Not Settling for a Settlement

August 20th, 2011 at 1:03 pm

Back when I was a teenager, I lent my funky old electric guitar to my friend Tony.  Tony lent it to Bill, and Bill pretty much lost it.  Those were some fairly hazy times.

One day, I called Tony and told him I needed it back.  He called Bill who told him it was lost.  They then decided to give me an old, broken electric keyboard instead.

And that, my friends, is the story of the mortgage banking settlement now underway across this country.

Let’s review.  Banks and mortgage lenders like the infamous Countrywide originated millions of housing loans which they then bundled into securities (MBS) and sold to investors.  Investors paid servicers, sometimes the originating banks themselves, to manage the loans.

Problem 1: when you sell a loan, you tend not to take your underwriting or your paperwork too seriously.  Sort of like how Tony didn’t spend a lot of time thinking about whether Bill would take good care of my guitar.

Problem 2: the housing bubble burst and loans started to default.

Problem 3: because of the shoddy work done by originators, not to mention the attempt to cover up that shoddy work with forgeries (robo-signers), establishing ownership of the loans became problematic to say the least.  And you can’t foreclose if you can’t document ownership of the loan.

So what’s the best way out of this mess?

Well, the fastest way is for the banks to get off the hook with a big, national settlement.  They pay a fine and they’re held harmless— indemnified— against further legal action for all their screwups.

But is that the best way?  Eric Schneiderman and Beau Biden think not, and I think they’re right.

Schneiderman and Biden are, respectively, the NY and DE state Attorneys General and they are essentially saying “just hold on a minute” to the majority of AGs pushing the national settlement (disclosure: I used to work for Biden’s dad, the VP).

Right now, the two AGs are pressing a case that will allow investors, borrowers, and the public to get the facts about another suspiciously cushy deal between Bank of America, which (for reasons I’ll never understand) bought Countrywide, and a small group of 22 investors.

If Schneiderman and Biden prevail, they will preserve the rights of far more investors left out of but bound by the deal…a deal which could force them to accept pennies on the dollar, and does nothing to advance the loan modifications that would benefit both borrowers and investors, not to mention the macroeconomy.

If they fail, or give up as powerful forces would very much like them to, then once again, a bank rides off into the sunset, with barely a nick.  As David Dayen of FDL reports, the deal Schneiderman and Biden are trying to block:

“… would release BofA and its trustee, Bank of New York Mellon, from liability on a broad range of violations of securities statutes, including the agreements made with investors, the representations and warranties contained within and overcharging of fees by BofA. This would apply to almost all Countrywide MBS.”

(Dayen’s been doing great work following this case.  Ditto Yves Smith.)

But this case is really a microcosm of two AGs bigger target: they’re ultimately trying to block a much larger sweetheart deal between the banks and law enforcement officers representing virtually every other state in America.  Under the proposed settlement, the banks that created the market for toxic loans, and sold trillions of dollars of securities backed by those loans, would get off the hook for around $20 billion.

A lot of people would like Schneiderman and other renegade AGs to get out of the way and let the grownups handle this by themselves.  Problem is, that leaves the investors out of the deal and when you leave the investors out, you leave the borrowers out.  That’s because investors have no incentives to deal with the borrowers— to modify loans, for example— if the settlement doesn’t include them.

Schneiderman’s key insight here, and one that anyone interested in actually fixing this problem should support, is that until you bring in all the relevant stakeholders, you’ll neither clean up the mess—e.g., the excluded investors would pursue legal action in the BofA case noted above— nor mete out the relevant punishments of the relevant magnitudes to actually impose some discipline.  The way things have gone so far, no wonder banks have been sloppy at best and fraudulent at worst.  No one’s held them accountable.

I’m sure old Tony and Bill were glad to fob off that old, broken Casio keyboard on me, and put the whole lost guitar incident behind them.  But it was a bad settlement, and I shouldn’t have settled for it.


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7 comments in reply to "Not Settling for a Settlement"

  1. John says:

    I had just a few similar experiences when I was a teen.

    The rule that quickly evolved for me was to never make “personal” loans.

    If I can “afford” to give something away when I’m asked for it, I do. If I can’t, I don’t. But I don’t do loans.

    I’ve followed this rule my entire life since, and have never regretted it for a second.

    Loans have a never-ending life of their own, and it’s not a good one except in rare circumstances. Gifts, on the other hand, bless both giver and receiver.

    Your guitar was a gift to Tony and Bill; but none of you saw it that way. So it’s not been a blessing to any of you. And that’s what’s sad about your story. I doubt you still place any value on that keyboard – if you ever did. I don’t know if you place any value on your “friends” Tony and Bill, either. That kind of risk is why I don’t do loans.

    I distinguish impersonal financial loans from loans between friend and family, by the way. But I’ve had very few of the former, only two that I can recall. Banks are not people, and the problems I have with loans are problems that arise between people.

    My rule doesn’t explain why I’m a socialist and not a capitalist, but it’s certainly not inconsistent with it, either.

  2. Larry weisenthal says:

    First, Excellent, well written blogpost. NYT quality. I think that yours will be my new favorite, go to economic blog. Great substance and also great writing style. Loved the anecdote. Second,heard your discussion on KPPCs “Air Talk.”. You are a far superior communicator to Roemer, Geithner, Summers,et al, and even to the economist-in-chief. You should have been point man for both ARRA and healthcare. The Dems got killed in the messaging battle. I loved your pithy comment during the KPCC session regarding when it takes so many words to explain why it’s not a gaffe, then it really is a gaffe.

    Obama needs someone running point to explain the economics of debt origins and solutions, origins and continuing effect of the meltdown, and, most of all, healthcare economics –problems and solutions.

    I hope your blog grows rapidly in stature. You deserve a much larger soapbox.

    Larry Weisenthal/Huntington Beach CA

    • Michael says:

      The problem is that Obama himself doesn’t know his own mind. That’s why his actions are so all-over-the-place. He knows oligarchy is bad, but he’s got too much Reaganomics in his head.

  3. fyzzics says:

    I’d suggest pointing readers to Yves Smith’s blog, Naked Capitalism. She’s been on this story for months (on Biden and lots of other earlier ones).

  4. Michael says:

    Wake me when somebody is going to jail.

  5. stuhlmann says:

    Why aren’t the two attorneys general pushing criminal investigations for the use of fraudulent documents in foreclosure cases, assuming that robo-signed documents were used in any foreclosures in their two states? Isn’t it considered perjury to knowingly present forged documents to a court? I would think that a few arrests and a few trials would really get the pot bubbling. It would also make for some good headlines.

    • fyzzics says:

      Early days yet. Schneiderman is still investigating, but he seems pretty hard-nosed, so if he uncovers serious evidence of criminal acts, I think you could see some criminal indictments. Remember, in court it’s not what you know, but what you can prove that counts.

      More amazing, is that the Obama administration is starting to pressure him directly to drop his investigation and “get with the program”, in the person of HUD Secretary Donovan. Check out Gretchen Morgensen’s NYT article yesterday. Here’s a bit:

      In recent weeks, Shaun Donovan, the secretary of Housing and Urban Development, and high-level Justice Department officials have been waging an intensifying campaign to try to persuade the attorney general to support the settlement, said the people briefed on the talks.

      But Mr. Donovan and others in the administration have been contacting not only Mr. Schneiderman but his allies, including consumer groups and advocates for borrowers, seeking help to secure the attorney general’s participation in the deal, these people said. One recipient described the calls from Mr. Donovan, but asked not to be identified for fear of retaliation.

      Yikes! Retaliation?! Are they threatening these people? Anyway, anyone reading this who lives in NY and wants to keep Schneiderman on the case, you might want to call the AG’s office (212-416-8000) and let his staff know you support him.