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In Proposed Mortgage Fraud Settlement, a Gift to Big Banks


Tom Miller, attorney general of Iowa 

Luis Alvarez/Associated Press
Tom Miller, attorney general of Iowa.

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 Senator 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.

Jesse Eisinger is a reporter for ProPublica, an independent, nonprofit newsroom that produces investigative journalism in the public interest. Email: Follow him on Twitter (@Eisingerj). 

15 Responses

  1. The Attorney Generals serve at the pleasure of the President of the United STates of America to enforce laws.

    The law serves a purpose but only when laws are enforced.

    We have here pure Banking & Insurance Frauds!
    They write off the 2nd loan and get paid thru insurance. They would still get paid thru insurance and now get to keep the loan on the books?

    Iowa is in the pocket of ‘Wells Fargo’ a private brand label.

    Wells Fargo Home Mortgage Institutional lending actually in post-closing as Servicer are responsible for the dirty deed of creating a new loan during Default Events to try and collect payments thru the ERRORS and OMISSIONS POLICIES by filing in foreclouse a loan trust that the loan never appeared inside of.

    When will the President of the United States enforce laws and force Congress to stop overstepping their limited powers for they have harmed the economy, third element of our national security by preventing enforcement of laws and allowing consumers to be targetted as an inferior class of consumer the banks choose SANCTIONS and pay gladly. More profitable to break the laws that are never enforced. Believe me that took that into serious consideration when they designed this diabiolical plan.

  2. ukg- can you dredge up any reports re:Libor manipulation from 2008. I remember reading about it in depth at the time, but forget the specifics. As I recall, the large banks have to report periodically as to what interest they are paying on overnight or short term borrowings. They were all reporting their borrowing costs as lower than they actually were, in order to conceal the fact that the market regarded their creditworthiness or business operations as less than public conception. Within a few days after the story broke, the banks had restated their borrowing costs at higher than previously reported. And then the investigation fizzled out. Was that the gist of it? Thanks.

  3. A theory I expounded on three years ago has caught the interest of the Justice Department. Nice to know I could help…….

    BofA, Citi, Barclays Subpoenaed In LIBOR Probe

    U.S. regulators have subpoenaed Bank of America NA, Citigroup Inc. and Barclays Capital Inc., according to Wednesday news reports, as they continue investigating whether the banks, UBS AG and others tried to manipulate interbank interest rates used as a global benchmark.

    yes, a benchmark for the ARM loans. Where’s HSBC on that list? They’re on the LIBOR Panel.

  4. You can get rid of your second mortgage in bankruptcy. Just indicate it is one of your creditors. They go away during the bankruptcy–if the bankruptcy goes all the way to discharge.

  5. Let us call all these 50 clowns and get them to stop this fraud game.

  6. On a different computer the color is more deep navy blue than black. Okay..not black and gold…navy blue and gold, but still that that bright blue.



  8. I’m last.
    All the money I put into the property toward ownership was my lien.
    I get paid first!
    I’m real, corporeal, life; the bank by name is fiction.
    I’ll stand there with hands and feet and accept my settlement. They will be represented by an attorney who will ‘sign on their behalf’.

    They are not real, so they do not deserve a ‘gift’.

    Ian, my, you made me think.
    If the last is first, then only one has claim to the second mortgage, there was no requirement to record the second mortgage in the real property records, no recording fees, no violations of any law, no reason to seek criminal penalties against anyone. By having a second mortgage, it gives the first mortgage some validity because the only way a second would exist is if there was a secured interest in the home.

    The fact that first mortgages never ended up in the trusts or pools they claimed to be in, but second mortgages were not subject to the same things so there is no IRS violations. If the bank settles with a home owner over a fraud foreclosure on a first mortgage and that homeowner had a second mortgage, they get paid what they paid out in the settlement.

    Ah, that last one makes sense.

    All of the above are opinions and not statements of fact, since I know nothing.

    Light and Love,
    Trespass Unwanted, life, life, life, life, life

    Anyone notice the Department of Justice seal changed from Blue and Gold to Black and Gold? Is there a significance in the colors?

    I love the motto:
    The common law is the will of Mankind issuing from the Life of the People

    Life is such a powerful word. Fictions have no legal right to harm ‘life’. Wish I knew then what I know now, but it doesn’t matter, things are unraveling, what you see is the autopilot not wanting to let the captain take over so it’s a bumpy ride right now.

  9. SWARM, there is the “Mortgage Debt Forgiveness Act” that makes those writeoffs untaxable.

  10. There is no settlement for fraud!!! Wtf? I don’t think so. Please explain how we can stop this nonsense. The only settlement for fraud that we should accept is JAIL for all involved. This is such bs I can’t stand it!! What do we do to stop this crap. So sick of the lies deceit and greed. Why would this even b an option??? Are they INSANE!? How do we stop this neil. Please let me know and i will start doing it asap. This is nothing but sick wrong and so immoral and disgusting. I could vomit. Fraud is a felony not a accident. It was intentional. If the AG’s settle, they should do jail time. That would stop it I would think!!! Try that one for starters. Debi.

  11. There is something to this mystery of the second-lien writedown. If the banks are claiming to own the mortgage-no, their subsidiary is servicing the mortgage-for the investors in the nonexistent trusts,no-wait,that’s not it- the HELOCS were sold multiple times to numerous pools, then it would follow that the….were these 2nds used as collateral for loans at the FED discount window, valued at 100 cents on the dollar, with no obligation to repay? And then the banks turned around and sold the same 2nds collection rights to distressed debt buyers? Anybody else have a clues?

  12. No more money to the banks – besides its not nearly enough. Do they just not get it?? We have 67 million + mortgages out there that drank the kool aid. Eventually, whether or not they need it now – all homeowners may need it to fight clouded titles or face some stranger showing up with the real note, “Senor, I believe I own your home…Mr. JP Chase sold me this note” and there will still be legal fees to fight to prove ownership…this isn’t nearly over – because there is no place to put all the mortgages they wrote – even if they could modify.

  13. If the banks write down the home equity line of credit, the homeowner may then be hit with the IRS claiming the writedown as income to the homeowner, no?

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