Research support for this article was provided by the Investigative Fund at The Nation Institute.

Veronica Gallon went and got her gun. This was just the kind of thing she and her husband, George, had left the north Jacksonville ghettos to avoid: some guy banging and rattling the door in the middle of the night, like a crazed killer or God knows what. Veronica wasn’t having it. So she grabbed her gun and plopped down on the front room rug.

“I was in my PJs, looking at TV and getting ready to go to bed for work,” she recalls. She doesn’t answer her door at night, so at first she just ignored the knock. “Then the knock becomes a banging,” she continues, her voice rising. “I peep out the blinds, and I see this white guy,” she explains. “I could see him, but he couldn’t see me.” She noticed his car was idling, with the driver-side door standing open. “Whatever he came to do, he was gonna do it and jump!”

Veronica knew the house was in foreclosure, of course; not a day goes by without a reminder. “First time the phone rings in the morning, it’s them,” George says with a sigh. “Last time the phone rings at night, it’s them.” But she long ago checked out of the process in frustration. She couldn’t keep up with the bizarre twists and turns, the seemingly random letters from companies she’d never heard of making demands she couldn’t believe. But she never imagined that the man banging on her door worked for a company that worked for a company that services her loan on behalf of some Borg-sounding entity called ABFC 2006-HE1 Trust.

Veronica is an ebullient woman. At 45, she radiates giddy teenage youth, doubling over in belly laughs at her own jokes. But she insists her quick smile morphs just as effortlessly into a snarl, and it was only after Veronica called George, at his job as a night security guard, that she calmed down. They both swear it’s just dumb luck that American Home Mortgage Servicing didn’t lose a contractor that night.

We hear a lot about the big picture of the mortgage crisis: at the end of last year, a little more than 11 percent of homeowners were delinquent or in foreclosure. But the Gallons reveal what it looks like in the micro. All over the country, confused, struggling borrowers and an opaque army of industry contractors are fumbling toward each other in the dark, with guns drawn.

Every effort to date to order that chaos has failed utterly. The mortgage industry got things started in July 2007 with its cruelly named HOPE NOW program. George W. Bush offered a narrowly tailored Federal Housing Authority (FHA) refinancing program, dubbed FHASecure. And last summer, Congressional Democrats finally came in big with HOPE for Homeowners, which put up $300 billion for FHA-administered refinances. All these plans have two things in common: they relied on the industry’s voluntary participation, and they didn’t work.

HOPE for Homeowners has generated the most laughable data. The program launched in October. As of late March, it has prevented exactly one foreclosure. “Needless to say, the program isn’t working terribly well,” an FHA spokesman deadpanned to

HOPE NOW’s press shop has been less modest. The program claims to have helped millions avoid foreclosure through loan modifications. But despair lies just below the surface of the industry’s assertions. In early April, the Office of Thrift Supervision (OTS) released a fourth-quarter report that found more than half of all loan workouts last year failed to reduce monthly payments, and nearly one-third actually increased the payments.

No surprise, then, that 60 percent of loans modified in the first three quarters of 2008 were at least thirty days delinquent at year’s end, according to OTS. Valparaiso University consumer law scholar Alan White describes it as “converting risky subprime loans into risky modified loans.”

There are myriad reasons for the dismal performance of all these efforts to arrest foreclosures. Everybody from the Mortgage Bankers Association to grassroots housing activists now largely agree on the technical aspects of the problem–servicers are scared to modify loans they don’t actually own; the industry’s fee structure blinds it to the long-term costs of foreclosure; and many borrowers are far too deep in debt to be helped.

President Obama unveiled his own proposal in late February, the fourth major initiative in less than two years. Key elements of it–like a plan that would let bankruptcy judges reduce the principal owed by mortgage borrowers–require Congressional approval. His plan dutifully pushes and pulls the market’s jammed levers, offering servicers significant payments for altered loans and giving them legal cover for doing so, among other things.

But what Obama’s plan doesn’t do–so far–is address the larger question: can any solution work if it doesn’t strengthen the negotiating hand of overwhelmed borrowers? Like all previous initiatives, industry participation in the president’s plan is largely voluntary, if heavily subsidized. He’s proposed allowing homeowners to modify mortgages through bankruptcy courts, which could reduce their principal, but the industry, led by firms like JPMorgan Chase, Wells Fargo and Bank of America, has fought hard to kill the legislation, blocking it in the Senate since March. And the plan does nothing else to give borrowers more leverage, such as freezing foreclosures–as candidate Obama pledged he’d do back in October. Instead, it pumps $75 billion into a servicing industry that Veronica and George Gallon and millions like them would just as soon see killed off.

“It sounds more positive than anything we’ve seen before,” says California Reinvestment Coalition’s Kevin Stein, who has studied mortgage modifications in his state. “But those things looked positive when we first saw them, too.”

Many of the players in the global economic collapse have filled mysterious, difficult-to-comprehend roles. Not mortgage servicers. Their role is clear and familiar. If the recession were a gangster movie, they’d be the big, bumbling guys who barge in and threaten to off you if you don’t pay your gambling debts.

Lenders who originate loans rarely handle the month-to-month work of managing them. They hire contractors to collect and process payments and to manage foreclosures for loans that default. So when lenders started rapidly unloading loans on investors, the investors hired “third-party” servicers to manage their massive loan pools. It was good business: by one count, lenders pooled and sold 8 million nonprime loans in 2005 and 2006 alone. As a result, according to OTS, 91 percent of all outstanding home loans are now serviced by third-party banks and firms that don’t own the note.

But the subprime explosion coincided with a dramatic restructuring of the mortgage servicing industry. In 1989 the five largest firms controlled just 7 percent of the market. By 2007 they controlled 46 percent. After Bank of America’s July 2008 merger with Countrywide, the top three servicers–arms of Bank of America, Wells Fargo and Chase–controlled 48 percent of the nation’s $11.5 trillion in mortgages.

Automation and outsourcing followed this consolidation, allowing the mega-servicers to process huge numbers of loans without increasing costs. Like the brokers originating the loans, they shoved as many mortgages as possible through their software programs. They outsourced everything from tax processing to call centers. They hired low-skilled workers to do what amounted to data entry, then overburdened them and skimped on training. And it all worked brilliantly. “In good times, the servicing business has been profitable,” a Federal Reserve Board working paper on the industry bluntly concluded last year.

Why shouldn’t it be? Most of the firms absorbed by the big banks had specialized in subprime loans. And servicers generally get paid twice as much to manage subprimes as primes, based on the idea that subprime loans require more work–frequent contact with borrowers and specialized labor. But the boom obscured these costs; because very few loans demanded more than collecting and processing more and more payments, few firms invested in developing the kind of skills necessary to service subprime loans–doing so would have undermined the savings from consolidation, outsourcing and automation.

The industry’s business model fell apart, however, when the default rate shot up to more than 10 percent–a number that’s getting worse fast, according to OTS. Subprime loans continued failing at high rates last year, but now prime loans are hemorrhaging, too. OTS found that delinquency among formerly stable prime loans more than doubled in 2008, to 2.4 percent, with the most significant rise happening in the fourth quarter.

The industry has tried to blame borrowers for its unsuccessful effort to save these failing loans; people who redefault are called “recidivists.” But the OTS data offer damning evidence to the contrary. The problem is that a surprising number of workouts have done nothing to change the loans; more than half are merely repayment plans that give borrowers more time to catch up. Which leaves people like the Gallons in an exhausting, no-win game of chase, in which separating predation from plain incompetence is nearly impossible.

* * *

Jacksonville was once a sea of relative calm in Florida’s economic maelstrom. It had a diverse economy, with everything from financial services to a deep-water port. But ultimately the regional waterfront drew the city into Florida’s turn-of-the-century real estate explosion. New developments spawned a booming construction industry packed with well-paid jobs. In 2008 one in five of those jobs disappeared. Last fall Forbes magazine predicted that Jacksonville–in the heart of Duval County, where joblessness recently hit 9.7 percent–would be the national “foreclosure capital” of 2009.

Investment properties and second homes have undeniably driven up Florida’s foreclosure numbers, but Jacksonville is a place where thousands of people are losing the roof over their heads. The resulting loan defaults so overwhelmed the Housing Partnership of Northeast Florida, says vice president of lending services Richard Paige, that he had to retrain homeownership counselors to do loss mitigation instead. “Early in this process, we were seeing people who were victims of just horrible loans,” Paige explains. “But now I would say well over half of what we’re seeing, they were in affordable loans” and lost their job.

The Gallons managed to keep up with their $200,000 subprime refinance until late 2007, when they started missing payments and piling up late fees. In February 2008, George called their servicer, Option One Mortgage, an H&R Block subsidiary managing $53 billion in subprime loans at the time. “I says, ‘Well, things are kind of tight with me right now. What can I do to bring my mortgage current?'” recalls George, a jowly 62-year-old with a pencil mustache and graying mane.

The person George spoke with told him to apply for a loan modification, which meant digging up a dozen documents establishing income and expenses. So they did. “March goes by; I don’t hear anything. April, I’m thinking no news is good news, so I send them a payment.”

But no news was bad news: the following month’s payment came back with a notice that the Gallons had been foreclosed upon. The surprise notice came from American Home Mortgage Servicing, which had absorbed Option One in May 2008. That fact alone sent George reeling. “I’m paying Option One. All of a sudden, American Home Mortgage tells me that my loan modification–that I sent to Option One–has been denied?” When he called and asked why his application failed, he says an agent told him it was short one document. “You mean to tell me you asked for twelve pieces of documents and you got eleven, and you didn’t have the courtesy to pick up the phone or drop me a line?”

Fed up, George and Veronica found Chip Parker, who has developed a national reputation for successfully wrestling with servicers in 250 foreclosure defenses. Parker filed papers challenging the foreclosure, and soon the Gallons got a package from American Home offering the workout they’d previously been denied. “All is forgiven,” George summarizes. “They’re charging me another $25,000, but we start fresh.” As long as the Gallons waived their right to sue, that is. That’s a controversial clause regularly slipped into loan workouts, which advocates argue is the final stop in a long line of predation. Servicers lure desperate borrowers into agreements that accomplish nothing more than making sure a judge never sees the ugly details of either the original loan or the fee frenzy of servicing.

At Parker’s urging the Gallons rejected the offer, which led to a second foreclosure filing–despite the fact that the first one remained an open case. And it didn’t end there. They got yet another offer from American Home, a forbearance deal–a five-year, interest-only repayment plan that would cost them $67,000 in additional interest. “I think the idea is to have the homeowner keep chasing his tail until he gives up in frustration,” Parker complains, noting that nothing in the Gallons’ case is unique among his clients. “The default servicer has no interest in modification, because they’re not paid for modification.”

Indeed, researchers argue that the servicing industry’s pay structure creates perverse incentives that impede loan modification, even when modification is in the best interest of both the investor and the borrower. Every month a servicer must send investors an advance with its take from the loan pool. The servicer then recoups that advance, plus its fee, when it collects from the borrower. As long as loans are performing, this system works well. But when one-tenth of all loans stop paying, servicers are stuck with the hot potato. Every month a delinquent loan doesn’t perform, the servicer gets burned more. Which makes foreclosure the fastest way for servicers to stop the damage. It halts the advances, plus they get to charge investors and borrowers new fees.

And that means, for now, the only way for borrowers to slow the race to foreclosure is to make it a costly process for servicers, too. Now that the Gallons have a lawyer, for instance, American Home has let the case languish. Parker says that’s where every case he’s taken in the past two years stands today: once a borrower exerts leverage through a countersuit, the servicer disappears. The case becomes too expensive to pursue and thus moves to the bottom of the pile. Counselors and lawyers all over the country echo Parker, arguing that servicers have ceded no ground without being forced through litigation.

* * *

Even when servicers offer help, they often bungle the deal so badly that borrowers can’t accept it. Take the tail-chasing game Litton Loan Servicing put Maryann and John Myers through en route to foreclosure. After nineteen years in their home, the Jacksonville couple took out an $84,000 subprime refinance in 2003. They worked hard to keep up, but when John got laid off last spring, they fell behind.

The Myerses dutifully contacted Litton to work things out, and Litton offered them a repayment plan that increased their monthly bill by nearly $300. John still had his second job, so they signed on and tried to comply. Within two months they were in trouble again–“recidivists,” as it were. Litton filed for foreclosure.

But the Myerses kept trying to work things out, so Litton offered them a forbearance agreement. It said that if the Myerses could make even higher payments–another $200 more–the foreclosure would go on hold. The agreement’s language was harsh. Late fees would continue to mount. There would be no grace period on monthly payments. “Even the slightest default shall be considered a material breach,” it warned.

The Myerses sent the agreement back the same day they got it. But later that day a messenger arrived at the door with an entirely different deal–an actual loan modification that would have saved their home. It would have rewritten the loan so that the Myerses’ monthly payments were nearly two-thirds less than that of their original loan, with an interest rate of just 4.6 percent. It gave the Myerses one month to make the first payment.

Maryann, who answered the door, was befuddled. “I said to [the messenger], ‘Sweetheart, can I have a copy?’ And she said, ‘I can’t give it to you. If you don’t sign it I gotta give it back to Litton saying you refused.'”

But the forbearance agreement, with its tough talk about no grace periods, demanded the Myerses send a down payment in the next four days. And John says an operator at “some 800 number” he called told him that the foreclosure would move forward until he paid the forbearance. That meant the Myerses would have to pay on both plans simultaneously until Litton got in sync with itself. But they could barely pay one, let alone both. So they sent in the forbearance money and painfully passed up the modification that would have actually helped.

April Charney of Jacksonville Area Legal Aid argues that this mortgage maze is more insidious than hapless, because few servicers can foreclose without committing fraud. The mortgage-backed securities market is terribly byzantine, but it’s also one governed by hard and fast rules that make it labor intensive for all involved. And that militates against the high-volume, low-cost business models of originators and servicers. How have they gotten around this dilemma? Charney and a growing number of lawyers and judges say they simply cheat.

The first step of foreclosing is to show a court a mortgage assignment saying you own the loan. But it turns out that in the rapid-fire process of securitizing loans, few players slowed down long enough to mind this legal detail. So servicers and their law firms–which earn a flat fee per foreclosure and are loath to drag the matter out–fill out assignments and backdate them, sloppily leaving all kinds of tells. The signer and the notary will be in different cities. Origination dates will be left blank. The trust, which represents the investors who bought the loan, will appear as assigning the loan to itself, from itself.

Charney cites the infamous deposition of a Citi Residential Lending employee, Tamara Price. Jim Kowalski, a former prosecutor now handling foreclosure defense cases in Jacksonville, sat Price down in April 2008 to determine why her name appears over and over again as the signer on mortgage assignments in Citi’s foreclosures. Price described an automated process for faking the assignments.

Does she prepare the documents? Kowalski asked. No, the foreclosure lawyer does. Does she review the case files, as testified in the affidavit? No. Does the notary witness her signing the documents, or even notarize them on the professed date? No. Price even revealed that the “vice president” title attached to her name on assignments is bogus. “They’re lying,” Parker rails. “They’re filing fraudulent documents and giving this to a judge in order to kick somebody out of their house.”

* * *

Servicers argue that they’re unable to modify loans they don’t own, which might anger investors by cutting into profits. Obama’s plan addresses this assertion. It establishes federal standards for an appropriate modification–primarily by creating monthly payments that are no more than 38 percent of a borrower’s income. If a servicer gets a borrower’s payment down that far, the feds will chip in to bring it down to 31 percent. That encourages steep payment reductions, but it also gives servicers legal cover: the government has said, Here’s a reasonable way to rewrite loans.

But many researchers and consumer advocates have long insisted that the servicers’ professed fear of angering investors is a red herring. Valparaiso’s Alan White has shown that investors lose far more money on foreclosures than they would on modifications. Looking at January’s investor reports, White found that the average loss on a completed foreclosure was $130,000, or about 60 percent of the original loan amount. Meanwhile, the average loss for the few loans in which servicers wrote down principal was just $26,000, or 13.5 percent of the original loan.

Jim Carr of the National Community Reinvestment Coalition says the only firm that has grasped this fact is Ocwen Loan Servicing, based in Florida. “The question’s not, Why are they doing it?” says Carr. “It’s, What in the world is the rest of the industry thinking?”

Ocwen general counsel Paul Koches says the problem is that his industry isn’t doing much thinking. “I’d love to some day be able to say to the media, it’s all charitable and blah, blah, blah. But honestly, it’s a win-win-win for us” to modify loans, Koches offers. The homeowner keeps the home, the investors get more money than they would for a foreclosure and Ocwen keeps collecting money from servicing the loan.

Ocwen is the largest remaining firm among a small crop that specialized in servicing subprime loans before the boom. Predictably, then, Koches is among those who consider the industry’s consolidation an original sin. “You have prime-loan, big institutions that have acquired subprime operations but don’t fully appreciate the difference.” It’s this fact that’s held up modifications, says Koches, not the “various and sundry reasons” the broader industry has offered. “I think it’s a smoke screen to cover an inability to execute modifications.”

But here again, the Obama plan sets aside these structural concerns and instead aims to entice industry into better business by giving servicers billions of tax dollars. Rather than strengthening borrowers’ hands, it aims to make working with borrowers as cost-effective for servicers as rushing to foreclosure. The administration will pay $1,000 for every loan modified in line with the new federal standard, and another $1,000 per year for every year the loan continues to perform. In addition, servicers will get $500 for every loan they modify that avoids default.

Of course, investors and borrowers have already paid servicers to do all these things, which already make the most sense for investors and borrowers alike. But the industry’s high-volume, low-cost business model doesn’t account for doing the hard part of the job. And that poses a larger question than the ones addressed by Obama’s many technical fixes: can an industry built to rapidly and cheaply process huge numbers of overvalued loans be retooled as an industry that slogs through the detailed, highly skilled negotiations needed to rewrite those loans? And if so, does it make sense for taxpayers to foot the bill?

“The whole paradigm is a little frustrating, in that servicers have maintained that their hands are tied,” says the California Reinvestment Coalition’s Kevin Stein. “Now they say, ‘Sure, Mr. President, if you give us $2,500, maybe we can do something.’ So let’s just say what it is: they have not been helpful because it’s not in their financial interests to do so.”

Obama’s plan aims to fix this by offering servicers major incentives. It whittles away at the margins but avoids foundational questions: can the crisis be stopped as long as the mega-servicers call the shots, and can we simply buy them off?

The mega-servicers, for their part, certainly say their participation can be bought. The top three answered an ACORN survey by declaring that they plan to participate and that they intend to start right away. Nonetheless, the Mortgage Bankers Association sent a February 23 letter to the administration asking for “realistic expectations” of how quickly servicers will be able to move. The group offered its help to craft ways to “streamline the process.”

One way industry lobbyists don’t want the process streamlined is by giving borrowers leverage. Currently, bankruptcy judges are barred from modifying loans on primary residences. Changing that law has been a priority for consumer advocates for years, and Obama’s plan asks Congress to finally do it. The point isn’t so much to help borrowers who end up in bankruptcy court–hardly an ideal outcome–but rather to arm borrowers with a countering threat when offered crappy loan workouts. The large servicers do not relish the idea of a judge digging through poorly made and poorly serviced loans, many of them riddled with fraud.

Obama has repeatedly refused, however, to go to the mat on bankruptcy reform, and the banking industry sees this opening. After the House hustled its version through in March, industry lobbyists conspired with Republicans and moderate Democrats to kill it in the Senate, where it was stripped from the broader housing bill, leaving Obama’s foreclosure relief plan toothless.

Many advocates say bankruptcy reform is, in any case, just the beginning. Some have called for a national moratorium on foreclosures. “We could lose a million homes in 2009 while we wait for servicers to catch up and implement modifications,” says White. Problem is, the foreclosure process is governed by states, which means any federal move would be legally cumbersome and likely too narrow. So ACORN is lobbying the administration instead to entice states with TARP money to create mandatory “pre-foreclosure mediation” programs–sort of like arbitration for failing loans.

In an April 3 letter to Housing and Urban Development Secretary Shaun Donovan, ACORN pointed to the widely reported success of a mandatory mediation program launched under court order in Philadelphia last spring. Several states and localities have followed Philadelphia in creating some variation of mediation or are debating it. ACORN wants the administration to divert TARP money into matching grants for states that join the movement. It also asked HUD to let states fund mediation from the $6 billion in “neighborhood stabilization” cash that Congress allocated in the past year.

Mandatory mediation would give borrowers leverage to plug another hole in the Obama plan: that servicers are not forced to write down loan principals. The plan puts lowering interest rates ahead of writing down principal; it doesn’t address the fact that many borrowers were conned into loans they could not afford, regardless of the interest rate.

Meanwhile, economist Dean Baker argues that the ideas on the table are mere stopgaps. He says the best way to give borrowers real leverage is to give them the right to stay in a foreclosed property as renters–making the house impossible to resell. “Suddenly, foreclosure looks like a less attractive option” than working out a deal, Baker says. He has pushed the idea in Congressional testimony, but it’s gone nowhere. He blames “this ideology of homeownership” that says owning is always better than renting. A right-to-rent law, he argues, would force investors and servicers to work with viable loans while accepting the reality that some inflated equity never existed in the first place.

So far, none of these ideas for strengthening the borrower’s negotiating hand have gained traction. In February ACORN launched direct action campaigns in twenty-four cities. Even as ACORN praised Obama’s initiative, it declared that activists would begin blocking foreclosures. In many ways, that civil disobedience represents an escalation of the legal hand-to-hand combat defense lawyers have engaged in for more than a year.

“I feel like, at this point, bring it on,” George Gallon declares angrily. “But I feel blessed. Because there are people with children, working really hard, and now they don’t have a roof over their head–because of this.” He thumps the mess of documents sprawled across his kitchen table. “It’s ridiculous, and if you don’t have somebody like Goliath, there’s no end.”