On Wednesday, three federal regulators -- the Federal Reserve, the Office of Thrift Supervision, and the Office of the Comptroller of the Currency -- released an enforcement order against 14 of the nation's largest banks and two third-party service providers for persistent irregularities and outright fraud in the way they process mortgages. These regulators are, respectively, the gang that missed the housing bubble, American International Group's overseer (whose colossal lapses caused it to be disbanded in last year's financial-regulatory law), and an entity most recently headed by a former bank lobbyist. The product of their deliberations, then, is no surprise: a toothless federal consent decree that essentially lets the offending banks off the hook and puts them in charge of their own prosecution.
And yet, paradoxically, this weak consent decree could be the best chance for accountability in the mess that banks have made of the housing market.
It certainly wouldn't appear that way on the surface. The banks' sentence is confoundingly light: They have to promise not to do any of this criminal activity again, and they get to set their own terms for compliance. As The Nation's Chris Hayes said on MSNBC when the order was leaked last week, "Imagine for a moment all the people accused of robbery in this country who would happily take the same deal."
It gets worse. The consent decree holds out the possibility of future monetary sanctions, but only through an outside review from an independent third party -- paid for by the banks themselves -- that will determine how much money each servicer must pay back homeowners for wrongful foreclosures. If the bank-funded investigator finds no wrongdoing, the investigation would end there. In fact, that outcome would likely be a prerequisite for the bank to hire the investigator. To extend Hayes' metaphor, the robber would only have to do jail time if someone funded by the loot concluded that he stole it.
The consent decree is based on a months-long interagency review of foreclosure policies and practices, which found that servicers "failed to conform to state legal requirements." But the review basically stopped at robo-signing and other forms of document fraud; it didn't investigate the illegal imposition of fees, failure to comply with loan-modification requirements, or a host of other alleged servicer abuses. In fact, the regulators only looked at a small sample of the loan files containing key information on foreclosure practices, never asking to review all foreclosures. They relied in many cases on the banks' self-evaluation of those files.
This inadequate settlement undermines the other major investigation of foreclosure fraud, headed by a group of state attorneys general. Initially, there were hopes of a "global settlement" covering state and federal regulators, but the agencies, led by the OCC, broke off from that and delivered this consent decree. While the federal regulators and the attorneys general maintain that this order won't affect their probe, now the banks can say that they've already been punished for violations of law, that an independent review is determining damages, and that they won't agree to an additional settlement when they've already been cited by their regulators.
But it may be advisable to give the state attorneys-general investigation a decent Viking funeral. The settlement, leaked in a 27-page term sheet last month, was undertaken without any real investigation of the industry, offered very similar servicing guidelines to the OCC consent decree, and low-balled the penalty, imposing a mere $20 billion to $25 billion in principal write-downs for underwater homeowners and an undetermined fee for those wrongfully foreclosed upon. Several attorneys general on both sides of the aisle were concerned over what they would have to give up in the exchange. Some, like New York's Eric Schneiderman, balked at limiting the pursuit of allegations of wrongdoing as a condition of the settlement. Overall, it was hard to see how enough attorneys general would sign on to the settlement to give it any meaning.
The federal-state hybrid action was never a good fit, as they have different roles to play and mandates to honor. With that off the table, the attorneys general can focus on protecting their constituents. They don't have to follow the federal preoccupation with the safety and soundness of the banks. If the attorneys general cannot come to an agreement with the banks or among themselves, those interested in doing their jobs can go to court to prosecute fraud and violations of state consumer protection laws. Several states have already done this. Ohio sued Ally Financial for fraud back in October; Nevada and Arizona have an ongoing case against Bank of America for servicer abuse; Schneiderman just subpoenaed two "foreclosure mill" law firms in New York; and even Republican Rob McKenna in Washington state just announced the discovery of unlawful business practices by foreclosure trustees.
These investigations have a better chance of providing bank accountability than a rushed settlement with questionable enforcement capacity. And the courts have already begun to play a role on a state-by-state basis. Judges across the country are becoming wise to the consistent fraud in the processing of foreclosure documents, with forged signatures, false affidavits, misdated notarizations, and the like. In a landmark case this week in a Louisiana bankruptcy court, Lender Processing Services (LPS), one of the key document producers for foreclosures, was found to be committing fraud with phony affidavits and foreclosure documents and will be sanctioned for its conduct. The judge in the case, Elizabeth Manger, wrote, "The fraud perpetrated on the Court, Debtors, and trustee would be shocking if this Court had less experience concerning the conduct of mortgage servicers. One too many times, this Court has been witness to the shoddy practices and sloppy accountings of the mortgage service industry."
The lack of a global settlement allows the legal process to occur organically, letting the law work in the states rather than preempting it. In at least one case, the federal settlement might even facilitate this. The OCC consent decree against LPS affirms that the company created inaccurate and improper foreclosure documents, which "constitutes unsafe and unsound business practices." Now homeowners can refer to that consent decree when they challenge foreclosure documentation in court. If the result is that foreclosures are dismissed en masse, the banks and their servicers may suddenly come around to the value of principal write-downs to cut their losses.
Involving the industry-friendly federal regulatory apparatus in foreclosure fraud could only lead to a bad outcome; the OCC order serves to prove that. But it may end up doing everyone a favor. By taking ineffectual action off the table, the consent decree empowers the legal process -- the only process equipped to bring about justice in the housing mess.