It took about 500 days of negotiation. But on Thursday, February 9, attorneys general representing nearly all 50 states made the announcement: Five banks will pay a combined $25 billion over three years in civil penalties and loan write-downs for having serviced mortgage foreclosure paperwork over the previous four years without proper review. The settlement, say supporters, will compensate homeowners for prior predatory lending practices, reform the banking industry and give the economy a boost. But the context of the case suggests an ulterior motive: socializing the housing market. This by no means is the first such attempt during the Obama years. And the true cost of this shakedown, the largest of its kind since the 1998 tobacco industry settlement, may be far higher than $25 billion.
National Legal and Policy Center less than two weeks ago reported on President Obama’s broad housing policy initiative, “Plan to Help Responsible Homeowners and Heal the Housing Market,” which he unveiled on February 1. The heart of the plan is a measure that would enable about 1 million “underwater” (negative equity) mortgage borrowers current on their payments to refinance on favorable terms. The program’s projected cost of $5 billion to $10 billion would be covered by a Financial Crisis Responsibility Fee, originally set a year ago at $30 billion over 10 years but since boosted to $61 billion over that period. The latter represents 0.17 percent of a penalized financial firm’s assets. It’s a bank tax all but in name. The President views it as a corrective to the financial industry’s “abdication of responsibility.” Regardless of interpretation, the administration expects banks to prop up mortgage borrowers in trouble.
Now the notion that a homeowner has a right to remain indefinitely in his dwelling, even if far behind on scheduled payments, ought to strike one as absurd and dangerous. Yet that is the implicit assumption of the states’ $25 billion out-of-court settlement against five banks: Ally Financial, Bank of America, Citibank, JPMorgan Chase and Wells Fargo. The coerced agreement has its origins in the formation of a 50-state working group in October 2010 led by Iowa Attorney General Tom Miller. Attorneys general and regulators sought to get to the bottom of a growing litany of reports that mortgage servicing operations had been prematurely signing off on foreclosure-related documents. The project, known as Mortgage Foreclosure Multistate Group, would investigate whether servicers recklessly glossed over information to facilitate foreclosures and whether they signed foreclosure affidavits outside the presence of a notary public, among other issues. “This is not simply about a glitch in paperwork,” said Miller at the time. “It’s also about some companies violating the law and many people losing their homes.”
Lenders were growing increasingly frantic. Ally Financial, Bank of America and JP Morgan Chase days earlier announced they had suspended foreclosures in nearly two dozen states in the wake of allegations of “robo-signing” by their own or contracted servicers. Wells Fargo, meanwhile, submitted additional affidavits for 55,000 pending foreclosures in those states, conceding there had been flaws in paperwork. And Bank of America began sifting through more than 100,000 foreclosure files to fix potential problems; most of the loans had been underwritten by the financially-troubled Countrywide Financial Corp., which BoA acquired in 2008 at the encouragement of the Treasury Department.
All of this was occurring against the backdrop of the largest foreclosure crisis since the Great Depression. In 2010, the year the robo-signing revelations broke, foreclosure-driven sales accounted for around 30 percent of the nation’s residential sales, estimates the Irvine, Calif.-based RealtyTrac. That figure declined to 20 percent in 2011, a drop primarily owing to the reluctance of lenders to foreclose because of the scrutiny suddenly upon them. A lot of troubled properties, in fact, remain in the pipeline, given that foreclosure filings can refer either to default notices, scheduled auctions and bank repossessions. According the Jacksonville, Fla.-based Lender Processing Services, the nation’s largest contractor of residential foreclosure services (and a reason for the state probes in itself), 4.29 percent of all active residential mortgages in the U.S. in October 2011 were in foreclosure, the highest figure on record.
The rapid upswing in foreclosures that began in 2008 was a wipeout for many home sellers, but it was a bonanza for companies handling the paperwork. With severely delinquent loans piling up, especially in fast-growing high-population states such as Florida and California, lenders recognized that foreclosure often was the only way to take non-performing loans off their books and bring the properties back to market. The Obama administration’s Home Affordable Modification Program (HAMP), set up to lower monthly payments, was making at best a modest dent. Unfortunately, foreclosure is a complex legal process, typically taking months and often over a year. Processing all those extra documents required extra help. And mortgage servicers either couldn’t or wouldn’t hire that help. Overwhelmed by the growing caseload, several lenders and servicing operations took brazen short cuts, processing foreclosures without reviewing the details. At one point, GMAC Mortgage (now Ally Financial) was cranking out about 10,000 assembly-line affidavits a month.
Lawmakers, regulators and consumer advocates grew alarmed. Some took action. Interim Sen. Ted Kaufman, D-Del., chairman of a bipartisan congressional oversight panel looking into the Treasury Department’s foreclosure prevention programs, remarked that credibility problems in the foreclosure process “are already undermining investor and homeowner confidence in the mortgage market, and they threaten to undermine Americans’ fundamental faith in due process.” Phyllis Caldwell, head of the Obama Treasury Department’s homeownership preservation office, called the behavior of mortgage servicers “unacceptable.” The Office of the Comptroller of the Currency dispatched investigators to examine foreclosure operations at federally-chartered banks. Some judges in the New York City-area were dismissing anywhere from 20 to 50 percent of all foreclosure petitions because the paperwork was potentially inaccurate. And attorneys for a Baltimore-based nonprofit group, Civil Justice, filed a class-action suit to dismiss all Maryland foreclosure cases that involved a named robo-signer each for GMAC and Wells Fargo.
The states recognized a rare opportunity to reap the whirlwind. A tide of anti-bank populism was rising throughout the country, as banks and their servicing operations, far from denying they had operated foreclosure mills, were admitting it. Attorneys general and other officials coaxed the five mega-banks to the bargaining table. The banks complied, knowing the alternative was a lawsuit. Negotiations began in October 2010; the face-to-face phase of the talks began the following March. Support for state negotiators came from the Obama administration in the form of Elizabeth Warren, then-acting director of the new Consumer Financial Protection Board (CFPB) and currently a Democratic candidate for U.S. senator from Massachusetts. During early October 2010, Warren played a crucial behind-the-scenes role in getting President Obama to veto the Interstate Recognition of Notarizations Act, which would have streamlined the foreclosure process by compelling notary public officials to accept out-of-state notarizations. Less enthusiastic were U.S. Attorney General Eric Holder and Justice Department criminal division head Lanny Breuer; critics noted that before coming aboard the Obama administration, they were partners together at the Washington law firm of Covington & Burling, which had represented a number of the banks under investigation.
Banks initially offered $5 billion as compensation. That didn’t sit well with state negotiators, who refused to accept anything less than $20 billion. Some state officials thought even that way too low. As the months dragged on, the 50-state coalition, unable to reach an agreement with the banks, drew close to disintegrating. Some states jumped the gun and went to court on their own. Massachusetts Attorney General Martha Coakley in December filed a civil suit against the five banks in negotiation, plus the Reston, Va.-based Mortgage Electronic Registration System Corp. (MERS), on grounds they “charted a destructive path by cutting corners and rushing to foreclose on homeowners without following the rule of law.” Three months later, early this February, New York Attorney General Eric Schneiderman sued Bank of America, JPMorgan Chase and Wells Fargo, claiming these banks used MERS to avoid paying recording fees and to disguise the true chain of ownership of foreclosed properties. Delaware Attorney General Beau Biden, son of Vice President Joe Biden, also had sued MERS in October. And California and Florida were making lawsuit noises of their own.
Eventually, with some late-hour help of Housing and Urban Development Secretary Shaun Donovan, the banks and the states got on the same page. President Obama did his part by soothing the nerves of holdout AGs. He invited Eric Schneiderman, along with California’s new Attorney General, Kamala Harris, to watch his State of the Union Address last month from the president’s box, next to First Lady Michelle Obama. (Schneiderman attended; Harris didn’t). Obama also appointed Schneiderman co-chairman of a new joint federal-state anti-fraud unit, to be run out of the Justice Department, focusing on mortgage-backed securities. By Monday, February 6, more than 40 states had committed themselves to a $25 billion deal. Some late concessions to Florida Attorney General Pam Bondi to dissuade her from filing suit on her own eliminated the last major obstacle to the settlement, which was formally announced on the morning of February 9. In the end, 49 states signed on; Oklahoma had coaxed a separate agreement from the banks worth $18.6 million.
Here are the fundamental details of the settlement. Five major banks, over a three-year period, will pay a combined $25 billion to: 1) borrowers of currently privately-held mortgages that had been issued during January 1, 2008-December 31, 2011; 2) state housing and related programs; and 3) the federal government. The banks also would have to institute industry reforms. The contributions break down as follows, in descending order of payment size: Bank of America, $11.82 billion; Wells Fargo, $5.35 billion; JPMorgan Chase, $5.29 billion; Citibank, $2.21 billion; and Ally Financial, $0.31 billion. Here is the intended destination of these funds:
$17 billion – direct borrower foreclosure relief through principal reduction, short sales and enhanced homeowner transition programs. The $17 billion is a minimum figure because most loss mitigation efforts are expected to earn less than 100 cents on the dollar.
$3 billion – loan refinancing for homeowners who are current on their payments but owe more than their homes are worth (i.e., “underwater refinancing”).
$4.25 billion – payments to state governments, including $1.5 billion for payments to borrowers who lost their home to foreclosure by one of the five mortgage servicers.
$750 million – payments to the federal government.
In addition, the settlement calls for Bank of America and its Countrywide subsidiary to pay $1 billion in damages to resolve a separate federal lawsuit involving these institutions’ inflation of home mortgage loan appraisals from 2003 through most of 2009. This side settlement explains why a number of newspaper accounts have cited the general settlement figure as $26 billion.
Supporters believe the deal will initiate an era of trust and integrity. Attorney General Eric Holder, for one, is satisfied. The agreement, he announced:
…holds mortgage servicers accountable for abusive practices and requires them to commit more than $20 billion towards financial relief for consumers. As a result, struggling homeowners throughout the country will benefit from reduced principals and refinancing of their loans. The agreement also requires substantial changes in how servicers do business, which will help to ensure the abuses of the past are not repeated.
Iowa Attorney General Tom Miller, who led the states’ effort, similarly stated: “This agreement not only provides badly needed relief to Iowa borrowers, but it also puts a stop to many of the bad behaviors that contributed to the mortgage mess throughout Iowa and across the country. This agreement will protect homeowners and ensure they’re treated fairly.” Richard Cordray, the former Ohio Attorney General whose visible anti-bank activism during negotiations helped secure him the job as director of the Consumer Financial Protection Board (via disputed presidential recess appointment early this January), also believes justice was done. “Today’s $25 billion settlement will help struggling homeowners across the country stay in their homes,” he remarked. “Under the terms of the agreement, the largest five servicers must adhere to new consumer protections and provide customers with options for avoiding the pain of foreclosure.”
Yet amid the hoopla of this “historic” agreement are some unsettling realities. For the settlement was a product of populist sentiment, a manufacture of an image of rapacious, unscrupulous bankers throwing out millions of hapless, unsuspecting homeowners onto the streets. State and federal officials, sensing the moment at hand, milked the anger for all it was worth. Those who demurred were in the minority. In the end, a settlement was a virtual fait accompli. The following are several, and by no means all, downsides to the agreement.
First, the agreement is more expensive than it looks. That Obama wants to double his proposed Financial Crisis Responsibility Fee is telling enough. But there are other, less overt giveaways. For one thing, the settlement doesn’t preclude other legal action. It doesn’t grant immunity from existing criminal charges or affect future criminal prosecutions. It doesn’t prevent homeowners or investors from pursuing either individual, institutional or class-action civil suits against the five banks. And it doesn’t prohibit state attorneys general or federal agencies from going after related aspects of suspect behavior within the mortgage industry. Indeed, the future already has happened. On February 9, the day of the settlement announcement, federal regulators, following lengthy audits, slapped $394 million in additional fines on four of the defendants. Another sign that the real price tag is more than the official one is that banks will receive only partial credit for what they spend on required activities. A spokesman for California Attorney General Kamala Harris explained that a bank may have to write down the value of a mortgage by an amount exceeding its market value. The true value of the settlement, he conceded, is more like $40 billion, with California’s share amounting to $18 billion.
Second, the nominal $25 billion figure, never mind any higher estimates, is unjustified. That is because the problem, as the federal and state governments themselves admit, is not the fact of the foreclosures but rather how they were processed. To the extent certain employees of servicing operations cut corners – and they did – the carelessness was prompted by an explosion of paperwork related to mortgages underwritten to unqualified borrowers, many of them comically unqualified. Under pressure from Congress, regulators and nonprofit activist groups, it was almost inevitable that lenders would cut corners at the front end, drastically lowering risk assessment standards. During his tenure as Ohio Attorney General, Richard Cordray accused banks of creating “a business model based on fraud.” But who was defrauding whom? According to Lender Processing Services, a loan in foreclosure as of last summer was delinquent for an average of 599 consecutive days – not a single payment had been made. That’s well over a year and a half. If banks or their servicers raced through the foreclosure process, it was because their workloads were driven heavily by bums to whom they lent money.
Third, and related, the deal is manifestly unfair, as it punishes responsible home mortgage borrowers and rewards irresponsible ones. The deal is a political gift to the most delinquent borrowers, many of whom simply have walked away from their properties. This may be rational from the standpoint of individual borrowers who recognize they may never realize their equity, but it is highly irrational from a policy standpoint. A key reason why property values had sunk so far in the first place was precisely the rising tide of local defaults and foreclosures among homeowners who shouldn’t have been approved for loans. “Robo-foreclosures,” in other words, are a direct consequence of “robo-approvals.” And who will pay the price of the settlement, especially if the principal write-downs and loan modifications further depress neighborhood property values? The answer: the most capable and conscientious borrowers, the ones who made high down payments and timely payments thereafter. On such grounds, Dick Bove, vice president of equity research at Rochdale Securities, calls the settlement “the mortgage deal from hell.” He explains:
Those people lucky or smart enough to stop making payments on their homes may get their loan balances reduced. Other beneficiaries of the agreement may be homeowners who have seen the value of their houses drop below the size of their mortgages. They get a freebie that other homeowners who have paid their mortgages down will not get…The government has selected a small minority of homeowners to get this benefit (1 million of the 75 million or 1.3 percent of the total.) Homeowners who made large down payments on their homes or made the terrible mistake to pay down the principal on their mortgages do not qualify. Homeowners who made minimal or no down payments will get the windfall benefit of a lower principal repayment or a cash payment.
Fourth, the deal further politicizes the housing market under the guise of “fairness,” creating what amounts to an economic stimulus package minus the need for congressional approval. Bank shareholders and investors in mortgage-backed securities will do the paying; delinquent and/or undercapitalized homeowners will do the collecting. The $4.25 billion portion of the settlement going for state homeownership programs would be especially susceptible to political capture. Loan forbearance for the unemployed, “transitional assistance,” “anti-blight programs” and “other forms of relief” would be eligible for funds. The base of support for these programs would be providers as well as consumers. Anyone familiar with homeownership programs knows that for-profit and nonprofit contractors as well as government employees are integral to running them. All would have a stake in keeping the flow of funds going, whether generated by taxes or coerced “agreements.” Even if states and localities don’t contract with ACORN-style community activist groups – not a safe assumption – they would have an enhanced ability to transform housing into a quasi-public good.
Fifth, the settlement represents an abrogation of rule of law. It effectively tells people who can’t or won’t meet their contractual obligations that they don’t have to. As such, it functions as an amnesty. And like amnesty for illegal residence in the U.S. and other forms of lawbreaking, once granted, amnesty encourages the very behavior that led to it. The settlement, in other words, will enable more reckless lending, more avoidance of payments, more “robo-signed” foreclosures, and, in the end, more coerced settlements. In a larger sense, we are evolving an economy based on moral hazard. “There is no sanctity of contracts in the United States,” laments Rochdale Securities’ Bove. “Only fools meet their financial commitments. The non-payers are the truly enlightened.”
It’s hard to see the $25 billion settlement as anything but a slow-motion shakedown. The fix was in from the start. Banks were presumed guilty until proven innocent. The question of the settlement was never “if,” but “how much.” If the lenders didn’t come to terms, they would have faced a massive lawsuit, which, as noted earlier, is something they may face anyway.
In the final analysis, the source of the problem is the widely-held assumption that homeownership – “the American dream” – is a moral entitlement. If certain people can’t afford to own, whether they are currently renters or owners, government supposedly ought to “do something,” regardless of the consequences. This mindset is a bipartisan affair. Democratic and Republican state officials alike leaned hard on the banks. Democratic politicians at the national level such as Bill Clinton, Barney Frank and Maxine Waters helped create this crisis; so did Republican politicians such as George W. Bush, Newt Gingrich and the late Jack Kemp. Until we finally have the honesty to say that homeownership isn’t for everyone, more mass foreclosures and bank “scandals” are likely to be the order of the day.