Following the National Mortgage Settlement, B.L. Zebub, Belial Bank’s once fearless leader, is waffling on whether to jump into the fray, and start writing down the mortgage balances for his Beleaguered Borrowers. Not that the milk of human kindness flows through his icy veins – he’s just trying to figure out an “angle” so he can game the system and still appear to care about The Little Guy. For the last three years, Belial Bank has put up incredible loan modification numbers without actually having to modify a single borrower’s loan. The trick, of course, has been to continually move the goal posts, so while their borrowers may get to the 80, 90, or 95-yard line, they never quite get the ball into the end zone. Once they get close, Belial either tells them they don’t qualify, or they can’t get a mod because they didn’t get their paperwork in on time.
B.L. has perfected this insidious shell game ever since he attended a banking industry seminar entitled “Loan Modification as Performance Art” which blends the best of Kabuki dancing and Liar’s Poker. From that moment on, as if awakening from a deep sleep, B.L. had an epiphany: “It’s not what you do that counts – it’s what you appear to do.” This little known mantra explains why the Behemoth Banks continuously chant to distressed homeowners: “We’re here to help,” when what they’re really saying is “We’re here to help you out of your home.”
So once again, B.L. has convened his trusted advisors to discuss the national mortgage settlement, which, he has learned, contains some interesting “incentives” to encourage the Big Banks to take principal write downs on their borrowers’ loans. B.L.’s plan is not to erase ALL borrower negative equity, but just enough to keep them in the game and on the field. As a Big Bank Servicer, B.L. knows all too well that he needs his borrowers’ loans to stay in the servicing pool, however non-performing, as long as possible before letting them slip into the Abyss. Since servicing fees for non-performing loans means Big Money to Big Banks, he needs to find a new gimmick to entice his borrowers. He has concluded that principal write downs, courtesy of the National Mortgage Settlement, may be just the ticket. Thus, for those distressed homeowners awash in negative equity, the promise of a principal write-down – however meager – may keep them circling the drain a bit longer before he pulls the plug.
Participating in this hastily convened conference call is B.L.’s legal intern, Les Guile, who was successful at the last meeting in totally alienating the head of Belial’s South American Derivatives Trading Desk, Chase N. Prophett, by suggesting he was “small minded” and “morally vacuous.” Liz Pendens of the title industry is on the phone, fidgeting, as usual, in anticipation of some new hair-brained idea from B.L. and his cronies. Joining in on the call is Dee Faulting, the Queen of Hearts in default servicing. Dee has just arrived back from a recent default servicing convention where she was awarded the title of “Most Inspirational” for her unwavering willingness to foreclose as many homeowners as possible regardless of the severity of their hardship. Damian Faust, Belial’s chief legal counsel, is back with us, after weathering a storm of protest over the vanity plate, “TBTF,” that he ordered for his new Porsche Carrera. Kenneth Y. Slick III (aka “KY”), is also on the phone conference. He is B.L.’s “Idea Man” whose most recent claim to fame was to suggest that Belial institute a $10.00 debit charge fee after Bank of America, following a storm of protest, retracted its $5.00 fee. B.L.’s loyal secretary, Lucy Furr, has dutifully transcribed this conversation, careful to redact even the hint of profanity, just in case Julian Assange got ahold of the transcript and made it public. Alas, Lucy failed again, which explains how this purloined post fell into my hands. – PCQ
B.L. Zebub: “Well, I’m glad everyone could make it, even Damian, who has wisely decided to trade in his Porsche for a Chevrolet Volt, which he got used following the recall. Wise move Damien – especially if you can get the smell of burning battery acid out of the car’s interior. [Snickers] But Damien got the last laugh. He bought another vanity plate, but this time with a little less recognizable acronym, ‘SIFI.’”
Liz Pendens: “B.L. I’m affiliated with the title industry. We just did the heavy lifting for the banking industry when it came to explaining MERS to the state legislators – like we did in Oregon – so our respectability and benign reputations would provide you with cover. I’m afraid I’m not versed in the Big Bank Blather. So, pray tell, what does ‘SIFI’ stand for?”
Dee Faulting: “To you, Liz, it’s ‘Science Fiction.’ But to the rest of us on the line, it’s ‘Systemically Important Financial Institutions.’ [Muted laughter] There are 29 of us around the world, according the Forbes.”
B.L. Zebub: “OK, OK, enough levity and sarcasm. Liz, Dee can be as cutting as Lorena Bobbitt, so just ignore her. We’ve got some serious issues to deal with today. As we all know, every Big Bank in our industry, even Belial, continues its public relations slide. In a recent Pew Research poll of 30,000 adults, when asked to identify their favorite bank, 87.34% identified a blood bank or a sperm bank. The Big Banks came in dead last with .023% favorability ratings. And when asked who people thought could best lead a Big Bank through these turbulent financial times, not one of the familiar names came up. Not even Jamie Dimon, the JP Morgan rock star CEO. No. The person with the most votes was Willie Sutton.”
Les Guile: “Excuse me sir, sorry to demonstrate my ignorance, but who’s he?”
K.Y. Slick: “Guile, he was way before your time. He was the career criminal who, when asked why he robbed banks, supposedly said, ‘Because that’s where the money is.’ He didn’t really say it, but it made for good copy. B.L., I really don’t care about reputation. If you have enough money, your bona fides become irrelevant. I believe ‘Might Makes Right.’ Who cares what The Little People think?”
Les Guile: “Correction – that is, until you’re caught doing something you’re not supposed to be doing. Then, reputation becomes important. Look at Jamie Dimon, the CEO for JP Morgan. When he went to the Hill last week to explain what their derivatives trading desk in London had been up to, the senators’ slavish questioning bordered on feckless fawning. I’m surprised the senate staffers didn’t hand out drool bibs to their bosses. What’s worse, most of the senators didn’t have a clue what they were talking about. Most of them thought a bank’s “hedge fund” was its reserve for landscaping. They never realized that JPM’s London branch had just made a massive wager disguised as a hedge that never should have happened. By the end of the hearing, the senators were asking Dimon’s advice on what would constitute a permissible hedge under the Volker Rule – which is the very issue these guys have yet to figure out under Dodd Frank! They were literally asking the fox how to make the henhouse safer! The hearing was such a joke that all Jon Stewart had to do for laughs was to play snippets of the senators’ own bonehead questions. Brilliant! It’s good to know that the Peter Principle is alive and well at the highest levels of our government!”
B.L. Zebub: “OK, OK. Let’s get to the main agenda item, principal write-downs. Damien, can you tell us a little bit about the National Mortgage Settlement, and how we might use it to our advantage? Mind you, I’m not interested in hearing what we can’t do – I want you to tell us what we can do – without getting caught, of course. Remember, it’s not cheating if no one finds out!”
Damien Faust: “B.L., I’d be happy to. On behalf of the Big Banks, I was at the table during much of the negotiations. As you all know, supposedly, the Big Banks were hit with a $25 billion fine for servicing misdeeds, like robo-signing and such. As an aside, I think the robo-signing controversy was the best thing that could have happened to us….”
Liz Pendens: “Just a minute Damien. What do you mean it was the ‘best thing that could have happened’? You’re saying that using low level employees to fraudulently sign legal documents and use them to foreclose people out of their homes was a good thing? The banking industry may never recover from the reputational fallout. I was just invited to a large party last week, and the invitation said ‘Don’t BYOB.’ I called the hostess to tell her I assumed the bar was hosted and that I had no intention of ‘bringing my own bottle.’ After she got through laughing, she informed me that this was just a gentle reminder telling the invitees not to ‘bring your own banker.’ Bankers are social pariahs today. There is even a cottage industry developing that prints up fake business cards for bankers, giving them imaginary jobs such as used car dealers, payday lenders, even repo operators – so long as it’s a line of work that’s more respectable than bankers. It’s the only way they can get accepted in polite society these days.”
Damien Faust: “Liz, you’re an inveterate hand-wringer. No wonder you chose a business where the most exciting thing your employees do is hunting for wild deeds in a title chain. I’ll bet you hide in the ladies’ room when you walk into a Las Vegas casino. Risk is where the action is. Listen to me. Here’s the story: Robo-signing was child’s play when it came to Big Bank Bungling. Few people really got hurt, and if they did, things generally got cleaned up, since you guys were afraid to insure title out of our REO departments unless we made it right. So we made our amends, gave our “Mea Culpas,” and pretended to be embarrassed about the whole thing. Then we signed on to the National Mortgage Settlement which carries a $25 billion price tag for our supposed servicing misdeeds. Meanwhile, the SEC and IRS are still leaving us alone. All of our securities violations for breaching the Pooling and Servicing Agreements and tax violations for ignoring the “true sale” rules of our securitizations, are being ignored. By the time the regulators get around to doing anything, the statutes of limitation will have run and consumers have found another industry to vilify. And even if they don’t, the Politicians In Our Pockets will say ‘Leave these guys alone – they’ve already been fined, flogged and filleted. Enough already!’”
Les Guile: “Hmmm. That’s an interesting take on things. So you’re saying that the last four years of drubbing has been part of a larger Big Bank Burlesque, where you plead to the lesser charges and get a pass on the serious ones.”
Damien Faust: “Now you’re catching on Guile! So while all of the regulators have their ‘lines in the water,’ supposedly going after the Big Fish, the dirty little secret is that they never leave the dock, and are only using a 2-pound test line! Regulators just want to catch crappies – they don’t put up much of a fight and they’re much easier to reel in.
So, back to the settlement. The $5 billion we doled out to the various states was the only “real money” this has cost the Big Banks. Almost 1.5 billion goes out to almost any foreclosed homeowner that applies; they get an automatic payment – up to $2000 – even if they weren’t really a “victim” of robo-signing. It’s just a sort of reparations to buy some good will. Hell, we pay far more than that in attorney fees, political payoffs – err, contributions – and prime time advertising. $17 billion of the remaining $20 billion goes to writing down the principal balances of our borrowers.
B.L. Zebub: “Well, Damien, $17 billion isn’t exactly chump change. I don’t think I’m going to enjoy taking that kind of a hit, just to reduce a loan for The Little Guy. We’ve got our executive bonuses to think about, you know.”
Damien Faust: “B.L., that what’s slick about this – sorry K.Y., didn’t mean to use your moniker in a derisive way. You see, we don’t really pay any money! We get a ‘credit’ against our fines, for every loan we write down. With first mortgages, we get a dollar-for-dollar credit if we reduce principal first-position loans that we still hold, and 45¢ for each dollar in principal reduction on a first position mortgage that is held by a private label investor. We were able to convince the AGs that this arrangement would incentivize us to reduce principal on the first liens that we still carry on our own books. This would protect the private label investors from taking all the hits on their first mortgages. That way with dollar-for-dollar reductions in the fine, we could work them off faster by reducing the loans carried on our own books….”
Les Guile: “Excuse me for interrupting, Mr. Faust. But it appears to me that since Big Banks frequently retained the second mortgages, such as HELOCs, on their own books, they will actually be incentivized to reduce twice as much principal on investor-owned private label first liens and get the same amount of credits against the fines. This will enable the Big Banks to improve their own second mortgage positions so they would no longer be in negative territory vis-à-vis the first lienholders. Thus, the Big Bank servicers will be using the private label investors’ money to fund the credit payments for their own fines!”
Liz Pendens: “Hold on, Les. Slow down. Can you explain your comments in terms that a mere title examiner can understand? Our brains don’t process things like bankers’ brains. Our information is filtered through an actual conscience first. Big Banks are not troubled by moral distractions, so they process information faster. So while B.L., K.Y., Dee and Damien may have followed what you said, I didn’t. Can you go over that again?”
Les Guile: “Sure. I’m assuming you’re not accusing me of having no conscience, since I’m just a young intern at the bank, but I’m not really a ‘banker.’ I had a conscience long before I began working here, and it’s alive and well, thank you. So here’s the deal: Back during the Easy Credit Era, circa 2005-2007, most Big Banks securitized their loans – that is, they sold them as securities to investors in what became known as the “private label” secondary market – to distinguish it from the GSE secondary market. This meant that they almost immediately got paid from the investors who bought the loans the banks created and packaged. This is why the Big Banks were willing to make junk loans to unqualified borrowers; since they weren’t carrying the loans on their own books, they didn’t care whether they ultimately failed. Secondly, during the securitization process, the Big Banks appointed themselves as the servicers for these billion-dollar loan pools – so they received an added profit center to their books. Third, since loans that the Big Banks carry on their own books force them to meet certain capital retention requirements, securitizing and selling off these loans means they don’t have to set aside capital to compensate for the risk of nonpayment.
So in short, securitization to the Big Banks was a sweetheart deal all the way around; at least until they got too much of a good thing, and everything collapsed beginning in 3Q 2007. Although it started out as a “subprime crisis” where just the bad loans were defaulting, pretty soon, the collapse of housing prices eventually ate into the equity of homeowners who made good, prudent borrowing decisions during the same time. So, if you had 20% equity in your new home in 2005, for example, it is likely that after losing 40% of its fair market value by 2009, that home’s value may have dropped 40% and therefor is now 20% “underwater,” i.e. its value is 20% below the unpaid principal balance.
Also during this time, many borrowers – even prudent ones – were encouraged to take out second mortgages, such as HELOCS. The Big Banks retained many of these seconds. They were smaller and carried higher interest rates. Back then, no one regarded these loans as risky, even though they were in a second position, since everyone believed that property values could never go down. When everything collapsed, it was these second mortgages the Big Banks carried that ended up at risk, and the drop in housing values often fell below the first mortgage. This meant a second mortgage had no “security” to attach to. Borrowers could discharge the debt in bankruptcy if they wanted to.
Now with the National Mortgage Settlement, they have a choice: Get a dollar-for-dollar credit against $17 billion in fines, for a principal write down on a first mortgage they hold – and there weren’t that many – or get a 45% credit for each dollar written down on a first mortgage held by a private label investor. So Damien here is suggesting that Belial write down as many investor-held loans where it also has unsecured seconds on the same property. For example, assume a borrower with a $200,000 home, owes $200,000 on an investor-owned first and a $50,000 Belial Bank-owned second. If Belial, as servicer, makes a $50,000 principal reduction on the first mortgage, Belial’s second is now actually secured by the property. Thus, the private label investor ends up paying for the principal reduction and improves Belial Bank’s second position. Am I right, Damian?”
Damien Faust: “Bingo! So, B.L., what do you think? We don’t want to use our own money to give principal write-downs when we can use investor money. Don’t you agree?”
B.L. Zebub: “Damien, I think this is brilliant! Then we start going public with the billions of dollars of write-downs we’re making, the press picks it up, and our stock goes up, as does our reputation. And we don’t pay a penny, and work off the fines with investor money. Christmas in June! Are there any other goodies in the settlement we need to know about?”
Liz Pendens: “Just a sec. The investors can’t be too happy about this. Didn’t they oppose it while this was being hammered out? I can’t believe they rolled over on this.”
Damien Faust: “That’s the hilarious part! Even though they were one of the stakeholders in all this, they were never given a place at the table. Several of the lobbyists at the Big Banks changed the ring tone on their smart phones, so it would play Little Richard’s hit ‘Keep a Knockin’ (But You Can’t Come In)’ whenever we were around the private label investor lobbyists. It drove ‘em crazy!”
But, anyway, B.L. back to your question; the answer is ‘yes’ there are more goodies for us. Up to $2 billion of the settlement money can be applied to dozing down homes and donating the land to local nonprofits.”
Les Guile: “But, Mr. Faust, it was my understanding that the Big Banks were already doing this long before the settlement was announced. It revitalized blighted neighborhoods, got the nonperforming loans off the banks’ books, and eliminated their property tax burden. So these pre-existing routine efforts you were doing already can now be counted as credits toward the fine? Amazing! So while the public thinks that this $25 billion settlement is ‘real money’ coming out of the hides of the Big Banks, most of it is really being paid for by private label investors. And some of it is even applied toward pre-existing activities they had always been doing.”
K.Y. Slick: “Actually, Guile, it even gets better, if what I heard is true. Damien, is it correct that we get a “good behavior” credit?”
Damien Faust: “Well, we try to avoid calling it that in mixed company. There is $1.7 billion of the settlement money allocated to a credit arrangement where we “waive” our right to a deficiency judgment in states that permit us to pursue deficiencies. In reality, we rarely, if ever, seek a deficiency judgment against underwater homeowners we have foreclosed. I mean, if the borrower can’t afford their mortgage, how are they to afford a deficiency judgment? It would be a waste of time to pursue, and they could just discharge us in bankruptcy if they wanted to. So again, even though we rarely pursue borrowers for deficiency judgments, now we can get a credit against the fines for not doing so!”
Les Guile: “Well, all in all, not too bad a deal for the Big Banks. So, as I understand it, with the exception of the approximately $1.5 billion paid into a fund that nearly any foreclosed homeowner can tap for up to $2,000, the rest of the $5 billion ‘hard money’ has nothing to do with robo-signing or compensating ‘victims’ of any servicing misdeeds. And most of the remaining $20 billion of ‘soft money’ does not really have to be the Big Banks’ money at all, unless they make principal reductions for loans they carry on their own books. The Big Banks can decide which loans to write down and how much – and the private label investors have no say. And you don’t think they will ‘cherry-pick’ the best, safest, and least risky borrowers – leaving the most distressed ones twisting in the wind? And if they’re servicing loans owned by Fannie or Freddie, they won’t write down principal anyway, since the FHFA won’t let it happen. And if DeMarco changes his mind, since Fannie and Fredde are sucklings on the public teat, it really means the American Taxpayer will bear the cost – not the Big Banks that securitized their toxic brew of high-risk loans. This GSE exclusion must eliminate about half of all the eligible homeowners in the country. I kinda suspect that this widely touted $25 billion settlement is just a lot of smoke and mirrors, and will change little for many. Wow! A cynic like that irascible Phil Querin might say that ‘form is being elevated over substance’ just for political appearances. I wonder if, over the next twelve months, the American public will come to agree.”
 “The preferred definition of securitization with which this essay began thus reveals why securitization often is preferable to other forms of financing. It also explains most of the structural requirements of securitization. For, to take advantage of superior information of the expected behavior of a pool of assets, the ability of the investor to rely on those assets for payment must not be materially impaired by the financial behavior of the related originator or any of its affiliates. In most legal systems, this is not practicable without the isolation of those assets legally from the financial fortunes of the originator. Isolation, in turn, is almost always accomplished by the legal transfer of the assets to another entity, often a special purpose entity (“SPE”) that has no businesses other than holding, servicing, financing and liquidating the assets in order to insure that the only relevant event to the financial success of the investors’ investment in the assets is the behavior of such assets. Finally, almost all of the structural complexities that securitization entails are required either to create such isolation or to deal with the indirect effects of the creation of such isolation. For example, the (i) attempt to cause such transfers to be “true sales” in order to eliminate the ability of the originator to call on such assets in its own bankruptcy, (ii) “perfection” of the purchaser’s interest in the transferred assets, (iii) protections built into the form of the SPE, its administration and its capital structure all in order to render it “bankruptcy remote”, and (iv) limitation on the liabilities that an SPE may otherwise incur are each attributes of the structure of a securitization designed to insure that the isolation of the transferred assets is not only theoretical but also real.” Introduction to Securitization, by: Jason Kravitt, Mayer, Brown & Platt, 1998.