Even if the settlement being offered by the Obama administration is accepted, it doesn’t give the banks relief on the securities fraud claims or evasion of back fees for recording mortgages.
Reports have begun to appear in the American business press of a possible settlement among banks and their regulators over the mortgage mess in the U.S. The various players in this settlement are leaking stories to business reporters in order to place on the public square their negotiating positions, which can often serve to define the terms of the discussions taking place in private. For those of our readers who are not Americans, we need to apologize in advance for the convoluted, and you might even say ugly, manner in which policy is made in Washington when so many different players are involved. We’ll try to keep the description of what is going on basic and understandable, but don’t be surprised if you feel like you’ve wandered into an abattoir where sausage is being made. First, let’s go down the list player by player, and see what they want out of a possible settlement.
The Obama Administration - The administration is said to be taking the lead in settlement talks, trying to corral together in one room the big banks, the different regulators, the housing agencies, and the attorneys general from the 50 states who are looking into fraud charges against banks for the way they have handled foreclosures. The administration wants one basic thing: to make the housing problem go away, or at least appear to be on the mend, by the time President Obama is up for reelection in November 2012. Accordingly, they want a quick solution, with one year deadlines imposed on the banks for compliance. One of the basic things the White House wants to accomplish are “cramdowns”, which will force the banks to do two things: grant reductions in the principal amounts owed by borrowers whose mortgage now exceeds the value of the property (they are “underwater”), and write-off any second mortgages the banks may have on the property. The administration has something in place to do just that, called the Home Affordable Modification Program, but it has been a massive failure because the banks simply refuse to accept large write-offs on first or second mortgages. The administration, and quite a few economists, do not believe housing prices will truly bottom until large losses are taken by the banks to clear the decks.
The Banks - There are 14 large banks involved in the discussions, but the Big Four, known as the Too Big To Fail banks, handle over 50% of all mortgages in the US and are the key players here. These are: Bank of America, Citigroup, JP Morgan Chase, and Wells Fargo. These banks play multiple roles in the housing market. They have their own portfolio of mortgages which they originate through their branches. These portfolios are relatively modest in size, because the banks typically sell off their mortgages to Fannie Mae and Freddie Mac, the government backstops for the housing market.
The banks play two other roles. First, they sell home equity lines of credit to homeowners, which are loans that are secured by second or worse liens on the property. These HELOCs are still being carried by the banks at 100% face value, but they would have to take big write-downs if the first mortgage was modified in any way. The TBTF banks hold about $400 billion in HELOCs. The second role they play is as mortgage servicer on behalf of Fannie and Freddie and others who bought the mortgage, and who usually bundle mortgages together into a security to be sold to investors. The banks are responsible for collecting payments and foreclosing if necessary. This has been a modest fee income business for the banks, which were not prepared to see it converted into a money losing business once the housing crisis hit. Unfortunately, the need to hire thousands of new employees to manage millions of defaulting mortgages has created just that: a money losing operation that the banks would exit if they could.
The Attorneys General - The way the banks dealt with the explosion of defaults and foreclosures was to hire as few people in their servicing operations as possible, and farm out the work to local law firms that were paid by the number of foreclosures they managed to process in the fastest time possible. This led to all sorts of abuses: fraudulent statements were filed with the courts approving foreclosures, signatures were forged, documents were created after the fact and pre-dated, and junior clerks were given titles like Vice President and made to sign thousands of foreclosures a day they never even read much less understood. These abuses caught the attention of the state attorneys general, who have now banded together as a group of 50 states investigating this fraud. The attorneys general might not be able to file criminal charges, based on Supreme Court exemptions given to the banks, but they can press for fines. They have yet to announce the amount they are seeking.
The Office of the Comptroller of the Currency - The OCC is an obscure but powerful regulator formed during the Civil War to monitor national banks, which use the title National Association in their name. All four TBTF banks are national banks subject to OCC regulation, which is much more extensive than the Fed (which generally looks only at the holding company of these banks). When the foreclosure scandal broke in 2010, the OCC commenced a review of bank practices, and found that while a number of technical errors were common, few erroneous foreclosures were filed. This review only involved a sample of 2,800 loans out of millions that the banks are processing as servicers, so the OCC has been criticized for ignoring a much bigger problem.
The OCC recently sent out a Cease and Desist letter to the servicers, requiring them to correct these technical errors. Normally such a letter carries a fine with it, but in this case the OCC is deferring assessment of a fine until a broader settlement is reached. Reporters are hearing whispers that the OCC will settle for no more than $5 billion in penalties across 14 banks active as servicers. Lawyers involved in foreclosures think this amount is ridiculously small given the damages caused by the banks, and so they describe the OCC as a captive of the big banks willing to do their bidding. In some reports, the OCC is the biggest impediment to the White House achieving an overall settlement, which is rather odd because the OCC is part of the Treasury and can be ordered to enforce a cramdown, something the OCC and the banks strongly reject. As part of its bank-friendly approach, the OCC has refused to turn over to other regulators the results of its investigation of the servicers.
The Bureau of Consumer Financial Protection - The CFPB is the newest player on the block, headed up in its formation by Elizabeth Warren, and actively pressuring for the administration’s goals of a cramdown and write-off of HELOCs. Reports indicate that the CFPB wants a settlement as high as $30 billion, to be used to help homeowners who are underwater and at risk of default. The financial burden of this settlement would be imposed entirely on the servicers; the investors who bought the securities would not be required to participate in any losses. A penalty this large is viewed by some bankers as “crazy”. It would force the servicers to take losses on loans even though they are not direct parties to these loans. This could be justified on the grounds that the TBTF banks in particular were part of the general debasement of the mortgage system in this country, or it could be justified on the grounds that these banks originated some of the mortgages in the first place before they went into securitization. Either way, the banks are not buying into the proposal and will probably try to isolate the CFPB during discussions. This might be difficult; the CFBP is supported by numerous consumer organizations not party to the talks, but able to influence public opinion since the banks are extremely unpopular at the moment. Also, the CFPB is joined in its proposal by the Housing and Urban Development administration (HUD) the Federal Housing Administration (FHA), and the Federal Deposit Insurance Corporation (FDIC). Of these, the FDIC is the most influential as it takes failing banks into receivership, and it must be of the opinion that the banks can afford a $30 billion penalty without going bankrupt.
Fannie Mae and Freddie Mac - These two agencies are the principal support of the housing market, since over 90% of all mortgages are sold to them or guaranteed by them. They are under pressure from Republicans in Congress who want to abolish them altogether, so any proposal that allows them to continue in their current critical role would be welcome to them. So far, that is what the competing proposals do.
Organizations Not Part of the Settlement Talks
The Securities and Exchange Commission hasn’t formally begun investigating the TBTF banks for securities fraud, but there is plenty of evidence that a case for fraud can be made against these banks because of the manner in which they sold mortgage backed securities. Essentially the banks were negligent in registering change of ownership of the mortgage title with county clerks who keep legal track of claims against real estate. Instead, the banks kept a record of these changes on their own system, which courts increasingly are ruling has no legal basis. This therefore invalidates the lien on the property entirely. This also means the mortgage backed securities weren’t backed by any mortgages in the first place, which constitutes a fraud on the investors who bought these securities. Lawsuits are already being filed on these grounds, seeking hundreds of millions of dollars of damages from the banks.
Another group of organizations with keen interest in this matter are the county clerks who record property liens such as mortgage titles. Already these clerks are beginning to file claims for millions of dollars in lost fees over the years as the banks circumvented the county records department. The total across the US could easily reach in tens of billions of dollars of lost fees that could be reclaimed.
The Department of Justice is nowhere to be heard when it comes to the multiple examples now in court cases of fraudulent activity during the housing bubble and the foreclosure aftermath. Just why this is, is open to interpretation, but the issue is getting more and more national press, and ultimately the Obama administration is going to be caught with the political problem of being soft on the banks and indirectly complicit in condoning illegal behavior.
Where is This Heading?
A grand settlement is going to be difficult to reach given the wide separation in positions. The Obama administration had for a long time refused to countenance any cramdowns or large-scale write-offs of HELOCs, so its stance has certainly changed in these settlement talks. The administration may be motivated by the fact that the states are going ultimately to get some penalty from the banks, but the larger motivations seem to be political. Heading into a reelection campaign, President Obama may want to appear to be tougher on the banks, and he definitely would prefer to have the housing market healing. By pushing for cramdowns, however, he enters the delicate area of Cui Bono - Who Benefits? Should speculators who bought homes they could not afford receive principal reductions and cancellation of their second mortgages? A broad-scale program of housing relief could backfire on the administration, causing resentment among people who acted prudently during the housing bubble.
The banks would prefer someone wave a magic wand and make this problem go away. If, for example, there were a grand agreement offered where the banks would receive exemption from lawsuits against them for securities fraud, or evasion of county recorder fees, or mortgage and foreclosure fraud, they might be interested in accepting a penalty, even a large one. Such an offer is not on the table and may not be legally valid in the first place. Lacking that, the banks do not want to enter into any agreement that forces them to admit culpability other than for some minor technical errors in the foreclosure process – to do otherwise exposes them to enormous civil lawsuits.
Unfortunately for the banks, time is working against them. The civil suits are already arriving on their desks, and courts increasingly are striking down their foreclosure claims. County clerks have their hands out for back fees, sensing deep pockets are now open for reclaiming billions of dollars of lost revenue. Lawyers see years and years of business available to them, and as these suits proliferate, the TBTF banks may become desperate for relief from the administration, their regulators, or Congress. In fact, if the banks become desperate enough, they may use once again their trump card of claiming they are going to fail without such relief, and the whole economy will go down with them.
Even if the settlement being offered by the Obama administration is accepted, it doesn’t give the banks relief on the securities fraud claims or evasion of back fees for recording mortgages. These are potentially life-threatening damages for the banks, so this drama is only in stage one. Nor will the settlement really help the housing market; $30 billion is a drop in the bucket compared to about $750 billion in underwater mortgages, affecting more than 25% of all homeowners. Ultimately this means the housing collapse will drag on, so we should expect more fireworks from all the players in this deadly drama.
 Mortgage Settlement Talks Plagued By Infighting Between Regulators, Prosecutors Reuters, February 24.
 Obama Administration Pushes For Multibillion-Dollar Settlement Of Mortgage Cases Jonathan Stempe, Reuters, February 24.
 US Pushes Mortgage Deal - Obama Proposal Seeks Multibillion-Dollar Settlement of Loan-Servicing Cases Wall Street Journal, February 24.