American Banker posted the 27 page term sheet presented by the 50 state attorneys general and Federal banking regulators to banks with major servicing operations.
Whether they recognize it or not, this deal is a suicide pact for the attorneys general in states that are suffering serious economic damage as a result of the foreclosure crisis. Tom Miller, the Iowa attorney who is serving as lead negotiator for this travesty, is in a state whose unemployment was a mere 6.2% last December. In addition he is reportedly jockeying to become the first head of the Consumer Financial Protection Bureau. So the AGs who are in the firing line and need a tough deal have a leader whose interests are not aligned with theirs.
Moreover, Miller’s refusal to discuss even general parameters of a deal goes well beyond what is necessary. He knows that well warranted public demands that a deal be tough will complicate his job, but it also does the AGs whose citizens have been most damaged a huge disservice. Pressure on the banks from the public at large is a negotiating lever they need that Miller has chosen not to use.
The argument defenders of the deal make are twofold: this really is a good deal (hello?) and it’s as far as the Obama Administration is willing to push the banks, so we have to put a lot of lipstick on this pig and resign ourselves to political necessities. And the reason the Obama camp is trying to declare victory and go home is that it is afraid that any serious effort to deal with the mortgage mess will reveal the insolvency of the banks.
Team Obama has put on a full court press since March 2009 to present the banks as fundamentally sound, and to the extent they needed more dough, the stress tests and resulting capital raising took care of any remaining problems. Timothy Geithner was even doing victory laps last month in Europe. To reverse course now and expose the fact that writedowns on second mortgages held by the four biggest banks and plus the true cost of legal liabilities from the mortgage crisis (putbacks, servicer fraud, chain of title issues) would blow a big hole in the banks’ balance sheets and fatally undermine whatever credibility the officialdom still has.
But the fallacy of their thinking is that addressing and cleaning up this rot would lead to a financial crisis, therefore anything other than cosmetics and making life inconvenient for the banks around the margin is to be avoided at all costs. But these losses exist already. The fallacy lies in the authorities’ delusion that they are avoiding creating losses, when we are in fact talking about who should bear costs that already exist.
The example of Japan, confirmed by an IMF study of 124 banking crisis, shows that leaving a banking system full of overvalued dud assets ultimately costs more than the painful exercise of writedowns and renegotiation. And we may be well on our way to producing worse than Japan outcomes. Using super cheap credit to shore up prices of dud assets is producing all sorts of levered financial speculation. We know this movie ends always ends badly, and with the authorities already using all their firepower to keep asset prices aloft, they will have nothing left in reserve when things eventually unravel.
There is a an extremely aggressive push underway to get a deal inked. And it appears that the Federal banking regulators who are all co-opted by the industry (the only difference among them is how badly) have in turn succeeded in leashing and collaring the attorney generals’ effort. As we have discussed at length in previous posts (see here and here), the timetable guarantees that no meaningful investigations were done, particularly of what is called servicer driven fraud, meaning servicer impermissible charges and fee pyramiding. That leads a late payment or two to escalate into thousands of dollars of charges. Consider an example we discussed earlier, of a Michigan couple highlighted in Huffington Post:
The Garwoods had missed one payment, but this apparently was not unsalvageable; the husband’s roofing business was seasonal. Their servicer, JP Morgan Chase, contacted them and encouraged them to enroll in HAMP.
The HAMP trial mod, which was supposed to last three months, instead ran nine months and lowered their payments by about $500 a month. When they were ultimately refused a permanent mod (despite hearing encouraging noises from the servicer in the meantime), they were presented with a bill for the reversal of the reduction, plus fees, of $12,000.
Stop a second and do the math. Let’s be unduly uncharitable to JP Morgan and assume “about $500″ means $540. $540 x 9 is $4,860. That means the fees and charges were $7,140, or nearly $800 a month.
How can charges like that be legitimate? Answer: they almost assuredly aren’t. The payments were reduced as a result of a trial mod, so any late fees would be improper. Thus the only legitimate charges would be additional interest, perhaps at a penalty rate. So tell me how you have interest charges of nearly 400% on an annualized basis on the overdue amount and call them permissible? I guarantee there is not a shred of paperwork anywhere that can support this level of interest charge, either with the investor or with the borrower.
We have since learned of one way they could have been charged $800 for one of those months. When borrowers miss two payments, many servicing agreements require that the servicer get what is called a broker price opinion, which usually means the broker drives by the house and then provides an estimate of its sales price. The usual price of a BPO is $50 and it is supposed to be charged to the investors. Not only do servicers often double dip and charge the borrower too, but they greatly mark up the charge. Lisa Epstein told us of a borrower in Florida that was charged $800 for a single BPO. We’ve heard of $250 before, but apparently the sky is the limit if a fee is impermissible anyhow.
Similarly, consider what happens if your payment is late (whether it was actually late or whether check was held to make it late). The contracts and Federal law require that payments be applied first to principal and interest. But when the bank charges a late fee of $75, it deducts it from the borrower’s payments in its payment record for the borrower. And because the payment is now short, rather than applying, say, $925 out of the borrower’s $1000 check to principal and interest, it instead puts it in a “suspension account.” So the borrower is now $1000 behind on his mortgage, and is charged interest on that $1000 shortfall. And the borrower has not been informed by the bank that he is behind, so his next month payment will have the additional fees charged to it, making it below the $1000, which will again allow the bank to add this $1000 less the interest and any other fees to the suspense account, and charge the borrower interest as if he were $2000 behind on his payments.
And the investor gets ripped off in this process too. Servicers are required to advance principal and interest to investors until the debt appears to be unrecoverable from the borrower. They are also not permitted to charge investors interest on these advances. You would think that would mean servicers would have some parameters for when they stopped making advances, since they are not required to beyond a certain point. But in the scenario above, they’d treat the $2000 payment as an advance, even though the bank has, say, $1800 in the suspension account. Since the borrower caught in servicer pyramiding fee hell is pretty certain never to emerge, those extra interest payments the bank is charging the borrower on his now $2000 shortfall will be deducted from the sale proceeds when the house is foreclosed upon and eventually sold.
If you think these practices are rare, consider: Fairbanks, a stand-alone servicer that focused on troubled mortgages, EMC/Bear Stearns, and Countrywide have all been found guilty of pyramiding. We don’t know who else might be engaged in these practices because the deliberate rush to enter into a deal means no investigation has been made. And since a single firm, Lender Processor Services, provides the servicing backbone to the entire industry, it seems highly unlikely that other large servicers do not engage in similar practices.
What about the claim made by John Walsh, that the Federal regulators, led by the OCC, investigated 2800 severely delinquent mortgages and found only a small number of servicing errors? Guess what, they could not possibly have looked into this issue. To verify what happened, they would have had to do a real forensic examination of the detailed payment records, including comparing it against the borrower’s payment records and the provisions of the pooling and servicing agreement. Attorney fighting foreclosures seldom go this route because it is such a tortuous exercise; the servicer records are cryptic and often have numerous adjustments; it almost without exception requires a forensic accountant to get to the bottom of things. Given an eight week timetable that included Thanksgiving and Christmas, it is a certainty that no borrower verification was made; in keeping, nothing in testimony by Walsh about the servicer examswould lead one to think that the records review probed the validity of the charges made to borrower accounts.
Now do you see why servicers consistently report than when homeowners miss a payment or two, they proceed pretty much in a straight line to default? Once they miss a payment or start racking up extra charges that you are unaware of, borrowers descend into a designed-by-the-servicer escalating fee black hole, never to emerge.
To the specifics of the plan. If you didn’t know any better, you might be fooled into thinking the terms were tough. It provides for more reporting by servicers to borrowers of where they stand, ends dual track (in which servicers negotiate mortgage mods while still moving ahead with foreclosures), provides for a single point of contact for borrowers who enter into mod discussion, and has an “affirmative obligation” for servicers to offer mods, including principal mods “in appropriate circumstances”.
Even if these measures were tough-minded and vigorously enforced (two irrelevant “ifs”), they are still deficient. We don’t even know the extent of servicer abuses, since we are conveniently moving very quickly to avoid any serious probe, but there is considerable evidence that suggests that a lot of foreclosures were servicer driven. So merely fixing practices going forward, is necessary but far from sufficient. What are the remedies for people who suffered in the past? Of course, it’s horrifically difficult for individuals to prove their case, which is why having state AGs act on their behalf is the best remedy we have. And if that is going to be waived, the trade needs to be that the public gets something punitive, not just prescriptive.
It seems far more sensible to go in the direction of having servicers bear the cost of a real mod program, which is what investors would much prefer to have happen. Or as Adam Levitin suggested, have the banks pay $20 billion to fund legal aid attorneys.
And if you are familiar with the sorry history of the servicing industry, you recognize these things: that much of the verbiage in this “settlement” merely recaps the existing obligations of servicers under the law and their contracts, along with commitments they’ve made previously to investors and regulators and failed to adhere to. For instance, on page two: “Affidavits and sworn statements shall not contain info that is false or unsubstantiated.” Um, we have to have a settlement agreement to get the banks to agree obey the law? Similarly,”Servicer shall not impose its own mark ups on any third party charges.” Servicers were never “allowed” to charge excess fees, which are ultimately borne by investors. Stephanie at FedUpUSA, who looks to be a MBS investor, began a detailed shred of the agreement with this overview:
The entire document is a rehash of what servicers had a legal mandate to do right up front. Accurately apply payments. Respond to inquiries. Operate in good faith. Use a NPV test for HAMP (was in the HAMP program originally.) Document the assignment chain before foreclosing.
There’s exactly one substantive change, in that HAMP did not prohibit “dual-track” (that is, foreclosure while attempting modification.)
Essentially every other item in this 27 pages is something that Servicers already had a legal duty to do, either as a fiduciary to the investor or just through the ordinary covenant of operating in good faith (You know, the original standards that all businesses are held to that aren’t actually racketeering outfits and gangsters? Yes, that.)
There is actually one other new requirement which is single point of contact, meaning that one individual will be responsible for handling the loss mitigation process. This is something borrowers have wanted due to the utter incompetence of banks in handling borrower inquiries (see this not at all unusual horror story from Dana Milbank).
But the only place in banking you get that level of service, one person tasked to your needs, in retail banking is in private banking or near-private banking high net worth product groups. Trying to remedy lousy servicer record-keeping in a call center environment, which suffers from chronic high turnover, is simply unworkable.
There is an elephant in the room that this wrongheaded program fails to acknowledge: servicing large numbers of distressed borrowers is a huge money loser for any servicer. As a result, they have huge economic incentives to find some way to offset those expenses, i.e., cheat. This proposed settlement ignores the fact that the servicers do not generate enough income from their normal fees to pay for decent quality servicing, let alone the some arguably enhanced settlement imposes (more papering up of processes for third party review; providing a single point of contact for borrowers, which is not all that easy to implement in a call center environment).
The poster child of this conundrum was Fairbanks, a servicer which had acquired portfolios with high levels of delinquent loans and was soon sued for a whole range of abusive servicing practices. Both HUD and the FTC opened investigations which led to a settlement that included replacing the management team. Tom Adams was on the buy side at the time. His comments:
We also had heightened sensitivity to “predatory servicing” following the FTC settlement and these issues were an important part of our servicer diligence. Following the settlement servicers took great pains to highlight how their practices were distinguished from Fairbanks. Of particular importance was the economic distinction – Fairbanks was a stand alone servicer of distressed loans. They needed to grow their portfolio in order to break even (it was a variation on a Ponzi scheme, because as the portfolio aged it became more expensive to service). Other servicers had better economics because they could subsidize their subprime loans with low servicing cost prime loans or because they invested in the deal residuals (which would be worth more if the servicer was successful in reducing losses). Some servicers, such as Litton, pointed out that servicing was not a profitable business on a stand alone basis.
Now all servicers are in the position Fairbanks was in – large distressed portfolios which aren’t profitable just from the servicing fees, which pushes them to seek junk fees. Following the Fairbanks settlement, the economy appeared to be in good shape, servicers gave the illusion of being profitable, or sufficiently subsidized. Large servicers such as Countrywide or Wells Fargo, bragged about gaining significant efficiencies from having large portfolios, which helped them reduce servicing costs. All of that went away when large numbers of borrowers became delinquent. Servicing delinquent and distressed loans is vastly more expensive than servicing a current portfolio, but the fee remains the same for both, typically.
The problem is that the servicers, who ironically like to portray delinquent borrowers as deadbeats, are themselves deadbeats. Their expenses are chronically higher than their incomes, even with providing service that falls well short of their legal and contractual obligations. Unlike most strained homeowners, however, they have a way to fill the gap: large scale, institutionalized theft from both borrowers and investors (this post has focused on borrower abuses, but there is plenty of litigation on the investor side against servicers for improper fees and charges). So if this settlement does result in even a modest improvement in servicer standards on the borrower side, they’ll simply have to get more creative in how they rip off investors.
Josh Rosner, in an analysis for clients (no online source), argues that if a private sector attorney negotiated a deal like this, he’d be at risk of being sued for malpractice (emphasis his):
This “term sheet” may well tie the hands of states from bringing actions against prior improper servicing and back-end/foreclosure practices AS WELL AS improper front-end
or assignment practices….If a private-sector lawyer, representing any harmed party, settled for damages without an investigation of actual damages they would likely be exposing themselves to malpractice, why would that not be the case here?
In other words, this is simply another example of how the too big to fail banks are chipping away at the rule of law. The banks have over time have fought successfully to reduce the influence of state laws and regulations on their business while increasingly bending the Federal regulatory apparatus to their will. But the state AGs are still enough of a force to be reckoned with that the Federal bank regulators are now applying considerable to pressure them into abandoning initiatives that could help homeowners in their states. Hopefully at least a few of these AGs will wake up and have the self-preservation instincts to realize that this settlement is not in their or their constituents’ best interests.
And since the state attorneys general are under a lot of pressure to do the wrong thing, I strongly urge readers to call their state AG and say that you oppose this bailout in disguise. Demand real investigations, including servicing software audits, as a necessary step before any settlement. You can find their phone numbers here.