The Servicing Settlement: Banks 1, Public 0
What are we to make of the servicing settlement announced today with much hoopla? The short answer is not much. The settlement is the large consumer fraud settlement ever, but it accomplishes remarkably little in terms of either alleviating the foreclosure crisis of holding to account those responsible for the housing bubble and subsequent foreclosure abuses. As my Texas relatives say, it's “All sizzle, no steak.”
Instead, I think the settlement needs be seen as the conclusion to round one of an on-going struggle for accountability and reparations for the enormous damage the housing bubble did to the United States. Whether we will ultimately see meaningful accountability and reparations in the end is very much in question. Round two, featuring the Residential Mortgage-Backed Securities Fraud taskforce, could well be stillborn; the taskforce combines more motivated and more capable agencies, but it isn't clear of the motivated can leverage the more capable or will be bogged down by them. But as for this settlement, if this is all that we get, it’s a big nothing.
The settlement covers mortgage servicing abuses, as well as a $1 billion settlement of claims that Countrywide (BoA) was cheating the FHA. It also includes settlements of litigation by the Arizona and Nevada AGs for BoA’s violations of an earlier settlement. It also covers some origination claims on which the statutes of limitations have run or will shortly expire. The settlement apparently (and here the precise language is crucial) excludes securitization-related claims, fair lending claims, false claims acts violations, MERS issues, and criminal claims. It also doesn’t prevent homeowners or investors from bringing their own suits. So it’s really covering robosigning and overbilling in foreclosures.
Given the relatively narrow scope of this settlement, it’s not surprising that the dollars involved are quite small compared to the overall harms created by the housing bubble and aftermath. The formal price tag for the settlement is $25 billion, although it is projected to accomplish up to $40 billion in relief. Only $5 billion of that is hard cash contributed by the banks. Let me repeat that. The five banks involved in the settlement, which have a combined market capitalization of over $500 billion, are putting in only $5 billion. That’s less than 1% of their net worth. And they are admitting no wrongdoing. To call that accountability is laughable.
That $5 billion in hard cash is going to the state and federal government, only some of which will be given to borrowers. What about the other $20 billion? That’s to come in the form of $3 billion in refinancings and $17 billion in principal reductions, deeds in lieu, short sales, anti-blight measures, etc. The banks receive variable credit for these actions, depending on whether these measures are taken for loans owned by the banks or owned by others and serviced by the banks. Basically, it’s full credit if the bank owns the loan, and half credit if the bank merely services the loan. Because of this formulation, the $17 billion in principal reductions, DILs, short sales is anticipated to result in $32 billion in actual relief. In other words, it is expected that the banks will modify the loans owned by others rather than the loans they themselves own. And when a second lien loan owned by the bank is involved, it only has to be written down pari passu (at the same percentage) as the first lien loan. So from absolute to relative priority, which is a major handout to the big banks, which have large underwater second lien positions.
Or put differently, $32 billion of the settlement is being financed on the dime of MBS investors such as pension funds, 401(k) plans, insurance companies, and the like—parties that did not themselves engage in any of the wrong-doing covered by the settlement. This shouldn’t be a surprise—the state Attorneys General previously cut a similar deal with Bank of America, which promised to make up for its wrongdoing by modifying loans own by other parties.
But let’s get to the bigger problem. Whether this is a $25 billion or $40 billion settlement is really beside the point. It’s a drop in the bucket relative to the scale of the problem. There is approximately $700 billion in negative equity nationwide weighing down the housing market and the economy. Add to that legions of homeowners dealing with unemployment or underemployment and we’ve got a problem that absolutely dwarfs the settlement numbers. It’s Pollyannism to think that this settlement will have any impact on the national housing market. At best it makes some incremental improvements and helps a small number of homeowners. But at worst, it lets the banks off the hook for the largest financial crime in history.
I can’t say I’m surprised, however. There was no investigation was done prior to this settlement. That had been the sticking point for a number of attorneys general who eventually signed on to the settlement, but only once it was narrowed. But that doesn’t take away the problem that there was no investigation. If you go bear hunting without any ammo, you aren’t going to bag a bear.
To illustrate how little the settlement does for the housing market, let’s take the settlement’s most optimistic projections and assume that it really results in $40 billion of mortgage relief of various sorts. How much does that translate into per distressed homeowner? Let’s assume that the universe of distressed homeowners is limited to those underwater—roughly 11 million. So we’re talking $3,636 per homeowner. That doesn’t help a whit in terms of preventing foreclosure.
Now to be sure, the relief will be more concentrated on a subset of these homeowners. The settlement is estimated to help about 2 million homeowners, hopefully to the tune of about $22,000 each. That's certainly a lot better than $3,636, but consider that the average negative equity is about $50,000. At a very generous best, then the settlement only gets rid of less than half of the negative equity for 18% of underwater homeowners. So we're talking about a solution that has less than a 10% impact. Best case scenario is less than 1 in 10 are helped. In any case, those luck few, will be chosen not by where the relief will help the most or by who is most deserving, but by what will be most advantageous to the banks. So some lucky group of homeowners will have “won the lottery” and in some cases might avoid foreclosure. For most distressed homeowners, it’s “no soup for you!” And because fixing the housing sector is about volume, this means that there's no soup for all of us--the housing sector will remain severely depressed.
What about the argument that the settlement will help the housing market by enabling foreclosures to start up again and for banks to clear through the shadow inventory? Well, what’s causing the shadow inventory? Is it the possibility of state and federal prosecutions for robosigning? Is it lack of uniform servicing standards? Nope, and nope. The shadow inventory problem is at core the result of two problems. First, the foreclosure system only has limited bandwidth—there are only so many foreclosures that can be processed at a time. Second, the banks have their own staffing issues. And third, the bigger problem is that the banks don’t have their paperwork in order to foreclose. This servicing settlement doesn’t affect any of these problems (maybe it will encourage better staffing on behalf of the banks, but if that hasn’t happened by year 5 of the crisis, I can’t imagine it will any time soon). National servicing standards as part of a settlement in no way replace existing state and local requirements, and to the extent they supplement them, it may make things harder for the banks. The fact that a bank is in compliance with the servicing standards in the settlement doesn't mean that the bank can in fact foreclose, and litigation of foreclosure actions is private litigation, not governed by this deal. (And this leaves aside the question of bank compliance with this settlement.)
The settlement also creates really awful incentives. It has zero deterrent effect against future wrong-doing. This settlement set a price-tag for mortgage servicing abuses. If the abuses are more profitable than the cost of settlement, what rational bank wouldn’t engage in them? The early CFPB-settlement analysis that was leaked months ago envisioned $25 billion as being simply the disgorgement component, not the remedial component. Here we have a settlement with $ 5 billion in actual disgorgement and very little that’s remedial, let alone punitive (which is necessary to have deterrence).
Also announced in conjunction with the big settlement were the fines the OCC is imposing as part of its consent orders. They total $394 million, but they are payable either in cash or in kind via relief given to homeowners as part of the OCC Potemkin foreclosure review process. Please Hammer, Don't Hurt 'Em! (Hmm, maybe the banks' theme song should be "U Can't Touch This".)
Is this really the best our government can do? I hope not. This settlement might or might not be the end of the attempt to rectify the financial crisis, but as things stand, we have a settlement in which the banks commit to follow the law and pay out some pocket change. The settlement doesn’t fix the housing market. It doesn’t create accountability for the financial crisis. It doesn’t even create incentives against future wrong-doing. But it provides the Obama Administration (and those attorney generals who just jumped in for the settlement at the last minute) with a fig leaf of political cover. It galls me is that the Obama Administration is going to trumpet this settlement as evidence that it is serious about prosecuting the crimes behind the financial crisis and helping homeowners. It was heartening to hear Obama talk about protecting the middle class in his State of the Union address. It was the right message, but the President is simply not a credible messenger. If Obama wants to run as the champion of Main Street against Romney, the Captain of Wall Street, he’s going to need to do something a lot more credible than this settlement.
The score: Banks 1, Public 0.