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Mortgage settlement talks

January 25, 2012

If you haven’t been following the drama of the possible mortgage settlement between the big banks that committed large-scale mortgage fraud and the state Attorney Generals, then get yourself over to Naked Capitalism right away. What could end up being the biggest boondoggle coming out of the credit crisis is unfolding before us.

The very brief background story is this. Banks made huge bets on the housing market through securitized products (mortgage backed securities which were then often repackaged or rerepackaged). The underlying loans were often given to people with very hopeful expectations about the future of the housing market, like that it would only go up. In the meantime, the banks did very bad jobs of keeping track of the paperwork. In addition to that, many of the loans were actually fraudulent and a very large number of them were ridiculous, with resetting interest rates that were clearly unaffordable.

Fast forward to post-credit crisis, when people were having trouble with their monthly bills. The banks made up a bunch of paperwork that they’d lost or had never been made in the first place (this is called “robo-signing”). The judges at foreclosures got increasingly skeptical of the shoddy paperwork and started balking (to be fair, not all of them).

Who’s on the hook for the mistakes the banks made? The home owners, obviously, and also the investors in the securitized products, but most critically the taxpayer, through Fannie and Freddie, who are insuring these ridiculous mortgages.

So what we’ve got now is an effort by the big banks to come to a “settlement” with the states to pay a small fee (small in the context of how much is at stake) to get out of all of this mess, including all future possible findings of fraud or misdeeds. The settlement terms have been so outrageously bank-friendly that a bunch of state Attorney Generals have been pushing back, with the help of prodding from the people.

Meanwhile, the Obama administration would love nothing more than to be able to claim they cleaned up the mess and made the banks pay. But that story seriously depends on people not really understanding the scale of the problem and the meaning of the fine print of the proposed settlement.

If you want to learn more recent details about this potential tragedy, this post from Naked Capitalism got me so entranced that I actually missed my subway stop on the way to work and had to walk uptown from Canal. From the post:

The story did not outline terms, but previous leaks have indicated that the bulk of the supposed settlement would come not in actual monies paid by the banks (the cash portion has been rumored at under $5 billion) but in credits given for mortgage modifications for principal modifications. There are numerous reasons why that stinks. The biggest is that servicers will be able to count modifying first mortgages that were securitized toward the total. Since one of the cardinal rules of finance is to use other people’s money rather than your own, this provision virtually guarantees that investor-owned mortgages will be the ones to be restructured. Why is this a bad idea? The banks are NOT required to write down the second mortgages that they have on their books. This reverses the contractual hierarchy that junior lienholders take losses before senior lenders. So this deal amounts to a transfer from pension funds and other fixed income investors to the banks, at the Administration’s instigation.

Another reason the modification provision is poorly structured is that the banks are given a dollar target to hit. That means they will focus on modifying the biggest mortgages. So help will go to a comparatively small number of grossly overhoused borrowers, no doubt reinforcing the “profligate borrower” meme.

But those criticisms assume two other things: that the program is actually implemented. The experience with past consent decrees in the mortgage space is that the servicers get a legal get out of jail free card, a release, and do not hold up their end of the deal. Similarly, we’ve seen bank executives swear in front of Congress in late 2010 that they had stopped robosigning, which turned out to be a brazen lie. So here, odds favor that servicers will pretty much do nothing except perhaps be given credit for mortgage modifications they would have made anyhow.

Interestingly, Romney has gone on record siding with the homeowners. The following is a Romney quote:

The banks are scared to death, of course, because they think they’re going to go out of business… They’re afraid that if they write all these loans off, they’re going to go broke. And so they’re feeling the same thing you’re feeling. They just want to pretend all of this is going to get paid someday so they don’t have to write it off and potentially go out of business themselves.”

This is cascading throughout our system and in some respects government is trying to just hold things in place, hoping things get better… My own view is you recognize the distress, you take the loss and let people reset. Let people start over again, let the banks start over again. Those that are prudent will be able to restart, those that aren’t will go out of business. This effort to try and exact the burden of their mistakes on homeowners and commercial property owners, I think, is a mistake.

“This effort” must refer to the mortgage settlement. I’m with Romney on this one.

In 50 years, when we look back at this period of time, we may be able to describe it like this:

The financial system got high on profits from unreasonably priced homes and mortgages, underestimating risk, and securitization fees. When the truth came out they paid a pittance to escape their mistakes, transferring the cost to homeowners and the taxpayer and leaving the housing market utterly inflated and confused. The entire charade lasted decades and was in the name of not acknowledging what everyone already knew, namely that the banks were effectively insolvent.

Categories: finance
  1. Michael C
    January 25, 2012 at 2:30 pm

    It’s more than the bank freindly-ness of the deal that’s so revolting, it’s the citizen loathing capriciousness of the deal that gets my goat.

    Title on every home purchased in the last decade whose mortgage was sucked into the securitization vortex is now uncertain. It’s bad enough that the federal government will sell out taxpayers to cover bankers profits to pretend they are solvent. It’s an entirely different matter to sell out 200+ yrs of real estate law for a pittance. At this point no one can confidently claim title to assets they think they own. That includes bankers/ABS investors who lent the money, and buyers who’ve been paying for homes they think they own.

    A settlement will forgive the bankers for the decimation of property law. Homeowners will have to foot that bit for generations to come. This is the great travesty of any settlement.

    Romney is right, every underwater homeowner should simply stop paying the mortgage. Even better, every homeowner with a mortgage should refuse to continue paying until the payor can prove that they have the ability to provide clean title to the borrower making the payment. That would stop this mortgage settlement farce in its tracks.

  2. January 26, 2012 at 1:26 am

    If the banks were on the other end of the trade (for the mortgage settlement deal), they would own every acre in America.

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