44 posts from December 2008
December 29, 2008
December 27, 2008
December 25, 2008
The subprime mortgage crisis keeps getting worse-and claiming more victims. A Fortune special report.
Wall Street's money machine breaks down
 |
| Merrill Lynch CEO Stanley O'Neal lost his job. |
| Write-downs on structured products | ||
|---|---|---|
| Citigroup | $9.8 billion | This is the low estimate; Citi says the figure could be $3 billion higher. |
| Merrill Lynch | $7.9 billion | Analysts project that the broker will have to write down billions more this quarter. |
| UBS | $4.4 billion | UBS still has nearly $40 billion in CDOs and mortgage-backed securities on its books. |
| Morgan Stanley | $3.7 billion | Morgan's total subprime exposure after write-downs stands at $6 billion. |
| Wachovia | $2.1 billion | Wachovia was among the top issuers of subprime mortgage CDO debt this year. |
| Credit Suisse | $948 million | Credit Suisse lost nearly another $1 billion on leverage loans. |
| Lehman Brothers | $700 million | Total includes leveraged loans; Lehman does not provide more detail. |
| Bank of America | $3.527 billion | CEO Ken Lewis is cutting back the company's investment-banking operations. |
| Bear Stearns* | $1.65 billion | Big hedge fund losses in June kicked off the subprime follies. |
| J.P. Morgan Chase | $339 million | CEO Jamie Dimon is credited with losing less than his peers. |
Source: Company earnings releases
(Fortune Magazine) -- Two things stand out about the credit crisis cascading through Wall Street: It is both totally shocking and utterly predictable.
Shocking, because a pack of the highest-paid executives on the planet, lauded as the best minds in business and backed by cadres of math whizzes and computer geeks, managed to lose tens of billions of dollars on exotic instruments built on the shaky foundation of subprime mortgages.
Predictable because whether it's junk bonds or tech stocks or emerging-market debt, Wall Street always rides a wave until it crashes. As the fees roll in, one firm after another abandons itself to the lure of easy money, then hands back, in a sudden, unforeseen spasm, a big chunk of the profits it booked in good times.
"The fee engine becomes so huge that these products take on a life of their own," says Tiger Williams, CEO of Williams Trading, a leading financial services firm for hedge funds. "Everyone rationalizes that it's safe because they're making so much money. But it's far from safe."
In pure destructive power, the subprime mess has become Wall Street's version of Hurricane Katrina. It has wreaked havoc on the nation's iconic brokerage firm, Merrill Lynch (Charts, Fortune 500), and biggest bank, Citigroup (Charts, Fortune 500), which have announced billions of dollars in losses and parted ways with their celebrated CEOs, E. Stanley O'Neal and Charles Prince. Banks, brokerages, and lenders have announced thousands of layoffs, and more are sure to come.
The blow to shareholder wealth is staggering. Since June 29, Citi's share price has dropped 35%, from $51 to $33, while Merrill's stock has slid from $84 to $54, a 36% swoon. In the same period, the dozen biggest Wall Street firms and the commercial banks with the largest investment arms - a list that includes Bank of America (Charts, Fortune 500), J.P. Morgan Chase (Charts, Fortune 500), and Credit Suisse (Charts) - have lost more than $240 billion in market value. Dozens of smaller companies in the mortgage business have suffered huge losses or folded completely.
The crisis of confidence has exploded beyond Wall Street, driving the dollar to record lows - and helping send the prices of commodities, especially oil, soaring to historic highs.
The results could be devastating for the U.S. economy. "The subprime crisis and its fallout on commodity and foreign-exchange markets significantly raises the odds of a recession early next year," says Mark Zandi, chief economist at Moody's Economy.com.
And it's far from over. As stunning as today's losses are, more carnage lies ahead. Wall Street banks are holding tens of billions in risky securities on their books, and no one seems to have any idea what they're worth. In conference calls and press releases, banks have been changing their estimates of the value of these assets.
Merrill Lynch, for example, predicted a $4.5 billion subprime loss for the third quarter, then jolted investors and analysts three weeks later by announcing that its real deficit was $7.9 billion - or 76% more than the initial estimate. (Oops!)
In fact, Wall Street banks are sitting on rotting piles of highly suspect, thinly traded securities no one wants to touch. "Whenever the market turns against you, you take the biggest losses in illiquid securities," says Richard Bookstaber, former head of risk management at Salomon Bros. "Because there are so few buyers, you're forced to sell at a discount that is both huge and highly unpredictable."
What really spooks investors is the fog surrounding the future. One problem is that they can't trust management's estimates of future losses. Citi, for example, says it will take additional write-downs of $8 billion to $11 billion in the fourth quarter.
But it's impossible to know whether those numbers have any relation to reality. Presumably, they are based on a theoretical model, but such models have proved highly unreliable. When Citi actually brings the securities to market, it may have to slash their prices to unload them, forcing it to take a much bigger write-down.
The banks are also far from forthcoming with detailed information on their positions, making it difficult for analysts to assess what the future holds. "The risk to investors is far greater because we're getting so little information," says Michael Mayo, an analyst at Deutsche Bank.
Backed by Treasury Secretary Henry Paulson, Bank of America, Citi, and J.P. Morgan are trying to establish a giant fund that would buy distressed debt so that investors who own it don't have to unload it at fire-sale prices. The hope is that the market will rebound before too long and that the bonds will regain much of their value. But there's no guarantee that the bonds will ever bounce back, and the bailout fund may simply delay the day of reckoning, pushing losses further into the future.
Just how big could those losses be? Both Mayo and analyst Meredith Whitney of CIBC project that write-downs could total $50 billion or more by the end of the year. Longer term, Mayo sees losses climbing to $70 to $100 billion. The wide range simply underscores the uncertainty surrounding subprime. "This will take two to three years to play out," says Mayo, explaining that it will take that long for lenders to foreclose on troubled mortgages and sell the collateral - in this case, hundreds of thousands of homes - to recoup part of their loans.
In this special report, we take a broad tour of the financial wreckage, featuring a close look at Citigroup and comments on the plunging dollar, the echoes of Enron, and CEO accountability. Here, we'll try to dispel the biggest mystery of the subprime crisis: How did the Wall Street firms manage to pile mountains of high-risk mortgage debt, bonds that most investors and analysts thought the firms were selling to their customers, onto their own books?
Their gambit amounted to massive speculation in subprime mortgages. Investors are justly aghast that Wall Street ignored the obvious pitfalls. We'll explain how it happened by examining one of the firms deepest in the subprime swamp, Merrill Lynch. Presumably, many other banks followed similar paths -although Citigroup added a few twists of its own, as we explain in the Robert Rubin story. Hence, Merrill's story may shed light on the misadventures of its rivals, from Morgan Stanley (Charts, Fortune 500) to UBS.
Naturally we don't know the thinking behind Merrill's disastrous foray into subprime. The firm declined to speak to Fortune in detail for this story. But by talking to former employees, experts on risk management, and Wall Street analysts, Fortune has put together the most likely scenario for how Merrill's subprime business swung from a relatively steady channel for booking fees into a wild gamble that devastated the firm.
To understand how Merrill came to grief, we have to take a mind-bending trip inside the complex creation on which it nearly wagered the franchise: the collateralized debt obligation, or CDO, a type of investment vehicle that buys and sell bonds.
Merrill and other banks typically don't operate CDOs. True to their role as middlemen, they help clients create CDOs, take a fee, and then exit the deal. It was Merrill's decision to alter this template - by becoming a huge investor in the funds it assisted - that got the firm in trouble.
Here's how a typical CDO backed by subprime mortgages might work. The game starts when a client - known as the collateral manager - approaches Merrill Lynch and asks it to provide financing for a CDO that will hold, for example, $1 billion worth of bonds backed by subprime mortgages. The clients are mostly big money-management firms like Pimco, Trust Co. of the West, and Cohen & Co.
To get things rolling, Merrill makes $1 billion available to the collateral manager, taking a fee of 1.5% to 2%, or $15 million to $20 million. The collateral manager uses the balance to purchase bonds backed by pools of subprime mortgages (known as "subprime mortgage ABS," for asset-backed securities) issued by Wall Street firms, including Merrill.
At the same time, Merrill's structured-finance team gets to work creating a variety of bonds that will be backed by the interest and principal payments the CDO collects on the asset-backed securities it owns. (To make things more confusing, the bonds the CDO issues are also called CDOs. In this story, we'll use CDO to refer to the investment vehicle; we'll call the securities it issues CDO bonds.) Using complex mathematical models that predict default and payoff rates, among other things, the bankers create several tranches of securities with different interest rates and levels of risk.
At the top of the heap are the super-senior bonds, which have the first claim on the cash coming into the CDO. They are designed to earn ratings of AAA from agencies like Standard & Poor's - meaning they're supposedly as sound as the best corporate bonds - and they pay the lowest rates. The bonds that have a lesser claim on the cash flow pay higher rates and get lower ratings.
Merrill turns the bonds over to its sales force to peddle to hedge funds, pension funds, and other investors. The appeal of CDO bonds is simple: They pay better rates than corporate issues with identical credit ratings. And in the low-rate environment of the past seven years, yield-hungry hedge funds were eager to buy any paper that offered extra returns. "The whole idea," says Brad Hintz of Bernstein Research, "is taking a pool of risky, illiquid bonds and, through the magic of securitization, offering higher yields than on similarly rated securities."
How are CDOs able to offer premium yields on their bonds? Most of them did it by purchasing the riskiest, lowest-rated mortgage-backed bonds - you know, the ones built on loans to borrowers with spotty credit and dubious résumés. Such bonds paid what were then super-high rates of 9% to 11% in 2006.
Didn't those loans carry a high risk of default? Well, yes, they did. But here's the key point, and where Wall Street went astray. During the early years of the housing boom, default rates on all mortgages were unusually low. That led bankers - and more important, rating agencies - to build unrealistic assumptions about future default rates into their valuation models.
And because the subprime mortgage bonds paid such lofty interest rates, the financiers figured that an unimaginably high percentage of them would have to default to cause any real problems for the top-rated CDO bonds. Of course, that's just what happened.
None of this would have been a dire problem for Merrill if it hadn't gone from simply manufacturing CDOs and reaping fees to becoming a huge investor in the CDOs it created - getting high on its own supply, you might say. Merrill was willing, even eager, to speculate with its own balance sheet because of a dramatic change in culture engineered by Stan O'Neal. Until 1997, Merrill didn't engage in a lot of speculative trading for its own account; its trading unit concentrated on making markets for clients. Merrill made its money from relatively safe, fee-generating businesses, courtesy of its army of brokers, now numbering 16,000, and a thriving underwriting operation for stocks and bonds.
After O'Neal became co-head of the institutional business in March 1997, things began to change. There was a shift from trading for customers to trading for the firm's own account. Under O'Neal's watch, Merrill expanded its relationship with Long-Term Capital Management, providing the high-powered hedge fund with lucrative financing.
By the time LTCM collapsed in September 1998, O'Neal had become CFO. Then-CEO David Komansky, a popular former broker, was struggling to cut Merrill's bloated costs, and the board judged that O'Neal, despite the LTCM debacle, had the tough, clinical approach needed to do the job. O'Neal succeeded in putting Merrill in trim.
But he also remained a strong advocate for proprietary trading, especially because Goldman Sachs was generating such huge returns making aggressive bets with its own capital. "Management should have learned from the LTCM and Asian crises that when liquidity runs dry, it happens in a day," says former Merrill Lynch investment banking chief Barry Friedberg. "When it's over, you can't get out."
At first, Merrill treated the CDO trade as a client business. The idea was to get in and out quickly - help structure the CDO, hand it to the manager, and pocket the fees. But as the fees rose, so did Merrill's hunger for market share. The driving force was CDO chief Chris Ricciardi, who constantly pushed the troops to top the league tables. Merrill rose from a bit player in mortgage CDOs in 2003, with just $3.4 billion in underwritings, to the leader from 2004 through 2006, posting $44 billion in deals backed by mortgages last year.
O'Neal primed the pump by purchasing First Franklin, one of the nation's largest originators of subprime mortgages, in December 2006 for $1.3 billion. In early 2007 one unit at Merrill was busy packaging First Franklin's loans into subprime ABS that another Merrill unit bought for the CDOs. Incredibly, in the first half of 2007, Merrill underwrote $28 billion in mortgage CDO bonds, far exceeding its pace for 2006.
The market for CDO debt, however, changed radically starting in 2006. Anyone who picked up a newspaper read constantly about the woes in housing. Foreclosures were rising, home prices were falling in dozens of major markets, and the Fed was closing the era of supercheap money.
In February international bank HSBC suffered big losses on its subprime portfolio, sending tremors through the market. Under normal circumstances, such worries would have led to higher interest rates on subprime mortgage bonds. But these were not normal times. Instead of rising, rates on subprime mortgage bonds remained abnormally low until the summer of 2007, and in some months even dropped below 2006 levels.
What was going on? Instead of backing away from subprime paper, Merrill Lynch and other big players were gobbling all they could, because they needed it to feed their CDOs. Their bottomless appetite for the stuff kept prices high and yields low, against all economic logic. "What we had was a perpetual-motion machine driving mortgage prices to uneconomic levels of risk vs. reward," says Friedberg.
With the yields on the subprime paper falling, the yields on the CDO bonds sank as well. Even so, hedge funds and other investors continued to snap up the lower-rated paper, which still offered relatively generous yields. But they were rejecting the AAA-rated bonds, which paid just 30 to 50 basis points over LIBOR, the international interbank borrowing rate.
That put Merrill in a bind. It couldn't raise those yields on the AAA-rated bonds because it had paid such high prices for the subprime mortgage bonds that provided funding for them. "The hedge funds and other customers were demanding higher yields, so Merrill couldn't sell that supposedly safe AAA-rated paper," says Mark Adelson, a consultant on structured finance and a former analyst for Nomura Securities.
To keep the merry-go-round spinning, Merrill apparently made a pivotal - and reckless - decision. It bought big swaths of the AAA paper itself, loading the debt onto its own books. "Merrill took the top tranches onto its own balance sheet," says Scott Sprinzen, an analyst with S&P. "The amounts were staggering."
By the end of June, Merrill held $41 billion in subprime CDO and subprime mortgage bonds. Since the average deal is between $1 billion and $1.5 billion, and the AAA debt is around 80% of each deal, Merrill must have been buying nearly all the top-rated debt from dozens of CDOs.
The question is why Merrill would purchase bonds its customers were rejecting. Merrill hasn't given a detailed explanation of how it came to own such a large volume of subprime bonds. At first, Merrill made money on the bonds because it was able to benefit from the "carry trade" - borrowing money at low rates and using it to buy CDO bonds paying higher rates.
Also, Merrill execs apparently believed that the credit market turmoil would ease and the bonds would once again be easy to sell. That turned out to be far too optimistic, of course. But the overarching explanation is probably that Merrill became addicted to the fees that flowed from financing CDOs, which reached $700 million in 2006. "They must have had their eyes on the fees and not the risk," says Friedberg. Other big players, like UBS and Morgan Stanley, may have followed the same script.
That turned out to be one of the worst miscalculations in the annals of risk management. In late June the collapse of the Bear Stearns hedge funds helped trigger a big rise in rates on subprime mortgages. In early October, Merrill shocked the markets by predicting the $4.5 billion loss on subprime. But when it made its official earnings announcement two weeks later, investors were appalled to learn that the actual number was $7.9 billion.
Merrill's $41 billion exposure to subprime paper was more than its entire shareholders' equity of $38 billion. That this huge position went unhedged astonishes everyone on Wall Street. The $7.9 billion write-down meant that Merrill lost 19% on its bonds.
How did bonds rated AAA take the kind of hit you'd expect on junk bonds? One reason is that the rating agencies enormously underestimated the chance of default in subprime mortgages. And as subprime borrowers stopped making their payments, the cash flows weren't big enough to make full interest payments, or in some cases, any payments, to even the highest-rated tranches.
As a result, much of the AAA debt now sits at junk-bond status. "It never deserved to be AAA to begin with," says risk-management guru Bookstaber.
The high ratings are no excuse for Merrill. The spreads on the debt it was buying were far below the historic average. It should have realized that even if rates moved back to the levels that prevailed just a few years ago, it would take huge losses. "The banks were in denial," says Adelson. "They thought they were smarter than the market."
Merrill still has $21 billion of unhedged exposure to subprime bonds. It's also holding $11 billion in CDO bonds that it says are fully hedged. Analysts are worried about how effective those hedges will be as prices plunge. Analyst Mayo estimates that Merrill will have to write down another $4 billion in the fourth quarter.
The SEC is requesting information from Merrill and other firms on what they knew when they made sunny statements about subprime this summer, and how they priced their portfolios of CDO bonds.
The subprime saga is far from over. The markets remain on high alert. Each day seems to bring new rumors or announcements of losses. A golden age for banks and brokers has come to a sudden end.
The moral is clear. When Wall Street appears in genius mode, raking in huge profits on mysterious products and complex trades, the secret isn't genius at all. It's that hubris is running wild, and so is risk. And whether it's tomorrow or five years hence, risk will jump from the shadows, knife in hand, to cut genius down to size.
Reporter associates Marilyn Adamo, Lisa
Bergtraum, Katie Benner, Susan Kaufman, Eugenia Levenson and Joan
Levinstein contributed to this article. 
December 24, 2008
December 23, 2008
Hope Now ramps up foreclosure-prevention
Hope Now ramps up foreclosure-prevention
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NEW YORK (CNNMoney.com) -- Some 2.2 million at-risk homeowners will receive foreclosure-prevention help this year, according to an industry report issued Monday, with the number expected to rise to more than 3 million in 2009.
But some critics charge that a great number of these workouts will fail and many families will lose their homes anyway.
Hope Now, the private-sector coalition of major lenders, servicers and consumer advocates, said that it completed 208,000 loan adjustments in November, and that the number of such adjustments would rise to more than 300,000 a month next year.
The workouts being offered borrowers were of two types.
First, there are simple repayment plans, which allow borrowers time to make up missed payments. Second, there are mortgage modifications, the more comprehensive and effective of the two types, which involve reducing or freezing interest rates, expanding the time given to repay loans or lowering mortgage balances.
Many more of the workouts being issued by Hope Now members are mortgage modifications than in the past. These increased by 29% during the three months ended Nov. 30, while repayment plans increased by just 6%.
"The goal is to make these mortgages more affordable, more sustainable," said Faith Schwartz, director of Hope Now.
Hope Now's critics claim, however, that even a lot of the mortgage modifications being done will prove unsuccessful because they do little to actually lower mortgage payments. They may merely freeze rates -- at unaffordable levels -- but add missed payments to mortgage balances.
"Borrowers are getting put into modifications that are built to fail," said Bruce Marks, head of the Neighborhood Assistance Corporation of America, a community advocate.
Data released in early December by John Dugan, the U.S. Comptroller, revealed that 51% of those with loans modified in the second quarter were already delinquent with their payments within just six months of the workouts.
Steve Bartlett, president and CEO of the Financial Services Roundtable, a bank lobbying group, argued that the problems of the larger economy had a lot to do with that. "Any workout is designed to be permanent," he said, "but borrowers' circumstances often change after workouts are done."
The number of modifications completed in November fell to 99,823, a 4% decrease compared with October.
The good news was a decline in the number of actual completed foreclosures. There were 69,075 foreclosure sales during the month, a 14% drop from October.
Industry insiders attribute some of the foreclosure sale drop to state and local initiatives that have instituted moratoriums or delays on foreclosure actions.
For example, in Massachusetts, according to Rick Sharga, spokesman for RealtyTrac, the online marketer of foreclosure properties, every at-risk homeowner now has to be notified of their lender's intention to file a notice of default against them, and they get a 90 day window during which they can attempt to bring their payments up to date.
And in November, Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500) both announced moratoriums on foreclosures, and other major lenders also cut back on foreclosure proceedings.
"That
allows Hope Now members more time to put people into affordable plans,"
said John Courson, CEO of the Mortgage Bankers Association. "But some
situations can't be resolved. Obviously, borrowers who don't have jobs
can't pay their mortgages." 
December 19, 2008
December 18, 2008
Countrywide And Other Mortgage Servicers Use Dubious Foreclosure Fees For Profit
Countrywide And Other Mortgage Servicers Use Dubious Foreclosure Fees For Profit
Dubious Fees Hit Borrowers in Foreclosures
Dubious Fees Hit Borrowers in Foreclosures
In a study of foreclosures, Katherine Porter of the University of Iowa found questionable fees on almost half of the loans. Such fees can make the business of loan servicing even more lucrative.
As record numbers of homeowners default on their mortgages, questionable practices among lenders are coming to light in bankruptcy courts, leading some legal specialists to contend that companies instigating foreclosures may be taking advantage of imperiled borrowers.
Because there is little oversight of foreclosure practices and the fees that are charged, bankruptcy specialists fear that some consumers may be losing their homes unnecessarily or that mortgage servicers, who collect loan payments, are profiting from foreclosures.
Bankruptcy specialists say lenders and loan servicers often do not comply with even the most basic legal requirements, like correctly computing the amount a borrower owes on a foreclosed loan or providing proof of holding the mortgage note in question.
“Regulators need to look beyond their current, myopic focus on loan origination and consider how servicers’ calculation and collection practices leave families vulnerable to foreclosure,” said Katherine M. Porter, associate professor of law at the University of Iowa.
In an analysis of foreclosures in Chapter 13 bankruptcy, the program intended to help troubled borrowers save their homes, Ms. Porter found that questionable fees had been added to almost half of the loans she examined, and many of the charges were identified only vaguely. Most of the fees were less than $200 each, but collectively they could raise millions of dollars for loan servicers at a time when the other side of the business, mortgage origination, has faltered.
In one example, Ms. Porter found that a lender had filed a claim stating that the borrower owed more than $1 million. But after the loan history was scrutinized, the balance turned out to be $60,000. And a judge in Louisiana is considering an award for sanctions against Wells Fargo in a case in which the bank assessed improper fees and charges that added more than $24,000 to a borrower’s loan.
Ms. Porter’s analysis comes as more homeowners face foreclosure. Testifying before Congress on Tuesday, Mark Zandi, the chief economist at Moody’s Economy.com, estimated that two million families would lose their homes by the end of the current mortgage crisis.
Questionable practices by loan servicers appear to be enough of a problem that the Office of the United States Trustee, a division of the Justice Department that monitors the bankruptcy system, is getting involved. Last month, It announced plans to move against mortgage servicing companies that file false or inaccurate claims, assess unreasonable fees or fail to account properly for loan payments after a bankruptcy has been discharged.
On Oct. 9, the Chapter 13 trustee in Pittsburgh asked the court to sanction Countrywide, the nation’s largest loan servicer, saying that the company had lost or destroyed more than $500,000 in checks paid by homeowners in foreclosure from December 2005 to April 2007.
The trustee, Ronda J. Winnecour, said in court filings that she was concerned that even as Countrywide misplaced or destroyed the checks, it levied charges on the borrowers, including late fees and legal costs.
“The integrity of the bankruptcy process is threatened when a single creditor dishonors its obligation to provide a truthful and accurate account of the funds it has received,” Ms. Winnecour said in requesting sanctions.
A Countrywide spokesman disputed the accusations about the lost checks, saying the company had no record of having received the payments the trustee said had been sent. It is Countrywide’s practice not to charge late fees to borrowers in bankruptcy, he said, adding that the company also does not charge fees or costs relating to its own mistakes.
Loan servicing is extremely lucrative. Servicers, which collect payments from borrowers and pass them on to investors who own the loans, generally receive a percentage of income from a loan, often 0.25 percent on a prime mortgage and 0.50 percent on a subprime loan. Servicers typically generate profit margins of about 20 percent.
Now that big lenders are originating fewer mortgages, servicing revenues make up a greater percentage of earnings. Because servicers typically keep late fees and certain other charges assessed on delinquent or defaulted loans, “a borrower’s default can present a servicer with an opportunity for additional profit,” Ms. Porter said.
The amounts can be significant. Late fees accounted for 11.5 percent of servicing revenues in 2006 at Ocwen Financial, a big servicing company. At Countrywide, $285 million came from late fees last year, up 20 percent from 2005. Late fees accounted for 7.5 percent of Countrywide’s servicing revenue last year.
But these are not the only charges borrowers face. Others include $145 in something called “demand fees,” $137 in overnight delivery fees, fax fees of $50 and payoff statement charges of $60. Property inspection fees can be levied every month or so, and fees can be imposed every two months to cover assessments of a home’s worth.
“We’re talking about millions and millions of dollars that mortgage servicers are extracting from debtors that I think are totally unlawful and illegal,” said O. Max Gardner III, a lawyer in Shelby, N.C., specializing in consumer bankruptcies. “Somebody files a Chapter 13 bankruptcy, they make all their payments, get their discharge and then three months later, they get a statement from their servicer for $7,000 in fees and charges incurred in bankruptcy but that were never applied for in court and never approved.”
Some fees levied by loan servicers in foreclosure run afoul of state laws. In 2003, for example, a New York appeals court disallowed a $100 payoff statement fee sought by North Fork Bank.
Fees for legal services in foreclosure are also under scrutiny.
A class-action lawsuit filed in September in Federal District Court in Delaware accused the Mortgage Electronic Registration System, a home loan registration system owned by Fannie Mae, Countrywide Financial and other large lenders, of overcharging borrowers for legal services in foreclosures. The system, known as MERS, oversees more than 20 million mortgage loans.
The complaint was filed on behalf of Jose Trevino and Lorry S. Trevino of University City, Mo., whose Washington Mutual loan went into foreclosure in 2006 after the couple became ill and fell behind on payments.
Jeffrey M. Norton, a lawyer who represents the Trevinos, said that although MERS pays a flat rate of $400 or $500 to its lawyers during a foreclosure, the legal fees that it demands from borrowers are three or four times that.
A spokeswoman for MERS declined to comment.
Typically, consumers who are behind on their mortgages but hoping to stay in their homes invoke Chapter 13 bankruptcy because it puts creditors on hold, giving borrowers time to put together a repayment plan.
Given that a Chapter 13 bankruptcy involves the oversight of a court, the findings in Ms. Porter’s study are especially troubling. In July, she presented her paper to the United States trustee, and on Oct. 12 she outlined her data for the National Conference of Bankruptcy Judges in Orlando, Fla.
With Tara Twomey, who is a lecturer at Stanford Law School and a consultant for the National Association of Consumer Bankruptcy Attorneys, Ms. Porter analyzed 1,733 Chapter 13 filings made in April 2006. The data were drawn from public court records and include schedules filed under penalty of perjury by borrowers listing debts, assets and income.
Though bankruptcy laws require documentation that a creditor has a claim on the property, 4 out of 10 claims in Ms. Porter’s study did not attach such a promissory note. And one in six claims was not supported by the itemization of charges required by law.
Without proper documentation, families must choose between the costs of filing an objection or the risk of overpayment, Ms. Porter concluded.
She also found that some creditors ask for fees, like fax charges and payoff statement fees, that would probably be considered “unreasonable” by the courts.
Not surprisingly, these fees may contribute to the other problem identified by her study: a discrepancy between what debtors think they owe and what creditors say they are owed.
In 96 percent of the claims Ms. Porter studied, the borrower and the lender disagreed on the amount of the mortgage debt. In about a quarter of the cases, borrowers thought they owed more than the creditors claimed, but in about 70 percent, the creditors asserted that the debt owed was greater than the amounts specified by borrowers.
The median difference between the amounts the creditor and the borrower submitted was $1,366; the average was $3,533, Ms. Porter said. In 30 percent of the cases in which creditors’ claims were higher, the discrepancy was greater than 5 percent of the homeowners’ figure.
Based on the study, mortgage creditors in the 1,733 cases put in claims for almost $6 million more than the loan debts listed by borrowers in the bankruptcy filings. The discrepancies are too big, Ms. Porter said, to be simple record-keeping errors.
Michael L. Jones, a homeowner going through a Chapter 13 bankruptcy in Louisiana, experienced such a discrepancy with Wells Fargo Home Mortgage. After being told that he owed $231,463.97 on his mortgage, he disputed the amount and ultimately sued Wells Fargo.
In April, Elizabeth W. Magner, a federal bankruptcy judge in Louisiana, ruled that Wells Fargo overcharged Mr. Jones by $24,450.65, or 12 percent more than what the court said he actually owed. The court attributed some of that to arithmetic errors but found that Wells Fargo had improperly added charges, including $6,741.67 in commissions to the sheriff’s office that were not owed, almost $13,000 in additional interest and fees for 16 unnecessary inspections of the borrowers’ property in the 29 months the case was pending.
“Incredibly, Wells Fargo also argues that it was debtor’s burden to verify that its accounting was correct,” the judge wrote, “even though Wells Fargo failed to disclose the details of that accounting until it was sued.”
A Wells Fargo spokesman, Kevin Waetke, said the bank would not comment on the details of the case as the bank is appealing a motion by Mr. Jones for sanctions. “All of our practices and procedures in the handling of bankruptcy cases follow applicable laws, and we stand behind our actions in this case,” he said.
In Texas, a United States trustee has asked for sanctions against Barrett Burke Wilson Castle Daffin & Frappier, a Houston law firm that sues borrowers on behalf of the lenders, for providing inaccurate information to the court about mortgage payments made by homeowners who sought refuge in Chapter 13.
Michael C. Barrett, a partner at the firm, said he did not expect the firm to be sanctioned.
“We certainly believe we have not misbehaved in any way,” he said, saying the trustee’s office became involved because it is trying to persuade Congress to increase its budget. “It is trying to portray itself as an organ to pursue mortgage bankers.”
Closing arguments in the case are scheduled for Dec. 12.
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