Mar082012

Major banks steal from investors in foreclosure settlement

The more we learn about the foreclosure settlement, the more we see how much of a gift to the major banks this agreement really was. First, they no longer have to deal with any liability for their foreclosure practices. Second, they are allowed to credit their losses on short sales against the settlement payments, so they won’t actually have to pay any cash. And now today we find out they managed to get the administration to agree to allow them to steal from investors with first liens on properties where the banks have second mortgages. It’s outrageous. I don’t think it’s legal. But banks managed to get this perk as part of the settlement.

Banks Win Reprieve on Home Equity Loans in Settlement

By Kathleen M. Howley – Feb 27, 2012 1:35 PM PT

Bank of America Corp. (BAC), Wells Fargo & Co. (WFC) and three other banks that settled a nationwide probe of foreclosure practices this month will get a bonus from the deal: protection for $308 billion of home-equity loans they hold.

The banks that service about half the nation’s mortgages on behalf of investors will be able to share losses on their junior loans with bondholders and get credit toward the cash they pledged to spend in the settlement, said an Obama administration official involved in drafting the $25 billion agreement. Second liens would typically be wiped out before senior-mortgage investors take a loss, said Laurie Goodman, managing director at Amherst Securities Group LP in New York.

It’s “a gift to the banks, at investors’ expense,” said Goodman, a member of the Fixed Income Analysts Society’s Hall of Fame. “A proportionate write-down of the first and second represents a reversal of normal lien priority.”

I don’t understand how this can be legal. If I am a first lien holder and my servicer diverts money that should be mine to cover their losses on a second mortgage, I would sue them. The lien priority dictates they first lien gets paid in full before the second mortgage gets a penny. This was everyone’s understanding when these contracts were written, and the government can’t make such a sweeping change in the law by decree. First lien holders will sue, and they should win.

Loss-sharing will break the logjam that occurs when banks drag their feet processing modifications on mortgages that outrank their junior liens, said the Obama official, who declined to be identified because this arrangement hasn’t been made public. …

He is right about that point. The total losses on second mortgages are the primary reason most short sales don’t go through, and it’s also responsible for a significant amount of shadow inventory. Large banks don’t want to take the 100% losses on their second mortgages, so they drag their feet processing foreclosures on the first mortgage.

Roadblock to Modifications

“The roadblock to getting comprehensive modifications has been the efforts of these banks, the biggest servicers, to protect their second liens,” Wilmarth said. “To only suffer losses on an equal basis as first-lien investors is a good outcome for them.”

No kidding. This is a direct transfer of money from the first lien holder to the second lien holder. Second mortgage liens that used to be worthless now have value. This is a tremendous outcome for banks. They get to steal from first lien holders.

Make no mistake, this is theft, pure and simple. There is no reason the first mortgage holders should pay anything to the second lien holder. If there was even the possibility of such an occurrence, first lien holders would have forbidden second mortgage liens with clauses requiring repayment of the debt in the event a second mortgage was applied to the property. It’s the only way they could protect themselves from a second mortgage lien becoming a leach. If this decision stands, all new first mortages will have these protective clauses, and second mortgage lending will grind to a halt — not that much of it is going on today anyway.

… “This was a relatively cheap resolution for the banks,” Simon, the mortgage head at Pimco, which runs the world’s largest bond fund, said after the settlement’s Feb. 9 announcement. “A lot of the principal reductions would have happened on their loans anyway, and they’re using other people’s money to pay for a ton of this. Pension funds, 401(k)s and mutual funds are going to pick up a lot of the load.” …

Underwater Homes

Nearly 11 million home loans in the U.S. were underwater in the third quarter, according to CoreLogic Inc. in Santa Ana, California. About 4.4 million of them had home equity mortgages, with an aggregated value of $180 billion. That represents 20 percent of the $888 billion of outstanding second-lien loans, according to Federal Reserve data.

This understates the problem. All underwater estimates ignore second mortgages. If you look at total indebtedness, many more than 11 million mortgage holders are underwater. Based on the estimate above about $170 billion in second mortgages are completely worthless, and of the remaining $600+ billion, many of those are at least partially underwater. The total losses on second mortgages if liquidated today would likely be much closer to $500 billion.

Home equity lines of credit, or Helocs, were used during the 2001 to 2006 housing boom as a way for owners to cash in on rising real estate values for money to spend on cars, vacations and property renovations. In addition, some homeowners refinanced their primary mortgages into bigger loans to extract equity from their properties.

Homeowners everywhere felt richer and rushed to ‘monetize’ the increased value of their homes,” Warren Buffett, chairman and chief executive officer of Berkshire Hathaway Inc. (BRK/A), said in his Feb. 25 annual letter to investors. “These massive cash infusions fueled a consumption binge throughout our economy. It all seemed great fun while it lasted.

Warren Buffet understands HELOC abuse. To bad he doesn’t understand how widespread and pervasive it is. If he did, he wouldn’t have been so bullish on stocks and real estate over the last two years. His bullishness caused him to take significant losses.

Homeowners who took out Helocs were given checks and a debit card to make the loans easy to tap. Primary-mortgage holders couldn’t stop, and rarely knew about, homeowners who took out home equity loans on their collateral.

That will change is second mortgage losses are now absorbed by first lien holders.

‘Cash Registers’

“People turned their homes into cash registers,” said Keith Gumbinger, vice president of HSH Associates, a mortgage data firm in Pompton Plains, New Jersey. “They used their Helocs like pre-paid credit cards.”

Home-equity loans were also used as so-called piggyback mortgages that took the place of down payments. By 2006, when U.S. home prices peaked, most banks were willing to give “no- equity equity loans,” lending up to 100 percent of a property’s value, said Peter Ticktin, a Florida foreclosure attorney. Some banks advertised loans that exceeded home values by 25 percent.

“Now those home equity loans are so far underwater, they can’t see the surface,” said Ticktin, who negotiates with banks on mortgages in default. “The banks have been adamant about protecting their second-lien interests, no matter how underwater they are.

One of the main reasons so many peak buyers have been allowed to squat in shadow inventory is because lenders are praying prices will come back and provide value to their second mortgages.

Treating a senior and junior lien on an equal basis will result in higher rates for primary mortgages as investors add a risk premium to compensate for the danger of higher losses, said Amherst Securities’ Goodman.

It will ultimately result in more expensive first lien mortgages, as investor realize they will be less well protected than their lien priority would indicate,” said Goodman.

To contact the reporter on this story: Kathleen M. Howley in Boston at [email protected]

I think it’s worse than that. I think lenders will put in clauses forbidding junior mortgages entirely. It’s the only way they can protect their interest. There is no other way first lien holders can stop incredibly risky and stupid second mortgage liens from causing losses on first mortgages.