By Abigail Caplovitz Field | March 16, 2012
This post is a re-write of a post I’d done a few days before the settlement was filed. Much of the factual information is the same, however, this analysis is different in focus and in a couple places substantively. To avoid having two posts proffering conflicting analyses on the same facts, I’ve overwritten the old one. I’m sure it can be found on the net if you want to track the changing of my mind. Bottom line, as of 3/16/12, this is where I come out:
Representing the Bankers, Not the People
Priorities are everything. Once priorities are set, coherent decisions follow. Looking at the money in the mortgage settlement reveals that the bankers’ priorities are embedded in its terms, not homeowners’, taxpayers’ or any other broad slice of ‘We, the People.’ Banker priorities, not public policy ones, will shape the “consumer relief”/”homeowner help” delivered by the deal.
(The money isn’t the only place the bankers’ perspective shapes the deal’s reality; there’s simply no other way to understand the deal’s metrics.)
What do the top Bailed-Out Bankers care most about? “Managing” their balance sheets to maximize their take home pay. Maximizing company profits and thus take home pay at the expense of everyone bankers do business with is Wall Street’s current ethos. That’s what Greg Smith was talking about at Goldman Sachs, and everyone knows it’s not just a Goldman Sachs thing.
Why do I say the mortgage deal adopts the bankers’ priorities? Well, it’s set up to let them manage its impact on their balance sheets as they see fit, letting balance sheet management, not homeowner harm, shape how the “homeowner help” is done. As a result, the help that is offered is unlikely to help much.
Beyond the discretion to do the deal by prioritizing balance sheet managent, the deal contains another sign of disregard for homeowner harm: a grossly inadequate $1500-$2000 payment to foreclosed homeowners. Finally, the deal contains two gratuitous gifts of cash to the bankers.
Back to Basics: The Banks Are “Paying” for Their Wrongdoing
Let’s start with a very basic question: Why is there any amount of money at all in this settlement?
Well, the banks are getting something—a substantial liability release from state and federal prosecutors and regulators (Exhibits F and G in the Consent Judgments, available here). That means that the banks have done considerable wrongdoing; otherwise there’d be no peace to buy. If you have any doubts about the scale of bad acting involved, read the complaint filed with the deal, or the HUD memos released at the same time. So despite the “help for homeowners” rhetoric, don’t be confused about the nature of the money in the deal: It’s a penalty. The banks are paying money because they did wrong.
I know, I know, in the final settlement the language will say they neither admit nor deny wrongdoing. And I agree with Judge Rakoff that’s a travesty of justice. Doesn’t change the fact that the banks’ wrongdoing is the only reason they’re ‘paying’ anything.
How the Deal Prioritizes Balance Sheet Management
Why do I say the deal prioritizes balance sheet management? Well, it allows the bankers to pick and choose from a menu of different types of homeowner help, ranging from reducing mortgage principal on first mortgages, to reducing it on seconds, to forgiving deficiency judgments, giving money to facilitate moving, and a variety of other things. Beyond that, the deal allows the bankers to pick and choose whose money to pay the deal with: their own, or investors. And by investors, I mean mostly you, wearing your taxpayer and worker hats.
So riddle yourself this: Why do the banks get to ‘pay’ their penalties using other people’s money and shape the help given homeowners to deliver maximum banker benefit?
Frankly, there’s no excuse; the money in the deal just isn’t enough to blow up bank balance sheets–in fact, the bankers told shareholders in their annual reports that the amounts weren’t material and were fully reserved. Beyond that, doing a homeowner-taxpayer-We-the-People-centric method of homeowner help would have been much simpler. Consider the BP Oil Spill Fund: Fork up billions in cash because you harmed people and we the government will distribute it as fairly as possible to the people you harmed.
Why wasn’t the BP Spill Fund the template for this deal? That Fund was done by the Obama Administration; they know how to do this when they want to. If you enjoy indulging in Lotto-esque, a-dollar-and-a-dream escapist fantasy, imagine this alternate reality: The banks got fined, in cash, an amount that reflected the scale and depth of their wrongdoing and the damage it has caused us all. To assess that fine properly, our state and federal law enforcers cooperated and investigated thoroughly. Because of that thorough investigation, law enforcers knew how to compensate victims appropriately and did so. What a lovely vision.
Paying a “Penalty” With Other People’s Money
Here’s what I mean when I say the bankers can use other people’s money–largely your money, as a taxpayer and worker—to ‘pay’ their penalty. First, the bailed-out bankers (B.O.Bs) are allowed to modify loans they service but don’t own. Second, these B.O.Bs can violate a basic legal principle—“lien priority”—to spend your money when normally they’d have to spend their own.
Modifying Loans They Don’t Own
When a loan is modified, particularly when principal is reduced as the settlement intends, whoever owns the loan takes at least a paper loss. The homeowner owes less interest and principal to the creditor. (I call it a paper loss because if it prevents foreclosure, such a mod almost certainly nets the loan owner more money, unless the loan owner paid for mortgage insurance. Lori Goodman explained why to Congress.) And who owns most of these loans? Fannie Mae, Freddie Mac, pension funds, and 401ks. That is, taxpayer, taxpayer, worker, worker. You.
Why are our law enforcement representatives at the state and federal level accepting a deal that allows 1%er bailed-out bankers pay for their misdeeds with the taxes and retirement security of the 99%? As a matter of principle, that’s just wrong.
Making the Last First to Give the Banks More Money
The deal lets the bailed out bankers use other people’s money—your money—to pay their ‘penalty’ in a second way: keeping second mortgages alive when they should be wiped out.
According to long standing, basic legal principles (not to mention contracts), first mortgages are supposed to be paid in full before the second mortgage gets a dime. That’s what being “second” is all about. But that’s not what the deal requires. Under this deal, holders of the first mortgage can be forced to take losses while the second mortgage continues to exist. That means second mortgage holders get money that should have gone to the first mortgage holders. (See D-4 at 2 and D-1-2 at 2; see also A-26 at 5; D-3 at h; D-6 at d; E-5 at (iii).
Well, ask yourself: who benefits by keeping the seconds alive? The answer is the big banks taking the deal. That’s because the B.O.Bs own most of the second mortgages, but relatively few of the first mortgages. Indeed, they own so many of them, and currently value them at such inflated prices, that honest accounting of all of them at once would likely expose some or all of them as insolvent. But unlike when the government blessed this facially illegal money transfer from investors to banks under the HAMP program, this time the government can’t say hey, we’re just trying to save the banks from going under. See, the numbers in the settlement are too small to dent their balance sheet.
The big four value their second mortgages at about $370 billion. Yves Smith reports that marking to market would wipe out up to 70% of each B.O.B.’s second mortgage valuation (possibly less for Chase). That could wipe out some of the banks, or come close. Under an open-ended program like HAMP, maximum first mortgage modification with second lien wipeout makes that ‘doomsday’ scenario plausible.
But the numbers in this deal are too small. We’re talking $17 billion in homeowner relief–or maybe $40 billion–either way, too little to hurt the B.O.Bs. $40 billion is only 11% of $370 billion, and the amount of possible second mortgage wipeout is actually much smaller. All the different forms of consumer relief–first mortgage principal write downs, deficiency judgment forgiveness, etc. would be part of that $40 billion. And remember, $40 billion is the highest possible estimate; $17 billion might be a more realistic number. If every penny of $17 billion (again, there’s other types of relief involved) was second mortgage wipe out, it would be less than 5% of the inflated $370 billion on the banks books. No way the banks needed to be able to violate lien priority to fulfill their commitments under this deal. Letting them preserve the 2nds this time is just a big fat cash gift.
The Excuse: Investor Consent
The official claim is: ‘hey, there’s no problem, those B.O.Bs will only spend other people’s money with permission’. Well, if that’s true, it’s easy: not going to happen. But I think the claim that they’re going ask permission, much less than they’re going to receive it, is just more Obama Administration b.s.
See, each security is governed by a contract that requires a certain number, a high number, of investors to consent for consent to count. The exact number varies, but it can be more than 50%. Consider that under those same contracts, it can be significantly easier for investors to unite and demand that the security’s trustee bring the servicer to heel. Given the rarity of that collective action, despite tremendous servicer provocation, I can’t take Team Obama seriously when they say the B.O.Bs will get investor consent.
Add to that practical hurdle anecdotal evidence servicers aren’t making any effort to communicate with investors about modifications now, mods that are all better for the investor than foreclosing. Check out this Mandelman podcast with investor attorney Talcott Franklin. Now, asking investors for permission to modify a loan when it makes them money is one thing; asking investors in first mortgages to take a hit while a second mortgage survives is entirely another. What possible reason do investors have to say yes to that?
Consent or no, it’s incredibly galling, from the public’s point of view, to allow the banks to “pay” their penalty with other people’s money. The banks should pay cash–their own cash–to buy legal peace. The government could then spend that money to help homeowners, however it wants.
Investors who want to stop this nonsense before it starts need only do one simple thing: go on record as saying “no.” Send a letter to both sides of the deal stating which securities you own, and how much, and reject mods that violate lien priority and that are used to pay the banks’ ‘penalty’. And when you serve that notice, put out a press release and attach the letter.
Too Little Help to Matter
Beyond the design flaw that lets homeowner help decisions be shaped by balance sheet management concerns rather than public policy ones, the numbers in the deal just aren’t enough to make much of a difference. That is, a homeowner that is $75k underwater isn’t much helped if they’re suddenly $50k underwater. Beyond that, it’s not at all clear that the banks will use real money; that is, some or even many of the principal reductions may simply reflect money the banks have already deemed uncollectable. That is, the settlement may let banks “pay” by improving the accuracy of their accounting.
Similarly, the bankers can get some credit for writing off the difference between the foreclosure judgment and the loan amount, which is called a deficiency judgment. How real that write down is depends on what the bank would have done without the settlement. Was it going to try to collect it? Traditionally no, because if the person was foreclosed they don’t usually have enough assets to be worth pursuing. But maybe the bankers would sell deficiency judgments to debt collectors for cents on the dollar, so perhaps they’re taking a tiny loss on each. How much money, really, is the bank “spending” by writing off deficiency judgments?
Here’s the kicker: even if every dollar involved was real money, and all the dollars were maxed out, it still doesn’t matter. From a fixing-the-housing-market perspective, the numbers are tiny. Homeowners are three-quarters of a trillion dollars underwater. Even if all of the inflated $40 billion was principal writedown, and it’s not, the housing market won’t notice.
From a righting-past-wrongs perspective, well, most of the money doesn’t go to that purpose, and what does is grotesquely inadequate. Consider what the deal offers people whose homes have already been taken from them. In essence, the deal has the bankers saying: “Hey you there, look, we’re sorry we took your home. So here’s $1800. Now run along and give it to your new landlord, my Wall Street buddy.”
Worse, the cash only goes to 750,000 people, when some 3 million have been foreclosed and evicted in recent years. Also, how does $1800 square with what we know is the scale of the problem? It’s not like the government doesn’t know what’s going on. Foreclosure Secretary Shaun Donovan told Jon Stewart that the government’s investigation discovered that “as high as 60% of the foreclosures were being done wrong” (at 5:17).
The Second Cash Gift
When law enforcers do a proper deal with wrongdoers, the deal itself is enough incentive for compliance–otherwise more painful law enforcement follows. But this time, even with all the talk of a strict enforcement regime, the government thinks the banks need carrots as well as sticks to perform their obligations under the deal. Specifically, they think the banks need taxpayer dollars as an incentive to comply. I’m not kidding; the B.O.Bs get paid HAMP cash under the deal.
The administration likes to say that, hey, don’t worry, the bankers aren’t getting double credit; they can’t count the actual HAMP-compensated principal reduction dollars toward the credits the banks have to earn in the deal. But that misses the point. Saying that when the bank writes down $100, it gets HAMP cash for $20 and credit for $80, not credit for $100 doesn’t solve the problem. (I’m making up those numbers, but it conveys HUD’s point.)
The point is this: HAMP exists to give the banks an incentive to do principal modifications when arguably the banks don’t have an incentive to otherwise reduce modifications. But the principal modifications in this deal must be done to avoid law enforcement action; they already have a built in incentive.
Giving HAMP cash on top is unnecessary to incentivize the modifications, wastes taxpayer dollars and limits the effectiveness of HAMP outside the context of this deal. If HAMP incentives were excluded and the bankers wanted them, they’d do HAMP mods that didn’t count toward the deal, increasing the amount of principal reduction done.
And the salt rubbed in that wound? Well, JPMorgan Chase and Bank of America did such a lousy job honoring their HAMP commitments that the government has withheld some $80 million from each. But under this deal, Chase and BofA get all that money, and the right to collect HAMP payments again.
I can hear the bankers laughter echoing from behind their closed doors.