Hidden Gems in the Mortgage Deal

In the end, as at the start, Thursday’s deal between five big banks, the Department of Justice, and the attorneys general of 49 states came down to New York, the center of mortgage securitization and securities misrepresentation, and California, the center of mortgage mis-origination. Those states’ attorneys general—New York’s Eric Schneiderman and California’s Kamala Harris, both progressive Democrats elected in 2010—weren’t about the give the banks a pass. Which is why it wasn’t until two a.m. Thursday that the deal was finalized.

Schneiderman’s chief concern was to preserve and enhance his and other law enforcement agencies’ ability to investigate the banks. Harris’s foremost interest was to secure the best deal for the hundreds of thousands of California homeowners who were struggling to make the payments on their devalued homes. Together, they compelled the banks and the Obama administration to come up with a better deal than the one that the banks and the Justice Department had initially sought.

Looked at in vacuo, it’s not much of a deal. Five of the biggest home lenders—Bank of America, JP Morgan Chase, Wells Fargo, Citigroup and Ally Financial (formerly GMAC)—have agreed to pay $26 billion for abuses (such as robo-signing and not having clear title) in foreclosing on homes between 2008 and 2011. Most of that money will be offered as principle write-downs to the roughly one million homeowners on whose devalued homes those banks hold the paper—an average reduction estimated at about $20,000 per homeowner. The approximately 750,000 homeowners whose homes were already foreclosed by those banks will be getting checks of about $2,000 each. The $26 billion is a little less than 4 percent of the estimated $700 billion in underwater mortgage debt in the U.S.

So, in itself, no big whoop. Indeed, no whoop at all.

But the deal should be looked at as much for what it doesn’t do—for if it doesn’t even begin to provide adequate compensation for America’s beleaguered homeowners or former homeowners, neither does it preclude those homeowners from lawsuits of their own, or, more important, does it put an end to the civil and criminal liability of the banks for all they did to misrepresent mortgages both to homebuyers and investors in mortgage-backed securities.

Initially, the banks sought a release from all liability as a condition of signing on to the deal, and the administration did not push back against them. Several state attorneys general did—chiefly New York’s Schneiderman and Delaware’s Beau Biden, who had jurisdiction over the country’s biggest banks and insurance trusts, and California’s Harris and Nevada’s Catherine Masto, who represented the states with the highest incidence of foreclosures and the greatest drop in home values.

On the eve of President Obama’s State of the Union address, Schneiderman secured a commitment from the administration that the settlement announced yesterday would not release the banks from their liability for crimes committed in the origination and packaging of mortgages, and a further commitment from the president to set up a joint task force of attorneys and investigators from several state attorneys general offices, the Department of Justice, the FBI, the SEC, and the Consumer Financial Protection Bureau to delve into possible bank misconduct and bring cases if and when they found it. During the two weeks that followed, negotiations on the settlement continued, and Schneiderman made it very clear he would continue new lines of investigation when he filed late last week against Bank of America, JP Morgan Chase, Wells Fargo, and MERS—the Mortgage Electronic Registration System, which the banks established to expedite mortgage securitization and into which the legal title to properties were fed, often never to be seen again. Coming on the eve of the deadline for a settlement, the lawsuit drove the banks to paroxysms of fury—but facing the prospect that the deal would not include New York’s attorney general, the banks blinked. Schneiderman’s suit can proceed unimpeded by the settlement, and the joint task force’s work continues apace.

California’s Harris, too, won an agreement that enables her office’s sizable investigative unit to go after misdeeds in mortgage origination and packaging—including, under the terms of the California Fair Housing Act, the provision of subprime mortgages and other forms of predatory lending to particular classes of homebuyers. But with vastly more homes underwater than in any other state, her other chief concern was the size of the settlement. Last September, she withdrew from the negotiations because the banks' offer—at that time, roughly $20 billion—was too low. After reviewing the negligible consequences of an earlier settlement between Countrywide, a mortgage-security company bought by Bank of America, and homeowners it had wronged—despite agreeing to get $3.4 billion to homeowners in mortgage modifications, few of those homeowners actually received any significant relief, and many were foreclosed upon nonetheless—Harris also insisted on strong implementation safeguards and specifications if any deal was to go forward.

For months, Harris declined to negotiate with the banks. About ten days ago, with the deadline for a settlement looming and in the wake of the administration’s commitment to set up the joint task force and to hold the banks liable for pre-crash offenses, her talks with the banks and the administration resumed. Roughly 300,000 of the million underwater homeowners who’ll be compensated by the banks live in California, and Harris secured roughly $12 billion for those California homeowners in principle write-downs, with the stipulation that the banks would be penalized if the process took longer than one year, and the further stipulation that the money would go first to the 12 California communities with the highest foreclosure rates—chiefly, Inland Empire cities like Riverside and San Bernardino, and Central Valley cities like Stockton and Merced, which have among the highest incidence of foreclosures in the nation.

In the division of labor on the coming investigation of bank abuses, Harris and Masto will likely take the lead on fraudulent and lax origination—more of which took place in their states than anywhere else—while Schneiderman, Biden, and the Feds focus more on the misrepresentation and fraudulent marketing of mortgage-backed securities and derivatives. The mansion of financial fraud has many rooms, and since Thursday’s deal did not seal them off, Harris, Schneiderman, U.S. Attorney General Eric Holder, and Company will be looking into them in the months to come.

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