The National Mortgage Settlement – Will The Big Banks Pass The Buck?

IntroductionOn February 9, 2012, the U.S. Department of Justice issued a press release announcing the “landmark” $25 billion dollar settlement with five of the largest Big Banks.  On February 9, 2012 President Obama told the nation that the $25 billion settlement was:    “…about  standing up for the American people, holding those who broke the law accountable, restoring confidence in our housing market and our financial sector, getting things moving.”

But was it? Were those who broke the law held accountable and if so, how?  The purpose of this post is not to criticize the settlement or those who fashioned it.  Rather, my purpose is to examine a major financial component of the settlement, to determine if, as touted, those who “broke the law” will, in fact, be held “accountable.”

BackgroundIn June, 2010, Jeffrey Stephan, a low level employee at Ally Financial, admitted in deposition that he routinely signed hundreds of foreclosure notices daily without reviewing the underlying facts supporting the case.  This astounding practice, which was later revealed to be SOP in most Big Bank foreclosures, introduced a new verb into the American lexicon: “Robo-signing.”  While banking apologists were quick to characterize these acts as “technical paperwork problems,” no amount of spinning could erase the fact that people were being foreclosed out of their homes through the widespread use of fraudulent documents.

Over the following few months, we learned that a variety of laws were routinely being broken: (a) Documents were signed by persons who had no familiarity with the facts leading up to the underlying foreclosure; (b) Affidavits were sworn to as fact, when affiants had no knowledge of what they were swearing to; (c) Forged or falsified documents were regularly submitted into court as a part of judicial foreclosures; (d) notaries routinely violated state notarization laws; and (e) official titles, such as “Assistant Vice President,” were handed out to low level employees or subcontractors, to sign legal documents, as if acting in an official capacity.

Shortly after the revelations, the attorneys general of all 50 states joined together to bring claims against five of the largest banks for their servicing[1] misdeeds: (1) Bank of America Corporation, Charlotte, North Carolina [together with BAC Home Loans Servicing, formerly Countrywide Homes Loans Servicing LP, Calabasas, California]; (2) Wells Fargo & Co., San Francisco, together with Wells Fargo Bank NA, Des Moines, Iowa; (3) JPMorgan Chase & Co., New York, along with JPMorgan Chase Bank NA, Columbus, Ohio;  (4) Citigroup Inc., New York, along with CitiMortgage, O’Fallon, Missouri; and (5) Ally Financial Inc., Detroit [formerly GMAC], along with GMAC Mortgage LLC, Fort Washington, Pennsylvania, and GMAC Residential Funding Co. LLC, Minneapolis.

The complaint filed by the A.G.s included claims of unfair and deceptive loan servicing, foreclosure processing, loan origination practices, violations of the False Claims Act and Servicemembers Civil Relief Act, as well as various charges relating to the treatment of homeowners in bankruptcy.

The Settlement. On March 12, 2012, The Justice Department, the Department of Housing and Urban Development (HUD) and 49 state attorneys general announced a $25 billion agreement with the five Big Banks.[2]

According to Robert Stowe England, in his website of the same name, the settlement consisted of two broad categories, “hard money” and “soft money.”

The hard money consists of $5 billion in cash from the five banks.   It is to be distributed to all of the states, with larger sums going to those most seriously impacted by the foreclosure crisis: California received $410.5 million; Florida, $334 million; Illinois, $105.8 million; New York, $107.6 million; and Texas, $134.6 million. Oregon received a modest $30 million.  According to Mr. England, of the $5 billion:

 “…$1.49 billion goes to a borrower-relief fund for homeowners whose homes were taken or sold in foreclosures between Jan. 1, 2008, and Dec. 31, 2011. These funds will help an estimated 750,000 borrowers, according to the National Mortgage Settlement website (, set up by the attorneys general who negotiated the settlement.”  

This $1.49 billion appears to be the only portion of the settlement that is directly related to the servicing shenanigans engaged in by the five Big Banks.  Checks up to $2000 are to be sent to borrowers who were ostensibly robo-foreclosed.[3]   According to a February 2012 Forbes article describing the settlement terms:  “The borrowers must meet ‘certain criteria,’ and won’t give up their right to sue the lenders and servicers if they accept the checks.”

The $20 billion in soft money is not directly “out of pocket.”  That is, the Big Banks are not required to actually “pay” these funds to the federal or state governments, or to injured consumers.  Rather, a large portion of this sum represents “credits” given to the servicing banks for providing principal reductions, interest-rate reductions, forbearance, and other foreclosure avoidance measures to borrowers.  According to Mr. England:

“The $20 billion in soft money is roughly divided into two parts:  $17 billion for principal reduction and other forms of forbearance for delinquent borrowers; and $3 billion for refinancing for homeowners current on their mortgage, but who owe more than their home is now worth.

‘None of the $20 billion [in soft money] goes to any particular borrower who was allegedly injured as a result of the foreclosure package,’ explains Laurence Platt, practice area leader in consumer financial services at the law firm of K&L Gates LLP in Washington, D.C. He participated in the negotiations as a representative for one of the servicers.  ‘There’s no connection between who gets the consumer relief other than the $1.5 billion [in the hard-money part] and whether or not they had any issues with their servicer,’ says Platt.”

Let me paraphrase Mr. Platt’s statement for emphasis: Of the $20 billion “soft money” there is no relationship between the recipients who receive the benefit of the various foreclosure avoidance measures and whether they suffered from any servicer abuses. What this essentially means is that the Big Banks get to pick and choose who gets the benefit of a loan mod or a refinance, and who will pay for it.

So Who Will Actually Pay for the $20 Billion ‘Soft Money’ Portion of the A.G. SettlementIn order to answer this question, it is first necessary to understand who actually owns the mortgage loans today.  During the Easy Money Era, circa 2005 – 2007, most loans were securitized into the secondary mortgage market.  This means that shortly after the loans were first made and all documents signed in closing, the banks sold their notes and mortgages [or trust deeds, as they are known in Oregon] either: (a) To Fannie, Freddie or Ginnie [the Government Sponsored Enterprises, or “GSEs”] who then securitized and sold them to investors, or (b) To the “private label,” secondary market,  i.e. the non-GSE market, who then securitized and sold them to investors.

Since the GSEs have not agreed to permit their securitized loans to be subject to servicer write-downs or modifications under the A.G. settlement, the only investors affected by it are those who invested in private label secondary market securitizations.  Nevertheless, these investors are a significant group, inasmuch as more than half of all securitizations during the Easy Money Era, were privately sponsored,[4] and not GSE sponsored.

When loans were sold into the private label secondary market, the investors who purchased the securities did so upon the belief that they were acquiring a stream of income over a period of time.  For example, a 30-year $300,000 fixed mortgage at 6% per annum, would spin off $X per month in interest income as the borrower paid it down.  Some loans were high risk, e.g. subprime or Alt-A loans to borrowers with adjustable rate mortgages [also known as “ARMS”], and others were lower risk loans, e.g. prime borrowers with fixed rate loans.  Higher risk loans yielded higher returns [e.g. like Ravelo’s Boy, a 25-1 longshot in Sunday’s Belmont Stakes] and lower risk loans yielded lower rates of return [e. g. like Dullahan (3-1) in the same race – but after “I’ll Have Another” – this year’s Triple Crown Contender, was scratched].[5] Investors could pick and choose the mix of loans, loan types, and loan risks, they wanted.

Keep in mind that most – but not all – first position loans during the Easy Money Era were securitized into the private label secondary market, meaning investors bought them; and most – but not all – second position loans were retained by the original lender [i.e. they stayed on the Big Banks’ Books].

Secondly, know that most Big Banks in the securitization process retained servicing rights in the private label trusts they created.  Thus, even though they were promptly repaid by investors for the loans they pooled and sold, they remained in the game, so to speak, and got paid to service their loans for the investors who bought them.

As discussed below, this fact – the retained servicing rights – has created an inherent conflict of interest under the A.G. Settlement, between the Big Banks acting as “servicers” and the private label investors whose loans they service.

Quick Question: So, are the private label investors, e.g. the large retirement and pension funds, objecting to the AG settlement, and if so why?

Quick Answer: You Bet Your Bootie!

Here’s why:

  1. The private label investors were never included in the AG settlement talks.  They were stakeholders – i.e. directly affected by the outcome – and yet they had no say in what was to happen. This never sat well with them.
  2.  The wrongs ostensibly sought to be righted in the A.G. Settlement focused on the servicers’ bad acts.  The investors, i.e. the owners of billions of dollars of private label securitized loans, had clean hands.  Quoting Mr. London, “…they are innocent of any wrongdoing in this matter.”  These investors were, under the tax and securities laws, passive – playing no role in servicing the loans in their portfolios; the Big Banks, as servicers of the loans in the trusts, process and account for payments, and have virtually complete control over the foreclosure process, if borrowers fall into default.[6] Yet there is a sense – a fear – by the investors, that they will be the ones – not the Big Bank Servicers – who will foot much of the bill under the A.G. Settlement.
  3. Lastly, since many of the loans, especially the second mortgages, are retained by the very banks servicing the first mortgages, the investors fear that the A.G. Settlement wrongly incentivizes these servicing banks to modify the private label securitized mortgages before modifying the loans they are carrying on their own balance sheets.  Again, the investors fear they will end up paying for the bad acts of the Big Banks, acting in their capacity as servicers.


Remember, approximately 20% of the $25 billion settlement – $5 billion – is “hard money.”  The remaining 80% is composed of “consumer relief” efforts, such as principal write-downs, refinancings, forbearance, and other foreclosure avoidance measures, such as short sales.  The settlement, despite its advertised $25 billion price tag, is largely comprised of a system of “credits” given to the banks in exchange for their consumer relief efforts.

Example: With first mortgages, a servicer receives a dollar-for-dollar credit if it reduces principal on its own first-position mortgage, and 45¢ for each dollar in principal reduction on a first position mortgage held by an investor.

Theory: The bank/servicer will be incentivized to reduce principal on the first liens carried on its own books, rather than letting the  private label investors taking the hit; thus, the banks could work off their “fines” faster by reducing the loans carried on their own books.[7]

Fear: Since banks frequently retained the second liens on their own books, they will be incentivized to reduce over twice as much principal on investor-owned first liens [i.e. 2+ times 45%] for the same dollar credits, thus propping up their relative security position on the seconds they still carry on their books.  Thus, Big Bank servicers would use the investors’ money to fund the credit payments for their own fines for servicer shenanigans! 

Riddle Me This BatmanWould Big Banks really do such a patently dishonest, unethical, and immoral thing?[8]

Moreover, the current record shows that loan modification programs [both HAMP and proprietary – i.e. in-house programs] have abysmal reputations, in terms of the failure rates, discrepancies in calculation, and recidivism.  This means that if a loan mod or principal write- down fails – i.e. the borrower re-defaults, the home could still end up in foreclosure.  But for those servicers holding second lien positions, they stand a better chance of recovery than they did before the write-down was taken on the investors’ first position lien.

Credits for ‘Good Behavior’.  Digging deeper into the terms of settlement that the Big Banks hammered out with the A.G.s, we learn that if they do ‘good’ things, they will also save money. It seems that $1.7 billion of the settlement is allocated to a credit arrangement given when the Big Banks “waive” their right to a deficiency judgment.  Problem is, servicers rarely, if ever, seek a deficiency judgment against underwater homeowners they have foreclosed.  Why?  Because: (a) If the borrower can’t afford their mortgage, how are they to afford a deficiency judgment?; (b) And if the banks recovered a deficiency, the borrower would likely discharge the debt in bankruptcy; and (c) The reputational damage to a Big Bank servicer trying to wring an extra ounce of blood out of a beleaguered homeowner would put them where they don’t want to be – i.e. on the front page of the local paper, above the fold.

A credit allowance is not a bad gig for waiving something you’d never seek to collect anyway.  And lastly, remember, these deficiencies represent mostly unpaid principal – owed not to the servicer, but to the investors!  Again, it seems the Big Banks are settling their fines with Other People’s Money.

And, if that wasn’t enough, long before the settlement was announced, banks were dozing down homes and donating the land to local nonprofits.[9]  Now, up to $2 billion of the settlement money can be applied to these anti-blight activities.  According to a March 27, 2012 New York Times article [“Foreclosure Deal Credits Banks for Routine Efforts”]

“JPMorgan Chase has donated roughly 3,300 homes to nonprofits or municipalities since 2009, according to a bank spokesman. Last year, Citibank donated 205 properties, and Bank of America agreed to pay for the demolition of 100 abandoned homes in Cleveland, 100 in Detroit and 150 in Chicago. William K. Black, a law professor at University of Missouri and former senior deputy chief counsel at the Office of Thrift Supervision, said he worried that banks might overstate the fair market price of the homes donated.  The credits over all, Mr. Black said, “are a pretty sweet deal for banks since it gives them a pat on the back for what they are already doing.”

[For an interesting interview about these credits, go to Bloomberg Law with Neil Barofsky, the former Special US Treasury Department Inspector General for the Troubled Asset Relief Program (TARP), and Matt Stoller, a fellow at the Roosevelt Institute. – PCQ]

Conclusion.  As with most such events, the A.G. Settlement will likely not be as bad and not be as good, as most people predict. Time will tell.  But from where I sit, there is a troubling message coming out of this entire process.  Despite the fact that when the A.G. investigation commenced, Iowa Attorney General, Tom Miller, vowed that “people will go to jail” for their servicing shenanigans, no such thing has happened.  To the contrary, the Big Banks appear to have been given yet another opportunity to literally “pass the buck” by shifting its cost for much of the settlement to holders of pension and retirement funds, 401K investors, union funds, and everyone else – but themselves.  Some might say that as for the financial industry, might does make right. If 50 attorneys general can’t bring the Big Banks to their knees, politically, financially, and criminally, who’s left to do the job? Certainly not the feds in an election year. Thank God for the First Amendment and the Court of Public Opinion.

[1] A bank that acts in the capacity of a “servicer” takes over responsibility for collecting borrower payments on the loan, impounding reserves and paying taxes and insurance, and generally monitoring the borrower’s performance under the loan.  Some banks service their own loans, while others delegate that responsibility to third party servicing companies, that may or may not also act as lending institutions, i.e. banks.

[2] This amount was subsequently increased to $26 billion, to be paid by Bank of America and its predecessor, Countrywide, to settle claims by the Federal Housing Administration (FHA) that it originated bad loans that FHA had insured.

[3] It appears there is a variance in opinion on whether proof of being robo-foreclosed is required.  According to Anthony Randazzo of Reason Foundation, no such proof is required.

[4] The reason for the rise of the private label market was simple:  The GSEs’ requirements, i.e. their conforming loan rules, were perceived to be too strict in their underwriting criteria.  If Big Banks were to make more and bigger loans, they had to offer up programs that lowered the credit bar and raised the maximum loan limits.  With the aid and assistance of the credit rating agencies, these private label loans received bogus investment grade ratings, and were scooped up by investors looking for higher yields. For more on this sordid alliance, see my post here.

[5] According to the L.A. Times, “He has tendinitis in his left foreleg and will be retired to the stud barn. That’s a fine consolation prize for the horse and a lousy deal for the sport….”

[6] It is correct that governance of the loan pools is regulated by a “rule book,” i.e. the trust’s Pooling and Servicing Agreement or “PSA,” but that, like most contracts, is subject to interpretation.

[7] I wonder if, during the settlement discussions, the Big Banks didn’t sound a little like Brer Rabbit, begging Brer Fox to do anything he wanted to him, but, “Please, please, please, don’t throw me into that briar patch!” – PCQ

[8] It is true that the A.G. Settlement expressly provides that the pooling and servicing agreements, or PSAs, must be honored.  It is also true that PSAs uniformly mandate that all servicing actions be done in the best interest of the securitized trust.  [Note that the trustee identified in the PSA – which invariably is another Big Bank – does not owe fiduciary duties to the investors, but to the trust itself. – PCQ] One of the main factors is the Net Present Value Test, or “NPV test”.  But some complain that the NPV model incorporated into the settlement is opaque.  In short, what is in the best interest of the trust as a whole depends upon one’s perspective; e.g. that of the financial interests of the investors or the political interests of the regulators.

[9] Keep in mind that once a bank forecloses, it legally becomes their property, with all of the accumulated taxes, assessments and maintenance responsibilities. Donation to a nonprofit stanches the financial hemorrhaging experienced by banks holding loans in distressed neighborhoods, so these contributions have significant long term cost-benefits.