U.S. banks face big costs in improving their foreclosure and mortgage servicing practices as regulators unearth widespread problems in the area, a top Federal Reserve official said on Wednesday.
Fed Governor Daniel Tarullo told lawmakers that regulators have expanded their probe after a preliminary review suggested "significant weaknesses" in how banks have dealt with the millions of troubled mortgages that have emerged from the financial crisis.
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The Senate Banking Committee is holding a hearing on problems in the mortgage servicing industry and whether they pose a broader risk to the economy or amount to an isolated if nettlesome problem.
"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," Tarullo said in prepared testimony.
The issues facing the still-struggling housing market have been exacerbated by allegations that banks have used "robo-signers" to sign hundreds of foreclosure documents a day without proper legal review.
Regulators have been criticized for not catching the widespread flaws, which have reignited public anger with banks that received billions of dollars in taxpayer aid during the financial crisis.
Federal bank regulators and all 50 state attorneys general are probing Bank of America (NYSE:BAC), JPMorgan (NYSE:JPM), and other major mortgage servicers, many of which temporarily halted foreclosures to examine their practices, only to then resume them.
Regulators hope to wrap up their review by the end of the year and publish an analysis in January. The state AGs have been negotiating a settlment with the major banks and Ally Financial, which may include the creation of a fund for borrowers wrongfully evicted from their homes.
Another top bank regulator said that the new U.S. risk council created by the financial reform law, the Financial Stability Oversight Council, should take the lead in addressing foreclosure paperwork and mortgage servicing problems.
"Its mandate includes identifying risks to financial stability and potential gaps in regulation and making recommendations for primary regulators and other policymakers to take action to mitigate those risks," Federal Deposit Insurance Corp Sheila Bair said in prepared testimony. "As such, these issues represent just the type of problem the FSOC was designed to address."
The council, which has 10 voting members, is headed by Treasury Secretary Timothy Geithner and includes representatives from the major financial regulators such as the FDIC, the Federal Reserve and the Securities and Exchange Commission.
Senate Banking Committee Chairman Christopher Dodd expressed concern that the paperwork issue could become a bigger problem for the economy than originally thought.
"This situation could ultimately have ramifications for the safety and soundness of our whole financial system," Dodd said.