Is Foreclosure Settlement Déjà Vu All Over Again?

Today, the Attorneys General of 49 states (with Oklahoma being the lone holdout) announced a record $26 billion settlement with the nation’s five largest servicers over false and fraudulent foreclosure practices like robosigning.  That big number looks great on paper, but I’ve seen far too much during my time covering MBS developments to trust in optics alone.

As expected, when I dig into the details of this settlement, I realize that only $5 billion of the total consists of cash payments, while another $17-20 billion consists of principal write-downs and other aid to homeowners at risk of default. What this means is that, once again, regulators have allowed banks to shift penalties based on their improper servicing practices onto the bondholders that actually own the loans.  As Yogi Berra famously said, “it’s like déjà vu all over again,” only this time, the regulators should have known better.

To understand why, let’s flash back to 2008, the last time we saw a massive, multi-state settlement sponsored by the AGs.  Back then, the target was Countrywide, and the lender was being sued from all sides by AGs over predatory lending practices.  The proposed solution back then, as it has been in every regulatory effort to solve the housing crisis to date, was widespread loan modifications (this is why you’ll notice that the cover of Way Too Big to Fail features Uncle Sam futilely swinging a hammer labeled “Loan Mods” at the problems that keep popping up in a game of Mortgage Crisis Whack-a-Mole).

With great fanfare, the AGs announced in October 2008 that they had reached an $8.6 billion settlement with Countrywide, in which Countrywide would modify 400,000 loans.  What I soon realized was that this would not be a cash payment of $8.6 billion — instead, most of that figure consisted of, you guessed it, principal writedowns and other loan modification “credits.”  The only problem was that 88% of the mortgages that Countrywide had agreed to modify were no longer owned by Countrywide, meaning that the bulk of the costs of this settlement would be born by others.

The settlement resulted in a lawsuit by Greenwich Financial Services on behalf of unnamed bondholders that essentially said, “hey, we actually have contracts with Countrywide that say they can’t modify loans willy-nilly and take money our of our pockets without compensating us.”  The lawsuit put Greenwich CEO Bill Frey in a position to be a spokesperson for aggrieved bondholders, thrusting him into the spotlight and the crosshairs of controversy.  The banks’ response was to begin a massive lobbying effort that led to the passage of the Servicer Safe Harbor in 2009 – a provision that in its original form said that banks could ignore its contracts with investors in the interests of public policy.  Only the Senate’s fears that such a law would run afoul of the Takings Clause of the 5th Amendment (I wrote a feature-length article on this issue), and a last-minute lobbying effort by bondholders, led to the provision being severely watered-down before it passed in its final form.

The question I asked at the time, along with several other astute commentators in the media, was whether the AGs had purposefully bailed out the banks by allowing them to pass costs onto investors, or whether they had been played by a more sophisticated counterparty.  I guessed that it was the latter – the AGs simply didn’t understand that most of these loans were in securitizations, and that the banks that had originated them and still serviced them, didn’t actually own them any longer.

But, what’s their excuse now?  Enough has been written about this issue in the 4 years since the last settlement, and enough trips have been taken to Washington and state capitols by bondholder advocates, that our elected officials should be reasonably knowledgeable about mortgage securitization and the transfer of ownership that took place.   They should understand that the bank that services a mortgage, and has the power to reduce the principal balance or otherwise modify the mortgage, may not actually own it or bear the cost of this modification.  And yet, we see the same strategy being implemented today to solve the housing crisis that was being attempted back in 2008 – yell at the banks about poor practices while bailing them out with a back-door loss shifting strategy, give a small amount of money to underwater homeowners in the form of loan mods, and ignore the fact that our pension funds, college endowments and life insurance investments are being looted in the process (note that homeowners haven’t even received the benefit of many of these bargains, as servicers have been reluctant to actually go through with loan mods due to uncertainty regarding their contractual rights to do so).

This doesn’t even get into the other 800 lb gorilla lurking in the corner of room — the $400 billion of second lien loans held by the biggest four servicers on their books.  These loans are being kept at close to par on banks balance sheets despite being worth a fraction of that because they sit behind underwater first liens in  priority.  Though the terms of this settlement are still emerging, I would bet dollars to donuts that 2nd liens are being handled as they’ve always been by regulators — they’ll be modified in pari passu or “on equal footing” with first liens, which essentially disregards their contractual standing as subordinate to first liens (that is, seconds should be wiped out if a first lien modification becomes necessary).

To someone who has been writing for four years about the dire consequences of this type of loss shifting and contract trampling — including a loss of confidence in the financial markets and the rule of law that will discourage desperately-needed private capital from returning to the mortgage market — it’s incredibly disappointing that this message has apparently fallen on deaf ears. If this crisis is to be resolved, it must be resolved in a way that honors contracts and restores investor confidence, or the housing market will never recover.

The one silver lining in this otherwise grey cloud of an announcement is the fact that the settlement does not release any claims that regulators or private parties may have surrounding the origination or securitization of mortgage loans.  Thus, there remains some hope that by aggressively pursuing remedial action against the banks for the way in which they created and sold mortgage backed securities in the first place, regulators (the Mortgage Fraud Task Force, for example) could create a resolution framework that would disincentivize future fraud and irresponsible lending while sending a clear message to bondholders, insurers and homeowners that contracts and the rule of law still mean something in this country.

Based on what I’ve seen thus far, I’m not holding my breath.  Returning to the always-appropriate Yogi quotes, we may have “made too many wrong mistakes,” to dig ourselves out now.

About igradman

I am an attorney, consultant, book editor, and one of the nation's leading experts on mortgage backed securities litigation. I am the author of The Subprime Shakeout mortgage litigation blog, a partner at Northern California law firm Perry Johnson, Anderson, Miller & Moskowitz, LLP, and the editor of the critically-acclaimed book, "Way Too Big to Fail: How Government and Private Industry Can Build a Fail-Safe Mortgage System," by Bill Frey. Follow me on Twitter @isaacgradman
This entry was posted in allocation of loss, Attorneys General, bailout, banks, BofA, consitutionality, contract rights, costs of the crisis, Countrywide, education, foreclosure crisis, global settlement, Government bailout, Greenwich Financial Services, Helping Families Save Homes, homeowner relief, improper documentation, incentives, investigations, investors, irresponsible lending, junior liens, lenders, liabilities, loan modifications, lobbying, MBS, media coverage, moral hazard, mortgage market, predatory lending, press, private label MBS, probes, public perceptions, Regulators, RMBS, robo-signers, securitization, Servicer Safe Harbor, servicers, settlements, sophistication, subprime, Takings Clause, The Subprime Shakeout, Way Too Big to Fail, William Frey, workouts. Bookmark the permalink.
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