The roots of foreclosure-gate: incentives and lawyers

Cite this Article
Larry Ribstein, The roots of foreclosure-gate: incentives and lawyers, Truth on the Market (October 17, 2010),

Careless or even fraudulent documentation in foreclosure actions has stalled foreclosures, stymied recovery of the housing market, threatened the earnings and even financial stability of banks, and may lead to massive securities fraud actions.  How did this happen?  Per CR:

[A] combination of getting swamped with foreclosures, lack of experienced staff, the poor economic environment for servicers, and outsourcing to the lowest bidder, all contributed to the servicers using “robo-signers”.

From WaPo:

To keep up with the crush of foreclosures, document processors and mortgage service firms rushed to hire anyone they could – hair stylists, Wal-Mart clerks, assembly-line workers who made blinds – and gave them key roles in their foreclosure departments without formal training, according to court papers. A number of these employees have testified that they did not really know what a mortgage was, couldn’t define “affidavit,” and knew they were lying when they signed documents related to foreclosures * * *

More on incentives (WaPo again): 

[V]irtually everyone involved – loan servicers, law firms, document processing companies and others – made more money as they evicted more borrowers from their homes, creating a system that was vulnerable to error and difficult for homeowners to challenge. * * * The law firm of David J. Stern in Plantation, Fla., for instance, assigned a team of 12 to handle 12,000 foreclosure files at once for big financial companies such as Fannie Mae, Freddie Mac and Citigroup, according to court documents. Each time a case was processed without a challenge from the homeowner, the firm was paid $1,300. It was an unusual arrangement in a legal profession that normally charges by the hour.  The office was so overwhelmed with work that managers kept notary stamps lying around for anyone to use. * * *

Law firms were rewarded with additional bonuses from document processing companies if they met deadlines for preparing and filing foreclosures in courts. * * * Fannie Mae imposes a $100 fee on contractors for each day they fail to notify the firm that the foreclosure process was a success and that it has the right to move ahead with the resale of a home. On top of that, Fannie charges a penalty – which escalates for larger mortgages – on contractors who delay selling off such properties. * * * Speed is also rewarded by the nation’s credit-rating agencies, which give higher grades to mortgage service firms that accelerate the foreclosure process and generally hand out lower grades to those who hold onto delinquent loans. A Fitch Ratings manual calls the speed of foreclosures “the key driver in the servicer rating,” according to a report by the National Consumer Law Center. * * *

(So here we have Fannie Mae in the middle of yet another financial crisis.)

More on the lawyers (NYT, via CR):

[F]ormer employee recently testified that Mr. Stern’s firm, in a rush to file and complete thousands of foreclosures, routinely violated procedures by having foreclosure-related documents notarized that were never checked for accuracy — all with the lawyer’s knowledge. * * *

Years ago, lawyers once handled and verified most of the paperwork involved in a foreclosure. But the advent of mortgage securitization a decade ago, financial experts say, gave rise to a parallel legal industry. In it, a law firm is paid a flat fee by loan servicers to handle a foreclosure, which is lucrative for lawyers who process a high volume of cases.  “This is a very profitable business model,” said O. Max Gardner III, a lawyer in Shelby, N.C., who defends homeowners in foreclosure proceedings. “You’ve got five lawyers and four hundred people without legal training working for them.” * * *

According to the lawsuits filed this month against Lender Processing Services and Prommis Solutions, plaintiffs’ lawyers accused the companies of using various mechanisms to steer legal work to foreclosure mills, then splitting legal fees with the lawyers running those operations. In many states, it is illegal or unethical for lawyers to split fees with nonlawyers. Both Lender Processing and Prommis essentially act as informational middlemen between mortgage servicers and law firms doing foreclosure work. Both have denied being involved in such practices.

In recent papers (Death of Big Law, and the in-process Owning the Law) I have described an industry in transition from one-to-one legal advice to more commoditized legal information and mass production.  When I present these ideas I’m often accused of inviting the degradation of a once-proud profession.  My response is that this is not something I’m advocating.  I’m describing changes that are already occurring.  The disaster will come if lawyers and others fail adequately to recognize and deal with these developments.

Foreclosure-gate is partly a product of a law industry which has already embraced mass production and in which non-lawyers (e.g., mortgage servicers and the “informational middlemen” named above) are calling the shots.  Current ethics rules require legal work to be done by lawyer-owned law firms.  So we get “law firms” with “five lawyers and four hundred people without legal training.”  Discarding outmoded regulation and ethical rules that fail to deal with the realities of modern law practice would help involve more credible firms that could put the industry on a sounder business footing.

Of course, there’s another possible future:  regulation that attempts to stop these practices without taking account of the pressures and incentives that caused them to happen.  This is likely to make things worse.