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The Multistate Foreclosure Settlement

posted by Adam Levitin

The New York Times came out with a strong editorial urging state AGs and the Administration not to rush into the proposed multi-state settlement deal. I think it's worthwhile reviewing what we know about the deal and the arguments for and against it.  Let's start with the facts that we know.  There aren't many that are publicly confirmed; the Administration, the AGs leading the multi-state settlement, and the banks very much want to avoid public comment on the deal--they want to present it as a fait accompli.  As a result, there hasn't been definitive reporting on the contents of the term sheet currently circulating among AGs.  It appears, however, the the deal has the following features.

Some 16 banks that do mortgage servicing will:

  1. contribute a total of $5 billion in cash;
  2. contribute total of mortgage assets with a face value of $20 billion, but a market value considerably lower; 
  3. agree to uniform servicing standards.

In exchange, the state and federal authorities signing on would give the banks:

  1. a release of all servicing claims;
  2. a release of all origination claims, including discriminatory lending claims;
  3. a release of all MERS claims against the banks, leaving MERS Inc. as a potential defendant for MERS related issues (MERS Inc. has no financial assets of note.)  

Perhaps $20B of the money would be used for principal write-downs and for interest rate reductions (via refinancings, which have the added benefit of relieving the banks of rep and warranty problems on the old loan) on the loans owned by these banks, which is less than 10% of the first lien loans in the U.S. 

Let's start with the argument for this deal and then consider why it is wrong.  

The defenders of the deal make no bones that it is perfect.  Instead, they make two related arguments for the deal:  Too-Big-to-Fail and Exigency. 
  • The Too-Big-to-Fail argument is that the US housing market is too fragile and can't afford anything upsetting status quo; it is necessary to close some sort of deal for stability's sake. 
  • The Exigency argument is that every day of delay means more foreclosures, so it's imperative to close the deal fast to get help to homeowners. 

So what's wrong with these arguments?

What's Wrong with the Too-Big-to-Fail Argument

The housing market is too-big-to-fail. It's true. The problem is that it has failed, and the proposed multi-state deal doesn't fix the market. The deal simply isn't broad enough to put all the housing market concerns to rest. The deal doesn't buy peace for the banks or stability for the US housing market.  It just blows the government's last wad on a sideshow issue, robosigning. Consider all the critical issues the settlement does not (and cannot) address:  

  • The $700B in negative equity in the US.
  • Clouded title from MERS 
  • Clouded title from wrongful foreclosrues
  • Billions in investor putback and securities fraud claims
  • Investor suits against trustee banks
  • Disposal of the REO inventory and the shadow REO inventory
  • Foreclosures

If the deal is to help the US housing market on a macro-scale, it has to take a major bite out of negative equity. $20B isn't even a scratch. 

The Too-Big-to-Fail argument, like all TBTF arguments, also grates against the rule of law.  In this case, it elevates housing market stability over the rule of law.  Ignoring banking law like prompt corrective action and source of strength doctrine and perverting section 13 of the Federal Reserve Act are all problematic, but the law being violated there is law designed to protect the banking system.  That means it is at least susceptible to the argument that its violation actually furthers its purpose. 

The same cannot be said about robosigning and fair lending and securities laws.  Those laws are not enacting to protect the banking system.  They are enacted to protect the citizens for whose benefit the government suffers the banking system to exist.  Ignoring the rule of law in these contexts deeply undermines the legitimacy of the US legal system.  It starts to look like the only rule of decision is "banks win."  That's a recipe for social disaster. But that seems to be the message that is going out now.  If you're a bank, you get bailed out and then get a get out of jail free card to boot.  If you're a homeowner you get some empty promises of help, some more empty promises, and then you lose your home.  The fate of an $11 trillion market is hardly trivial, but when compared to the importance of rule of law in society, it looks like 30 silver shekels. 

Now I recognize that there is a seeming tension between saying that robosigning is a sideshow issue and that it goes to the heart of the rule of law.  My point is this:  if the goal here is macroeconomic stability, who gives a fig about robosigning and why is the multistate settlement wasting its time on the issue?  But if our goal is to be a society of laws, not banks, then robosigning is a hugely important and symbolic issue.  

If one takes the Too-Big-to-Fail argument seriously, then this is simply the wrong settlement.  Instead, we need a global settlement that addresses negative equity and makes the market clear, that clears MERS title, that compensates for wrongful foreclosures and for the harm to society via robosigning.  We need a settlement that can put investor claims to rest too.  

Alternative, if this is about robosigning, then there shouldn't be any settlement, much less any rush. Instead, we should just see prosecutions, fines, and jail time. 

What's Wrong with the Exigency Argument

The exigency argument REALLY galls me. It's got all the chutzpah of the patricide pleading for mercy because he's an orphan. Where the fuck was the exigency for the past three years?  The Administration wasted years dicking around with HAMP and HARP programs that were patently flawed from the get-go.  Look at the Congressional Oversight Panels' original reports of HAMP.  All of the problems were obvious to anyone who wasn't willfully blind. 

And what of the AGs?  It's not like servicing is a brand new issue to many AGs--some of them have been dealing with servicing since 2003 or so.  If there was some exigency, the AGs inclined to sign onto the settlement should have been putting resources on investigation years ago, and they should have closed this deal months ago. 

Now, it is true that every day of delay means more foreclosures.  But rushing a crappy deal doesn't serve homeowners' interests.  A quickie deal that gives token relief won't prevent any foreclosures.  Better to take a little more time and have a serious deal that gives serious relief. 

If we want to prevent foreclosures, we need to see something more than a token attack on negative equity.  We need major principal reductions (remember, however, that principal reductions are a GAAP accounting write-down, not hard cash).  We also need serious hands-on involvement with borrowers.  It is time-consuming, and expensive, but these are our neighbors, our friends, our family, our countrymen.  Their fate affects us all.  And the evidence is clear that hands-on involvement works.  It saves money and homes in the end.  A recent HUD door-knocking program for FHA loans cost $17 million and saved taxpayers $1 billion. Fortunately HUD insisted on the program, because the bank that services those loans had no interest in it. 

The two arguments for the multi-state deal, Too-Big-to-Fail and Exigency don't hold any water.  But pointing out the flaws in these arguments are not an affirmative argument against the deal. So here they are:

The Multi-State Deal Gives Too Much Away.

The settling AGs and federal government would be giving away claims that they have not investigated and therefore cannot possibly value, something the NY and DE AGs noted in a recent op-ed.  The Huffington Post has previously reported that the AGs have done virtually no investigation of robosigning (excluding now NY, DE, and NV).  And there has been even less investigation of origination claims.  Many of the origination claims have statutes of limitations are will expire soon, but these are serious fraud and civil rights claims.  They are much, much more serious issues than the mass perjury of robosigning in terms of harms to individuals. 

The Multi-State Deal Accomplishes Too Little.

If the goal of the settlement is to bring stability to the housing market, this won't do it.  Consider all the issues left unresolved.  Investor claims, including putbacks and trustee suits are left untouched.  Homeowner claims for wrongful foreclosure and wrongful denial of modifications are left untouched.  Homeowner claims for discriminatory lending are left untouched.  Servicing standards will, hopefully, reduce servicer abuses, but that requires real enforcement.  It's hard to imagine the AGs who sign this deal ever cracking the whip on compliance.  We know the OCC won't.  And the CFPB can't yet.  Critically, NOTHING in the settlement will stop the unending parade of foreclosures or get rid of the $700 billion in negative equity that is dragging down the US economy.  Indeed, it's laughable to think that $25 billion of nominal assets would possibly cover these liabilities. 

To put hard numbers on this, what does $20 billion buy?  At $65,000 negative equity per mortgage, it doesn't buy very much.  It puts 307,692 homeowners back to zero equity. That less than 3% of the 10.9 million homeowners with negative equity. Or what about in terms of interest rate reductions over 5 years?  Let's assume an average mortgage balance of $150,000.  That means a 1% (100bps) reduction in the interest rate on that mortgage would be $1,500.  How many homeowners does $25 billion over 5 years help?  $20b/$1500/5=2.6 million.  So $20 billion gets 2.6 billion homeowners a 1% (100bp) reduction in their interest rate.  These homeowners save $125/month for 5 years.  At the end of which the homeowner will still have deep negative equity. And it would still be helping less than a quarter of underwater homeowners. 

Here's my proposal:  let's just call this HAMP 2.0.  It's like a sequel to a bad movie.  We know how it is going to end. Let's just stop wasting everyone's time here. If this is the best the Administration can do, we might as well adopt the Mitt Romney foreclosure plan--stand aside and let the system do its work. (Gosh, that sounds an awful lot like the Geithner non-plan...) Even if one thinks of the settlement as a one-two punch with HARP 2.0, it's a wishful featherweight in a heavyweight bout. 

Here's the question you should be asking the AGs and the Administration:  is this going to matter on the macro level?  And if not, is it doing justice?  A settlement better be doing one or the other, if not both. If it's neither, all this is a little gravy to a handful of random homeowners and some unconvincing political C.Y.A.  

The Administration Only Gets One More Bite at the Apple

A final thought.  Yves Smith made a trenchant political observation at the AmeriCatalyst mortgage conference yesterday:  the Administration only gets one more bite at the apple in terms of getting the housing market right. If the Administration flubs this, as they have consistently flubbed the housing issue, by going small bore and trying to sweep problems under the rug, rather than addressing them, there are serious political implications. It doesn't take a lot to connect the dots between the multistate settlement and the deep national demand for accountability for the financial crisis that is manifesting itself in OWS and the need to take real action to deal with the housing market problems that are at the core of the US's economic woes.

I'm not sure where the Administration's political team is on this one, but imho, it seems like they are letting Treasury drive the 2012 campaign off the cliff via this settlement that will confirm the perception that the Administration works for Wall Street, not Main Street. And if you think I'm nuts on this, just read the first line of the NYT editorial:  "The banks want California, and the Obama administration hopes they can get it."  In a country craving accountability for the financial crisis and its aftermath, being cozy with the banks is the wrong place to be when approaching a general election. 


10.9 million homeowners is an awfully big pool of voters. Thanks for being the voice of reason while at the same time broadcasting your anger. Shared with my network...

"10.9 million homeowners is an awfully big pool of voters. "

It is, but who are they going to vote for that will actually do better for them? One vote gets them basically bupkis, the other gets them less than bupkis. It's not so much a choice of getting reamed or not, it's how hot the poker is going to be when it happens.


MacCruiskeen puts it extremely well. If the choice is merely how hot the poker, I think a lot of voters stay home or vote anti-incumbent.

Just a note here that foreclosure ALSO eliminates negative equity. So the choice here is between principal writedowns and an even higher foreclosure rate. The appreciation fairy returning atop a candy-cr@pping unicorn and saving us all is NOT an option.

Would this settlement preclude homeowners in foreclosure (present and future) from bringing claims and raising defenses, or just the claims that could/would/should be brought by the AGs and the feds?

Frankly, nothing is expected from either the AGs or the feds - they don't bite the hand that feeds. I'm not sure the Republicans would be all that much better, but the Dems are clearly bought and paid for.

Turn on sarcasm:

Gee Whiz! Doesn't everyone get it? Announcing a settlement would have one tremendous effect: the stock market would surge and all the 1% can make more money.

Turn off sarcasm:

I submit to you HAMP was not flawed. It was never designed to modify anything. It was designed to get people to reaffirm a debt the banks couldn't prove existed or that they specifically owned. What verifications did the government even require that a particular bank actually held a mortgage over a HAMP applicant property? None that I'm aware of. FHA insurance claims are the same thing. The banks merely had to assert without any verifiable paperwork.

Every level of the housing industry has been gamed and stolen from. When the smoke clears this is going to go down as the greatest land grab since Ghengis Khan

JimA: "Just a note here that foreclosure ALSO eliminates negative equity. So the choice here is between principal writedowns and an even higher foreclosure rate. The appreciation fairy returning atop a candy-cr@pping unicorn and saving us all is NOT an option."

This is not entirely true: states vary in their treatment of foreclosure, and in many foreclosure does not preclude seeking other forms of restitution.

Are we ok here?....................... we are talking about saving the titanic.

The "GSE Business Model" is the titanic----what can't we understand about "fatally flawed"?

There will always be a mortgage business. Let us formulate one that will leave the government out, lest we think we can raise the dead!

Nothing gets me madder than this attempt to whitewash the utter greed of these banksters. The cherry on top is the Obama admin's attitude as they've positioned themselves as protectors of the thieves, not of the people. It's an adversary position at best, not to speak of the other violations of "Hope & Change" in other areas such as the PATRIOT(not) Act, Gitmo, Afghanistan, and a single-payer or at the very least public health plan.
Our country is in for a VERY bumpy ride for the next 5-10 years. The only way to make it better is to speak out and let your feelings be known, shouted from the rooftops (as in Network?), and now, rather than later when bullets may be flying in the "Homeland" (I hate that moniker; too close to "Fatherland" for me).

Another great article by Adam Levitin.

Adam wrote:

"I'm not sure where the Administration's political team is on this one"

Well, lets take a guess. Who is his Chief of Staff? (the former senior executive in charge of lobbying at JPMorgan Chase). Unfortunately President Obama has repeatedly made clear that he is beholden to the big banks, who are funding his re-election campaign.

Clearly the President figures his allegiance to the banks is more important than his allegiance to the American people. Sadly, I suspect he is right.

how does the fhfa play into all of this? that article by gretchen morgenson said that the settlement's principal writedowns could only happen on portfolio loans because demarco wouldn't budge on allowing them for fannie/freddie loans. IANAL, so my question for you is: this is a law enforcement action. couldn't the AGs force demarco's hand, even if the president can't? or am i misunderstanding how this works? because if fannie/freddie loans are out of the picture, what's the point?

The whole problem with all this is that when these mortgages were originated the loan notes were basically a promissary note. When they were sold into a pool and securitized, they changed the loan notes into stock without our permission to satisfy the SEC law. Remeber the term "Stock Market". You can't sell notes on Wall street, you can only trade "stock". Now when they want to "refinance or modify" the notes, they have to turn the notes back into Notes from stock. This is all highly illegal and that is why so many notes were destroyed so there would be no evidence of their illegal activity. So why are all the AG's going nowhere with their "attacks" on the TBTFB, just follow the money and you'll see all these Bozos receiving large cash donations to their campaign in the next few years.

Roy Blizzard has it correct, State AG's have completely backed off due to political pressure. The larger concern is how these transactions were permissible in the first place.

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