naked capitalism

We have yet another example of media cravenness. You would assume that when official positions presented in the media contradict each other, it would represent an obvious opportunity for reporting, and an intrepid young journalist would take up the task. But since the job of US news outlets is increasingly to distribute propaganda, they manage not to notice.

We’ve had a stenography masquerading as reporting on the results of the recent Foreclosure Task Force “review” of servicer practices. After looking at 2800 severely delinquent loans, it found only some operational shortcomings and no unjustified foreclosures. Given that all that this cross agency effort did was to have tea and cookies with the servicers while reviewing their documents, as opposed to doing any validation of their data, this means the “exam” was a garbage in, garbage out exercise.

Similarly, today the Fed made the similarly ludicrous statement that there were “no wrongful foreclosures” based on a review of a mere 500 loan files. Given that there are 14 major servicers, that means it looked at 36 files on average per servicer. Heck of a job, Brownie!

Aside from the fact that there have been numerous reports of colossal errors that should be impossible in a system with any integrity (homes with no mortgages or where the mortgage had been paid off, where borrowers had been given letters that they had been approved for permanent HAMP mods being foreclosed upon), there are also numerous accounts of servicer-driven foreclosures. As Karl Denninger noted:

We have myriad reports of homeowners who are told to intentionally default by servicers, a clear act of bad faith. We have documented instances of banks breaking into homes that are occupied, an apparent serious state felony. We have documented instances of banks playing games with forced-placed insurance, escrow accounts and similar acts leading to foreclosure.

But the most telling contradiction of the banking regulators’ “nothing to see here” stance is the Administration’s aggressive pursuit of servicing abuses against active duty soldiers. When a Congressional hearing focused on how JP Morgan illegally foreclosed on soldiers, the bank went into overdrive to do damage control. As David Dayen reported:

The big bank went out of their way to fix the problem yesterday, knowing that abusing service members could get you in big trouble in this country, and lead to further scrutiny of their abusive practices. Calling these violations a “painful aberration” on a track record of honoring military families, JPM CEO Jamie Dimon announced:

• New pricing. Under the Servicemembers Civil Relief Act, servicers are required to cap mortgage interest rates for active duty personnel at 6%. JPM will lower that cap to 4%.

• Military modification program. JPM will go beyond HAMP requirements for all personnel who served on active duty going back to 9/11. If the borrower has a second lien with them, they will reduce the interest rate on it to 1%.

• No foreclosures. JPM will not foreclose on any active duty military personnel overseas. Anyone who was wrongly foreclosed upon previously will not only get their home back, but JPM will forgive all remaining home debt. They promise to do that in the future with any other wrongful foreclosure of a military family.

• Donations. JPM will donate 1,000 homes to military and veterans, through a non-profit partner, over the next five years.

• Jobs. They will commit to hiring 100,000 military and veterans over the next ten years. They will also offer a Technology Education certificate for veterans to take free to get technology training for future careers.

• Advisory Council. They’ll form an Advisory Council to determine other ways to help military families. They’re also opening a bunch of Homeownership Centers near military bases to assist families.

Needless to say, this is a PR gambit to the nth degree. But look how incredibly scared JPM is that anyone will look past the abuse of military families. They are going out of their way to burnish and repair their public image on this one, and the goal is to whitewash the fact that they were merely engaging in standard servicer practices of abusing homeowners and illegally foreclosing.

To underscore Dayen’s point, servicers are factories with highly routinized, bad procedures. If you see one abuse reported more than a time or two in the media, like force placed insurance or fee pyramiding, it is not a mistake. It’s policy.

Not surprisingly, JP Morgan appears to have company in the “grinding up servicemen for fun and profit” school of banking. And while the Administration has bent over backwards to protect servicers by disputing any suggestion that they’ve made unwarranted foreclosures, they’ve been fast to saddle up the Department of Justice to investigate over the very same issue,20 probably impermissible foreclosures at Saxon, a servicer owned by Morgan Stanley, because it involved active duty personnel. From the New York Times:

The Justice Department is investigating allegations that a mortgage subsidiary of Morgan Stanley foreclosed on almost two dozen military families from 2006 to 2008 in violation of a longstanding law aimed at preventing such action.

A department spokeswoman confirmed on Friday that the Morgan Stanley unit, Saxon Mortgage Services, is one of several mortgage and lending companies being investigated by its civil rights division. The inquiry is focused on possible violations of a federal law that bars lenders from foreclosing on active-duty service members without a court hearing.

Mark Lake, a Morgan Stanley spokesman, declined on Friday to comment on the investigation. However, in the fine print of a recent regulatory filing, Morgan Stanley disclosed that it was “responding to subpoenas and requests for information” from various government and regulatory agencies concerning, among other issues, its “compliance with the Servicemembers Civil Relief Act,” the law that governs the actions creditors can take against service members on active duty.

This two-tier approach is intriguing: aggressive pursuit of abuses when members of the armed forces are the victims, flat-out denials for the rest of us. Dave Dayen thinks it’s politics, but I wonder if something deeper is at work. The Pentagon has been aggressive in blocking other forms of exploitation of soldiers, such as locating payday lenders near military bases (the Pentagon sought and won interest rate ceiling. My 2007 post on that tussle was “The Pentagon as Financial Regulator.” Maybe that’s an idea we need to entertain more seriously. It seems to be the only body with the authority and firepower to take on the mortgage industrial complex.

We commented earlier this week on bank defenses of their foreclosure practices:

I’ll spare you several paragraphs of the “but they were deadbeats and no one was hurt by robo-signing and all our foreclosures were warranted.” Well, if you normally operate as judge, jury, and executioner, and it’s too costly for borrowers to counteract predatory servicing, in your little self-referencing world, everything will look hunky-dory and challenges to your authority will be deemed to be improper and unwarranted.

As we have indicated repeatedly. lawyers fighting foreclosure estimate that 50% to 70% of the cases they represent are ones where the borrower is in foreclosure as a result of bank fee pyramiding and other improper fees (note there is sample bias here; contrary to bank spin, most borrower attorneys fight foreclosures when they think the case has merit). But they just about never argue in court on those grounds; the cost of hiring an expert witness and doing the forensics on full details of the banks’ overcharges is too costly.

But of course, the Fed is throwing its authority behind the banking industry spin that all foreclosures are warranted. From Shahien Nasirpour of the Huffington Post:

A months-long investigation into abusive mortgage practices by the Federal Reserve found no wrongful foreclosures, members of the Fed’s Consumer Advisory Council said Thursday.

During a public meeting attended by Fed chairman Ben Bernanke and other regulators, consumer advocates on the panel criticized federal bank regulators for narrowly defining what constitutes a “wrongful foreclosure.” At least one member of the panel voiced concerns that the public would not take the Fed’s findings of improper practices seriously, since the wide-ranging review did not find a single homeowner who was wrongfully foreclosed upon….

Kirsten Keefe, a member of the Fed consumer panel and an attorney at the Empire Justice Center in Albany, New York, said the Fed’s report defined “wrongful foreclosures” as repossessions of borrowers’ homes who were not significantly behind on their payments….

But Keefe, who represents troubled borrowers, argued that the definition should be expanded to include foreclosures in which the wrong party brought the foreclosure action or cases that involve significant errors in foreclosure documents, like an inflated past-due amount, for example. Other consumer advocates at Thursday’s public meeting appeared to agree.

FYI, the Fed apparently has not released the actual document, no doubt to save itself well warranted ridicule.

The more this sort of whitewashing of abuses goes on, the closer the US gets to its Egypt moment.

The level of complaints about servicer screw ups in the HAMP program and more recent horror stories from borrowers not seeking loan modifications confirms something we’ve noted on this blog: that servicers fee structures aren’t set up for them to handle the workload associated with high volumes of foreclosures. Accordingly they devised processes like robosigning, which are legally impermissible, as a way to contain costs. Many of the abuses still have not gotten the attention they deserve. For instance, the most widely used foreclosure platform for the industry, that of Lender Processing Services, does not have a field in its software to allow a foreclosure of a person in a Chapter 13 bankruptcy to be processed differently. This results in impermissible charges. For instance, when a Chapter 13 debtor is in a bankruptcy plan and sending his payments to the Chapter 13 trustee, who in turn disburses them to various creditors, there is no such thing as a late payment. But if the old borrower due date was the 10th of the month and the trustee sends checks on the 15th, the bank will record a late fee. Then when the borrower emerges from Chapter 13 which means he is current on all the debt under the bankruptcy plans, the bank will send him a bill for what is typically several thousand dollars of fees. The borrower who is still under a lot of financial stress (Ch. 13 plans by design soak up all of a borrower’s income) then has to spend money he does not have to go to court to get the charges removed.

We also pointed in previous posts to signs that foreclosure filings had fallen markedly versus year prior levels. From Bloomberg:

U.S. foreclosure filings fell last month to the lowest level in three years as lenders under legal scrutiny struggled to process a backlog of defaults and put new systems in place for home seizures, RealtyTrac Inc. said.

A total of 225,101 U.S. properties received notices of default, auction or repossession, down 14 percent from January and 27 percent from February 2010, the Irvine, California-based data seller said today in a statement. The number was the lowest since February 2008, and the year-over-year decrease was the biggest since the company began keeping records in 2005…

“It’s clearly taking the lenders and servicers longer than anyone had anticipated,” Rick Sharga, RealtyTrac’s senior vice president, said in an e-mail. “Beyond that, the industry itself is in a state of dysfunction.”….A glut of resubmitted paperwork is “taxing the resources” of loan servicers, and judges are demanding greater scrutiny in states where courts oversee foreclosures, Sharga said….

In Florida, a judicial state that’s been among the hardest- hit by the crisis, total foreclosure filings plunged 65 percent from a year earlier. It still ranked second for total filings.

The Florida slowdown may also reflect the fact that the state attorney general is investigating the state’s major foreclosure mills. One of the very biggest, the Law Offices of David Stern, announced this week that it was closing at the end of March.

Mike Konczal also highlighted a very illuminating chart from a paper by Diane Thompson of the National Consumer Law Center, Why Servicers Foreclose When They Should Modify and Other Puzzles of Servicer Behavior, which shows how payments to servicers influence their behavior in foreclosures:

The folks at ForeclosureFraud were kind enough to pass along an archival document that I thought readers would enjoy.

This Moody’s report illustrates what the prospect of higher fees for securitization-related ratings did to rating agencies’ quality of analysis.

Moody’s MERS Report 1999

The arrogance of the MERS position (the Moody’s document is basically MERS dictation) is evident:

The recording system has been set up to provide notice of security interests, but not necessarily the identity of the secured parties…..

There will probably be an adjustment period during which the courts and the foreclosure attorneys will need to get familiar with MERS and learn how to deal with issues concerning foreclosure by a nominee that the foreclosure statues did not contemplate.

This makes for entertaining reading, in a sick sort of way. You’ll see again and again the notion that the law and the courts should give way to MERS. That’s consistent with what Gretchen Morgenson reported over the weekend, namely, that no review was made of the legality of MERS in any of the 50 states. The assumption was that MERS could simply be imposed.

I’d normally go through this document in more detail but it is a fairly short piece and I’d rather have readers read the original. It is a vivid example of the danger of uncritical acceptance of supposedly expert opinion.

In a move not noticed much three weeks ago, Bank of America announced that it was segregating its crappy mortgages into a “bad bank”. It got more attention today by virtue of being discussed long form in an investor conference call (see related stories at Bloomberg and Housing Wire).

The use of a “bad bank” is strongly associatied with failed institutions. Some of the big Texas banks that went bust in the 1980s (Texas Commerce Bank and First Interstate) used “good bank/bad bank” structures to hive off the dud assets to investors at the best attainable price, and preserve the value of the performing assets. The Resolution Trust Corporation, the workout vehicle in the savings and loan crisis, was effectively a really big bad bank. The FDIC is (and I presume was) able to sell branches and deposits pretty readily; the remaining bad loans and unsellable branch operations reached such a level that the FDIC was forced to go hat in hand to Congress and get funding while it worked out the dreck. A similar structure was used in in the wake of the banking crisis in Sweden in the early 1990s.

I am told by mortgage maven Rosner and others that this move is not meant as a legal separation, but a mere financial reporting measure, so that BofA can declare, “See, we do have this toxic waste over here, but we are chipping away at it and we’ll have that resolved in some not infinite time frame” (the current talk is 36 months) “and look at how the rest of the bank looks pretty good!.”

So I may be accused of being cynical, but I read more into it than that. One distinction I like to make is between “stated truth” and “operative truth”. If a woman of a certain age starts working out, she might truthfully say to her buddies (”stated truth”): “I used to do a lot of sports when I was young, I’ve gotten out of the habit. I started exercising over the holidays, and it made me feel SO good I’ve now decided to stick with it.” The operative truth instead is, “I notice my husband eyeing younger women way too much. I have gotten a little porky. If I don’t get some semblance of the beautiful body of my youth back, he could stray.”

As we all know, shareholder presentations are a realm where stated truths are used routinely to mask operative truths. So the question is: can we infer the operative truths behind the BofA move?

What is striking is the tension between Bank of America saying that this is a measure designed provide more transparency to investors and put dedicated resources on a festering problem to get it resolved versus the specific and loaded terminology they used to describe it, “good bank/bad bank”. Normally, you’d assume that an investor presentation by a big public would be a deliberate affairs. But as Chris Whalen said to me by phone, “I wouldn’t assume that the people at Bank of America are being any more logical than they have ever been. They are just making this up as they go along.”

It is important to stress that this is not a mere accounting separation, it’s an operational split. I encourage readers to look at the investor presentation (click here as an alternative to the embedded version). In particular, note page 6. It shows the creation of a dedicated management team for what was described to investors as a new division. Most of them were probably part of the old Countrywide servicing unit. But the head, Laughlin, is new, and I would assume that at least Ellison and Schloessmann were at BofA corporate but already working close to full time on Countrywide matters.

Bank of America Bad Bank Presentation

But the weird part is, per Whalen, this is NOT a legal separation. However (putting on my M&A hat, and Whalen did not disagree) normally the big obstacle to companies hiving off divisions is the lack of a stand-alone management team. Note that that does not impede a sale, but selling a legal vehicle with revenues, staff, but a less than full management structure means you are basically selling a bunch of assets (which includes some management people and maybe some systems) rather than a business. It can only go to buyers who can provide the missing operational parts. Stand alone entities are vastly more saleable and command higher prices. And my belief (readers welcome to correct me) is having achieved operational segregation (in particular a stand alone management team, good stand alone operational reporting and financial controls), making a legal separation would not be that hard.

Thus the use of “good bank/bad bank” lingo, given what Whalen and others see as serial improvisation on behalf of BoA, may amount to a Freudian slip. The bank is probably enough in denial to believe that their putback and other losses really are well under $10 billion (we agree with them on putbacks, we’ve written repeatedly that we think those cases are overblown, but we think there are other chain of title issues that they have not treated seriously that will add up to much more in the way of legal liability and operational costs).

Having a separate operational unit means in a worst case scenario, BofA might be able to amputate this business in classic “bad bank” form. So whether by design or accident, the coded message in the choice of “bad bank” is: “If those crazy hedgies who say our liability is $70 billion are right, so what? They can all go pound sand.”

But could it really hive off ugly legal liabilities? Even though that may be what the BofA people would like to tell those nasty hedgies, the Charlotte bank stopped running the old Countrywide as a separate, bankruptcy remote entity not long after the deal was closed. So it would now seem hard to limit the legal liability to what would amount to a reconstituted Countrywide (but as we discuss later, with some help from their friends, who knows what might be possible…)

But let’s say those crazy hedgies are right in the dollar amount of liability, even if for the wrong reasons. BofA would be in serious trouble.

I’ve been completely skeptical of the resolution provisions of Dodd Frank for a simple reason: I’ve assumed, as in the financial crisis just past, and the big recent ones (the LTCM meltdown of 1998, the 1994-5 derivatives wipeout, which produced more losses than the 1987 crash) that they would center on the dealing operations of the major dealer banks (you may not have realized it, but the US rescue of Mexico was really a bailout of US banks that had written a boatload of derivatives on various Mexican exposures).

In our modern world, where major dealers have globe-ringing trading operations, there are two insurmountable obstacles to a tidy resolution of a major dealer. Any “resolution” will be subject to the laws of the multiple nations in which it operates. Dodd Frank does not have any authority outside the US. In addition, no counterparty wants to have his positions frozen while the courts are sorting out who gets what. If any major dealer is believed to be in serious trouble, no sensible counterparty will want to be exposed. And an untested resolution regime is not very reassuring. The run on Bear Stearns took a mere ten days. The authorities will be forced to bail out a major dealer if it starts to founder. And the banks know that all too well.

However, there is one place Dodd Frank resolution procedures might work, and that is on a strictly domestic non-trading operation. As former White House counsel Boyden Gray discussed disapprovingly in the Washington Post last year:

The Treasury can petition federal district courts to seize not only banks that enjoy government support but any non-bank financial institution that the government thinks is in danger of default and could, in turn, pose a risk to U.S. financial stability. If the entity resists seizure, the petition proceedings go secret, with a federal district judge given 24 hours to decide “on a strictly confidential basis” whether to allow receivership.

There is no stay pending judicial review. That review is in any event limited to the question of the entity’s soundness – not whether a default would pose a risk to financial stability or otherwise violate the statute.

The court can eliminate all judicial review simply by doing nothing for 24 hours, after which the petition is granted automatically and liquidation proceeds. Anyone who “recklessly discloses” information about the government’s seizure or the pending court proceedings faces criminal fines and five years’ imprisonment. As for judicial review of the liquidation itself, the statute says that “no court shall have jurisdiction over” many rights with respect to the seized entity’s assets (thus apparently eliminating many actions that would otherwise be permitted to seek compensation in the federal Court of Claims).

Gray described the process as a “star chamber” and further warned:

This means the U.S. Treasury and Federal Deposit Insurance Corp. are acting as a sometimes secret legislative appropriator, executive and judiciary all in one. Although there is little direct precedent, it is hard to believe that the Supreme Court would not throw out parts of this scheme as violations of either the Article III judicial powers, due process or even the First Amendment, assuming the justices do not find all of it a violation of the basic constitutional structure….Dodd-Frank strips the courts of the right to make statutory and constitutional determinations in critical circumstances, a throwback to the very first draft of the Troubled Assets Relief Program from the Treasury Department, which would have permitted no judicial review at all.

The problem is that the idea of Supreme Court intervention would wind up being theoretical. As former federal district court clerk Hans Bider of the Washington Examiner noted, district courts are incapable of actin on anything in 24 hours, so the inaction means the seizure by the Star Chamber will be deemed to have been approved. And the odds that anyone will be fast footed enough to run to the Supreme Court and get an injunction is unlikely (and may be a jurisdictional non-starter, given that matter would still be in the hands of the district court, even though it is clear that it will not rule in time). Once the Star Chamber has made the bank seizure, that hoary old saying will apply: possession in nine-tenths of the law.

Boyen’s concern was a repeat and probable escalation of the controversial actions during the bailouts, in particular the sort of favoritism we saw in the the AIG rescue, with creditors like Goldman and Merrill being paid 100% on credit default swap exposures that were clearly worth a lot less.

But I see another way this could operate. Let’s say the Lilliputians really do continue winning against the banks, and in particular Bank of America, in the courts. Their litigation losses and projected litigation liabilities mount at a faster pace (and that could happen even more quickly if investors decide to sue).

The FSOC tells Bank of America to put the legacy assets in a separate legal entity. Using its Star Chamber powers, it seizes the bank (either the entire bank, immediately spinning out the rest, or just the bad bank, the niceties of how you’d execute this maneuver are above my pay grade).

The powers that be then by fiat treat all the mortgage-related claims as liabilities of the bad bank. That bank has very little in the way of assets, so those creditors get paid a fraction of the value of their claims. Since this mechanism is beyond legal review, the creditors would be stuck with a fait accompli. They’d have no way of getting recoveries from other bank assets (the notion being that every penny paid in dividends and bonuses since the Countrywide acquisition really belonged to the bank’s creditors and claimants, so recoveries from the bank as a whole are fully warranted).

You can assume any scheme like this would be subject to Constitutional challenge. The creditors would no doubt argue that they had valid claims against the good bank, ergo the regulations surrounding the resolution would not apply (this risk might argue for resolving the whole bank and spinning the good bank assets, and probably the publicly traded liabilities out).

Is this way of screwing those who win in court as a result of foreclosure fraud possible? This scenario no doubt sounds like a stretch. But if you had told anyone in June of 2007 the events of the next two years, particularly the extent and ad-hoc-ness of the bailouts, they would have said you were nuts. And I would not underestimate the creativity of the powers that be in preserving the privileges of the banking classes at the expense of the rest of us.

By Tom Adams, an attorney and former monoline executive

Back in 2003, Fairbanks Capital billed itself as the largest servicer of subprime mortgages. It was also a stand alone servicer, in that it was not in the business of lending.

In a high profile case within the mortgage industry, the Federal Trade Commission brought an action against Fairbanks for violating the FTC Act, the Fair Debt Collection Practices Act, the Fair Credit Reporting Act, and the Real Estate Settlement Procedures Act (RESPA) . Fairbanks was accused of a host of improper servicing activities that will sound remarkably familiar to anyone following the foreclosure and servicing issues in today’s mortgage markets. Among the transgressions, Fairbanks was alleged to have:

-failed to post payments in a timely manner, resulting in additional late fees or interest,
-charging for forced place insurance,
-assessed improper fees, such as for attorneys, service, appraisals, FedEx,
-misrepresented the amounts owed by borrowers,
-submitted misleading or false information to credit reporting agencies,
-failed to report disputed charges to credit reporting agencies,
-failed to respond to borrowers written requests for information or investigation into charges, and
-failed to make timely payments of escrow funds for insurance and taxes.

The FTC intended the settlement with Fairbanks to provide guidance for the mortgage servicing industry for the boundaries of acceptable business practices for the treatment of borrowers, deadbeat or otherwise. The case introduced the notion of “predatory servicing” to an industry that had been previously more familiar with the notion of predatory lending. Following the settlement, mortgage servicers developed best practices based on the deal terms and, for a few years, it appeared that servicers generally followed them.

Roughly eight years later, the state Attorneys General are working on a settlement that covers remarkably similar ground as the Fairbanks settlement. In 2003, Fairbanks was enjoined from various activities, and the settlement terms included:

Fairbanks Settlement Order

-requiring the servicer to accept partial payments,
-requiring the servicer to apply borrowers payments first to interest and principal (ie a provision against fee pyramiding),
-prohibiting forced place insurance when the borrower already has insurance,
-prohibiting unauthorized fees to be charged to the borrowers, including continuing to charge late fees after foreclosure has been commenced,
-requiring the servicer to acknowledge, investigate and resolve consumer disputes in a timely manner,
-requiring the servicer to provide timely billing including itemization of fees charged,
-prohibiting the servicer from initiating foreclosure unless they’ve confirmed the borrower’s delinquency and no disputes remain outstanding,
-prohibiting the servicer from piling on late fees,
-prohibiting the servicer from enforcing certain forbearance agreements,
-prohibiting the servicer from violating the Fair Debt Collection Practices Act, Fair Credit Reporting Act and RESPA,
-requiring the servicer to correct wrongly classified accounts and credit reports, and
-requiring the servicer to audit and monitor its practices to ensure compliance with the settlement

In addition, the servicer was fined $40 million, which was used to establish a fund for harmed borrowers, and Fairbanks’ CEO and founder was fined $400,000 (and he was fired from the company).

Despite the tough regulatory enforcement action taken by the FTC back in 2003, many of the same “predatory servicing” practices have made a comeback. How likely are they to return again after the settlement put together by the attorneys general, which is less punitive than the FTC were in 2003, goes through?

I’ve pointed out how effective a non-negotiable posture can be, at least until the other side pulls out its ammo or threatens to walk from the deal. Most people in negotiations go on the assumption that the other side is reasonable or at least sincere (even if sincerely deluded) and will offer concessions on the assumption the other side will reciprocate.

The poster child of the usual outcome of offering concessions to a party who is non-negotiable is can be summarized in one word, as in “appeasement” circa 1939. And the ridiculous part is that the banks are being allowed to cop a ‘tude when the other side holds all the cards.

Let’s get this straight: this “settlement” should not be a negotiation. Virtually all the items in the 27 page outline of mortgage settlement terms that was leaked yesterday simply restates existing law or existing contractual obligations. If the officialdom wants to rely on mechanisms beyond the courts (since some judges are more pro-bank than others, which can produce the dreaded disease of “uncertainty”), the same results could be achieve by rulemaking without regulators or state attorneys general providing any releases from legal liability to the banks.

As banking/mortgage expert Josh Rosner said in an e-mail to clients:

Very high level sources within the CFPB point out that every item in this AG proposal could be required of servicers by CFPB rule-making. This begs the question, why release servicers and banks from claims and tie state Attorneys General for items that can be had free?

Following on that point, Iowa AG Tom Miller has apparently been unwilling to discuss the substance (even with the AGs) of the releases of claims he is asking the AG’s to sign onto. From the term sheet is seems that it is likely he is seeking to release claims not only related to robosigning but to other servicer practices and likely to front end assignment and underwriting issues.

The White House has supposedly begun to assist Miller in an arm twisting campaign to pressure state AGs to sign onto the agreement and release claims. We have heard that President Obama supposedly had a private meeting with Tom Miller and at least one Democrat AG who has been on the fence regarding the deal. For the White House to pressure state representatives appears to blur the lines between federal and state interests.

But instead of recognizing that their days of rule-breaking might be coming to an end, servicers are complaining bitterly, as Kate Berry tells us in an American Banker article:

Privately, mortgage servicers are fuming.

The proposed settlement agreement with state attorneys general and federal regulators, the companies will tell you, is unfair and impracticable.

I’ll spare you several paragraphs of the “but they were deadbeats and no one was hurt by robo-signing and all our foreclosures were warranted.” Well, if you normally operate as judge, jury, and executioner, and it’s too costly for borrowers to counteract predatory servicing, in your little self-referencing world, everything will look hunky-dory and challenges to your authority will be deemed to be improper and unwarranted. For borrower to fight “servicer driven foreclosures” on the issue of erroneous charges and the impermissible fee pyramiding requires hiring costly expert witnesses. That’s something beyond the reach of broke borrowers. So they fight the cases based on issues of standing, which allows the banks to preserve the myth that their records are always accurate. Estimates I’ve gotten from attorneys fighting foreclosures of how many cases they handle are the result of servicer driven foreclosure ranges from 50% to 70% (note that people who fight foreclosure more often than not feel they are the victim of origination or servicing abuse, and they want a mod, not a free home).

The interesting next bit is that Berry undermines the banks’ biggest excuse for not giving mods (emphasis ours):

Lawyers for the servicers maintain that the proposal does not distinguish between loans a bank services for itself and a loan it services for others. And servicers insist they don’t have the authority under the pooling and servicing agreements governing securitizations to do a great deal of what the proposal calls for them to do.

The servicers say they are not authorized by PSAs to make principal reductions on loans held in private-label securities, as the draft settlement calls for them to do, so the companies argue it is unclear if a proposed government settlement would override such contracts.

Industry lawyers are saying the AGs are “shooting the messenger.” But the industry has been pinning the blame for the glacial pace of loan mods on the alleged straightjacket of the PSA for several years now. And when pressed, officials quietly acknowledge that no one at a servicer ever goes back to the investors asking for authority. (It’s also worth noting that the regulators’ term sheet does try to address the issue. If a borrower requests a modification and the servicer believes the PSA prevents one, the servicer must still perform a net present value test and, when that test indicates a mod would be less costly than foreclosure, present that result to trustees or other authorized parties to obtain consent for a modification.)

Some PSAs do prohibit mods, some limit them, and some have no restrictions. The fact that the industry has never mad any effort to reduce principal is due to two reasons. First, their fees are set as a percentage of outstanding principal, so a principal mod works directly against their economic interests. Second, as we have discussed before, writing down a first mortgage would require a writedown of a second mortgage, and banks usually hold seconds on their own books. That writedown would be a hit to capital.

But it appears investors think this settlement is a great deal. And it is. Even if the banks wind up incurring the dreaded $20 billion among them and get a broad waiver from liability (not private suits, but regulators and AGs are far more logical parties to pursue some actions than others), this will be a steal.

As Barry Ritholtz pointed out:

Today’s bank rally lets you know exactly what the Street thinks about the proposed mortgage settlement. The big up could reflect the belief that it is a giveaway/bailout, and lets the banks get off scott-free from their criminality.

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.

By Richard Smith, a recovering capital markets IT specialist

Housing Wire’s Paul Jackson has another post up continuing his row with Yves over securitization chain of title issues. It presents itself as a rebuttal of her previous post, about an Alabama trial court decision that Jackson deems to be a significant defeat, but which Yves and more recently Adam Levitin have argued is both insignificant and not very relevant.

Normally I’d leave the two of them to slug it out. However, Jackson’s weekend submission, in which he says he is “going to address her latest talking points” piqued my interest. Rather than addressing any of the substance of the post itself, he mounts a bizarre attack on the motives of the attorneys behind the Alabama case, based on a pretty peculiar interpretation of one of Yves’ comments to the post. The comment:

Are you kidding? Each side spent over $250K on this case. Trials where you are making real legal arguments, as opposed to presenting papers for a judge to approve, are costly. And Alabama billing rates are a lot lower than in other states. For borrower’s counsel, since the borrower has no money, the “spent” is what their time was worth plus hard dollar expenses (experts witnesses and so on). They are out the real out of pocket real costs.

The banks’ lawyer gets paid, so yes, this is an epic fail for the bank. I’ve mentioned this in other posts. The more borrowers fight cases, the more loss severities are gonna rise. Investors already are losing 70% on the average foreclosure and housing prices are projected to fall further in most states this year. If on top of that they start having more cases with 300% losses on foreclosure, investors might wake up and finally do something a lot more serious to pressure servicers.

Sooo…bank attorneys run up a tab fighting a foreclosure in a pretty obscure courthouse, that results in a 300% loss to investors, when all the borrower’s attorney wanted was the house back and a loan modification. The big numbers are the result of the bank attorney’s posture, and of eleventh hour moves that many judges would have rejected: introducing an allonge on the eve of the trial. This was clearly a bad economic result for the borrowers’ attorney! It was not hard to see that the trial had become a war of escalation, with the bank’s attorney in an ideal position to up the ante. The post makes clear that unlike the bank’s lawyers, borrower’s counsel was “out”, in hard dollar terms, vastly less than the total, which would have to include the opportunity cost of unpaid for billing time.

For Jackson this somehow becomes the basis for a statement of his worldview: that everyone is greedy, ergo these attorneys must be too! In his own words:

Morality and the accompanying emotions to that noble love of justice are simply a varnish for the fires of greed. In other words, everything is about the money, and if you can find a viable angle to make more of it than someone else. And I mean everything.

Taking guidance from this exceedingly dubious, indeed self-refuting claim (if it’s all about the money, we can’t trust Jackson either, can we?) is quite foolish. In fact Jackson doesn’t really believe it either: elsewhere in his oeuvre, we find a bizarre exception to his rule:

Believe it or not, mortgage servicing is a noble industry. Or, at least, it’s supposed to be. Even in managing borrower defaults and repossessing property, there is something noble to the work, underneath it all — and it comes from following the law, enforcing contracts, ensuring that our nation’s system of property rights maintains its integrity for all Americans.

Though it could be that he’s just slapping a spot of varnish, on some fires of greed, for the money; I do hope that varnish isn’t flammable, Mr Jackson, or you may decide you are underpaid.

At any rate, armed only with his distractingly inept imagery and his defective moral compass, Jackson sets out on a fishing trip, in his latest, and gets hopelessly lost almost immediately:

Yves tries to suggest that in writing about the Congress case I was claiming “Mission Accomplished,” attempting to associate me with an infamous Dubya moment during the far-from-over war in Iraq. Nothing could be further from the truth.

If you have the attention span of a gnat, you might take this at face value. On the other hand, the very next sentence says this:

Yves spends a fair amount of time suggesting that the effect of the Congress case elsewhere will be muted, if it has any effect all. In attempting to minimize the relevance of this case, however, what she misses is an important reality: that the defense here saw fit to mount one in the first place.

So make your mind up, Mr Jackson: is the case widely relevant or not?

Or was the choice of court and case, perchance, simply something of a goof by some attorneys looking to develop a theory that might have more lucrative applications? That’s one sensible conclusion you could draw, and a basic step in puzzling that out, that does not even occur to Jackson, is doing some minimal research and actually looking up the plaintiff’s lawyers. And the idea that deep pockets types would go to of all places Alabama, not exactly known for cutting edge jurisprudence or friendliness to consumers, and hire two no-name attorneys to represent a black borrower, is beyond belief. If you are Jackson, though, you skip the homework, or the sanity check, and go for the ASF paranoia:

In many ways, the plight of the distressed borrower is a convenient lever to pull if — for example— you’re a buyside Wall Street firm that decided to load up with cheap nonagency mortgage-backed securities in the wake of the market’s collapse, betting on a mechanism that could open the door to damage claims and settlements worth more than the securities themselves. Or maybe a mortgage insurer looking for novel ways to repudiate claims en masse.

I’m not at all suggesting that’s what went on here…

I have a suggestion straight back at Mr Jackson: if you want to not suggest something, the best way is simply not to make the suggestion. Otherwise, it looks as if you’re trying to have it both ways.  Keeping the accusation vague is a smart move, admittedly, if you happen to be a bit clueless and not very brave. Bill Gross for one has made the trade that Jackson mentions, but does Jackson actually mean Bill Gross? He doesn’t say. Perhaps he doesn’t want Bill Gross on his case.

Yves by contrast doesn’t care a bit, roundly dissing Mr Gross’s self interested utterances. Ultimately, Jackson is too vague to be interesting here: it’s just a smear. As for the mortgage insurer theory: there’s no evidence for that either; just Tom Adam’s prior employment history and his occasional contributions at this blog. Mortgage insurers can make claims directly, on the very same theory that Naked Capitalism and the Congressional Oversight Panel have discussed. They have no reason to test a theory on a case in a largely irrelevant jurisdiction. And there are business reasons that the monolines are going the putback case route rather than this one. Remember that most of the MBS exposure (excluding CDOs) that monolines have is via HELOCs or second liens. That may put them in a position similar to that of the big banks: unwilling to take action on the first lien mortgages for fear of write downs on the second liens.

Yes, Bill Gross and MBIA and others are out there. And if they want to work the legals to make some money, or claw some back, they, or others like them, will. It’s really hard to see why the output of “Naked Capitalism” would so heavily in their ruminations as to be worth paying for (if that is what Jackson’s insinuating: he doesn’t seem to be able to bring himself to spell it out).

All of this stuff of Jackson’s is irrelevant and pretty much content-free;  but still, it’s an interesting glimpse of sell-side anxieties.

So what really matters about this case? Three things: the unfortunate Erica Congress, who has had her hopes dashed twice over now, once when she couldn’t pay her mortgage and a second time when she was turfed out of her house; and two blithe but pernicious affirmations by the judge: first, that an allonge doesn’t have to be affixed to the note, which just opens up the floodgates for document fabrication, and second that “digital signatures” are valid endorsements to the note.

Unfortunately, neither Jackson nor the judge seem to grasp the difference between a digital signature, “a mathematical scheme for demonstrating the authenticity of a digital message or document”, as Wikipedia has it, and a digitally reproduced signature, a simulacrum that can be knocked up in minutes by any sad sack in a servicer that can use Photoshop, Word, and a laser printer, and doesn’t authenticate anything at all, least of all a transfer of title. Using 21st century technology to recreate a state of screwed-up title that hasn’t existed in anglophone countries since the mid-17th century is nothing to crow about, Mr Jackson. As a citizen of the US, it ought to make your blood run cold. It’s not just about the money.

At any rate, the more this stuff is talked about, the more lawyers (in less frivolous jurisdictions) will furrow their brows about the damage being done to the integrity of basic property transfers. So we will keep the pot boiling.

Georgetown law professor and securitization expert Adam Levitin has weighed in on the ruling in an Alabama case, U.S. Bank v. Congress, in which a state court judge ruled against what we have called the New York trust theory. For readers new to this terrain, the short form is that the parties to mortgage securitizations are governed by a so-called pooling and servicing agreement. The PSA, among many other things, described how the notes (the borrower IOU) were to be conveyed to a trust that would hold them for the benefit of investors. The trust was almost without exception a New York trust. New York was chosen because its trust law is both very well settled and very rigid. New York trusts have no discretion in how they operate. Any measure undertaken that is inconsistent with explicit instructions is deemed to be a “void act”.

Now it appears that the notes were not conveyed to the trusts as stipulated in the PSAs on a widespread basis. (You can read the details here). Because the trusts are New York trusts, that means you have a really big mess. You can’t convey the notes in now, that’s not permitted because the trust had specific dates for accepting the assets that have long passed. The party that has the note (someone earlier in the securitization chain) can foreclose, but no one wants to do that. It isn’t just that this would be an admission that that parties to the agreement didn’t fulfill their contractual obligations; there is no way to get the money from the party that foreclosed to the trust and then to the investors.

Since the securitization industry has had so little good news of late, and this New York trust issue has the potential to make the chain of title problems that banks are facing in courtrooms all over the US even more acute, Paul Jackson of Housing Wire was quick to jump on this pro-bank decision as a major victory. We argued that it was probably not a significant precedent, and that some of the legal reasoning looked like a stretch, other parts were at odds with decisions in other states (meaning those states were unlikely to change course based on a lower-court decision in Alabama). But we acknowledged that parts of the decision were hard to parse and over our pay grade.

Levitin has taken an even more dismissive view of the decision (although since his writing style is more measured than ours, you need to read for substance, not tone). As he reads it, the judge rejected the borrower’s case on procedural grounds. That means it cannot be seen as a ruling against the New York trust theory. So effectively, the New York trust theory remains untested rather than defeated on its initial outing. As Levitin wrote:

Perhaps the most important thing to note about the opinion is what isn’t there. There was no consideration of the chain-of-title issue in the opinion. Let me repeat, the court said nothign about whether there was proper chain-of-title in the securitization. Instead, the court avoided dealing with it. That means that this ruling isn’t grounds for sounding the “all clear” on chain-of-title. At best, it is grounds for arguing that homeowners won’t be able to raise chain-of-title problems…

The court played on the procedural posture of the case to reject this argument. First, the court explained that because this was an ejectment action, not a foreclosure, the question of ownership of the note was not an issue of standing, but an affirmative defense for which the homeowner had the burden of proof. The trial court here was citing to a recent Alabama appellate court decision (reversing a previous Alabama appellate decision) that concluded that standing is satisfied by virtue of the bank being named party on the foreclosure deed. That’s just crazy given that the foreclosure deed is a nonjudicial sale. [G.S.—maybe this explains why your shop saw your notaries' seal forged on those foreclosure deeds.]

Crazy or not, however, this meant that the homeowner wasn’t actually challenging the trust’s standing. From there it was a small step for the court to say that the homeowner couldn’t invoke the terms of the PSA because she wasn’t a party to it…..

I don’t think there’s much to get excited about with Congress. If the homeowner had prevailed, the banks would have been saying “it’s just an Alabama state trial court,” and it might well have been overturned on appeal. But that doesn’t mean that the chain-of-title issue isn’t real. It just means that there’s still a search for the proper channel on which to advance the argument.

There’s more to his post, and I suggest legal types read it in full. There is an important discussion in it about the differing considerations regarding legal action on the note (the IOU) versus the lien (which is what allows the bank to make the foreclosure) that I want to address that in a separate post. It warrants some unpacking and further discussion.

Finally, he points out that investors have been getting their own reading on these legal issues and see them as valid, hence serious, concerns:

….numerous buy-side people (read MBS investors) have told me that they think there’s a serious problem with the securitization documentation. The problem that they have is that they don’t know what to do about it—they are trying to figure out a way that this can be used to put the mortgages back to the banks without it tanking the entire financial system. In other words, the banks are being protected by the too-big-to-fail problem. That’s letting them externalize their violations of their securitization contracts on MBS investors.

That suggests that investors are looking for the right leverage point on this matter but have yet to find one that is sufficiently surgical. Given how much they have at stake, I would bet they find it sooner rather than later.

We pointed last week to an analysis by Lynn Syzmoniak that showed that foreclosures across a number of different servicers were way down in January 2011 versus the same period in January 2010. This was admittedly a tally in only two Florida counties, but she indicated that a quick look at other counties in Florida showed a similar pattern.

So the question then becomes: is this a Florida only development, due perhaps in part the fact that all the big foreclosure mills in the state are under investigation by the state AG and are imploding (as in losing clients and shedding staff)? Or is this a broader trend due to the robo signing scandal leading judges being more receptive to arguments about chain of title and validity of transfers? Before, the assumption was “bank right, borrower trying to abuse the law to stay in house”. Now more judges, seeing that banks have run roughshod over legal requirements, are prepared to give borrower arguments a hearing. That forces banks to up their game, which in turn may be the real driver for this apparent slowdown in foreclosure actions. If that was the main driver in Florida, we’d expect to see similar patterns in other states.

We are seeing analogous developments, but the drivers appear to be state specific, as judges give adverse rulings on common practices in foreclosure land. Reader wc4d pointed to a report in the Portland Oregonian, that lenders are withdrawing cases because five court decisions have found that lenders that used MERS violated state recording laws.

This is a vivid illustration of a point made in an article on MERS yesterday by Gretchen Morgenson:

MERS was flawed at conception, those critics say. The bankers who midwifed its birth hired Covington & Burling, a prominent Washington law firm, to research their proposal. Covington produced a memo that offered assurances that MERS could operate legally nationwide. No one, however, conducted a state-by-state study of real estate laws.

“They didn’t do the deep homework,” said an official involved in those discussions who spoke on condition of anonymity because he has clients involved with MERS. “So as far as anyone can tell their real theory was: ‘If we can get everyone on board, no judge will want to upend something that is reasonable and sensible and would screw up 70 percent of loans.’ ”

As we’ve also noted, recording clerks in single counties in Massachusetts and North Carolina are looking into how to recover recording fees from MERS, but the cost of litigation means they’d need other counties in the same states to join or the state attorney general to take up the matter. By contrast, the Oregon decisions don’t hit small fry MERS; they are a big problem for the banks themselves. As the Oregonian reports:

Sales of hundreds of foreclosed homes in Oregon have been halted or withdrawn in recent weeks after federal judges repeatedly questioned their legality, according to a number of real estate attorneys in the state.

Lenders have withdrawn more than 300 foreclosure sales since February in Deschutes County alone, one of the Oregon area’s hardest hit by the housing collapse. About 130 of those notices were filed in the past week, attorneys say.

Dozens of foreclosure listings by ReconTrust Co., the foreclosure arm of Bank of America Corp., have disappeared from its website, attorneys say…

Since October, federal judges in five separate Oregon cases have halted foreclosures involving MERS, saying its participation caused lenders to violate the state’s recording law. Three of those decisions came last month, the key one in U.S. Bankruptcy Court in Eugene.

Attorneys say it’s not clear whether lenders in Oregon will simply start over or head to court to foreclose, steps that could prolong the crisis for months and drive up costs, attorneys say. Some suggest lenders might not have access to the documents they need to comply with state law.

“A lot of us are questioning whether there is a solution,” said David Ambrose, a Portland attorney who represents lenders in mortgage transactions. “It’s pretty amazing. There are a lot of unanswered questions.” ….

In Oregon, lenders can foreclose without going to court. But state law also requires that the loan’s ownership history, or assignments, be recorded with local county governments before proceeding with a nonjudicial foreclosure.

In the Eugene court case, Donald E. McCoy III filed for bankruptcy protection in part to block U.S. Bank from foreclosing on his Central Point home. He then sued the bank and MERS, along with his original lender BNC Mortgage Inc., claiming they had not properly recorded BNC’s subsequent sale of the loan to investors.

Chief Bankruptcy Judge Frank R. Alley III found McCoy’s allegation persuasive and refused to grant the bank’s request for a dismissal.

“Oregon law permits foreclosure without the benefit of judicial proceeding only when the interest of the beneficiary (lender) is clearly documented in a public record,” Alley wrote. “When the public record is lacking, the foreclosing beneficiary must prove its interest in a judicial proceeding.”

This looks like an epic fail for the banks, at least in Oregon. To save maybe $50 on recording fees, they are now going to have to go to court to foreclose. And worse for them will be cases where the records don’t pass muster. Recall that servicers advance principal and interest to investors when borrowers become delinquent. They then reimburse themselves out of the foreclosure proceeds. No foreclosure and they are out a lot of dough.

As Morgenson’s source indicated, the banks brazenly assumed that the courts would simply roll over rather than block the extra-legal imposition of a new system. But there is enough of a semblance of rule of law in the US to undermine all the cost savings and corners-cutting they engaged in. Recall this recent New York decision:

This court does not accept the argument that because MERS may be involved with 50 percent of all residential mortgages in the country, that is reason enough for this court to turn a blind eye to the fact that this process does not comply with the law.

The courts are delivering the banks an unrelenting series of deserved unkind cuts. This is getting to be interesting, and for a change, in a good way.

Paul Jackson has posted on a decision by an Alabama trial court involving the so-called New York trust theory that we have discussed at some length on this blog. Given how banks have been taking it on the chin ever since the robo-signing scandal broke, I suppose I’d be inclined to gloat a little, as Jackson does, in response to a verdict in favor of a bank; bank PR has been a particularly tough assignment these past few months.

But Jackson tries to treat this particular lower court decision as an important precedent, when this is anything but. In addition, Jackson evidently is not familiar the normal process of getting new legal arguments accepted in court, or of how decisions in one court are viewed in another. Finally, as I will touch on here and discuss at greater length next week, there are good reasons why it is unlikely courts in other states (or even Federal bankruptcy courts in Alabama) will look to this decision as a precedent.

Because Alabama is widely known to have an anti-consumer state court, a decision in favor of the borrower would be seen as far more surprising, hence noteworthy, than a decision in favor of the bank. Alabama used to be a state where juries in class action suits would give mind-numbing awards to plaintiffs. As a consequence, big corporations have labored mightily and successfully in repopulating the judiciary with more pro-business jurists. I’m told it has the most costly Supreme Court elections in the US. If nothing else, they are considerably more expensive to win than the gubernatorial election.

Second, it is not unusual for new arguments, particularly in unsettled areas of the law, to lose on their debut. Think how long tobacco and asbestos litigation took to start getting traction in courtrooms. Plaintiffs’ lawyers go through a learning process as determine what hurdles they need to overcome to persuade a judge or jury. And we’ve seen a similar process in the foreclosure crisis. Even though borrowers’ attorneys had been devising strategies to contend with robo-signing abuses since at least 2009 (it’s hard to find a start date on the specialists blogs), it was a non-issue until it was validated last fall and led most major servicers to halt foreclosures in some or all states (and even now, it appears that the pace of foreclosures may have slowed appreciably as a result of continuing documentation issues).

I will need to look at the trial transcripts and affidavits more closely, as well as confer with independent experts, but as an initial check, I sent the decision to a couple of attorneys who do not have a dog in this fight. One deemed the decision to be “amazing”, which in context is “amazingly bad”. The other thought the decision to be unlikely to be looked at as a precedent, and was critical of some of the key aspects of the legal reasoning.

US Bank v. Congress Order

This is merely a quick pass but let me flag three troubling issues which call the legal analysis into question. The first is on page nine. The Court sets up a straw man argument, that the borrower asked that New York law be used to determine the matter of ejectment. The borrower never took that position, so the matter was never in dispute. I received this comment by e-mail from a former Federal and state prosecutor:

….the PSA’s choice of law provision should control the threshold fact issue whether or not the promissory note is trust property. This basic fact issue is one that the trustee has agreed should be decided by New York trust law. The trust’s beneficiaries have every expectation when they purchase the trust’s certificates that the trustee will promote a uniform interpretation of the trust’s terms no matter where the forum.

In fact, it was discussed in the hearing at some length that the trustee was unable to establish conclusively which trust held the loan. There were multiple trusts created around that time by the same issuer that could potentially have owned the loan, and the same loan number appeared in two SEC filings (I need to reread the transcript on this issue but I do recall considerable time spent on this matter). Instead, the decision finesses this issue:

[w]hen GMAC referred the note to plaintiff’s attorney, GMAC informed her the Trust was the current holder of the Note.

In reality, the referral came from the default subservicer, Fidelity/LPS, and the subservicer’s identification of the trust is hearsay. How Fidelity/LPS came up with the name of the trust remains a mystery.

Second are the questions raised about a “tah dah” document appearing on the eve of trial (literally Thursday evening before Memorial Day weekend, when the hearing was the following Tuesday, which would normally be considered too close to trial to be permissible to introduce new evidence), namely, an allonge. For those new to the foreclosure mess, what laypeople call a mortgage has two legal elements: a promissory note, which the borrowers signs, and a lien on the property, which is in most states confusingly called the mortgage. In many states, and Alabama is one of them, the note is the critical instrument. You need to have legitimate rights to the note to be able to foreclose; the lien is a mere accessory and follows the note.

Notes are negotiable instruments, meaning to be conveyed from one owner to the next, they need to be signed, just like a check. They can be endorsed in blank (no specific party named, so whoever has possession could claim ownership) or to a specific party. The documents governing securitization, the pooling and servicing agreement, typically required that the note had to have the full chain of endorsement through multiple specific parties before it got to the trust, and this one was no exception.

Under the Uniform Commercial Code, an allonge, which is a separate document attached to a note to permit more signatures to be added, must be “affixed”. The language in the old version of the UCC was “firmly affixed”; most states have now adopted an newer version of the UCC which merely required “affixed.” The reason for concern is tampering. A note has clear monetary value; a note endorsed in blank is a bearer instrument. Notes are (or should be) handled as carefully as checks, particularly since they typically have considerable monetary value. If you could just assert “I have this piece of paper, it shows that check you have really was endorsed to me” you can imagine what mischief would result.

This part of the decision is a stunner:

In this case the allonge was attached by means of a rubber band and the instruments were together in a file folder. The court finds that the allonge in this case was adequately “affixed” to the note and the signature on the allonge a valid endorsement of the note.

To be clear, the note was in the collateral file at the beginning with other documents in between, and the allonge was at the end with a rubber band around the whole file folder, which was not all that skinny. What makes this a matter of concern is the mysterious appearance of this document at the eleventh hour when it was absent from bank’s evidence submission, after it became clear pre-trial, thanks to affidavits submitted by the borrower’s lawyers, that they were going to argue that there was no evidence that the note had been properly conveyed (as in the note lacked the needed signatures).

Now from what I can tell, there are no Alabama court precedents on allonges since the new UCC was put in place. Courts in other states that have adopted the UCC don’t accept the standard asserted by this judge. For instance, Massachusetts requires physical attachment. The Ohio appeals court recently also required attachment and looked to a Texas Supreme Court decision and an Arizona decision, both of which concluded the allonge needed to have been attached (there was discussion in the Texas decision that it was OK to detach the allonge that was known to be previously attached (presumably for purposes like photocopying) as long as there was good reason to believe tight controls had been maintained over the documents. Consider this section (page 20):

In contrast to Watson, no evidence was presented in the case before us to indicate that the allonges were ever attached or affixed to the promissory note. Instead, the allonges have been presented as separate, loose sheets of paper, withno explanation as to how they may have been attached. Compare In re Weisband,(Bkrtcy. D. Ariz., 2010), 427 B.R. 13, 19 (concluding that GMAC was not a “holder”and did not have ability to enforce a note, where GMAC failed to demonstrate that an allonge endorsement to GMAC was affixed to a note. The bankruptcy court noted that the endorsement in question “is on a separate sheet of paper; there was no evidence that it was stapled or otherwise attached to the rest of the Note.”) {¶ 68}

Third is the judge’s arguing for the use of digital signatures, which he acknowledges were evidently Photoshopped to fit on the allonge. Most states require so-called wet-ink signatures; indeed, I had been under the impression that that was close to a universal standard for real property transactions. Real estate transactions were specifically exempted from the Federal laws related to digital signatures for that very reason.

Jackson misses the fact that these fights over new legal issues are not battles but campaigns. And Jackson’s record at calling their outcome is on a par with the National Association of Realtors’ record on housing price forecasts. For instance, in October, he wrote:

The real fact is that the ‘robo-signing’ scandal is a procedural one, albeit one that offends the very nature of due process. That said, until someone can provide consistent and repeated evidence suggesting that the information contained within ‘robo-signed’ affidavits is factually incorrect — not just some of the time, but most of the time — the end result of this mess is nothing more than a very public, brand-damaging, headline-making procedural blip.

Jackson set the standard that one had to reach before anyone should take robo-signing concerns seriously was that the underlying inaccuracies had to be pervasive:

Thus far? Not a whit of credible evidence has been produced suggesting that foreclosure affidavits are factually incorrect on an endemic level. And this, despite a debtor’s counsel that for years has been actively and aggressively sniffing out every possible way it can to forestall foreclosures. If false debt amounts were being pushed by banks onto the courts en masse, and there was any credible evidence to support such a claim, you can bet all the apple pie in America that every single one of us would have heard about it by now — and well before anyone started to complain about the arcane technicalities of which nameless, faceless bank employee was signing a particular document.

As Barry Ritholtz argued pointedly, that’s the wrong standard. The process should be error free. No one should ever be at risk of losing their house to a documentation “mistake”. Real estate was historically deliberate and procedure intensive for a very good reason: these transactions were very important to the parties involved. And judges also taken issue with the idea that the proper submission of affidavits is merely “procedural”; this sort of casualness strikes at the heart of the processes designed to insure that evidence submitted to the court is accurate and reliable.

For instance, we pointed out that the state attorneys general and the Federal regulators did at most a cursory exam of servicers (knowing how hard it is to reconcile servicer records with borrower payments, the review of 2800 loans cannot have involved checking the integrity of servicer record and payment and their use of impermissible pyramiding fees). Thus the only abuses that they’ve apparently looked into are HAMP abuses (the Treasury was somewhat on the case, no doubt due to the ministrations of the Congressional Oversight Panel). So it appears that the authorities are pressing for principal mods at servicer expense (when as we’ve said, investors would be happy to see them go to viable borrowers) that would involve meaningful hard costs to the banks. If these abuses were the nothingburger that Jackson has maintained they are, why is the bank-friendly Administration pushing for these measures?

The problem with Jackson’s reading is he is so deeply invested in defending the securitization industry that it distorts his interpretations. Consider this statement from a recent post:

Believe it or not, mortgage servicing is a noble industry. Or, at least, it’s supposed to be. Even in managing borrower defaults and repossessing property, there is something noble to the work, underneath it all — and it comes from following the law, enforcing contracts, ensuring that our nation’s system of property rights maintains its integrity for all Americans.

In fairness, in the rest of the post, he did discuss how servicing had gone badly awry due to cost cutting pressures (which he blamed on Fannie and Freddie). But consider his assumption: he sees servicers playing a judicial role. That is in fact what has too often happened, and that’s wrong. Real property transactions are governed by the law, and the courts, not the servicers, are the mechanisms for enforcing contracts and upholding property rights. Richard Smith discussed at some length precisely why these procedures have remained the foundation of property rights for over 300 years.

We also have this:

By subverting our nation’s real estate law to favor borrowers who have no intention of fulfilling their debts, we risk undermining everything that establishes private property rights in our country — and perhaps the coup de grâce of it all is that the American public will be cheering when it happens.

Sorry, Paul, the overwhelming majority of borrowers who eventually default struggle to stay current and have every desire to meet their commitments. They don’t want a free house, they want a modification. And while many are hopelessly over their heads, some would be viable on a principal mod that would still put the investors ahead. That’s not my view, that’s the view of Wilbur Ross who has actually tried it.

It’s ironic that Jackson keeps presenting himself as the voice of reason, when in fact his world view is that of a one-sided morality where those with the most money are right. And on top of that he holds himself as a defender of law, yet frequently defends practices that undermine the very foundation of property rights. That stance is, at its core, unreasonable, unfair, and profoundly dangerous.

We are getting only odd tidbits out of the so-called settlement negotiations among the fifty state attorneys general, various Federal banking regulators, and mortgage servicing miscreants (meaning all of them). As Matt Stoller pointed out last weekend, the lack of transparency is troubling. Nevertheless, certain things are apparent.

1. There has not been anything even remotely resembling an investigation. As we have said earlier, the eight week Federal exam was a joke. As Adam Levitin noted:

…we don’t actually have a tally of servicer malfeasance. Neither the AGs nor the federal regulators have done the sort of investigation necessary to really know the full extent of servicer wrong-doings. Servicers might downplay the harms, but we just don’t know. This isn’t just robosigning. The banks forfeited their ability to make the “trust me” argument some point in fall of 2008.

How can you possibly settle when you don’t know the extent of the abuses? Yes, I know this is intended to be a whitewash, but in the stress tests, the Administration engaged in a lot of persuasive-looking theatrics to somewhat disguise the fact that the end result was pre-determined. This time, they aren’t even bothering to make the cover-up look credible. This is yet another sign of how the banks are effectively beyond the reach of the law.

2. The fact that the AGs and the Federal regulators have joined forces is another sign that no one has the guts to administer anything more than a slap on the wrist relative to the damage done. I should have realized Tom Miller, the Iowa AG who is acting as the leader of the AG effort, when he spoke warmly of the cooperation he was getting from Treasury in Congressional hearing last November.

The state and Federal issues are very different. It is one thing to coordinate, another to combine forces. The reason a joint effort is less powerful is that each group has the ability independently to do considerable damage to the banks. An effort with participants this disparate (the 50 AGs already have divisions within the group as to how tough to be on the banks, as do the Federal regulators) almost assures lowest common denominator, meaning less ambitious, demands.

3. The latest sign of the weak stance being taken by the supposed enforcers is that they have offered an outline of standards separate from an economic deal. From the Wall Street Journal:

U.S. banks received a 27-page proposal late Thursday from state attorneys general and several federal agencies that could require them to reduce loan balances of troubled mortgage borrowers, according to people familiar with the matter.

The document, sent to the nation’s largest mortgage servicers, doesn’t specify penalties or fines but instead represents a detailed code of conduct for how they must treat borrowers throughout the loan-modification process, these people said….

The proposal outlines formulas that would force banks to consider offering loan write-downs to troubled borrowers more regularly during the modification process. Banks have resisted reducing loan balances in part because of concerns that it could encourage more borrowers to stop making payments in order to receive smaller loan.

This is not normal negotiating process. You put all your demands on the table at once. And as much as the banks might howl, the authorities have the upper hand. Their timidity has very little to do with what could or should be extracted from the banks and everything to do with the authorities being reluctant to inflict much pain (or in the case of the OCC, being completely captured by the banking industry). This posture, that the powers that be cannot ask too much of those fragile banks, is completely contradicted by the fact that the banks have apparently gotten the New York Fed to agree that they are in such robust health that they should be permitted to increase dividends.

So you might still ask, why is it bad to put this part of the deal out first? Aha, see what is at work. The enforcer types have said “This is what we want you to do.” They might fight over details, but the next step is the banks will say, “That is gonna cost us $X.” That will then be traded off against any settlement amount that this group had in mind.

Of course, given how terrible the bank compliance was with HAMP and the failure of Treasury to set goals, supervise properly, and claw back payments to servicers, any “$X” that the banks say they will lose as a result of any new programs will wind up being much larger than the costs they actually incur.

Frankly, the best we can hope for is that no deal results. The Arizona Senate, by a 28 to 2 margin, passed a bill that would void foreclosure sales that lacked a full title history. The language is draconian:

ANY PERSON WITH AN INTEREST IN THE TRUST PROPERTY MAY FILE AN ACTION TO VOID THE TRUSTEE’S SALE FOR FAILURE TO COMPLY WITH THIS SECTION AND IS ENTITLED TO AN AWARD OF ATTORNEY FEES AS WELL AS DAMAGES AS OTHERWISE PROVIDED BY LAW IF THE PERSON SUBSTANTIALLY PREVAILS, INCLUDING AN AWARD OF ATTORNEY FEES FOR ANY INJUNCTION OR OTHER PROVISIONAL REMEDIES RELATED TO THE CLAIM.

The award of attorney’s means servicers have a lot to lose (sadly, the losses on the inability to foreclose are borne by the investors, not the servicer). If the failure to convey notes to trusts is as widespread as we believe it to be, having one or two of the epicenters of the foreclosure crisis effectively halt foreclosures (by only letting servicers that really do have standing to proceed), investors are not likely to take that sitting down. This may force them to pull the trigger and take action against trustees for falsely certifying that notes had been conveyed to securitization trusts in accordance with the terms of the pooling and servicing agreement.

Thus you could expect the banks to start offering mods if they had the sort of pressure on them that this legislation would provide, and indeed that might be happening. A reader in comments said Bank of America had suddenly gotten religion about offering mods. And having banks offer mods quietly, on a case by case basis, is less likely to produce resentment by other homeowners than a highly visible program. Of course that assumes the banks become competent at doing mods. They’ve had every reason to be bad at them, since saying they can’t possibly work operates to their advantage.

So we can hope that the banks overplay their hand, and that it results in no deal, but the Administration and the attorneys general are not doubt very eager, in classic Vietnam “peace with honor” fashion, to declare victory and go home. So the next best hope is that some of the AGs break rank with this “settlement” and declare it to be the farce that it so patently is.

The propaganda strategy for selling the public on the creation of supposedly new improved GSEs is becoming more apparent. Recall that we had an initial skirmish a month ago, when the Center for American Progress published a plan to reform Fannie/Freddie and the housing finance system. It would create an FDIC-like insurance fund to stand behind private Fannie/Freddie like entities that will offer reinsurance with an explicit Federal guarantee on mortgage-backed securities. These new firms can also be controlled by banks.

This plan, which was very similar to ones presented by the Mortgage Bankers Association, the Federal Reserve and the New York Fed, t was clearly an Administration trial balloon; the CAP is the mainstream Democrat think-tank, with close ties to Team Obama. But after the CAP proposal got some resistance, the Treasury’s report, which came later in the month, went the route of presenting three alternatives rather than a specific plan. But we argued at the time that this seeming change was merely a tactical move, to present the Administration as fair brokers in a politically fraught process, and that it still favored what we called the GSE 2.0 plan.

We think the idea of reconstituting the GSEs in somewhat improved form a terrible idea because it preserves the bad incentives of a public/private system and launders housing market subsidies in an inefficient and unaccountable way through the banking industry (see here and here for more detailed discussions).

So now the challenge for the Administration is to sell this plan without looking like it is selling it. Timothy Geithner set expectations for a long process by saying that the Administration wanted legislation approved in two years. Huh? Nothing important (except extortion exercises like the TARP) gets passed in the months before a Presidential election. Early summer 2012 is the last viable window in this Congress. That’s a lot less than two years, according to my calendar. So more than 16 months is guaranteed to be more than two years. But the message from Geithner is to expect this to take a long time, and that is consistent with trying to build support for their preferred option, which is to create new mini-me GSEs that are made to look more palatable by having better balance sheet support.

The more official PR salvo came in the form of a front page New York Times article, “Without Loan Giants, 30-Year Mortgage May Fade Away.” The argument is that without a government guarantee, there would be no thirty year mortgage in the US.

That might actually be true, but the reasons why provide further proof that this proposal is just another example of throwing taxpayers under the bus to save the banks from suffering the consequences of their incompetence and criminality. We have gotten increasingly specific reports from mortgage investors that they aren’t buying residential mortgage bonds due to the lack of securitization reforms. We have further been told by an industry expert that investors are very worried about the chain of title issues that are leading to gridlock and more and more adverse decisions on standing issues in courthouses all over the US. The only reason they haven’t acted is that they fear applying more pressure on this front will ignite a new financial crisis.

So let us be VERY clear about this: this is GSE non-reform. It’s merely reconstituting the GSEs with better capital cushions but also a full faith and credit guarantee on their mortgages, which is a better backstop than Fannie and Freddie enjoy now. And the only compelling reason for continuing to offer government guaranteed mortgages is to escape exposing and cleaning up mortgage and securitization industry abuses.

The Times is running with the biggest and best threat the fans of this plan can come up with: that the US will lose its much-loved thirty year mortgage without it. We have a new version of TARP type extortion tactics, that of Bill Gross claiming that investors would demand three percent more to invest in mortgages without government guarantees. That’s patently untrue even now. Jumbo mortgages, which were never GSE guaranteed, are now being done at a 75 basis point (3/4%) premium to Fannie and Freddie mortgages (the premium before the crisis was 25 to 40 basis points).

A government guarantee also comes with not-widely recognized systemic risk. Freddie and Fannie engage in hedging on a massive scale to manage the interest rate risk of their exposures. This hedging iss “pro cyclical”, which meant it increased the amplitude of interest rate movements. In 2002 and 2003, Fannie and Freddie hedging had reached the scale where it was economically destabilizing. And as John Dizard described in the Financial Times in 2008, this interest rate risk was also a hazard to Fannie and Freddie themselves.

We can also look to the example of other markets to challenge the need for the new GSEs. No other market, save Canada, has a government mortgage guarantor (I am in the process of trying to read the expert on this topic, since it’s apparently a complicated program). Yet they all have long-dated mortgage products, virtually all also have a high level of middle class homeownership, some like Australia even higher than the US, with no Freddie/Fannie equivalent or other form of large scale government mortgage guarantee program (and you can verify the sort of mortgage products you can get overseas readily; here’s a search tool from Australia, for instance).

The Treasury document subtly argued that it was important to preserve the thirty year fixed rate mortgage, and the New York Times picks up this argument. But a thirty year fixed rate mortgage is not always the best product for borrowers. An adjustable rate mortgage, particularly one with floors and ceilings on interest rate movements (which was a staple of co-op loans in New York in the early 1980s) would in many cases be a better deal. But only a right wing economist (Alex Pollock of the American Enterprise Institute) makes this case; the opposing argument from Susan Wachter, that “There needs to be a systematic way of preventing” fragmentation,” is peculiar and unconvincing. Are the mortgage markets in Britain, Australia, France, and other countries “fragmented”? How exactly are consumer hurt by having more choices? We seem to think that’s a good thing in toothpaste and credit cards; why not in mortgages?

For reasons I cannot fathom, the traditional affordable housing-banking coalition is still holding together on this issue. It should be clear by now that affordable housing programs and mortgage finance are two separate beasts, and the extent of the sops demanded by the banksters mean affordable housing goals will take a back seat. The government should be out of the mortgage finance business; the taxpayer should not backstop risks when foreign markets show that the private sector can handle them perfectly well on its own. Housing subsidies, like the old Section 8 program, can be used to advance important social goals, and should be provided as government programs, with clear targets, performance measurement, and accountability, not as contingent liability timebombs.

I must confess I get a perverse sense of satisfaction from watching MERS suffering pushback on a variety of fronts. The latest, as we mentioned a few weeks ago, is the prospect of litigation by various local governments asserting the right to the recording fees that the MERS system bypassed.

The press release below is from the Guilford County Register of Deeds in North Carolina. As you can see, he is exploring the county’s options for recouping recording fees he believes that MERS owe to Guilford County, to the tune of $1.3 million (hat tip Lisa Epstein via ForeclosureFraud).

I particularly like this sentence:

“Do we want land records in America to be governed by major banking conglomerates on Wall Street or the people and laws of the United States of America?”

As we have indicated, MERS is far from a deep pockets target. And no one has yet filed a lawsuit; litigation is an expensive proposition for both parties. You could easily see the county spending more that it could possibly collect in legal costs.

The real question is whether a clever lawyer can find a legal theory that would allow the local governments to sue not just MERS but one of the parties that benefitted from the MERS process, presumably the sponsors. And then you’d need to file it on a class action basis so that the legal cost divided over a large number of plaintiffs would still allow for reasonable recoveries.

Thigpen to Take on MERS, Mortgage Giants