer to hire its own monitor with regulator approval.
So what practical effect will yesterday’s settlements have both on the servicers and on the state AG’s settlements?
First, to believe that the terms of the federal consent orders will change how servicers operate would mean placing our faith in the same regulators who have monitored and been on site at banks throughout this crisis and, as just one example, let “dual-tracking” (that is, foreclosing on a homeowner who is in the midst of mortgage modification procedures with the servicer) continue despite contractual commitments by servicers under HAMP to ensure it did not occur. As with many other practices, the current consent order once again seeks to prevent dual-tracking through internal controls, but one has to question whether federal regulators with a poor supervisory track record will suddenly do a better job.
Second, the practical effect of the consent orders could be to force the state AGs to hold fast to—or even significantly raise—fines reported at $20 billion instead of mandating servicing standards for fear that federal consent orders would preempt them. OCC stated that its consent orders "create a framework for remedial action, but there’s no reason that additional procedures sought from the states can’t fit within that framework. … Nothing that we’re doing is intended to impede any action by the state attorneys’ general.” Per the statements quoted about, Iowa AG Miller would like to agree.
But some aren’t buying it, including Attorney General Eric Schneiderman of New York, who has splintered from the group of AGs over concerns about the effect a federal settlement would have. The AGs could be excused for being skeptical. OCC has for many years aggressively sought to pre-empt state banking regulations under its statutory authority, including the National Bank Act. OCC pursued pre-emption so aggressively that in 2009 the Supreme Court struck down its attempt to prevent state attorneys general from enforcing state fair lending and consumer protection laws under a claim of pre-emption, despite years of rulings in OCC’s favor. (See Cuomo v. Clearing House Association, LLC.) The Court held that OCC could not pre-empt the attorney generals’ power to enforce state consumer protection laws by, for example, bringing a lawsuit, but that it did pre-empt any attorney general’s attempt at “visitorial” powers, those aimed at setting bank policies and procedures and enforcing them.
The current AG settlement straddles the line. On the one hand, it clearly arises from the state attorneys’ general investigation to enforce state fair lending and consumer protection laws related to mortgage servicing. On the other hand, the proposed settlement terms on both sides would create obligations and procedures for servicers that would otherwise fall under the federal regulators’ “visitorial” powers.
That uncertainty could push state AGs to focus on fines instead of procedures, hoping to ensure they get something from servicers to assist homeowners rather than risking procedures that may not hold up in court. From the start of the settlement process, servicers have pushed hard to reduce or eliminate monetary fines. Ironically, it may be their rush to settle with federal regulators that makes that impossible.
The fact that the Dodd-Frank Act, which created the Consumer Finance Protection Bureau, likely eliminates this kind of national-level OCC pre-emption where states regulate servicers actions for the purpose of consumer protection may not prevent AGs from having to refocus their efforts on fining servicers. The Dodd-Frank provision does not take effect until July 21, 2011, and is not retroactive, so any settlement done between now and then is governed by the concerns raised above.
Attorneys general could stall their settlement until and avoid pre-emption, but the wait carries risks too. The loss of momentum will strain a coalition that is already starting to fragment. The delay will allow banks to retrench against the risk of state regulation and give them the argument that further settlement in the face of an existing federal settlement—already in place for months—is unnecessary.
Alon Cohen is a Housing Policy Adviser for the Center for American Progress.
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