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Don't Make the Perfect the Enemy of the Good -- But What Does the Good Look Like?

02/03/2012 12:06 pm ET | Updated Apr 04, 2012

Many -- including me -- have attacked the idea of a multi-state and federal settlement with the biggest bailed-out banks (wearing their mortgage servicing hats) on the grounds that it's wrong to settle something that hasn't been thoroughly investigated. We've also objected by pointing out the numbers on the table are too small by at least a zero to make much of a difference to homeowners or the housing market as a whole. We've raised more specific objections too, like the scope of the liability release and concerns about enforcement since the banks have exactly zero credibility.

But community groups and others have countered 'hey: homeowners need help now, and desperately, so don't make the perfect the enemy of the good.' Fine; I can agree with that. But what's been described to date is so far from good the plea is irrelevant. To make that clear, here's a guide to what "the good" would look like, at least from where I sit.

1) Enforcement. Now, there's been rumors about an independent court appointed monitor to do enforcement. That sounds fine as far as it goes, but here's what real enforceability means:

a) The monitor must have the ability to access and review servicer databases and other records at will. Servicers can't be allowed to manage the info flow to the monitor.

b) If the monitor finds problems, s/he must be able to impose immediate penalties of a variety of strengths without going through a process that enables the servicers to appeal and object and delay. Think of the monitor as a probation officer.

c) The monitor should have a process for homeowners to file complaints, and a certain threshold of substantiated complaints should trigger enforcement action.

d) The monitor must be truly independent with the skills, experience, staffing and other resources to do the job right.

e) The monitor's job and powers must continue into perpetuity unless the agreement is superceded by statute or regulation. This is important because homeowners are not servicers' customers. The economic interests of the servicer do not align with homeowners, and after a deal's expiration there's zero reason to expect compliance to continue.

We know the deal as delivered to the AGs as of last Friday doesn't look anything like my suggestions above; see NV AG Masto's letter, at questions 6 through 13.

2) Servicing Standards. When the "deal" was first leaked early last year I took it apart for DailyFinance here. What was abundantly clear from the proposal was that it mostly required servicers to obey the law, including the duties of good faith and fair dealing. That is, the document mostly exposed how much of the problem is a failure to enforce existing law. The biggest addition was the idea that servicers can't foreclose on someone they're considering for a modification. Of course, that is also a blatantly deceptive (and therefore illegal) practice, and that's why Massachusetts AG Martha Coakley included it in her suit against five bailed-out banks (at paragraph 142).

Beyond the very vanilla stuff in that original, "obey the law" term sheet, the settlement must force the banks to let the independent monitor's team audit their account records. Evidence keeps surfacing that their records of who owes how much, to whom, are simply wrong far too much of the time. Consider these recent stories by Reuters and iWatch News or this one I wrote about a year ago. Or consider that servicers have been playing games with amounts borrowers owe in bankruptcy court so frequently that the court did a two year, seven step process to change the rules and force the banks to deal in good faith. (I write about the rule changes and background here, starting under "Measuring Up: The U.S. Trustees Program".)

Bottom line: mortgage servicers will never be able to do a good job unless their databases are totally overhauled, and they'll never do that overhaul without an independent audit. And no, I don't mean "independent" in the OCC sense; I mean actually independent, by the settlement monitor.

What the current servicing standards are on the table isn't clear, since we've not seen anything in nearly a year. It's impossible to evaluate the terms on the table without seeing them, but unless the terms are better than that initial leak, they're nowhere near good enough.

NV AG Masto's letter doesn't talk much about the servicing standards as such, except to ask in q.5 when the various, unnamed provisions kick in. So the servicing standards are still a black box to the public. Given that these provisions--and their enforceability--are the most helpful part of the settlement to homeowners, the secrecy around them is unjustifiable. (Given the tsunami-scale of the flood that has millions of homeowners underwater, $25 billion will have no meaningful impact on the housing market; for homeowners nationwide, good, enforceable servicing standards are worth much more.)

3) Principal Reductions

One of the oddest features of the settlement as discussed to date is the idea that the banks will be given total discretion to allocate most of the billions of dollars involved among borrowers. Several bad consequences flow from that.

First, no state can know how much it's getting (except the rightly-rejected CA bribe) as Masto's q.24 confirms the problem. How can an AG, in good conscience, take a deal without knowing what it's worth to his or her state?

Second, structuring the deal this way enables the banks to focus on managing their balance sheets rather than providing relief to homeowners. That is, decisions about who to help and how much will have nothing to do with who needs help or how much help they need.

Third, as part of that balance sheet management, the banks will be able to shift losses from themselves to pension funds. How is that just?

Most of AG Masto's questions from #14 on get at various aspects of the banks' discretion, showing she's wise to this issue. Indeed, Senator Sherrod Brown has pushed back on it as well.

This banks-get-all-the-power-to-decide is completely unnecessary. Consider what happened after BP turned the Gulf of Mexico into a toxic waste dump: we made them stick $20 billion in a kitty, put Ken Feinberg in charge, and he cut checks to victims. Why isn't that the model in this case? The answer cannot be that anteing up $25 billion in cash, divvied up among the settling banks, is enough to blow up their balance sheets. That number is just too small to take that threat seriously.

Instead of letting the banks manipulate the numbers to their advantage, they should cough up the full amount in actual cash, and the AGs should hire fully staffed and independent special masters to pay down the mortgages. The special master for each state should be appointed by that state's AG, and the banks should not have a right to object to the person chosen. More; the rule should be that the settlement payments made by the special master are applied, 100%, to principal and interest. Any outstanding fees that the servicer has charged to the account only get repaid if the servicer submits a fully documented bill to the special master.

Having a state-AG named person run a fund aimed at helping that state's victims changes the mortgage modification and principal reduction from balance sheet management to homeowner help. Second, by forcing the banks to cough up cash, the approach is punitive, which it's supposed to be.

4) Regardless of how the DE's MERS lawsuit is resolved and liability for its past actions addressed, the settlement should include an agreement to stop using MERS on all loans made after the date of the settlement. We need to limit the damage. The original term sheet punted on MERS; AG Masto's letter doesn't use the word. So MERS is another black box in the settlement.

5) The settlement has to deal with the fact that most mortgages' documents are FUBAR. 'Robosigning' isn't simply about signing documents in a funny way; it's about creating documents the banks don't have because they didn't do their job right at the outset. Why are they creating the documents? So they can win foreclosure cases. That's obstruction of justice. When you don't have the evidence you need, you're not supposed to just make sh-t up. But the servicers are, systematically. And it's not like they're doing things they have the right to do, just late. For a variety of reasons these documents are just fraudulent. (At link, start at "Document Fraud Defined.") They're creating documents in the name of companies that have long since gone out of business, for example. AG Masto's letter gets at this at least a little bit in Qs 13 and 17.

Bottom line: You can't solve "robosigning" simply by slowing the process down long enough for people to review newly-minted documents before submitting them. Similarly, if the database the reviewer is checking the numbers against is wrong, the review doesn't help either. How to resolve the FUBAR documents situation? I don't know. All I know is that the topic has to be dealt with head on, but most likely the settlement doesn't.

6) The liability waiver should be narrow. Perhaps that's a done deal; certainly there's considerable reporting to that effect. All I can say is 1) the text isn't released, and 2) if the origination fraud waiver was so narrow, why were the banks willing to give CA a $15 billion bribe to sign on? What is it about California's released liability that inspired such a big bribe? More concretely, Yves Smith has a couple of good posts on why the liability waiver just isn't as narrow as promised. Most fundamentally, AG Masto's first three questions show that she doesn't know the scope of the liability waiver, so it's impossible to imagine media reports of its narrowness are well informed. (Here's the letter again, for convenience.)

But let's say, ok, the waiver's narrow. If 1 through 5 above aren't also part of the deal, then it's a joke; the help for homeowners is too little in terms of dollars and too ephemeral in terms of servicing improvements. So the banks aren't getting much liability released, but homeowners also aren't getting much help.

And if anyone is remotely confused about where things stand, and takes seriously the idea that the deal is enforceable, will help homeowners, and meaningfully addresses the document fraud that is 'robosigning', consider MA AG Coakley's statements on why she withdrew from the settlement negotiations and filed suit:

This servicing fraud has been the subject of negotiations for over a year, between Attorneys General across the country, the federal government and the banks who are named in today's lawsuit. I will say that when those negotiations began over a year ago, I was hopeful that we would be able to reach a strong and effective resolution. ...But it is over a year later, and I believe that the banks have failed to offer meaningful and enforceable relief to homeowners for their deceptive conduct and the scope of the harm they have caused. ...They have had more than a year to show that they have understood their role and the need to show their accountability for this economic mess, and they have failed to do so. That's why we are filing suit today.

And that folks, is why AG Coakley is a law enforcement champion like her colleague AG Masto.

Given how far from "good" the proposed settlement is, and how uncertain its terms are, per AG Masto's letter, how can any state take the deal on Friday?