Point of View: The System Is the Solution.(First American Second Lien Outsourcing)(Viewpoint essay)

Mr. Showalter is senior vice president of product and analytics for First American Second Lien Outsourcing. Mr. Benson is vice president and managing director for FASLO Capital Markets Group.

Economic conditions of the last few years have brought about an environment of low interest rates and extremely high home price appreciation in many areas of the mortgage market. The result of this phenomenon was higher origination volumes, particularly subprime mortgages, along with relatively low-loss expectations. The popular assumption that housing prices would forever continue their steep ascent further inflated the issue. Resulting loss levels of 2006 during what seemed to many like a utopian environment in the mortgage industry were approximately $10 billion - typical of the prior few years although volumes had increased significantly.

It was, however, this virtual utopia that contributed to the forthcoming perfect storm within the industry. The subsequent implosion of the mortgage industry led to losses in 2007 of approximately $100 billion - nearly tenfold that of the prior year - and some predict total losses related to subprime mortgage debt in the neighborhood of $450 billion.

The consequent increase in the number and volume of distressed assets poses problems for traditional servicers. The volume and complexity of the distressed asset problem created a paradigm shift for servicers. As recently as 12 months ago, servicers were largely coupon processors. Now they are asset managers, one of the few remaining ways of mitigating a tidal wave of loan losses.

In the past, servicers have relied heavily on the expertise of their people in servicing mortgage loans. This expertise was embedded in an age-old process where the expert made critical decisions regarding which path to follow to ensure maximum economic value.

Referred to here as the "expert-is-the-solution" model, servicers historically have viewed each loan as having a unique problem that required expert opinion for resolution. The primary faults of this model are that it is neither scalable nor consistent. Expert opinion differs many times and thus produces inconsistent results. Further, it is extremely difficult to find, hire and train legions of new experts especially at the rate the distressed space has grown recently.

Resolving distressed loans is now more complex than ever. The complexity of loan resolution has quickly evolved beyond the comprehension and infrastructure of the typical mortgage servicer. The multi-dimensionality created by combining the assessment of the current economic environment with the consideration of the borrower, property, product and treatment among other variables attached to servicing a pool of distressed assets is far too tall an order for a process-driven model based primarily on expert opinion.