Feb132012

Banks greatly benefit from foreclosure settlement

Last Friday, I posted an opinion piece about bailing out California debtors. The post was more about moral hazard than about the details of the bank settlement. Now that I have had time to review the bank settlement, I see the issues raised in Friday’s post were completely wrong. From what I now understand about the agreement, it only pertains to the big commercial banks, and it really doesn’t bail out anyone other than the banks. The moral hazard I was concerned about does not appear to be a big issue on the settlement. The real beneficiaries are not loan owners, it’s the banks.

California’s size lands state big share of foreclosure settlement

Bank of America’s desire to escape the legacy of its Countrywide problems also helped secure a combined $12 billion in principal write-downs for the state.
By Alejandro Lazo, Los Angeles Times — February 11, 2012
California walked away with the biggest chunk of this week’s landmark foreclosure settlement partly because of the state’s size but also because of Bank of America‘s desire to escape the legacy of its Countrywide problems.The nation’s three largest mortgage servicers — Bank of America, JPMorgan Chase and Wells Fargo & Co. — committed to provide California $12 billion in principal write-downs, including through short sales, over the next three years, the single largest such commitment to come out of the negotiations. About 250,000 Californians are covered under that part of the deal, struck between five big mortgage lenders, states and the federal government.

The devil is in the details as always. By slipping in the provision to count short sales, banks have created a huge loophole that allows them to look like they are doing something substantive for loan owners when in fact they are not.

California passed legislation last year which barred lenders from collecting on bad debt after a short sale. In effect, they made every loan in Califonria non-recourse if the seller goes through the short sale process. As a result, lenders must write down this bad debt when a short sale occurs.

So if lenders are already having to write off this bad debt, what do loan owners gain when lenders agree to write down the principal in a short sale? Nothing. Lenders had to do this anyway. Lenders are almost certain to lose $12 billion on short sales over the next several years, so they could easily provide $12 billion in principal reduction without doing a thing for loan owners struggling to make payments.

Its a brilliant move by both the California Attorney General and by the banks. The Attorney General looks like a champion of the little guy and grabs headlines. The banks carry on as before, but they look like they provide debt relief. Everyone involved maintains appearances, and the banks get to insulate themselves from further lawsuits.

This should be characterized as a complete victory for banks. They get good public relations and insulation from further litigation for taking write downs which were inevitable.

Taking into account a complex series of credits designed to encourage the banks — which also included Ally Financial and Citibank — to make payments to homeowners, California’s share of the settlement could climb to as much as $18 billion. That aid would go to an estimated 460,000-plus borrowers, many in areas of the state hit hardest by the housing bust, according to the state attorney general’s office.

It doesn’t look like this aid will go to borrowers at all. Most will go to debt forgiveness of sellers. It doesn’t look like 460,000 loan owners are getting principal reduction and getting to keep their house and future appreciation. I actually find that rather comforting. If the principal write downs concentrate on short sales, moral hazard will not result.

“This outcome is the result of an insistence that California receive a fair deal commensurate with the harm done here,” Atty. Gen. Kamala D. Harris said Thursday in announcing the settlement.

California’s large share came even though there have been few complaints among state homeowners about the kind of improper robo-signing practices that launched the talks, which quickly morphed into settlement negotiations about errors that occurred throughout the foreclosure process. More than a year ago, evidence began emerging about robo-signing, in which foreclosure documents were signed without being read or with phony names and titles.

“The robo-signing was the hook for the investigation, that was the most outrageous thing that got the whole thing started. But the robo-signing does not amount to the worst things that servicers have done. What caused the ball to pick up steam was all of the other abuses,” said Kurt Eggert, a professor at Chapman University’s law school. “The servicers really needed California in this deal.”

What other abuses? I have been writing about this for five years, and I have yet to see any credible documentation of servicer abuses here in California. I don’t recall any allegations of abuses here in California. What we have is a lot of underwater loan owners who are suffering because they participated in the Great California Housing Ponzi Scheme.

By signing on, California waived a litany of claims it could have brought against the banks, including unfair or deceptive business practices and general consumer protection statutes that applied to wrongdoing in the loan modification and foreclosure process, according to a person familiar with the talks not authorized to speak publicly. California retained some claims that other states gave up, including fair lending cases.

How can this be construed as anything other than a victory for banks? This settlement amounts to a smoke-and-mirror payout of losses lenders were going to endure anyway in order to provide protection to lenders from future lawsuits. For lenders, this is a win-win.

“California gets an extraordinary amount of it,” said Iowa Atty. Gen. Tom Miller, who led the negotiations for the state attorneys general. “That’s one of the things that amazed us as we went through this — how much problem there was in California.

What he means to say is that people in Iowa are truly shocked at how incredibly stupid loan owners in California really are. The fact that they need a $12B to 18B bailout just to cover a fraction of the losses banks will endure via short sale is truly remarkable.

The settlement covers only homeowners whose mortgages either are owned by the banks in the deal or are serviced by them on behalf of private investors. The settlement doesn’t include homeowners whose loans are owned by government-controlled mortgage giants Fannie Mae and Freddie Mac, a share Harris estimated to be about 60% of the state’s homeowners.

That leaves a huge open question. What about the GSEs? Isn’t California going to try to extort some money out of the US government by attacking the GSEs? Why wouldn’t the GSEs be part of this settlement? Doesn’t that make it even more obvious this is merely a bank bailout in disguise?

Think about it, if California really wanted to get debt relief to loan owners outside of the debt relief they are already entitled to under current debt forgiveness laws governing short sales, wouldn’t the Attorney General insist on having the GSEs kick in some cash?

If there were actual debt forgiveness in this agreement, it would be grossly unfair in its application. Loan owners whose loans are held by banks get relief while loan owners whose debts are held by the GSEs get nothing. Since nobody is really getting anything, it isn’t unfair, just completely deceptive.

… Bank of America, which has a huge portfolio of Countrywide loans from its 2008 acquisition of the Calabasas lender, was especially insistent on getting California on board. For Bank of America, the deal “made no economic sense” if California wasn’t included, and most of that bank’s commitment is aimed at Countrywide borrowers, according to the person involved with the negotiations.”Because of the Countrywide challenge, we had the most at stake for our customers and shareholders,” Bank of America spokesman Dan Frahm said.”Our approach to the negotiations was rigorous and disciplined with a sense of urgency to provide additional assistance to our customers and get the mortgage crisis behind us.”Wells Fargo spokesman Tom Goyada said the settlement “is not a one-issue agreement. It covers a range of issues and we are happy to have those set aside and put behind us.” Chase declined to comment. Ally and Citibank did not respond to requests for comment.

Of course the banks are happy with the arrangement. They no longer have to worry about being sued as the process the rest of their foreclosures. Look for foreclosure processing to really kick into overdrive with this agreement in place.

Key to Harris was getting a significant amount of principal reduction for borrowers. Under the terms of the deal, banks can write principal down to the current value of the loan, or so the monthly mortgage payments make up only 31% of a borrower’s income, according to the person familiar with the deal.

Look at the language in that sentence carefully. What does it mean that banks can write down principal? Of course they can. They always could at their own discretion. Notice the word can is very different than the word must. Banks will keep an accurate tally of the write downs from short sales which will count toward their $12 billion. They may also reduce principal on some deeply underwater loan owners to make them less underwater hoping they don’t strategically default. They are doing that now.

I will go out on a limb here and state I don’t believe any loan owner anywhere will receive principal write downs to current market value with no strings attached. But that is not what loan owners are going to hear or believe. I foresee more false hope coming from this agreement as loan owners make a few more payments hoping they will hit the principal reduction jackpot which will never materialize.

If the banks don’t fulfill the $12-billion guarantee, they will have to make cash payments of up to $800 million directly to the state, a provision that is enforceable in California court, instead of federal court in Washington, where the rest of the deal is covered.

Incentives will direct aid to areas hardest hit by the foreclosure crisis, a “Stockton provision” that Harris sought after a visit this year to that foreclosure-ravaged city, negotiators said. Those areas are to receive relief within the first year.

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I wouldn’t be surprised if a few lottery winners in Stockton who are 60% underwater get principal reductions that leave them only 30% underwater. Lenders will try to find the debt forgiveness level which will prompt the hopeless into making a few more payments. Anyone in Stockton thinking they will get a principal reduction down to fair market value is dreaming. Think of what would happen if such principal reductions were forthcoming. Think of the outrage among those who didn’t get it. What about the people with GSE loans who don’t see principal reduction?

Bankers should be giddy over this deal. They get good public relations for taking write offs they were going to take anyway, they get to insulate themselves from future litigation, and they get a few more loan owners to sign up for false hope and make a few more payments. They got everything they wanted from this deal.