Of particular concern to the States last summer was the anticipated increase in foreclosures nationwide due to the escalation in monthly payments (commonly known as “payment shock”) for subprime adjustable rate mortgage loans (“hybrid ARM” or “ARM”) as those loans adjusted through late 2007 and 2008.⁷ While not the sole driver of foreclosures, this impending wave of loans with increased payments suggested a need for proactive efforts to refinance or modify these loans before they led to significant increases in the number of defaults and foreclosures.

Led by Iowa Attorney General Tom Miller, the goal of the State Working Group is to reduce the number of foreclosures by encouraging loan modifications and other sustainable, long-term solutions. Given the expected increases in foreclosures and our assessment of structural flaws in the fractured and complex mortgage origination and securitization system, the State Working Group decided to focus its efforts on the prevention of unnecessary foreclosures, foreclosures where the homeowner has the desire and reasonable ability to make payments on a mortgage loan and the secondary market investors that own the mortgage loan have a financial incentive to modify the loan rather than incurring the significant costs and likely greater losses from foreclosing on the loan.

In September and November 2007, the State Working Group met with representatives of the 20 largest servicers⁸ of subprime mortgages. Collectively, these top 20 companies service approximately 93 percent of the nation’s subprime loans. The State Working Group asked these servicers to identify and implement comprehensive and systematic programs to prevent unnecessary foreclosures.

Any effort to reduce foreclosures requires a clear-eyed assessment of the underlying causes of the foreclosure crisis. There is no one cause for the foreclosure crisis – and accordingly, no single solution can solve it. However, the State Working Group believes that weak underwriting and mortgage origination fraud played a central role in the scope and scale of the foreclosure crisis. Servicers now have to address an unprecedented number of loans that never had a realistic prospect of fully performing.

7 For a fuller discussion of the hybrid ARM problem, see Overview of the Subprime Foreclosure Crisis, by Iowa Assistant Attorney General Patrick Madigan, available at: http://www.iowa.gov/government/ag/latest_news/releases/sept_2007/Foreclosure_analysis.pdf.

8 A servicer is an agent that collects payments on mortgage loans and transfers those payments to the investors who own those loans. When a borrower misses payments, the servicer attempts to contact the borrower to collect the outstanding amount owed. In the event the borrower fails to pay the outstanding amount, the servicer initiates and manages the foreclosure process.

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