With memories of the last foreclosure crisis still fresh, policymakers working to address the current crisis have taken pains to protect homeowners and renters alike. Section 4022 of the CARES Act makes clear that lenders must forbear for at least 180 days on any borrower that asserts - no documentation required - a financial hardship caused by the COVID-19 emergency. Section 4033 precludes any landlord with a federally-backed loan from initiating a foreclosure proceeding for 120 days.
Numerous cities, counties, and states across the country have enacted similar prohibitions to cover loans without a federal guarantee. Federal and state banking regulators have also jumped on board. The OCC, FDIC, CFPB, and other federal agencies issued a joint statement encouraging the banks they supervise to give borrowers’ slack, including by not reporting delinquencies to the credit bureaus.
There have been many complaints about the adequacy of the CARES Act’s relief for individuals. But while $1200 checks may not be enough to close the gap, for many households the ability to forego paying mortgage or rent for a few months amounts to real money. And unlike the stimulus payouts, which aim at lower income earners, the only real limitation on mortgage forbearance or the eviction moratorium has to do with the presence of federal insurance on the underlying loan. According to the House Committee on Financial Services, up to 70% of homeowners could qualify.
Problem solved? Well, maybe. By virtue of these statutory protections for borrowers and tenants, we can be pretty sure that one thing that will not be a feature of this terrible crisis is a near-term massive wave of foreclosures and evictions.
On the other hand, if you’re the sort of person who worries about these things, the downstream effects of these measures might give you a lot to worry about. Intended to help people impacted by the coronavirus get through a temporary crisis, there isn’t much to stop other people, people perfectly able to keep up their mortgage and rent payments, from taking advantage of them, too.
This unintended consequence could have a profound impact on mortgage servicers, because most mortgage servicers are contractually obligated to continue making principal and interest payments to investors in their mortgage-backed securities even when borrowers stop paying their mortgages. And while some mortgage servicers have greater financial strength than others, none of them have infinite resources.
To put a finer point on it, you might worry that a lot of mortgage servicers, starting with small independent servicers of federally-insured mortgages and moving up the size ladder as the months go on, will begin to go broke, requiring the various insurers of mortgage-backed securities, chiefly FNMA and FHLMC, to step in. Those companies, as we learned in the last crisis, only have so much money themselves.
Bailing out the GSEs wasn’t fun the first time. Should a reasonable person really worry that something like that is coming? Or would you only have that sort of worry if you’ve got a particularly negative, pessimistic outlook on life?
Well, the Mortgage Bankers Association is worried. They wrote a letter to the Treasury Secretary raising the specter that 25% of borrowers might seek forbearance and estimating the potential costs at $75-100 billion - amounts that seemed like a lot of money until recently.
On the other hand, Mark Calabria isn’t worried. He regulates the GSEs, so you’d think he’d have a good vantage point. According to yesterday’s American Banker, from where he sits, Calabria doesn’t see a systemic problem, just a few small servicers under stress. No big deal.
Somebody’s going to be right, but who? We won’t know for a while, but - call me cynical - Calabria’s stance strikes me as a little cavalier under the circumstances.
First, there’s the obvious point that a lot of people are truly suffering and will have legitimate claims for relief under the CARES Act. An estimated 40% of Americans have lost their jobs or some portion of their incomes in the past few weeks. Even if there are no abuses of the forbearance provisions, the potential for this to get expensive for servicers is clear.
Second, the protections against foreclosure and eviction in the CARES Act are undeniably rife with potential for abuse. If you need protection, you should, of course, get it. But if you don’t need protection, if you’re one of the remaining 60%, you can get it anyway. If you’re a tenant, you’ll want to do a little research to confirm that your landlord has a federally-insured mortgage. But after that, no application required, you can just stop writing rent checks for a while. If you’re a borrower, just call your servicer and say you’re experiencing financial hardship related to the coronavirus and, presto, you’re out from under your mortgage payment, no proof needed.
Third, it’s pretty clear that ordinary Americans haven’t suddenly become immune to moral hazard. Sure, we’re all in this boat together, but have you looked at the toilet paper aisle lately? It’s a scary time. Depending on whether you’re more worried about the virus or economic collapse, the future may look even scarier. As people realize that the CARES Act creates an opportunity to hoard personal liquidity just like they’re hoarding toilet paper - and that realization will surely sink in as the weeks go by - why wouldn’t they take advantage of it?
The irony is that in the middle of all that’s going wrong, this is one conversation we really shouldn’t need to be having. While the coronavirus and its economic fallout, depending on how you count, are at least one crisis, maybe two, there wasn’t a systemic crisis in housing finance (other than the perennial lack of affordable housing) when Congress and the Administration dreamed up the CARES Act. Foreclosures were not climbing. Tenants were not being forced out into the streets, certainly not as a result of the coronavirus.
Of course they weren’t. Foreclosures and evictions are legal processes that take months (in most parts of the US, two to three months for an eviction and about six months for a foreclosure). We’ve only been living with coronavirus for weeks.
Maybe foreclosures and evictions would have begun to surge down the road, but that’s not at all clear. With plenty of exceptions, lenders and landlords are not stupid. If you’re a lender and your borrower who used to pay regularly has suddenly stopped, you might very rationally decide on your own to give your borrower a break during the crisis. The same goes for landlords. The alternative, after all, in both cases is a long legal process, during all of which the property will generate no income, and at the end of which, in what looks likely to be a challenging economic environment, the property may or may not be saleable or rentable.
Sure, if the economic collapse goes on long enough, lenders and landlords would have needed to rethink their strategies and perhaps then foreclosures and evictions would have begun to tick up, but that problem would have had a long fuse on it - plenty of time in which to monitor the situation and address issues if and as they arose. But because all of that’s been preempted by the CARES Act, we’ll never know. In rushing to respond to a crisis that didn’t exist and might never have come to pass, Congress and the Administration have manufactured a potential systemic crisis in housing finance.
Servicers and large multi-family landlords, in particular, should consider taking steps now to protect themselves against the potential legal and regulatory fallout from this crisis. If, as many now forecast, tens of millions will be unemployed for an extended period, the fact that the current crisis didn’t begin in housing may do little to shield lenders and landlords from political and regulatory pressure.
The public health response to the coronavirus crisis offers interesting lessons for mortgage servicers. As a consultant to a number of mortgage servicers and originators during the last crisis, I saw one after another wait too long to respond to rising delinquencies and foreclosures. By the time they fully absorbed the magnitude of what was happening, their operations were overwhelmed and quality plummeted. Operational errors then magnified their borrowers’ underlying economic problems. Borrowers who would have been quickly and appropriately dispositioned in normal times instead received extraordinarily poor service. Files fell through the cracks, applications got lost, promises were broken, and a raft of avoidable bad outcomes ensued. Media attention, public outrage, and regulatory enforcement proceedings became inevitable.
Just as the public health system has worked hard in recent weeks to prepare for the influx of new patients, mortgage servicers and landlords must move now to build the capacity and the protocols they need to avoid replicating the mistakes of the last crisis. Now is the time to invest in call center operations; develop clear and detailed policies and procedures to guide CSRs in their borrower interactions; train CSRs thoroughly; and establish rigorous, comprehensive, and independent compliance programs. Servicers will need to prove to regulators (and the public) that borrowers receive the treatment they should, that necessary operational follow-up occurs, and that senior executives and directors have a clear, consistent and timely appreciation for how things are going. By taking quick, aggressive actions now, servicers may yet have a chance to “bend the curve” and avoid turning a gratuitous crisis into an industry catastrophe.