Journalism in the Public Interest

In Proposed Mortgage Fraud Settlement, a Gift to Big Banks

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Lurking in a proposed mortgage fraud settlement with the state attorneys general is a clause that could be worth billions for the big banks.

Yes, I mean the settlement that might extract the supposedly large sum of $20 billion from the banks to settle foreclosure fraud. The one denounced as a "shakedown" by Sen. Richard Shelby of Alabama.

Despite such rhetoric, the settlement might let the banks avoid tens of billions of write-downs, thanks to a clause with a biblical flavor: the last shall be first.

The proposed agreement -- which is preliminary and subject to intense negotiations being led by Tom Miller, the attorney general of Iowa -- would allow banks to treat second mortgages, like home equity lines of credit, just like the first mortgages. Under the proposal, when a bank writes the principal down on the first mortgage, the second should be written down "at least proportionately to the first."

Suddenly, the banks would be given license to subvert the rules of payment hierarchy, as Gretchen Morgenson pointed out in The New York Times on Sunday. Yes, the clause says the other alternative is to wipe out the second's value entirely, but given a choice, the banks would be extremely unlikely to do that.

So how is this a gift? Because when the principal on the first mortgage is reduced, the second lien is typically wiped out. The first lien holder has the first right to any money recovered, and the second lien holder has to wait its turn.

The proposal "seems astonishingly generous to the second-lien holders," said Arthur Wilmarth, a law professor at George Washington University. "And who are those? Of course, they are the big mortgage servicers."

And who owns the big mortgage servicers? The biggest banks. Throughout the financial crisis, we have heard plenty of intoning about the sanctity of contracts. But this suggests that the banks, with the authorities' tacit approval, think contracts are for thee and not for me. The price to get the banks to do the right thing contractually with mortgage modifications and foreclosure is to allow them to not do the right thing elsewhere.

To understand the significance of this issue, cast your mind back to the height of the housing bubble. People used their homes as A.T.M.'s, withdrawing billions from their equity to finance motorboats and meals at Applebee's.

The top four banks now have about $408 billion worth of second liens on their balance sheets, according to Portales Partners, an independent research firm specializing in financial companies. Wells Fargo, for instance, has more money in second liens than it has tangible common equity, or the most solid form of capital. If banks had to write these loans down substantially, acknowledging the true extent of their losses, they would have to raise capital -- and might even teeter on the brink of insolvency.

The performance of second liens is among the biggest puzzles in banking today: why are they doing better than the firsts? When Wells Fargo disclosed its earnings, for instance, it classified 5.3 percent of its first mortgages as nonperforming, but put only 2.4 percent of its second liens in that category. That seems very odd because it's much easier to lose your home if you don't pay your mortgage than if you don't pay your home equity line.

Investors are deeply skeptical about the value in these loans, bidding about 50 cents on the dollar for them these days. Even allowing that banks probably hawk the least attractive loans and that investors bid low to generate a high return for the risk, many of these loans are still probably not worth 100 cents on the dollar.

Yet banks have taken relatively few write-downs on second loans so far. In fact, even when the first clearly is in trouble, sometimes the banks appear to resist writing loans down. Bill Frey, who runs Greenwich Financial Services, has instigated lawsuits to try to recoup the value of mortgage securities by getting the banks to buy back faulty mortgages that were in the pools he examined. He analyzed mortgage securities made up of loans by Countrywide Financial, which is now owned by Bank of America, looking for instances when the second lien was still extant, even though the first lien attached to the same property had been modified. Such a situation would suggest that a bank was not marking down a second lien even when the underlying, more senior first lien was impaired. He says he found multiple instances in every one of the 200 pools he examined.

Mr. Frey argues that the banks should charge off those seconds. "That's the concept of subordination," he said. "It's been around since the Magna Carta. Maybe we should get on the bandwagon."

This is not simply a fight between hedge funds, which own the securities that contain the first liens, and banks that house the seconds. Many mortgage securities are held by small banks, life insurance companies and pension funds. "I can see little reason why a pensioner should take the loss instead of Bank of America, when it's Bank of America's bad loan," Mr. Frey said.

A Bank of America spokesman said that it charges off second loans when borrowers haven't made payments for 180 days. The bank doesn't, nor is it required to, charge them off just because the first lien has been modified, he says. But if a first mortgage is modified, the bank will increase its reserve because it's more likely that the second will sour.

Since the fall, the Office of the Comptroller of the Currency has been examining how banks across the industry are treating their second liens, according to two people familiar with the review. The O.C.C. declined to comment.

But so far, the agency has evinced a rather blasé attitude about the potential problem on banks' balance sheet. Don't expect forceful action any time soon.

In this case, making the last first may mean that weak banks continue to inherit the earth.

O M G !!!!!!!!!!!!!!!!!!!!!!!!

Re:  “But this suggests that the banks, with the authorities’ tacit approval, think contracts are for thee and not for me.”

Made me laugh, albeit bitterly.  You see, I firmly believe that the right, the banks, Big Oil, Wall Street, Big Insurance, Corporate America?  That whole gang?  That entire subversive anti-democratic fifth column?

I think they don’t see it as “My country ‘tis of thee”, but rather as this country ‘tis of them.

Where is the ...ummm ..  SEC or the ... ummm ... FRB in ALL of this???!!! [No wonder Utah wants to secede).

REDUCE PRINCIPAL !!!! Reduce the loan to what the house is worth!!!

Remember"Too Big To Fail”??? Welcome to the UCA,United Corporations of America!!!

In Response to E.McCoy re the FRB;  The FRB was created by the big banks; The FRB’s job is to make sure the big banks make money.  why do you think the FRB is trying to eliminate the small mortgage banks and brokers?  Eliminate competition and allow the big bank to charge more, make more money and screw the public.

“When Wells Fargo disclosed its earnings, for instance, it classified 5.3 percent of its first mortgages as nonperforming, but put only 2.4 percent of its second liens in that category. That seems very odd because it’s much easier to lose your home if you don’t pay your mortgage than if you don’t pay your home equity line.”

Not if you actually read the 10K.  If you had, and looked at table 25, you would note that as of December 31, 2010, that for its core HE portfolio only 3.24% of the portfolio was 2 payments or more past due.  Do you write off loans that are current in their payments - I know I don’t.  In addition, almost 20% of the core HE portfolio is actually first lien, again, something you would know if you had actually read the 10K

Please try harder

Let the gov file bankruptcy. That would get rid of the federal reserve. They are the big bank. Stop paying mortgages that will take down the rest of the banks. Let’s vote for Donald trump.

When the financial industry famously gave Obama almost a “Billion” dollars in campaign funds…it’s paying off a second time. Thanks Timmy Geitner.


Under no circumstances should principal be reduced. Current owners priced out other people. They should not be given discounts now.

You can always tell a banker…doesn’t matter about morality, ethics, or what the bank got away - extra-legally - with in exponential fashion:  Did you read the paperwork?

Is that $20 Billion per state?  If 500,000 loans = $80 Billion… $20B isn’t very much considering there are at least 67 million clouded titles…

Interesting, this issue of accounting for second liens.  I haven’t read the 10K, and probably wouldn’t make much sense of it anyway.  I will say, however, that I have still not received a proper 1099 from the servicer of my second lien following foreclosure in 2009.  The loan value was about $60K on the second at purchase.  The 1099 was not generated until I requested it from the lender (perhaps understandable given heavy volume and insufficient staffing).  When it arrived, though, it totalled about $150 related to interest payments.  I should think that if the bank charged off $60K, that the loss should be reflected in my tax document.  Curious that it wasn’t.

I will throw my hat in the ring on this one thing. 

DC is corrupt. Shelby is not a good guy.  We had laws on the books that should have been enforced when the Banks went around scamming and screwing the American People.  A complete body of work called TRUTH IN LENDING.

Now, what can be done?  Where each of us live there is a high potentate called the Sheriff.  He has more power over your domain than any in Washington DC that is why you are a sovereign citizen.  So run for Sheriff and began to build the right kind of protection that is needed to stop about anything that comes along that takes away justice found in acts of equity.

Why not maybe you would be better that who is they’re now, or better yet run for sheriff win and then appoint good gunslingers to work by your side.

The reason why there are fewer delinquencies in the second mortgage field is the same reason why delinquencies and outstanding balances have dropped on consumer credit card debt.
The second mortgage/equity line is the lender of last resort, and when tapped out, the borrower turns to the credit card to pay for food, gas, other credit cards, etc.
The credit markets are so tight that anyone with either of these vehicles at their disposal treat them the same way my grandmother treated money under the mattress. 
The only diferences between those who continue to use their homes as ATM’s and their credit cards for living expenses, whether or not they have no choice other than to strategically default are, for example, as follows:
My grandmother stopped school in the 8th grade to work at a hat factory and live in a rooming house in 1909, and understood the nature of cyclical events.  My sister, with a Ph.D, a burned out TIAA-CREF and deferred student loans, doesn’t.
So you have to wonder who was smarter, more forward thinking and more responsible.
But what one should also remember is that the Republican administrations introduced and adopted both pieces of law (1982 AMTPA and 1986 TRA…........although under Jimmy Carter we DID remove usury ceilings under DIDMCA as part of the concept of developing parity between thrifys and banks,which by the way, all three led to interstate banking and the decline of community banking and the consolidation of the credit markets and then the merging of them with Wall St. while Glass-Steagall was repeatedly stripped until it vanished; yeah; that’s kind of a problem, they would have said in Its A Wonderful Life, which is when it was created) that allowed for alternative mortgages, and securitized instruments, which today even include such ridiculous assets as goodwill (you know, an intangible, a bit better than thin air, Gordon Gecko style.).
This is the same party that introduced subsidized housing by funding the private development for elderly and then Section 8 units at little or no interest, with tax abatements, tax credits, a guaranteed income stream to the owner/developer/management company of rental cash flow for 30 years and then the right to sell the real estate outright for profit after the 30 year cycle. 
You think they created subsidized housing for poor people with no free lunch on the other side? 
No, they didn’t.
You think people with FHA loans don’t have to pay back the equity earned at sale as a trade-off for the discounted pricing on the mortgage?
Yes, they do.
And read one of those FHA notes smmeday that originiated in the 50’s and 60’s; here were clauses that if anyone black were living in the house (other than a servant), the borrower was in default on the mortgage, maingit turn into a demand note; i,.e. pay now or get out..
How many minorities do you think qualified for FHA loans?
This is a REALLY old story.
So much for all those whiners who blame the crisis on minorities/poor people who were given easy credit and were too stupid too understand it and got us all in trouble.
So much for everyone else who doesn’t follow history and the regulation of the poor for the benefit of others.
No spell check so I apologize for any typos.

Read second: I forgot; HAMP was designed to help the servicers/banks on an extend and pretend program; here’s why: contract law supersedes public concepts of morality, so HAMP had no power to begin…..............the non-bankers who wrote it didn;t understand even what securitization was, but I think Timothy Geithner had a clue, for sure, and I think he may have been allied with the other side, don’t you thnkk?) ; i.e. the PSA (pooling and servicing agreement) holding the securitized notes between the trusts/hedge funds—-whose custodians are usually banks—-dictates who and what tranche withinn and under what curcumstances if any, any loan can be modified; google the American Securitization Forum and see how many times they prevailed in courts based on this constitutional concept.
HAMP was just a smokescreen .

How is letting “banks avoid ... write-downs” worth billions to the banks?  Either the 2nd liens ultimately fall to perform and are then written off (with possible need to raise capital), or they perform and they aren’t.  Are we confusing delay and pray accounting gimmicks with economic reality?  The reckoning will one day arrive.

Or is your point that the settlement would effectively allow captive servicers to cram down what should be losses on their parent banks’ 2nd liens onto passive investors in 1st liens?  Why would borrowers continue to service a home equity loan if they couldn’t carry the primary mortgage?  And why would MBS investors allow this?

The Times article doesn’t make this any clearer.  Nor do the comments.

Our church counsels people with credit problems.  I know of at least 5 cases of people headed to default on their first that continue to make payments on their home equity.  While the first is senior to the second, if the borrower sends the check to the second and not the first there is nothing the owner of the first can do about that.  Two of these cases show sophisticated thinking behind it: they think that their firsts were clearly insane loans….next to nothing down, with very weak (bogus) appraisal process in a geography that was among the first to head south.  They believe that in a few years that the credit industry will look at this default with a great deal of understanding, since millions will have done the exact same thing and the industry will want these people as customers.  They view the second as much closer to a unsecured loan for consumption and the industry will view their paying this as a very good reason to extend them similar credits in the future.  They might be wrong, but they could also be right.  So maybe seconds, with smaller and more manageable payments, are more secure than the first, when the first is clearly hopeless.

At Joe McHugh:  Clearly your first speculation is in keeping with recent history.  See repo 105, CDO & CDS blackbriar financial instruments.  This approach scales up volume and paper profits against latent risk.  Lots of money was made by delay.  There was no need for prayer.  Who do you reckon will settle when this time comes?

Parallel Foreclosure

March 18, 2011, 3:58 a.m.

If the banks write down Home Equity Lines of Credit, wouldn’t the IRS simply consider it income for the homeowner and then tax the homeowner for the value of the write down?

If the banks get a 100,000 write down credit on a homeowner’s already spent home equity line of credit, would not the IRS come knocking requesting the homeowner be responsible for the income tax on that 100,000 dollar write down?

I hope this article was researched enough before laying blame on the banks for not wanting the write downs.

I also took offense to how HELOC’s were used by people.  Many people used the HELOC’s as a hedge to pay their bills while they took care of ill family members, other’s used it to put kids through college, others to try their hand at a new business.

To imply that HELOC’s simply went for boats and applebee orgies is frankly pathetic in my view and the writer should apologize for making such an irresponsible statement.


March 18, 2011, 3:40 p.m.

The middle class people have been earning less and less (if you take inflation in to account) So the middle class responded first by working 2 jobs or husband and wife working in the same household to make ends meet, when that was not enough any more the middle class responded by making use of Helloc’s and 2nd loans it did not simply went for boats and applebee’s and SUV;s this is just another way to try to take the blame again on the homeowner

I Give Credit to The Titanic !!!!  Our Government Gets on the Loud Speaker and Says The Ship Is Not Sinking !!! ” It Is To Big To Sink “
  But would All ” First Class ” Passengers Please Make your Way to the “Life Boats ”  Lets Maintain Our Sense of Humor Folkes and Stick Together !!!  Sincerely Shawn Mc.

“It’s been around since the Magna Carta”

Well president Bush threw out the Magna Carta at Guantanamo Bay, so that explains that. We can now throw “subordination contracts” on the ash heap of history, along with the bill of rights and habeas corpus.

Parallel Foreclosure: I think his statement about applebee’s and boats is not out on a limb… several of the crisis books, like Trillion Dollar Meltdown (Charles Morris) mention how HELOCs were used for consumption (in addition to the worthy causes you mention).

There is also the interesting case of Alan Greenspan; one of the big accomplishments of his career was his realization that the equity people gain when they own/sell a house is a major factor in the consumption economy (if i remember the argument correctly).

Wells Fargo is asking for higher payments to increase the escrow accounts so they can “lend” more money. How much money do the banks need to take from retires, medically disabled, hard working people. You don’t need to take MY money to loan to others, are you going to pay ME INTEREST to use MY money?  You’re just a bunch of common crooks, common crooks, thieves, mafia, thugs. That’s what you all are. Too bad you have to use the health care system when sick. I hope all those big PhARma products fail only when the bankers and housing industry people get sick. WE are sick of YOU!

Alessandro Machi

June 21, 2014, 5:55 p.m.

Come on propublica, IT’S TIME for you to do an expose on first lien HELOC’s. millions are coming due by retired homeowners who now won’t qualify for a replacement HELOC because of Dodd/Frank’s income requirement and their definition of a predatory loan.

This country needs an interest only loan collateralized by a homeowners paid off home so that retirees don’t die equity rich but cash poor.

Jesse Eisinger

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