March 18, 2012
Who is REALLY paying in the $25bil TBTF mortgage settlement

The surprising tale that I will attempt to pen in this blog entry has a very familiar cast of characters; the Obama Administration, the Housing Bubble, “Toxic Mortgages”, and Too Big To Fail “TBTF” Banks among others.  While the headline of TBTF banks in a $25bil mortgage settlement is known to many, the underlying details of the settlement are less known and quite appalling when you pull back the covers.

The wounds on past and present homeowners are still fresh from the housing crisis.  As Jonathan Laing points out in this weekend’s Barron’s cover story, “five million of the country’s 76million mortgage holders have lost their homes to foreclosure or lender ordered short sales since 2006, and an estimated 14million more own more on their homes than their properties are currently worth.  In all, some $7.4 trillion in homeowners’ equity has been destroyed according to Mark Zandi…”  

Cries for Accountability

While blame deserves to be cast upon numerous parties for the housing bubble, Americans have rightly called for accountability on the TBTF banks.  Accountability for what? Among other faults, robo-signing became prevalent among TBTF banks as they forged mortgage documents in order to ensure proper paperwork was done to foreclose on properties. 

Details of the $25bil Settlement (in the words of HUD) & Public Lauding

"On February 9, the Department of Justice, the U.S. Department of Housing and Urban Development, other federal agencies, and 49 state attorneys general announced the largest federal and state settlement agreement in history with the five major mortgage servicers for their mortgage servicing practices. The agreement has the potential to help nearly two million American homeowners through a variety of means, including loss mitigation tools such as principal reduction and refinancing of loans for borrowers who owe more on their house than it is worth (“underwater” homeowners), payments of billions of dollars to federal and state parties, and payments directly to individuals who lost their homes to foreclosure and meet certain other criteria." The public seemed to buy right into this news.  After all, $25bil being paid by the bank sounds pretty tough right? Upon news of the $25bil Mortgage settlement many media members gushed over President Obama’s “accountability” of these banks.  President Obama said himself that it was about “standing up for the American people” and “holding those who broke the law accountable.”

What’s the Truth?

Only $5bil of the $25bil is actual cash being paid out by the banks.  The banks earn “credits” for the remaining $20bil by modifying either loans that they own on their own books or securitized private label MBS that they service. Which will they choose to modify?  Alison Frankel described the incentives last week in this article, “Banks receive a $1 credit for every dollar of principal they reduce in a loan they own outright. They earn a 45 cent credit for every dollar written down on a securitized loan. That incentive, in combination with the strictures of the pooling and servicing agreements with investors, was intended to limit the number of securitized mortgages the banks would modify.”  The major question you should be asking yourself, and the overall premise of this article, is why are non-agency mortgage investors who did no harm being asked to foot the bill for the sins of the TBTF robo-signers?  If you were a bank holding a loan at par, would you rather modify a given loan and take a dollar for dollar capital hit to get a credit towards the $20bil bogey, or modify twice as much of a MBS holders loan that you service (taking no capital hit yourself) and get the same credit?  As former SIGTARP Neil Barofsky tells Bloomberg, ”this would be comical if it wasn’t so tragic”.

Massive 1st Lien vs 2nd Lien Conflict of Interest-  It isn’t even as simple as an “all else equal” decision for banks. Frankel continued to hit the nail on the head “Most securitized mortgages, remember, are first-lien loans. The vast majority of second-lien loans, by contrast, are bank-owned. When banks reduce the principal in a first-lien mortgage, they improve their own prospects as a second-lien holder….The Association of Mortgage Investors highlighted the conflict between first and second lien owners in a statement issued immediately after the settlement documents were released. “The settlement is expected to also draw billions of dollars from those not a party to the settlement (because) it places first and second lien priority in conflict with its original construct,” the AMI press release said. “It is unfair to settle claims against the robosigners with other people’s funds.”  

Curious Responses By HUD, Frustration for Main Street Investors

-On a mid-February conference call, the HUD’s secretary Sean Donovan reportedly promised the MBS bondholders on the call that a maximum of 15% of modified loans by the five banks could be on securitized loans.  Others were under the impression that the final settlement would have this 15% cap in writing.  Needless to say, when the final report was released, there was no sign of any limit.  ”If we’ve missed (documentation of the 15 percent cap), please Secretary Donovan, let us know where it is,” said Vincent Fiorillo, a portfolio manager at DoubleLine Capital and president of the board of the Association of Mortgage Investors.

-Just this past week, and presumably in response to heat they are feeling, the HUD put out a "Myth vs Fact" blog post on the HUD website. A few curious statements are written within the modifications within securitized trusts section including: 

"…principal write down modifications must be NPV positive…".  If these loans are NPV positive, shouldn’t they have been modified already?

"…Fourth, 2nd liens are written down according to HAMP 2MP. Fifth, 2nd liens greater than 180 days delinquent are extinguished."  Why is it even a question of whether 1st liens or 2nd liens should be extinguished first?  Further, there are ways for banks to avoid having 180 day delinquent loans in second liens. They can either change the amortization to negative-am or simply advance to make them current.

-The AMI, Association for Mortgage Investors, reportedly reached out to numerous Attorney Generals with no success.  It’s easy to see the frustrations of this organization which represents pension funds, mutual funds common in 401k plans etc…As they write on their website, “AMI supports long-term, effective, sustainable solutions to the housing foreclosure crisis. It is generally supportive of a settlement if it ensures that responsible borrowers are treated fairly throughout the foreclosure process; while at the same time providing clarity as to investor rights and servicer responsibilities. The ultimate settlement should ensure that our clients, who were not involved in the alleged activities and, who likewise were not a participant in any negotiations, do not bear the cost of the settlement. Specifically, mortgage servicers, if at all, should only receive limited, reasonable credit for modifying mortgages held by third parties, which are often pension plans, 401K plans, endowments and “Main Street” mutual funds. To do otherwise, will damage the RMBS markets further and limit the ability of average Americans to obtain credit for homes for generations to come.”  I’d have to take the side of AMI here as it appears that they are willing to work with the AG’s, HUD, and the White House to find the best solution possible.

Detrimental to Resumption of Private-Label Mortgage Finance?

The irony of this whole debacle might be that the AG’s and Obama Administration could be missing “the forest for the trees”.  With private-label mortgage investors potentially bearing the costs of this settlement, could this shake the confidence of a resumption of private label origination?  The GSE’s have been under fire and continuous cries have been heard for the eventual wind down, if not at least a reduction of the reliance upon them  A healthy private MBS market would be essential to any move away from nearly complete reliance on the GSE’s.  Placing the costs of the settlement on the very investors who are an integral part of the private label MBS market is NOT a way to instill confidence.

Summary

It’s hard to believe that such decisions are being made on such a hot button issue.  I suppose the general public sees the $25bil stick and assumes the Banks are being appropriately punished.  In reality it is quite the scam.  The Attorney Generals and White House look like they are dropping the hammer on evil Wall Street TBTF banks while simultaneously sticking up for the average American borrower.  The banks pretend they’re paying the price for past sins (with the money of the victims, the investors). 

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