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U.S. mortgage servicers face a new era of tighter oversight as regulators seek to cut the number of botched foreclosures and increase loan modifications for struggling borrowers.

The industry, which oversees $10.6 trillion in loans, has been overwhelmed by more than 3 million foreclosures since 2006. The housing-market collapse exposed failures -- in the way servicers are paid, track loans and process property seizures -- that threaten to stall a fledgling rebound in prices and sales.

"If we fail to act decisively now to deal with the foreclosure crisis, we risk triggering a double-dip in U.S. housing markets," Sheila Bair, chairman of the Federal Deposit Insurance Corp., said in a Jan. 19 speech to mortgage-industry executives in Washington. "The problem is serious, and the need for action is urgent."

Changes being studied include a new fee structure for servicers, independent reviews of rejected requests to ease loan terms and a fund to compensate victims of improper foreclosures, according to Bair and other federal and state regulators. 

While regulators are in the early stages of their work, any changes probably will raise the cost of servicing loans, which would mean higher costs for homeowners. The reforms are in part a response to a long list of court cases that showed banks trying to foreclose using shoddy documentation or without being able to demonstrate they had the standing to do so.

Until last week, Jacqueline Yulee was defending her Jacksonville, Florida, home against foreclosure by two banks, each claiming it owns the $213,750 mortgage she signed on Halloween in 2003.

Wells Fargo & Co., based in San Francisco, filed its complaint against the 58-year-old insurance agent on April 14, more than a year after Minneapolis-based U.S. Bancorp started its proceedings. The companies are trustees for investors in two separate mortgage pools, and her loan couldn't be held by both at the same time. Last week, after being asked about the dueling foreclosures, Wells Fargo withdrew its lawsuit.

The second suit shouldn't have been filed, said Ron Bendalin, general counsel at Irving, Texas-based Vantium Capital Inc., whose Acqura Loan Services business is servicing the mortgage for Wells Fargo. The loan was sold to the Wells Fargo trust on Feb. 3, 2010, and the trust should have replaced the plaintiff in the first case, he said.

"I think we put too much trust in banks," said Yulee, who stopped paying her mortgage two years ago after losing a previous job. "We assume they know what they're doing."

The Mortgage Bankers Association, the industry's Washington-based trade group, is seeking a role in developing new rules and has put together a panel of executives to study proposals, Chief Executive Officer John A. Courson said.

"Anytime you see a situation like this it will typically result in regulation and oversight," Courson said in an interview. "All of us agree the process would need improvement, but what you don't want to do is overreact."

Servicers collect monthly mortgage payments, and may modify or foreclose on a loan in a default. They often don't own the loans they are servicing. The four biggest companies by portfolio size -- Bank of America Corp., Wells Fargo, JPMorgan Chase & Co. and Citigroup Inc. -- service about half of home loans by value, according to data from news website Mortgagedaily.com.

Industry revenue is based on the size of the loan, not the cost to manage. That means servicers make less money on delinquent or defaulted loans, which are more expensive to administer.

Servicers have an incentive to push for foreclosure, which can generate additional fees, and they also can charge borrowers when they are late making payments, giving them a reason to delay loan modifications. Accounting rules allow banks that foreclose to hold off writing down any loss until the home is sold. They must take the loss immediately when allowing a sale by the owner for less than value of the mortgage.

While the flat-rate fee system worked when the market was rising, it failed during the meltdown, Federal Housing Administration Commissioner David Stevens said in an interview. One alternative would be to impose fees that vary with the cost of servicing a loan, he said.

"Servicers' lack of reserving appropriately and not creating infrastructure to manage nonperforming markets like the kind we're in is inexcusable," Stevens said. "You cannot overstate the concern" among regulators that the industry doesn't have enough capital, he said.

The FHA can impose triple damages on servicers that violate its rules on handling foreclosures.

The FDIC's Bair is also calling for variable fees.

Banks, which are typically paid 0.25 percent of the principal balance to service a loan, "created perverse incentives to automate critical servicing activities and cut costs at the expense of accuracy, reliability and currency of loan documents and information," she said in written testimony for a Senate hearing last month on housing.

Bair this month proposed giving borrowers the right to an independent, third-party appeal of requests to modify loan terms when they have been denied. She also suggested that servicers fund a foreclosure commission -- modeled after the one formed to distribute money to victims of BP Plc's Gulf of Mexico oil spill last year -- to resolve borrower complaints.

Edward DeMarco, acting director of the Federal Housing Finance Agency, on Jan. 18 directed Fannie Mae and Freddie Mac to work with the Department of Housing and Urban Development to consider alternatives to flat servicing fees.

Fannie Mae and Freddie Mac, the two largest mortgage- finance companies, were taken over by the government in 2008 and are overseen by the FHFA. New rules wouldn't be implemented until mid-2012 at the earliest, DeMarco said in a statement.

The U.S. Treasury Department endorsed DeMarco's approach, while Bair said more rapid change is required. She wants to include new mortgage-servicing standards in risk-retention rules required by the Dodd-Frank Act that are being written now, a position that puts her at odds with the mortgage industry. She has support from consumer groups and state regulators including New York Banking Superintendent Richard H. Neiman.

Regulators stepped up their scrutiny of the industry after evidence emerged in court cases of bank employees and contractors submitting hundreds or thousands of affidavits weekly to support foreclosures without proper review. The so- called robo-signers were papering over a bigger problem: loan files marred by erroneous, incomplete or missing information, according to Thomas Adams, a partner at New York-based law firm Paykin Krieg & Adams LLP and former executive at bond insurers Ambac Financial Group Inc. and FGIC Corp.

Shortcomings have included promissory notes or mortgages that are missing or not properly assigned or endorsed as securitized loans are bought and sold. Maintaining an accurate chain of title is crucial because it shows who has the right to foreclose when the loan goes into default, Adams said.

"They didn't bother to document all the traveling," Adams said. "To foreclose they had to fill in all the steps that happened three years earlier."

Agencies including the Federal Reserve and FDIC began investigating the industry in September, more than three years after foreclosures started to surge. All 50 state attorneys general announced their own probe the following month.

The attorneys general, who initially began investigating the use of robo-signers, have said they plan to address the loan-modification process in settlements with major servicers. They may push to bar foreclosures when borrowers are already seeking modification and to create a fund to compensate victims of wrongful foreclosures.

Iowa Attorney General Tom Miller said in an interview this month that additional issues, such as whether borrowers are being charged appropriate fees, may be included in any settlement.

Michael Waldron, a partner at Washington-based lobbying firm Patton Boggs LLP, which has represented mortgage companies in meetings with the attorneys general, said state officials will get the most immediate and "impactful reform" because they can seek sanctions such as fines.

"There will be reform through investigation and findings," Waldron said. "Some of those will result in settlement agreements with monetary penalties of significance."

While regulators are focused on servicers, U.S. Representative Marcy Kaptur has proposed legislation to curb the role of Merscorp, the Reston, Virginia, company formed in the mid-1990s by the industry to track servicing rights and beneficial ownership of loans. Many large servicers log the changes on the private database run by its Mortgage Electronic Registration Systems Inc. unit rather than filing mortgage assignments with county records offices. The system has allowed the industry to save at least $2 billion in filing fees.

Kaptur, a Democrat from Ohio, introduced a bill in November to prohibit Fannie Mae, Freddie Mac and Ginnie Mae from owning or guaranteeing any mortgage for which MERS is the mortgagee of record. The House didn't act on the legislation, and Kaptur plans to push it again this year.

Consumer advocates have said that MERS, which has 60 percent of newly originated loans on its system, masks the real owner of a loan and is subject to lapses and mistakes because it isn't authoritative or transparent. Judges nationwide have issued diverging opinions on whether MERS can act as the nominee, or agent of the lender on the mortgage.

"For the first time in the nation's history, there is no longer an authoritative public record of who owns land in each county," Christopher Peterson, a University of Utah law professor, wrote in a recent paper on the electronic-tracking system.

In a statement, MERS said there has never been a requirement that assignments be filed with local land offices and that its system shows the beneficial owner of loans.

MERS was designed to "build upon and supplement, but not displace, the existing public land-record system," the company said in the e-mailed statement. "The MERS process creates accountability and transparency, helps keep costs low, reduces the risk of errors in record-keeping and makes it easier to keep track of the lien if a loan is sold to other banks and investors."

Kaptur's bill includes a proposal for a HUD study of changes including the feasibility of a federal title-recording system for property transfers. MERS says it could provide such a national system.

MERS could be "harnessed by Congress and the industry to improve the mortgage finance system," R.K. Arnold, its president and CEO, told a House subcommittee in November. Arnold retired this month.

All residential home loans should be tracked on a national database that would include the name of the borrower and servicer, the location of the property and the owner and physical location of the promissory note, he said.

Regulators waited too long to address the servicing industry's failures, said Julia Gordon, senior policy counsel in Washington for the Center for Responsible Lending, which seeks to prevent abusive financial practices. The volume of foreclosures, the dual role of banks as servicers and lenders, and complaints by consumer advocates should have prompted an investigation years before the robo-signing scandal, she said.

The Office of the Comptroller of the Currency, which has long had full-time examiners onsite at large banks, relied on the firms' internal controls and audits to ensure federal and state foreclosure laws were being followed, Bryan Hubbard, a spokesman for the agency in Washington, said in an e-mail.

"The dependence on internal audits and controls failed to identify these issues as the volume of foreclosures increased rapidly during the past few years," Hubbard wrote.

Kurt Eggert, a professor at the Chapman University School of Law in Orange, California, said it isn't clear whether regulators will make changes that benefit consumers.

"My fear is they're going to see how they can fix this to save the banks rather than fix it so borrowers aren't abused by servicers," he said.

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U.S. mortgage servicers face a new era of tighter oversight as regulators seek to cut the number of botched foreclosures and increase loan modifications for struggling borrowers.


U.S. regulators focus on loan servicers to fix foreclosures

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