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Investors (and Others) Realizing Their Ox is About to be Gored in Mortgage Settlement

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Investors have been remarkably passive as banks and servicers have taken advantage of them. We’ve heard numerous reports of servicer fee abuses that amount to stealing from investors (remember, if you overcharge a stressed borrower and that borrower loses his home, the money in the end comes out of pension funds and 401 (k)s when the excessive fees are deducted from the proceeds of the sale of the home). Investors can even see suspicious patterns in investor reports. We’ve also pointed out that they are guaranteed even more pain, since $175 billion of losses that have already recorded on loans in MBS pools have not yet been allocated to the related bonds.

But the fees to manage bond funds are pretty thin, and fixed income investors are generally a risk averse lot, and are not well set up to litigate. But the biggest obstacle to them Doing Something is that they don’t want to rile the banks. They think they need them for information and transaction execution.

So it shouldn’t be surprising that investors have sat on the sidelines during the mortgage settlement and “fix the housing market” debates, even as becomes clearer and clearer that the solution envisaged is to take from investors to make the banks whole. Remember, the major banks have very large second lien portfolios that should be written down. The banks claim the second loans, almost entirely home equity lines of credit, are current, but that is often an accounting fiction. The banks are often engaging in negative amortization (as in taking any trivial amount and deeming it to be acceptable and adding any shortfall to what should be a proper minimum payment to principal) and allowing customers to borrow in order to make their payments. MBS investors have told me that realistic marks on Bank of America’s second lien portfolio would exceed the market value of its equity, and would also take a big cut out of the equity bases of Citi, JP Morgan, and Wells.

So the plan, which was messaged in an interview with William Dudley in the Financial Times in early January and is embodied in the mortgage settlement plan, is to write down first liens and leave seconds largely intact (there have been some indications that seconds might get a modest ding in the case of a principal mod on the first, but that is backwards. The second should be WIPED OUT before anything modification is made to the first mortgage). Any principal mods on the first lien that leaves the second in place amounts to a transfer from retirement plans to banks. Pensions are being raided to avoid exposing the insolvency of the big banks.

We are, rather late in the game, getting some plaintive bleats from investors as they are being led to slaughter. Reader Deontos sent us a statement from the Association of Mortgage Investors:

The state Attorneys General, federal agencies, and certain mortgage servicers have worked for approximately one year on developing a solution to address our national foreclosure crisis. The time now may be nearing for a settlement of claims of alleged wrongdoing by servicers. AMI and mortgage investors have neither been involved in the negotiations nor are aware of the ultimate settlement terms. In anticipation of a possible settlement, however, AMI cautions these negotiators not to rush into a settlement, but rather work to get a properly constructed settlement that helps distressed homeowners with the right solutions. “Investors in mortgage trusts, such as unions and pensions, do not service these loans and certainly did not create these woes for borrowers. The use of mortgage trust money (from pensions funds, unions and charities) to settle the investigation is tantamount to a bank bail-out. We expect that principal modifications of private mortgages made to satisfy any kind of settlement will involve only mortgages held by the settling parties and that the criteria for all additional principal modifications be firmly established,” explained Chris Katopis, AMI’s Executive Director.

AMI would only support such a resulting settlement, if any, if appropriately designed to address such alleged wrongdoing while not implicating innocent parties. AMI is on-record as supporting long-term, effective, sustainable solutions to the housing foreclosure crisis. It is generally supportive of a settlement if it ensures that responsible borrowers are treated fairly throughout the foreclosure process; while at the same time providing clarity as to investor rights and servicer responsibilities. The settlement should be designed in a way that ensures that investors, who were not involved in the alleged activities and, who likewise were not a participant in any negotiations, do not bear the cost of the settlement. Specifically, mortgage servicers should not receive credit for modifying mortgages held by third parties, which are often pension plans, 401K plans, endowments and “Main Street” mutual funds. To do otherwise, will damage the RMBS markets further and limit the ability of average Americans to obtain credit for homes for generations to come.

Erm, the fact that you weren’t given a seat at the table means the power that be thought you were dispensable.

More amusingly, a Bloomberg report reveals what most insiders know full well, that industry associations that supposedly represent the buy side and the sell side, like the American Securitization Forum and the Securities Industry and Financial Markets Association, really take care only of the sell side, meaning Wall Street. SIFMA’s Asset Management Group, which represents investors, wanted to issue a statement objecting to the use of investor funds to settle bank misdeeds, but it was squelched by management:

Wall Street’s biggest lobbying group is split over a proposed settlement of state and federal foreclosure probes, after a committee of money managers signaled it opposes terms letting banks push some costs onto bondholders.

The Securities Industry and Financial Markets Association’s Asset Management Group planned to release a statement last week urging government negotiators to protect innocent investors, amid reports that banks will get credit for lowering the balances of mortgages packaged into bonds, three people familiar with the matter said. Sifma’s leadership said no. The panel’s members oversee $20 trillion and include BlackRock (BLK) Inc. and Pacific Investment Management Co.

Sifma elected not to issue the statement “because the settlement surrounds potential legal issues involving the commercial interests of many of our members,” said Cheryl Crispen, a spokeswoman for the group in New York. “Sifma generally does not intervene in such matters and remains focused on matters of policy and advocacy.”

What bullshit. This is a “all animals are equal, but some are more equal than others” statement.

Needless to say, as the propagandizing gets louder, a few lonely voices are decrying the settlement. For instance, Daily Kos had a refreshing piece, “Stop the Delusional Celebration: Victims of Foreclosure Fraud Have Little to Celebrate.” Dave Dayen gets to an aspect of the settlement that I have not had time to cover, namely, that the enforcement is a joke. A story by Loren Berlin and D.M. Levine at Huffington Post remind us “Robo-Signing Settlement Might Not Provide Homeowners With Needed Help.” The short form of their story: the deal looks to be targeting mods to not that deeply underwater borrowers. Addressing a related Administration PR effort, Alan White at Credit Slips, in The Permanent Foreclosure Crisis and Obama’s Refinancing Obsession says, in no uncertain terms, that refis won’t solve the mortgage mess.

There is a possible saving grace here. I am told by a principal that if this settlement goes through, the odds are 100% that it will be challenged on Constitutional grounds, as a violation. Taking from the first lienholders to save the second lienholders to keep otherwise insolvent banks from going under amounts to a transfer from private parties to the government, as in it saves the FDIC from needing an emergency injection from Congress, as it did in the savings and loan crisis. So as much as I’d rather see this deal scuttled, it would terribly amusing to see Obama tidy’s efforts to generate pretend to help homeowners while really helping the banks sidetracked by litigation. The courts have stymied bank efforts to get away with their heist, and they may prove to be their bane yet again.

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35 comments

  1. SteveA

    One of the most extraordinary, ongoing fictions of the financial crisis is the valuation of second liens. Alongside the holdings of securitized seconds by banks such as ETrade Bank (Christopher Flowers memorably referred to ETB’s “black hole”in 2008), the FHLBs were stuffed full of this stuff. Apparently all of these vanished assets continue to be grossly marked up because they are “recourse.” I have to believe the Government decided in 2008 to draw the line at seconds; otherwise as you point out, Yves, any number of banks (likely including the FHLBs) would have to be declared insolvent.

  2. Woodrow Wilson

    Re: “Robo-Signing”

    Here in MA, a police officer can arrest for any felony with Probable Cause.

    The County Registry of Deeds not only openly posts the Robo-Signing names, but has a search engine to find out of you’re a victim, we have 31,783 instances of Robo-Signing. No arrests, when it would be perfectly lawful to do so.

    1. Nathanael

      The problem is that the power of arrest has been restricted to “police officers” and the power of prosecution has been restricted to district attorneys. It turns out to be way too easy for the powerful to buy off one or both.

      This is why the UK still has “private prosecutions”.

  3. Jim A

    Wait, what? As it stands, most of those seconds are currently worth a pittance. They’re essentially unsecured so their net worth is either salvage value sold to debt collectors or possibly the nuisance payment that they can get to approve a short sale. But they’re going to be made (nearly) whole? WTF!

  4. Jim A

    OTOH, “We’re innocent bystanders who shouldn’t take any losses,” rings hollow to me. If the bondholders can convince a judge that the mortgages did not meet the terms of the prospectus, fine. Certainly there are plenty of cases of that. But when the prospectus TELLS you that the bonds are made from High CLTV, stated income, interest only mortgages to borrowers with a credit history somwhere between marginal and cr@ppy, you cease to have any right to be shocked that there is gambling going on in this establishment: “Your losses sir.”

    1. Mcmike

      The passivity of institutional investors is amazing, despite ample evidence of systematic abuse – from mere price fixing all the way now to open theft, the managers refuse to revolt. It must be stockholm syndrome. Actually it is indicative of why the banking system contibues to operate, like wyle e coyote running right off a cliff, the customers keep coming back to the only game in town. How else can you explain why the mf global did not kill the broker industry?

      1. ScottS

        Less Stockholm Syndrome, more a problem of agency. As in, these bondholders don’t benefit from doing good or bad, they’re managing money on behalf of pension funds, unions, 401(k)s, etc. They’ll probably fold if they all lose proportionally — it’s not their money. And I’m sure they all picture themselves on Wall Street one day, so will be quick to side with the villains.

    2. vlade

      Even if the prospectus said “This loana pile of sh*t, and unlikely to be ever repaid”, first lien is first lien, and takes priority over any other ones. It’s not about the quality of the loans per se, it’s about who eats the loss on first vs. other liens – and the law and contract there’s clear. NOT the first lien (unless you have a fairy dust in the first lien contrat/prospectus etc, that can magically subordinate switch the liens).

      1. Jim A

        Well yes. They are supposed to be first in line. That’s why those seconds had higher interest rates. But the point here was that the purchasers of MBSs created from firsts should not be regarded as wide eyed innocents when they purchased those bonds.

  5. Goin' South

    Don’t you people understand that this is THE MOST IMPORTANT ELECTION in our sector of the galaxy since the Big Bang? So what if a 1,000 year tradition of property transfer law goes down, taking millions of homeowners and pensioners with it?

    Get your priorities straight. ;)

    1. Mcmike

      Which election is important? The tweedledee v tweedledum circus?

      Do what i do. Vote third party in the general direction of your preference- it is the ONLY way to get their attention.

      1. F. Beard

        Agreed. I wrote in Ron Paul in 2008 and look where he is now!

        Btw, I doubt I will vote for RP in 2012 because he is for a gold standard – a hypocritical stance for a so-called “libertarian”.

        But yea, vote for who you want, not who you think can win and then wait it out for four years.

  6. Yearning to Learn

    The courts have stymied bank efforts to get away with their heist, and they may prove to be their bane yet again.

    Then we had better hope that this case doesn’t go to the Supreme Court of the United States headed by the Chief CFO, I mean Chief Justice, Roberts. Because we might find that only some types of corporations are people, and others are not… and thus we can transfer from non-person corporations like Grandma’s Pension to a person-corporation like JPMorgan Chase.

  7. Lambert Strether

    Isn’t this a “taking”?

    Taking from the first lienholders to save the second lienholders to keep otherwise insolvent banks from going under amounts to a transfer from private parties to the government, as in it saves the FDIC from needing an emergency injection from Congress, as it did in the savings and loan crisis.

    So where are the glibertarians on this? And RP? Why aren’t they all in to stop the settlement?

    1. taunger

      I can’t tell from the sidelines whether it would be a taking, by the AGs and other enforcement offices signing on, or a conversion (theft) by the defendants. I’m sure there are numerous other liability theories that could apply as well. It would be especially fun to see instiutional investors claiming consumer fraud violations by the state AGs.

      In either case, I do hope that we see some investors (a la MS pensioners fund) hitting back with lawsuits against the settlement players. Whatever the statute of limitations on the original crimes, now we have a whole new clock on the settlement violations.

  8. Norman

    And when the “Guillotines” come out. . . . . . . ! I still ask how many of the present active duty members, the enlisted ranks of the military are going to follow orders from the Generals, to arrest their fellow citizens? Being a veteran, I know what side of the street I stand on, along with every other veteran that has been used then thrown to the dogs.

    1. Mcmike

      Which side is that? Most military i am aware of routinely and proudly support the GOP in its multi decade erosion of liberty. Each step into fascism has been in fact cheered, even as that same gop treated troops as “fungible”, ie disposable.

      Now all the brownshirts are shocked to find out all that infrastructure of totalitarianism is aimed not just at muslims and liberals.

        1. Nathanael

          Luckily, today’s fascists, being greedier than Jay Gould, are not willing to actually pay half of the working class.

    1. R Foreman

      She may not know what that means. DDOS (Distributed Denial of Service) attack. Your website is loading really slow, leading people to believe you were getting hit with ping floods. I also experienced a veeeerrrry slow load of nakedcapitalism.com and I supposed it was due to heavy traffic resulting from the flurry of mortgage and foreclosure related news coming out today.

      1. Valissa

        I had similar thoughts as I have only gotten through to this site a couple of times today until a short while ago. Mostly I just couldn’t connect. And I was not having any delays or problems on any other sites today.

        1. Alex

          I suspect one of the advertising or monitoring services. I keep seeing the following error message on Firefox:

          “A script on this page may be busy, or it may have stopped responding. You can stop the script now, or you can continue to see if the script will complete.

          Script: http://images.intellitxt.com/ast/js/vm/jslib/core_1323346030.js:302

          Obviously the prime suspect would be Intellitext.com of course, but there could be other issues, like the network connection to Intellitext.com, or maybe something else.

          (I’m running Ubuntu Linux 10.04 with Firefox 9.0.1)

          1. Alex

            After considerable fiddling, I’ve come to the conclusion that the site is pretty much DDOSing itself, essentially by accident. I tried blocking intellitxt.com, then several other domains, which helped some, but the only thing that actually made the site load quickly was to essentially kill every advertising server I could using a great big list I got off the web. At that point the site loaded very quickly and reliably.

            The problem, as far as I can tell, is that there are so many advertising services loading along with this page – maybe as many as twenty or thirty servers adding stuff to the mix – that a little hiccup at any of them slows the site to a crawl. Note that each time the page loads you get a different mix of servers, which makes it very difficult to see exactly what is happening.

            My guess goes something like this: This site gets enormous amounts of traffic, and it must be gloriously expensive to run, so Yves has contracted with more advertisers than is technically feasible in order to keep the site paid for. Make a donation if you can. If not, look at the bottom of your browser and see which sites are loading slowly – some of them seem to be worse than others – and report those to Yves.

            Also note that what I did was an hour’s work to make the site load quickly on my machine. A real analysis of the problem should probably be done by someone with better skills than mine.

  9. chris

    have to say it doest get any better than this, but I am sure it will soon enough. It is as if the finanacial system’s major players have their own rules and are about and outside the law. I still can’t believe how agregious their acts have been toward the public and just how little the government has been willing to do to defend the public interest.
    Have to give nod to Nevada and attorney general here for taking a stronger stand against perpetraters, good article here stating what they have done and some results

    http://financialrealityrevisited.blogspot.com/2012/02/supreme-court-ruling-strengthens.html

    It seems to be starting to have an impact on bank efforts to push filings through without proper paperwork

  10. Pat

    It is amazing how passive institutional investors have been throughout this crisis, and during the last crisis, in 2001. Especially the large funds that hold the money of “little people”, pension funds such as CALPERS. Yves suggests that the institutional investors “don’t want to rile the banks.” That may be true, but I would suggest that the money-managers simply don’t care – it’s other peoples money and they don’t care much what happens to it, so long as they get paid their regular salaries. The big funds almost never get involved in corporate governance (for instance, by filing shareholder derivative suits), even when the companies are run into the ground through corruption and mismanagement. Why? Because it’s too much trouble, and because the losses ultimately fall on the “little people”.

    More background on the second lien situation can be found here:
    http://baselinescenario.com/2010/03/13/underwater-second-liens/

    From that article:
    “Konczal’s first point was that in the stress tests almost a year ago, the big four banks held $477 billion of second liens and estimated that these assets were worth 81-87 cents on the dollar, so they would take $68 billion in losses (under the “more adverse” scenario). Konczal estimated that they were instead worth 40-60 cents on the dollar, implying $191-286 billion in losses.”

    Mortgage investors push for banks to write down second liens
    March 9 2010 00:17 – FT.com / Debtwire – excerpts

    “A group of investors in mortgage-backed bonds dubbed the Mortgage Investors Coalition (MIC) recently submitted to Congress a plan to overhaul the refinancing of underwater borrowers by writing down the principal balances of both first and second mortgages. The confederation of insurers, asset managers and hedge funds hope to break a logjam between Washington DC and the four megabanks with the most exposure to writedowns on second lien mortgages, including home equity lines of credit.

    The private sector initiative coincides with House Financial Services Committee Chairman Barney Frank’s open letter dated 4 March to the CEOs of the banks in question – Bank of America, Citigroup, JP Morgan Chase and Wells Fargo – urging them to start forgiving principal on the second lien loans they hold.”

    But the banks are unlikely to take action until they get new accounting guidance from regulators that would ease the impact of such significant principal reductions on their capitalization ratios, sources with knowledge of the situation told Debtwire.

    A systemic program to modify second lien mortgages called 2MP does exist but Treasury has stalled on implementation because the banks that hold them can’t afford it, six buyside investors said. The sources all said implementation of the program, called 2MP, would result in “catastrophic” losses for the nation’s four largest banks, which collectively hold more than USD 400bn of the USD 1trn in second lien mortgages outstanding.”

    And from March 2010 WSJ:
    The Treasury has a program for modifying second mortgages, but bank participation has remained low. So why hasn’t the government leaned on banks, which hold nearly all the junior loans, to write down more of them?

    … The more likely reason is that writing down a second mortgage is, of course, principal reduction—and the Treasury seems to want to avoid that, presumably because it may spur opportunistic defaults.
    But if it wants to keep more people in their homes, the government may have to tolerate the freeloaders.”

    1. Damian

      on short sales in Phx and elsewhere the banks have been settling at much lower numbers for second mortgages – this estimate of 40-60% is way low just looking at schiller index

      http://www.nytimes.com/interactive/2011/05/31/business/economy/case-shiller-index.html?ref=economy#city/IND20

      peak to trough-market after market is north of 30% loss which means well into any second for loss without the costs associated with foreclosure or short sale which are major numbers

  11. steelhead23

    ” So as much as I’d rather see this deal scuttled, it would terribly amusing to see Obama tidy’s efforts to generate pretend to help homeowners while really helping the banks sidetracked by litigation. The courts have stymied bank efforts to get away with their heist, and they may prove to be their bane yet again.”

    Ah yes, the road from cynicism to schadenfreude is short indeed.

  12. Bravo

    Perhaps there is dissension within the investor ranks about what to do. They don’t like taking the haircut to benefit the big banks seconds, yet they realize that they could have difficulty collecting anything at all in way too many cases, thanks to securitization trustees’ failure to comply with the legalities relating to MERS and the pooling and servicing agreements. Given their compromised legal position, better to get most of their outstanding principal balance out of the collateral, versus a) nothing, or b) suing your friends in the 1% club (the securitization trustees). And In the case of the GSE first liens, it will be we taxpayers taking the haircut and seeing the collectability of our loans compromised if the MERS mortgages are proved to be defective as alleged.

    If the homeowner can’t hang on with even the modestly reduced debt under the settlement plan, or chooses not to hang on given the very real perception that his government was complicit in selling him/her out via a suspicious settlement, a strategic default tidal wave may ensue. It’s hard to see how that will help anyone. Better to use the leverage of popular support from most of the 99% and the facts as derived from Schneiderman’s investigation/lawsuit, to wipe out the bank seconds, write down the firsts to property market value, and give the investor/taxpayer the collateral security they were supposed to have in the first place, via a new participating mortgage that provides the investor (the taxpayer in the case of the GSE’s), 50% of the property appreciation over a ten year term in order to incent the borrower (with no equity) to keep paying. The neighbors who deride the debt haircuts given to their neighbors, could surely see the benefit to them of preventing a massive wave of strategic defaults that might otherwise ensue? No doubt, however, many neighbors will take the Romney view……let the market take its course and let middle America take on more pain since that’s what capitalism is all about.

  13. Tim

    Another reason the investors haven’t gone after the big banks is, since most as institutional investors like pension funds, they are investing other (little) people’s money. Who’s going to go to war over other people’s money when it’s so inconvenient?

    Only when they realize as you say that they are going to look SO BAD that they might actually get punished in some way for being at the helm when this went down will they stand up. Still, may be too little too late.

    That’s why I manage my own money whenever it’s an option ’cause nobody else is gonna care about my money the way I do.

    Motivation is EVERYTHING in the human factors of economics.

  14. Jack Straw

    I’m not sure about the “takings” argument here, either. There are some “takings” that do not require “just compensation,” for example, when the fire department destroys your house to create a firebreak, saving the rest of the neighborhood. This is also known as a “public necessity” taking. I also am not seeing what the “public use” is here for this taking.

    It’s early and I’ve only had a few drinks, so bear with me. It does seem like this is very much analogous to the GM “bankruptcy” where the ordinary rules were given the “meh.”

    While I have paid attention to this story pretty closely, the agency issues of which non-parties are precluded by the any agreement by the parties to this settlement is unclear to me. I’m not seeing how non-parties’ rights can be negotiated away in a contract they’re not party to.

    But in a similar vein to what was said above, or suggested above, I’ve never been able to figure out how dumb this money is/was. Back in 2003, I had numerous conversations with friends and associates about a “typical” structure of residential real estate purchases – 106% financing, with zero transaction cost to the buyer (which in reality was VERY OFTEN LARGE AMOUNTS of undisclosed cash TO the buyer). Given my vantage point in the market, I was already seeing a lot of foreclosures, and a lot of these transactions were structured as “flips,” buying distressed real estate – and getting paid to do it – and quickly selling at a “market price,” (again, with 106% financing) OR re-leveraging for as much as possible, as soon as possible. (NOTE: I was more-or-less barred from actually being a party to these transactions, and to the extent I was not, I did not participate anyway, for many and varied reasons – partly the sleaziness, mostly the personal safety concerns; these are the kinds of deals that can cause very ugly vendettae. But, I saw a ton of them. I saw who was doing them. And I saw that the money for them seemed to be coming from every direction.)

    So, I would agree that the subprime and ALT-A investors are not blameless. The other investors (A paper), however, weren’t really any better. Institutional real estate analytics, to me, seem designed to obscure reality. How could you possibly take real estate values seriously to the extent you knew that truly zero-cost (and cash-back) acquisitions were the leading edge of appreciation?

    Nonetheless, I don’t see how priority can be flipped to protect juniors at the expense of seniors (even though, apparently it will be). Under the current rules, the “estimated” losses on juniors seems laughably low. In many parts of the country, we’re not talking about $10-20k “add-a-new-bathroom” loans, but rather $200k second mortgages that have been entirely unsecured for years now. (NOTE: if you wanna see an End of Times clusterf&%k of Book of Mormon proportion (hey Mitt, do you guys have an End of Times?), look at these portfolios for systemic defects. In a Hegelian way, close attention here reveals virtually every scam, bad practice, futuristic promise, wishful thought, substitute for judgment that you could ever find ANYWHERE in financial consciousness).

    There, I got my eyes open now.

  15. Blissex

    «write down first liens and leave seconds largely intact (there have been some indications that seconds might get a modest ding in the case of a principal mod on the first, but that is backwards. The second should be WIPED OUT before anything modification is made to the first mortgage). Any principal mods on the first lien that leaves the second in place amounts to a transfer from retirement plans to banks. Pensions are being raided to avoid exposing the insolvency of the big banks.»

    The difficulty is that those pension funds, investment funds, life assurance funds everywhere did not just buy toxic debt from the banks on their “fixed income” allocation, they are also heavily invested in the same banks in their “equity” allocation.

    Because the financial sector was and is a large part of the index, and for stock-pickers at major investment funds financials were heavily overweighted because they were generating amazing earnings.

    So the governments of most first-world countries are running a desperate extend-and-pretend strategy hoping to keep hidden and diffuse in time pretty large capital losses in the savings of most patsies/voters, who in the aggregate largely borrowed their own savings to fund a gigantic bubble in the prices of their own houses.

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