The recent onslaught of bad press about nonbank mortgage servicer Ocwen is just the tip of the iceberg. Ocwen may be on everyone's radar these days but the explosive growth of nonbank servicers in general has regulators concerned. A report from the Inspector General of the Federal Housing Finance Agency (FHFA) detailed serious risks for homeowners and the government. The FHFA regulates both Fannie Mae and Freddie Mac, the two largest residential mortgage guaranty companies in the United States.

For those not familiar, a mortgage servicer collects payments on behalf of the banks and trusts that own the loans. The servicer also makes sure that homeowners insurance remains current and that property taxes are paid. So called nonbank specialty servicers handle mortgages that are delinquent or in foreclosure. Once, many banks handled these functions internally but the advent of large mortgage pools and mortgage backed securities resulted in the creation of a new industry, nonbank mortgage servicers. 

Things within the industry became so bad that last year New York sought to block Bank of America from handing over loan servicing duties to Ocwen. Last month California blocked Ocwen from acquiring any additional servicing rights in that state until they could demonstrate compliance with state laws and regulations.

As little as 4 years ago, the ten largest mortgage servicers were banks. Now half of those banks have been bumped out by nonbank servicers; companies like Ocwen, Nationstar, Walter Investment Company, PHH Mortgage and Quicken Loans.

Part of the problem rests with the government. When millions of Americans were underwater on their mortgages and seeking HAMP loan modifications, it became painfully obvious that many banks' servicing platforms were ill equipped for the job. The government recommended that banks sell the servicing rights to third parties, particularly for loans that were under water. Unfortunately, the "remedy" may have been worse than the disease it was designed to cure.

Often, high risk borrowers slip between the cracks when a distressed loan is passed from the lender to the specialty servicer. Worse problems, however, are created by the inherent conflicts of interest and the vertical integration present within the servicing industry.

Ocwen, for example, long had affiliate relationships with companies that managed distressed properties and with forced place insurance. That usually means keeping a homeowner underwater is more profitable for the specialty servicer. Nationstar did the same thing under the guise of providing "wraparound services."

Even without any affiliate relationships, inherent conflicts of interest still exist. Banks want to see the loan become profitable and keep expenses down. If the loan fails, they could be responsible for any deficiency if the debt is uncollectible. Specialty servicers, however, make their money by keeping the loan in special servicing. The longer the loan is distressed, the more the servicer is paid.

A final problem is a lack of regulation in the industry. Unlike banking, which is highly regulated, the nonbank mortgage servicing industry is relatively young and largely unregulated. That has created the perfect storm for distressed homeowners. We frequently see loan modifications that are improperly denied, gross overcharges for property "preservation" services and forced place insurance and frustrated homeowners who can't get anyone to answer their calls for help.

We even know of some instances where the servicer has managed to take title to the property and get paid from Fannie or Freddie on the nonperforming loan.

Whistleblowers and the False Claims Act

Enter whistleblowers. Last year whistleblowers filed over 700 False Claims Act lawsuits, many against banks and other financial sector businesses. One such suit against SunTrust collected $418 million for the government including $50 million to the federal and state governments for improper loan servicing practices.

Whistleblowers who bring claims under the False Claims Act can earn up to 30% of whatever the government collects from the wrongdoer. To qualify, one must have original knowledge or information about the fraud. Successful whistleblowers are usually insiders or former employees but not always.

Whistleblowers are also entitled to strong anti-retaliation protections under federal law. To obtain an award, one must first file a complaint under seal in federal court. The government is then afforded an opportunity to review and intervene. If the government does not take over the case, it is often possible for the whistleblower to do privately.

Becoming a whistleblower isn’t an easy decision. Although filed in secret, the complaints are ultimately unsealed and not everyone succeeds.