“They are who we THOUGHT they were — and we let ‘em off the hook!”
This famous postgame rant from former Arizona Cardinals coach Denny Green after his team’s epic meltdown on Monday Night Football against the Bears could just as easily apply to my reaction to reading the official terms of the Attorney General Foreclosure Settlement (the “AGFS”), filed today. The nation’s largest banks get off with a relatively small penalty (much of it paid by investors or in “credits” for things the banks should already be doing) in return for releases across a broad spectrum of misconduct that pervades just about every dark corner of mortgage servicing. The categories of servicer misconduct are laid out in detail in the complaint filed today in D.C. Federal Court, and include the following:
- Providing false or misleading information to borrowers,
- Overcharging borrowers and investors for services of dubious value,
- Denying relief to eligible borrowers,
- Foreclosing on borrowers who were pursuing loan mods in good faith,
- Submitting forged or fraudulent documents and making false statements in foreclosure and bankruptcy proceedings
- Losing or destroying promissory notes and deeds of trust,
- Lying to borrowers about the reasons for denying their loan mods,
- Signing affidavits without personal knowledge and under false identities,
- Improperly charging excessive fees related to foreclosures,
- Foreclosing on servicemembers on active duty,
- Making false claims to the government for insurance coverage, and
- Being unorganized, understaffed, and generally slower than molasses to respond to borrowers desperately in need of relief, while servicing fees continue to accrue.
The list goes on and on, but I can sum it up in one phrase, from the Honor Code of University of Virginia: lying, cheating and stealing. Such conduct would have broken every tenet of my alma mater’s Honor Code. There, we had a strict no-tolerance policy and a single sanction – violating any tenet of the Code resulted in automatic expulsion.
But what’s the result when lying, cheating and stealing is perpetuated on the largest scale imaginable, by five of the largest banks in the country, thereby exacerbating the worst financial crisis since the Great Depression? A broad release of liability, no admission of guilt, and a monetary settlement that pales in comparison to the size of the problem, even if it were paid in full by the banks themselves (which it will not be, as we’ll get into in a moment).
Ally, BofA, Wells Fargo, Citigroup and Chase get to continue on with their business (Ally’s purportedly received a discount so that it would have the means to pay), having agreed to process reforms that they generally should have already had in place, and only 5% of the nation’s 10 million underwater borrowers have even the faintest prospect of relief. What’s that you say, Denny? “WE LET ‘EM OFF THE HOOK!”
The Nitty Gritty
So, we now have confirmation about the actual terms of the monetary penalties and how they’ll be credited (conveniently summarized in Exhibits D & D1 of the Consent Judgments, or starting on p. 170 of the J.P. Morgan Chase Judgment, which I’ll use as a reference throughout). Frankly, there are few surprises here, as most of the key details have already been made public.
Of the $25 billion announced value of the settlement, only $5 billion will be paid in cash to state and federal regulators as penalties for the alleged misconduct. Another $3 billion will be paid in refinancing packages to lower borrowers’ interest rates. The bulk of the settlement – $17 billion – will be “paid” with credits that banks receive for engaging in various types of homeowner assistance.
The first problem is that, as the Wall Street Journal recently noted, the actual amount of loan forgiveness isn’t large relative to the problem of underwater debt. The WSJ attributes to Ted Gayer, co-director of economic studies at the Brookings Institution, the estimate that the settlement’s complex set of requirements mean that about 500,000 borrowers, or 5% of those who are underwater, may be eligible for help. Let me repeat that so it sinks in – if you are one of this nation’s 10 million underwater borrowers, you have only a 1 in 20 chance of getting any semblance of relief.
The second problem is that the banks have a right to “earn” credits towards that $17 billion bill by modifying loans held by investors. For every $1 of loans modified from securitized portfolios (i.e. loans in mortgage backed securities trusts), banks will get $0.45 of credit. Keep in mind, the defendant banks no longer have any ownership interests in these loans, they merely get paid a fee by the owners to protect their investments. And these owners typically have contracts that prevent the unauthorized modification of loans they own.
Now, regulators clearly intended this reduced credit to incentivize banks to modify more loans on their own books, for which they get a full $1 of credit for principal reductions for the portion of principal below a 175% loan-to-value (“LTV”) ratio. But when you actually think about how these incentives will play out, it quickly becomes apparent that they will lead to unintended conequences.
Let’s say Brutus, the school bully, has been stealing kids’ lunch money for a few years. When he’s finally caught, the principal, who knows Brutus has stolen at least $20, says, “Ok, Brutus, your penalty for these crimes is to give $1 back to the poor kids of this school. You can either pay that $1 out of your own pocket, or go and steal the money from others and give it to the kids. But, you’ll actually have to steal $2.22 from others and give it to the kids you bullied to satisfy your $1 punishment.”
Now, Brutus has been stealing money for years, and has developed a plethora of clever ways to do so. And even if he might have had some fear of running afoul of authority, the principal has essentially condoned the act of paying the fine with someone else’s money.
What do you think Brutus will do? What would you do? It would be one thing if banks shared in the cost of modifying a loan in securitization, and the credit was proportionate to the cost they paid. But aside from transaction costs, banks absorb not one cent of a reduction of principal or interest on a loan held by investors. Thus, by giving banks the opportunity to pay their settlement amount with investors’ money, regulators may be encouraging banks to modify twice as many loans, but they are also encouraging banks to impose the costs of those loan mods on the investors who had absolutely nothing to do with these servicing atrocities.
Investors have said as much in initial responses to the AGFS, including this response from the Association of Mortgage Investors, as quoted by Bloomberg:
It is unfair to settle claims against the robosigners with other people’s funds… While we request that it not be done, at a minimum we request that a meaningful cap be placed on the dollar amount of the settlement satisfied by innocent parties. Restitution should come from those who are settling these claims, and lien priority must be respected.
Ah yes, and then there’s the topic of lien priority. Recall that second liens, which are overwhelmingly owned by the banks and held on their balance sheets at close to par, are subordinate to first liens and should be wiped out if the first lien is modified. Under the terms of the AGFS, seconds are only to be written off completely if they’re over 180 days delinquent – meaning the borrower hasn’t made a payment in 6 months and should probably be written off, anyway (servicers get $0.10 of credit for writing these nearly worthless loans off, by the way).
If the loans are less than 180 days delinquent, they will be written down a minimum of 30% of the unpaid principal balance or to 115% LTV, whichever results in less forgiveness, consistent with the oh-so-successful HAMP Second Lien Modification Program. In other words, rather than respecting lien priority, the AGFS resorts to the tired mantra of proportionate write-downs for subordinated second lien loans. This may be the biggest backdoor bailout in the entire settlement, as banks own $400 billion worth of these junior liens.
The Process Reforms
You’ll hear a lot of supporters of the AGFS tout in the media the process reforms to which servicers have agreed as a major success of the settlement. While it is true that many reforms will be put in place by way of this settlement that are necessary and will improve servicing, most of them are simple mandates that banks should have already been following. I won’t linger on this point for long, but I think it makes sense to point out some of the agreed “process reforms,” just to understand the consideration that taxpayers, homeowners and state and federal governments are receiving in exchange for granting the banks broad releases of liability (discussed next). These reforms may be found starting at Exhibit A (page 93 of the Chase Consent Judgment), and include:
- Servicers will ensure that factual assertions made to courts and borrowers are true,
- Servicers will ensure that people signing affidavits actually have personal knowledge of the facts to which they’re attesting,
- Servicers will ensure that affidavits properly identify the name and title of the affiant,
- Servicers will comply with state and federal law,
- Servicers will ensure they have a documented interest in the mortgage loan and note before foreclosing,
- Before servicers submit lost note affidavits, they must make a good faith effort to look for the note,
- Servicers will not intentionally lose or destroy notes (!), and
- Servicers will only charge default service fees for reasonable and appropriate services that are actually rendered.
Again, while some reforms called for in this section are steps in the right direction – elimination of dual tracking, single points of contact, and additional borrower disclosures, for example – the fact that the AGs had to include the above in the list of reforms speaks volumes to how far mortgage servicing has careened off the track.
We now have the language of the actual release, which the banks have been given in return for the penalties and reforms discussed above. As expected, the release is fairly broad in the arena of servicing activities, releasing essentially any claim that any regulator may have based on mortgage servicing, loss mitigation, collection or accounting of borrower payments, or foreclosure or bankruptcy practices. In other words, this is the last we’ll see of any government agency digging into the who, what, where, when and how of robosigning and forged affidavits.
However, to give credit where credit is due, the release does not appear to encompass the vast majority of claims based on the origination, purchase, securitization, transfer or sale to investors of mortgage loans, nor does it release the actions of securitization trustees. The state releases very clearly spell out that they will not apply to origination or securitization activity, while the federal releases state that they’ll apply to all origination or securitization activity except for certain exemptions (which include most of the origination or securitization issues that may engender liability for the banks). Either way, regulators appear to have done a good job of only releasing activity covered by their allegations and investigations (what little there were), and nothing more.
But here’s the rub. In the face of the litany of charges brought against them, the banks are not forced to admit to any wrongdoing. The language in the Federal Release (p. 231 – Chase Consent Judgment) makes this explicit:
This Release is neither an admission of liability of the allegations of the Complaint or in cases settled pursuant to this Consent Judgment, nor a concession by the United States that its claims are not well-founded.
The state release is not so explicit, but conspicuously absent is any language by the bank admitting to fault, mistake or wrongdoing.
In fact, this glaring omission may be the best source of leverage for investors and others seeking to challenge the propriety of the settlement. Ever since Judge Rakoff issued his scathing order rejecting the SEC’s proposed settlement with Citigroup, judges have been more conscious about rubber stamping government settlements where there is no admission of wrongdoing by the defendant and few details provided supporting the allegations. I would imagine that the federal judge assigned to oversee this case will have to contend with the same sort of misgivings – that he or she is being asked to enforce a $25 billion settlement in which the defendants have made no admissions of wrongdoing and the government has provided few specific details that would support their allegations.
Perhaps objectors can seize on Rakoff Fever to hold up the settlement in return for stiffer fines, admissions of guilt or caps on the amount of the penalty that should be born by innocent third parties. Now that we know these servicers are who we thought they were, maybe there’s still time to keep our elected and appointed officials from letting ‘em off the hook.