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Thursday, April 4, 2013

The Banks’ Consultants: Guarding the Hen House

Leaving it to consultants hired by mortgage servicers to right the wrongs that the services inflicted on foreclosed homeowners was the unhappy consequence of bank regulators giving ambiguous guidance and failing to install viable oversight mechanisms. According to the Government Accounting Office, “regulators risked not achieving the intended goals of identifying as many harmed borrowers as possible.” Even if the reviews had been completed, there was on guarantee that wronged mortgage borrowers would have received any compensation. On the other side of the ledger, the banks had received billions from the U.S. Treasury with no strings attached. Whether intentional or not, the banking regulators put too much stock in the consultants, who, after all, had been hired by the mortgage servicers.
"The report confirms that the Independent Foreclosure Review process was poorly designed and executed," Rep. Maxine Waters (D-Calif.) said. The "report confirms what I had long suspected -– that the OCC’s oversight of the supposedly independent consultants hired by the servicers was severely deficient. The report should serve as a wake-up call.” By referring to the consultants as supposedly independent, Rep. Waters implies in her statement that the flawed review process put the consultants in the position of being able to exploit a conflict of interest.
On the one hand, the flawed oversight means that the consultants were the ones to protect the public interest. The public had to rely on them to correct the wrongs in the interest of the foreclosed. We can label this the consultants’ “public interest” role. The consultants’ other role  was in working for the servicers. As Benjamin Lawsky, the superintendent of New York's Financial Services Department, pointed out, "The monitors are hired by the banks, they're embedded physically at the banks, they are paid by the banks and they depend on the banks for future business." This is the consultants' other role, which can compromise the first role.

 In a conflict of interest, one role can circumvent another, more legitimate role. Even if the conflict is not exploited with the more legitimate role taking the hit, a person or institution in such a position can be reckoned as unethical, according to some scholars. Other scholars argue that only the actual exploitation of the more legitimate role by the other is unethical.

In my view, if exploitation can be seen as a possibility in the relation between two roles, the relation itself is unethical. Put another way, it is unethical to put a person or organization in such a position, even if actual exploitation does not occur. In my view, to create or perpetuate the condition wherein a person or organization can exploit a conflict of interest is unethical.

It follows that the government has a moral responsibility to eliminate the conflicting roles even if they are not being exploited. Furthermore, the person or organization having two such conflicting roles  as can be counted as a conflict of interest is also ethically obliged to pick one role or the other. Often this is not convenient from a short-term financial standpoint, so business practitioners tend to look the other way, rationalized that since no actual exploitation of the conflict of interest has occurred, there are no ethical issues. They are wrong. The mortgage servicers should never have hired consultants to monitor the servicers. This circle itself is problematic, ethically speaking.
The regulators rather than the consultants should have been the key enforcers, and thus protectors of the public interest. The regulators can be faulted not only for their lack of competence, but also ethically in having allowed the conflict of interest to exist.  A business should not be allowed by the regulators to guard the hen house. To permit this to happen is unethical even if no hens are eaten.  


Ben Hallman and Eleazar Melendez, “GAO Foreclosure Report Finds Bank Regulators Failed to Provide ‘Key Oversight’,” The Huffington Post, April 3, 2013.

 Dan Fitzpatrick, "'A Dose of Healthy Competition' For Banking Regulators," The Wall Street Journal, April 18, 2013.