New Loan Mod Regulations Attack the Wrong Problem

A bad situation is about to get much worse.  Two bills pending before the California Legislature, AB 764 and SB 94, will apply criminal penalties and fines to real estate brokers and attorneys who charge advance fees or take retainer fees to handle loan modifications.  The primary basis for this approach appears to be the continuing assumption that homeowners can get these services for free from the lenders themselves, or from HUD authorized nonprofit loan counselors.  Any broker who wishes to charge for these services must first obtain approval from the Real Estate Commissioner and comply with the new provisions of the law.   Violation of these provisions by an attorney would constitute grounds for disciplinary action.  Unfortuately, this legislation — like many other recent regulatory actions — attacks the wrong problem.

On the surface, this consumer-protection legislation appears to address a serious problem:  the rash of scam artists seeking to profit from the thousands of homeowners facing hardship and possible foreclosure.  It is too early to predict whether these bills will pass, but the trend is clear.  Authorities are clamping down on the widespread abuses and scams that have plagued distressed homeowners for the past couple of years.  One company recently shut down by the FTC in Southern California had 400 employees, seven attorneys, and claimed a 98% success rate at “modifying” loans.  In one of these, the lender increased the mortgage payment by over $300 per month — even though the homeowner was current on their payments!  The “loan mod” company charged the homeowner $3,600 for this “modification.”  This was not an isolated case — approximately 60% of all “loan mods” approved by lenders in the first three Quarters of 2008 resulted in either no change or an increase in the borrower’s mortgage payments!  To no one’s surprise, a majority of these “modifications” failed and the properties went back into foreclosure, prompting renewed efforts by the Federal government to offer incentives to lenders to actually lower monthly payments.  (These Guidelines were released on March 4, 2009).

Nonetheless, thousands of homeowners, facing foreclosure and fearful of losing their homes, were scammed into paying money to unscrupulous individuals and companies who promised to “stop foreclosure” and “save your home.”  Responding to the problem, the California Department of Real Estate (DRE) issued a “Consumer Alert” and established a program which would allow real estate brokers to submit their Advanced Fee Agreements for review and the opportunity to be listed on the DRE web site if the DRE issued a “no objection” letter.  The DRE now lists hundreds of brokers on their web site who have been “approved” to charge advanced fees.  The DRE also list over 240 individuals and companies against whom the DRE has filed a “Desist & Refrain” Order and/or Accusation for loan modification activities.

On June 1, 2009, the California Attorney General issued a press release directing anyone who acted as a “foreclosure consultant” to register with his office and post a $100,000 bond by July 1, 2009.  The press release also lists several enforcement actions taken by the AG in relation to prosecuting loan modification scam artists.

Earlier, in February, 2009, the California State Bar had released an “Ethics Alert” that contained a fairly comprehensive discussion of the background leading to the current foreclosure crisis, and warned that attorneys who offered their names to non-attorney companies in order to allow those companies to collect advance fees were in violation of the Rules of Professional Conduct, which prohibit licensed attorneys from assisting non-attorneys in the practice of law, and prohibit attorneys from splitting fees with non-attorneys.  Also, the Ethics Alert reminded attorneys that it was a violation to file lawsuits to delay a foreclosure sale without good cause.

These and similar measures are designed to protect consumers and homeowners, ostensibly from the potential scams of companies seeking to profit from the chaos in the housing crisis.  However, as distasteful and outrageous as these practices may be, they are not thereal problem.  A blanket attack on real estate agents and attorneys will invariably sweep up many professionals who, by virtue of their expertise and training, are in the best position to actually provide much-needed assistance for these distressed homeowners.  At the same time, this regulatory approach does nothing to make the task easier for the homeowner to handle the task themselves — the legislation directs them to go to a local HUD office or to their website at to get a list of approved nonprofit housing counseling agencies.

The real problem is two-fold.  First, the process whereby these loans were securitized, fractionalized, sold, and resold means that in any given instance, the “lender” is merely a loan servicer for an investor two, three or four times removed from the original institution that originally approved the loan.  Each investor has specific restrictions and requirements beyond which the “lender” may not modify the terms of the loan.  There is no ability to negotiate directly with the investor, and the process for reviewing each application in light of these requirements takes anywhere from a month to 90 days or more.  The second aspect of the real problem is there is no real incentive to provide meaningful relief in the form of principal reduction, or otherwise offer modifications that will make a difference.  “Loan Mods” that simply shift the debt load to the back end of the loan, or offer insignificant adjustments (i.e., a 27-cent monthly reduction), as an alternative to foreclosure, really do not accomplish anything.  Forcing a distressed homeowner who has suffered a sudden loss in wages or other genuine hardship to endure three to four months of back-and-forth with an unnamed and undisclosed “investor” just to receive an unacceptable or meaningless proposal is bad enough.  Limiting — if not eliminating — their range of options to seek competent assistance merely adds insult to injury.  Making it virtually impossible for competent professionals to charge for legitimate services will only force them to refuse to participate, and do little to address the real problems.

There is no question but that there have been outrageous abuses by scam artists seeking to profit from the crisis.  Existing regulations govern the conduct of licensed real estate and legal professionals, and if properly applied and enforced, would address most of these types of problems.  What is needed even more is meaningful and effective regulations to allow lenders the ability to modify existing loans without the hidden restrictions imposed by silent investors lurking in the background.   Focus on the real problem — don’t attack the lifeguards and ignore the sharks!