I know I owe readers some comments on the mortgage settlement, but that will have to wait a few days, since I need to pack to go to DC later this AM. But that will give me more time to digest the voluminous filings, and at least as important, the onslaught of spin.
For a good overview, read The Subprime Shakeout (hat tip Deontos), with one major caveat: he is far too positive about the servicing reforms. Servicers have not only never met these standards, they cannot meet these standards. The sorry history has been that servicers lose boatloads of money servicing highly delinquent portfolios, make a hash of it and cheat to recoup the losses.
But I couldn’t let this bit of propaganda go without comment. From the settlement FAQ:
Q: Will investors in mortgage-backed securities ultimately pay for part of this settlement?
A: Participating banks own the vast majority of the mortgage loans that this settlement is expected to affect. The settlement could affect some investor-owned loans, depending on existing agreements servicers have with those investors.
When banks weigh which mortgage loans to modify as part of this settlement, they will do so based on first analyzing the costs and the benefits of minimizing their losses. If a loan modification, including principal reduction, is projected to cost the creditor or investor less than foreclosure, the creditor will earn more on that loan.
In other words, this settlement will not force investors to incur losses. That’s because any loan modification tied to this settlement will result in more of a financial return for an investor than a foreclosure would.
OK, readers: did you notice how the question in the headline is never answered properly? The answer is YES. Bet you’d never conclude that from the verbiage that follows. Instead it starts off on the utter irrelevance of “mortgage loans that this settlement is expected to affect.” We’re not talking about numbers of mortgages or the many ways they can be “affected,” which is certain to mean something more than just loan modifications.
This is nowhere near as hard as settlement propagandist in chief Shaun Donavan is trying to make it. The banks are getting a 45% credit for modifying mortgages they don’t own. They will do that all day in preference to modifying their own mortgages, except in those cases where they would have modified them anyhow.
And since the banks are held to a total dollar target, and can use mods of other people’s mortgages to meet this target, they are using other people’s money to pay off their misdeeds. There are no two ways about it.
Now HUD may actually live in a parallel universe where they “expect” that the banks will operate against their economic interest and prefer to modify bank owned mortgages. If Donovan and his staff are so dumb that they believe it, as opposed to running clearly phony expectations by the media, they aren’t qualified to run a dog pound, much the less a major Federal agency.
Now I can push numbers around, and sorta make them work. For instance, forgetting all those other “affected” mortgages, if you assume every first mortgage modified also has a bank owned second trailing behind, and if you assume 75% of the first mortgages modified belong to investors and 25% to banks, you get 62.5% of the total NUMBER modified coming from banks. But the dollar value of a first mortgage greatly exceeds a second, so the dollars involved even in this strained scenario would wind up taking more out of investors than banks.
Remember, the investor beef is not that they are anti-mod per se, but they want the seconds wiped out before the first mortgages are touched. The second lien investors knew they were second in line and got a higher interest rate as a result. Moreover, had investors had a seat at the table, you can be sure there are other servicing abuses they would have insisted be corrected, so railroading them benefits the banks in other ways too.
And as much as investors GENERALLY would prefer mods to foreclosures, in the sense there is a great deal of room to cut a deal when foreclosures on subprime loans deliver typical loss severities and will rise unless servicers quit attenuating foreclosures (unlikely), this statement is not true either:
That’s because any loan modification tied to this settlement will result in more of a financial return for an investor than a foreclosure would.
If you are an investor in the lowest paying tranche, you are getting interest only and benefit from attenuated foreclosures. You’d much prefer the status quo. A mod would reduce your income. Perversely, if you are in the top tranche that is left, you may also well be hurt by a mod. Principal losses on foreclosures are effectively distributed from the bottom of the waterfall up. Mods are distributed pro rata across all classes. If the settlement resulting in servicers speeding up foreclosures (unlikely, but we could be wrong, but faster foreclosures would reduce the amount of advances that effectively steal from the top tranches and distribute principal to the lower tranches via interest payments after the borrower had quit paying) top tranche investors will do worse with principal mods.
Put it another way: Donovan gave the Association of Mortgage Investors a long preview of the deal in its advanced stages, and they knew then their ox was being gored. The AMI released a statement critical of the deal and is quite clear that its members’ funds are being expropriated to pay for bank misdeeds. Key sections:
The Association of Mortgage Investors (AMI) represents the managers of mutual funds and long-term investors for state and local pension and retirement funds for a range of public institutions, including unions, teachers, and first-responders…
AMI has been on-the-record as supporting a settlement of claims against the mortgage servicers, provided that it does not harm average Americans and their 401Ks. This means that any settlement must be appropriately designed to address such alleged wrongdoing while not settling with the money of innocent parties. The retirement security of these innocent parties will likely be impacted by this settlement as it is currently filed..
As the federal court reviews the final settlement, AMI asks that the following changes be made on behalf of all investors:
Transparency. The NPV (net present value) model incorporated into the settlement must consider all of a borrower’s debts, be national in scope, transparent, and publicly disclosed; the NPV model must be developed by an independent third-party. An incorrect NPV model likely will lead to further re-defaults and further harm distressed homeowners.
Monetary Cap to Protect Public Institutions. As intended, the settlement causes financial loss to the abusers (the bank servicers and their affiliates). Unfortunately, the settlement is expected to also draw billions of dollars from those not a party to the settlement, including public institutions, unions, and individual investors. It places first and second lien priority in conflict with its original construct thereby increasing future homeowner mortgage credit costs. It is unfair to settle claims against the robosigners with other people’s funds. While we request that it not be done, at a minimum we request that a meaningful cap be placed on the dollar amount of the settlement satisfied by innocent parties. Again, restitution should come from those who are settling these claims, and lien priority must be respected.
You get the message. The AMI, sadly, is begging rather than trying to derail the settlement. And since banks have abused and lied to both investors and borrowers, and are getting a back door bailout rather than a kick in the butt, there is every reason for them to persist in their bad habits.