Some 23 states, known as judicial foreclosure states, require foreclosures to be reviewed and approved by a court. Nonjudicial foreclosure states have different processes for foreclosures that do not require the creditor to obtain court approval for a foreclosure, but instead impose varying waiting periods and documentation, filing, and notice requirements after a default occurs and before a foreclosure sale may take place. In nonjudicial foreclosure states, the homeowner typically has access to the court in a foreclosure matter only if the homeowner initiates a suit to stop the foreclosure process or seeks protection in a bankruptcy court.

Because mortgage servicers maintain the official accounting of all amounts paid and owed by borrowers, they serve as the critical link between borrowers and mortgage holders. In addition, servicers manage loan defaults, including the negotiation of loan modification and repayment plans with borrowers. Should the servicer decide to initiate foreclosure, it would often do so as the agent for third parties, such as securitization trusts. In this regard, servicers have responsibilities to investors holding residential MBS. Servicers also have responsibilities to borrowers to maintain accurate and complete records of payments received, amounts advanced, notifications made to borrowers, and changes of payment terms with respect to any mortgage modification discussions.

Foreclosure documentation typically requires an assertion that the agent bringing forth the action has the legal right to foreclose and that the loan is in default. The document filings contain details of the transactions and the amounts owed. These documents typically include attestations signed by individuals who have personal knowledge of the facts and who are properly authorized to make such assertions. In most jurisdictions, the documents must be signed by these individuals in the presence of a notary, following proper notarization procedures. Lenders and servicers are responsible for ensuring that the individuals who sign these documents are duly authorized and have appropriate knowledge of the facts and circumstances. In addition, lenders and servicers are responsible for ensuring the accuracy of records and the facts recited in the foreclosure documents.

State and local laws govern the recordation process for real estate transfers and mortgage filings and assignments. Given the multiple sales and assignments of mortgage loans that often occur, concerns have been raised regarding investors’ or servicers’ rights to initiate foreclosure actions. Although state-by-state practices vary considerably, generally the noteholder has the right to initiate foreclosure, once default has occurred, if an original note can be produced and the current holder’s ownership is verified. If there is no controversy concerning ownership of the note, but rather an inability to locate original documents, processes usually allow for foreclosure to proceed, albeit at some cost and delay. If there is some question of ownership, the investor or servicer may be required to produce evidence of ownership before a foreclosure can proceed.

Since matters regarding real estate titles and foreclosures are generally governed by state law, state attorneys general are undertaking a joint review of lenders and servicers focusing on the reported problems in foreclosures. In addition, numerous federal agencies have launched investigations, including the examinations in process by the federal financial regulators.

The Office of the Comptroller of the Currency, the Office of Thrift Supervision, the Federal Deposit Insurance Corporation, and the Federal Reserve are conducting an in-depth review of practices at the largest mortgage servicing operations. The interagency examinations and reviews focus on foreclosure practices generally, but with an emphasis on the internal control breakdowns that led to inaccurate affidavits and other questionable legal documents being used in the foreclosure process. The agencies are reviewing firms’ policies, procedures, and internal controls, including sampling loan files. We have also solicited the views of consumer organizations to help detect problems at specific servicers. The agencies expect the initial on-site portion of our work to be completed by the end of the year. The agencies plan to publish a summary overview in early 2011 that will describe the range of industry practices found in the examinations and identify weaknesses requiring remediation.

The Federal Reserve has supervisory and regulatory authority for bank holding companies and their nonbank subsidiaries, as well as for approximately 800 state-chartered banks that are members of the Federal Reserve System (state member banks), and certain other financial institutions and activities. We work with other federal and state supervisory authorities to ensure the safety and soundness of the banking industry, foster the stability of the financial system, and provide for fair and equitable treatment of consumers in their financial transactions. The Federal Reserve is engaged in both regulation, which involves establishing the rules within which banking organizations must operate, and supervision, which involves reviewing the efforts of banking organizations to abide by those rules and remain, overall, in safe and sound condition.

The Federal Reserve serves as the primary federal regulator for two of the 10 largest servicers affiliated with banking organizations, one a holding company affiliate and the other a state member bank. The Federal Reserve is participating with the other federal banking agencies in examining the foreclosure policies and practices of the other large institutions. For additional information on foreclosure processes, we have sent a self-assessment questionnaire to other Federal Reserve-regulated institutions that engage in mortgage servicing but are not part of the interagency examination effort.

While quite preliminary, the banking agencies’ findings from the supervisory review suggest significant weaknesses in risk-management, quality control, audit, and compliance practices as underlying factors contributing to the problems associated with mortgage servicing and foreclosure documentation. We have also found shortcomings in staff training, coordination among loan modification and foreclosure staff, and management and oversight of third-party service providers, including legal services. It is for this reason that we expanded the review to include an examination of pre-foreclosure loans, or those past due but not yet in the foreclosure process, and certain third-party service providers. As examiners identify weaknesses, they will require firms to take remedial action and, when necessary, require servicers to address resource shortfalls, training and coordination problems, and control failures.

It is important to recognize that the extent of these problems is not the same across all firms. Nonetheless, the problems are sufficiently widespread that they suggest structural problems in the mortgage servicing industry. The servicing industry overall has not been up to the challenge of handling the large volumes of distressed mortgages. The banking agencies have been focused for some time on the problems related to modifying mortgage loans and the large number of consumer complaints by homeowners seeking loan modifications. It has now become evident that significant parts of the servicing industry also failed to handle foreclosures properly.

While we are still in the process of determining the extent of these problems and the required supervisory response, it is clear that the industry will need to make substantial investments to improve its functioning in these areas and supervisors must ensure that these improvements occur. Moreover, fixing the problems in the mortgage servicing industry may also require thinking about some fundamental structural changes to the current mortgage system. I will discuss the issue of structural solutions to these issues in more detail later in my testimony.