Last week, District Court Judge Rosemary Collyer approved the Attorney General Foreclosure Settlement (“AGFS”) without a hearing, and without any objection from investors. According to the Judge, the Consent Judgment between the nation’s five largest servicers and the Attorneys General from 49 states is now “final and non-appealable.”
With that, investors have lost their chance to push for protections in the AGFS, and servicers have officially been let off the hook for the mountain of servicing abuses of which they were originally accused. In return for broad releases, servicers are to provide some cash to regulators and evicted homeowners, but the bulk of the “penalties” will come in the form of a purported $17 billion in “homeowner assistance” measures.
While the rant I was hearing as I first read through the proposed settlement was that of former Arizona Cardinals head coach Denny Green, the rant I hear now as I read about the various ways in which the banks will satisfy that $17 billion in homeowner assistance is that of Chris Rock complaining about people who take credit for the things they’re supposed to do. Though Rock’s 1996 rant was an over-the-top riff on racial stereotypes, his complaint could just as easily apply, with a slight bit of paraphrasing, to this country’s largest servicers:
[Servicers] always want credit for some [stuff] they’re supposed to do. They’ll brag about stuff a normal man just does.
Now, as many critics of the settlement have noted, the enforcement of the AGFS’s terms will be a major problem. Yves Smith of Naked Capitalism, in her post about the propaganda surrounding the settlement, called my original post a “good overview,” but suggested that I was “far too positive about the servicing reforms,” since servicers will never be able to meet those higher standards. That may be the case, as these reforms will simply be too expensive to implement and/or too vague to enforce, but at least they attempt to create a model for what quality servicing should look like.
The homeowner assistance provisions are a different story. Attorney Abigail Field, on her blog Reality Check, has a great summary of some of the reasons why the enforcement provisions of the AGFS are fairly weak, and won’t result in any meaningful change in servicing conduct. I agree with much of what she says – vague compliance metrics, deferential notice and cure requirements, and a lack of political will to file enforcement suits will likely lead to gross underenforcement of the settlement.
However, it would be one thing if the settlement terms themselves evinced an understanding of the problems that caused the robosigning and foreclosure crises, imposed sensible penalties that encouraged better behavior, and only fell short in their failure to set forth a workable enforcement structure. At least then you could say that the AGs had their heads and hearts in the right place, but could have done a better job of actually inducing the borrower assistance set forth in the settlement.
Instead, the bigger problem that I see, and what I want to focus on today, is that even if the banks complied with every term of the settlement, the AGFS will not achieve meaningful relief. In part, this is because the size of the relief is so small in comparison to the size of the problem (estimates I’ve discussed previously say about 5% of underwater borrowers will receive any semblance of relief). However, this failure also stems from the fact that the banks have too much freedom in deciding how to comply with the settlement, such that they can select the “penalties” most favorable to their bottom lines rather than those most beneficial to housing market or the victims of their misconduct. Not to mention the things they’re getting credit for are generally things that they’re already supposed to be doing.
One of the major themes of this blog has been the misalignment of incentives in standard MBS trust agreements from the years leading up to the Mortgage Crisis, which both contributed to the flood of irresponsible lending that engendered the Crisis and to the poor servicing of loans post-Crisis that has dragged it out. Much of Way Too Big to Fail, the book I published with Bill Frey, discusses how to realign the incentives in mortgage securitization going forward so that we can avoid these problems and allow the powerful tool of securitization to create a functioning housing finance market.
That’s why it’s so frustrating to see the AGs providing the major servicers (who just got caught red-handed forging documents and lying to courts) with a menu of options (the settlement itself actually calls them “menu items”) for satisfying their penalties. These options fail to recognize servicers’ inherent conflicts of interest and the incentives they create for self-interested conduct at the expense of real benefit to investors and homeowners.
Returning to the analogy from my last post on the AGFS to Brutus the bully, who got caught by the principal stealing kids’ lunch money, it’s as if the principal is giving Brutus a broad list of options for paying his debts – including some options that Brutus is already obligated to satisfy. Thus, for example, if Brutus had already been sentenced to community service for other misconduct, and could satisfy the principal’s demands by completing that same service, what do you think will Brutus do? Rarely does law enforcement defer to the preferences of perpetrators; sanctions are meant to be inconvenient and painful (that’s how they deter future misconduct).
A recent article in the New York Times highlights how, under the settlement, banks are getting credit for “routine efforts” and “standard bank practices.” The article quotes Neil Barofsky, the former inspector general of TARP, as saying, “The $17 billion [in borrower assistance] is supposed to be the teeth of this settlement. And yet they are getting all this credit for practices that they do every day.”
The article points to credits for waiving deficiency judgments and donating or demolishing abandoned homes as two examples of practices that banks already do on a regular basis. Georgetown law professor and Credit Slips contributor Adam J. Levitin is quoted as saying, “[The settlement] accomplishes remarkably little in the form of real relief for homeowners because it gives the banks credit for far too much.”
Another article, from Rachel Kurzius at Inside Mortgage Finance, does a great job of highlighting how different banks will choose different means of satisfying the AGFS, depending on their unique circumstances. Because this article is only available by subscription, and because it’s an interesting read, I’ve re-posted it in its entirety below, with the permission of IMF. As you read the IMF and NY Times articles, just see if you can get Chris Rock’s toothy grin out of your head as he talks about people taking credit for things they’re supposed to do.
Investors Worry About Their MBS Holdings Under $25B Settlement
Many non-agency MBS investors are upset with the $25 billion servicing settlement involving 49 state attorneys general, eight federal agencies and the nation’s five largest servicers, the full terms of which were filed in U.S. District Court this week.
Bank of America, Wells Fargo, JPMorgan Chase, Citigroup and Ally Financial will receive some credit for modifying loans they service but do not own, although several of these firms have indicated that they plan to focus their efforts on portfolio loans. The Association of Mortgage Investors said the settlement establishes a precedent under which the bad debts of some are paid by innocent, responsible parties.
Investor concern has been over the part of the settlement dealing in credits instead of hard cash. The banks are obliged to provide $16.3 billion of consumer relief, namely principal reductions, short sales, deficiency waivers, forbearance and anti-blight provisions. Each of these “menu items,” as the settlement calls them, have a correspondent credit towards paying off their penalties.
While principal forgiveness on a first-lien mortgages held in portfolio has a dollar-for-dollar credit, principal forgiveness on first liens held by investors has $0.45 credit per dollar of writedown. Servicers receive additional credit if the modifications are performed before March 1, 2013.
The Brookings Institution estimates that these principal reductions will help about 5 percent of homeowners who are currently underwater. Department of Housing and Urban Development Secretary Shaun Donovan defended the relatively small figure by saying that the settlement would induce the banks to perform more principal reductions.
Matthew Stoller, a fellow at the Roosevelt Institute, called such thinking the “Lays Potato Chip Theory,” noting that government officials are banking on the fact that the servicers “won’t be able to stop at just one” once they start modifying loans. The problem with the theory, though, is that many of the country’s loans are held by Fannie Mae and Freddie Mac, which have so far refused to perform principal reductions.
Wells Fargo, Citibank and Ally have stated that they will limit modifications to loans they hold in portfolio, at least for the time being. Considering that the settlement includes incentives to complete mods within a year’s time, it may make sense to focus on the loans with the fewest strings attached.
Bank of America has already identified 200,000 borrowers for loan modifications, and plans to reduce principal by an average of $100,000. If the bank were planning to get dollar-for-dollar credit for this, i.e., portfolio loans, they would far exceed the $7.6 billion of credits required of them. From this, Barclays deducted that BoA will perform writedowns on a large number of non-agency mortgages.
JPMorgan Chase has yet to tip its hand on its strategy. Deutche Bank expects JPMorgan will “perform most principal modifications on its portfolio loans given that it did not have a separate deal with the government earlier.”
Why is BofA going for investor loans, when at least three of the other banks said they won’t? Isaac Gradman, managing member of IMG Enterprises, chalks it up to BoA’s upcoming settlement with Bank of New York regarding a dispute over Countrywide MBS representations and warranties.
“Bank of America has a sense that the settlement with Bank of New York will go through and they’ll be able to modify investor loans without fear,” said Gradman. “Other banks don’t have that assurance yet.”
HUD, in a new fact sheet, said the notion that “the settlement will be paid on the backs of teachers, firefighters and unions because of pension or other investments in private label securities” is a myth. The agency pointed to the fact that “participating banks own the vast majority of the mortgage loans that this settlement is expected to affect,” and that net present value positive tests will ensure that “any loan modification tied to this settlement will result in more of a financial return for an investor than a foreclosure would.”
Several observers pointed out that large banks have considerable flexibility in implementing NPV models. In addition, the treatment of second liens has rankled investors.
The settlement terms make clear that, if the first lien is modified and the related second is owned by the servicers in the settlement, the second lien must also be modified. Deutsche Bank analysts characterize it as a “major concession” for the banks.
“The settlement will undo contractual obligations,” said the Association of Mortgage Investors.
Gradman concurred. “The contract obligates banks to wipe out the second lien altogether, but the settlement doesn’t respect that and treats the subordinated lien on par with the first lien,” he said.
The AMI suggested that the settlement be modified before it is approved by a federal court. AMI requests transparency in regards to the net present value model used, a monetary cap for principal reductions on loans not held by the servicers, monthly public reports on the banks’ progress and more investor participation in the proceedings.
Neil Barofsky, the former inspector general for the Troubled Asset Relief Program, said in an interview on Bloomberg News that he doubted the settlement would change. The political will behind it, he said, was much too strong.