Bankers began whining as soon as word of a proposed mortgage fraud settlement case hit the street, even though it was a pretty sweet deal for them. From the Wall Street Journal: "Banks Bristle at Mortgage-Loan Plan."
Even the lightest, most symbolic of penalties is apparently too much for their fragile egos. That's too bad, because the penalties we really need are a lot tougher than that.
I. Bristle at this.
We used a five-point grading process to evaluate the administration's reported proposal. We employed on simple principles of fairness and justice, along with some common-sense rules for any criminal settlement, such as: Does the punishment fit the crime? Are the victims being made whole? Will it deter future crimes?
The media's preference for euphemisms like "faulty robo-signing" and "erroneous paperwork" when describing bank criminality may be setting the stage for another free pass for banks. (If you think the Bonanno crime family's protection racket was "an improperly allocated form of taxation," you'll love their choice of words.) The mixed signals and signs of infighting in the federal government aren't encouraging either.
Neither the slanted media coverage nor the Executive branch's disorganization provides the right context for the kind of settlement that's needed -- one that includes much higher penalties and some criminal indictments.
II. Deal or no deal?
Here's the outline of the administration's proposed deal, according to most reports: Banks would have to write down the principal on underwater mortgages with $20 billion of their own money (investors in mortgage-backed securities and other financial instruments would not be held responsible). The banks would administer their own mortgage modification programs with these funds; no government money would be used. (Note: Any administration proposal would have to be accepted by the states.)
The reactions began rolling in almost immediately. John Carney said the deal could be "an attempt by banks to get off easy," especially if it includes amnesty from investor claims. Carney writes that he's been saying for months that "the government would attempt... some sort of legal forgiveness," asking: "Is this it?"
Felix Salmon at Reuters, on the other hand, described himself as "cautiously optimistic," while also making this observation: "A fine is a punishment for doing something wrong, while principal reduction, by contrast, can actually benefit banks if they do it right." He adds: "But in this case it seems that most of the benefit might go to homeowners and bondholders... "
Yves Smith called it a "Mortgage Fraud Whitewash: $20 Billion "Get Out of Jail Free" Settlement," agreeing with Marcy Wheeler that this program would amount to "HAMP 2.0" -- that is, a replay of the so-called "extend and pretend" program which gave many struggling homeowners a year or more of baseless hope -- bleeding more house payments out of them -- only to have the banks foreclose in the end anyway.
III. The score
Here are our screening questions and the results for this proposal:
1. Is the settlement comprehensive -- does it address all the misdeeds that took place?
A number of crimes fall under the "foreclosure fraud" heading, including the illegal transfer of home ownership from one bank to another, fraudulently misrepresenting the terms of a loan to borrowers, collusion to mislead home buyers about the current and expected value of their homes, concealing information from the authorities, perjury, and fraudulently deceiving both stockholders and securities investors.
Some people would prefer to see "foreclosure fraud" defined as narrowly as possible, limiting it to people who lost their homes because property documents were filed illegally. That would exclude the vast majority of those borrowers who are currently "underwater" on their mortgages (approximately one in four mortgage holders) from any settlement.
Grade: Unclear.The administration has yet to define the scope of people eligible for settlement funds. If they use the same definitions that applied to HAMP, however, the grade will be "fail." That seems to be where they're headed.
2. The punishment must fit the crime.
Is $20 billion enough to right the wrong that's been done? The U.S. housing market has lost nearly ten trillion dollars of value since the housing bubble collapsed, according to reliable data. The homes were never really "worth" all that money, but banks helped convince people that they were. And the Wall Street casino helped artificially pump up real estate values, setting homeowners up for a fall.
Even if we lay 80 percent of the "moral hazard" for excess borrowing at the feet of homeowners -- which I would strongly argue is unjust -- that leaves banks with roughly $2 trillion in moral culpability. The proposed settlement amount of $20 billion is 0.01 percent of that figure. It's also less than Wall Street reportedly paid out in bonuses last year, even as the U.S. taxpayer was rescuing them.
An excellent analysis by Charles Hugh Smith suggests that mortgages would have to decline by an estimated $4 trillion to establish the right ratio between debt and equity. I suspect Smith would disagree with my proposed solution -- which includes holding the banks responsible -- but I can't fault his estimate.
A $2 trillion or $4 trillion settlement is both politically impossible and economically catastrophic -- even the banks' harshest critics don't want to trigger another meltdown. What's more, other Wall Street misdeeds played a part in the crisis, too. Let's be both fair and conservative: What if we asked banks to assume only 10 percent of the imbalance between debt and equity, which is less than 5 percent of the loss in real estate values? That still gives us a $400 billion settlement.
Is that a practical, achievable settlement number? Not in this climate. But as William Shatner says, "Now you're negotiating!" The administration, on the other hand, started at $25 billion and then dropped their number down to $20 billion... before discussions even began. That's called "negotiating against yourself." (Or in this case, against us.)
Grade: Fail.$20 billion isn't enough. It's not even close.
3. The victims -- all of the victims -- must be made whole.
How should the settlement money be dispersed? The administration's proposal would let the banks give it out themselves. Worst. Idea. Ever. Even under the administration's watchful eye, the HAMP program has been an invitation for banks to plunder their victims even more. The administration says the banks' activities would be audited -- but by whom? PricewaterhouseCoopers, who said nothing as AIG and Goldman Sachs pulled their shenanigans? The ratings agencies that certified mortgage-backed trash as "AAA" gold?
Smith and Wheeler are right: Don't do this.
What's more, the proposal is apparently structured so that the funds will only be available to homeowners who have stopped making their payments. That helps banks, as Carney observed, since these homeowners represent a threat to the banks' self-interest. But there are other wronged parties, too, and any settlement should make provisions for them too.
Grade: Mostly fail.All homeowners need help, but with the banks administering the funds it probably won't help very many. A few will be helped, in all likelihood -- but a number of them will probably get hurt.
4. The settlement should deter bankers from future acts of fraud.
The fact that no Wall Street executives have been criminally prosecuted (see Yves Smith again) means bankers have no reason not to keep committing fraud again and again. They can continue to put their own banks at risk and break the law with impunity, secure in the knowledge that there will be no personal repercussions for them -- even if they shatter the world economy in the process.
Here's an opportunity to change that. But $20 billion isn't enough money. More importantly, criminal charges should be brought. Any comprehensive settlement should include, at a minimum, plea bargaining agreements with some senior bank officials. And some of the settlement money should come out of bank executives' own pockets, rather than forcing shareholders (many of whom were also defrauded) to bear the cost of executive lawbreaking one more time.
Grade: Fail.No jail and no financial penalties for individuals means no deterrence.
5. The syndicate must be broken up, and the system must be fixed.
Bankers set up a front organization that was essentially a syndicate. It was designed to bypass local property laws, conceal the true owners of mortgages from the appropriate authorities, and enable Wall Street to function as an electronic casino -- which in turn let them bundle mortgages and bet on them. The computer system behind this syndicate let them pump up the market by trading and gambling at light speed.
MERS, the bankers' front organization, combined an electronic database with a dummy corporation that allowed banks to conceal the true ownership of a mortgage from local courthouses by pretending that a company called "MERS Inc." held the title. To pull off this legal fiction, MERS let 20,302 employees at different banks represent themselves as "officers" -- of a company that doesn't actually employ anyone. ("MERS Inc." is a subsidiary of the database company, which itself only employs about 50 people. That's more than 400 "officers" for each employee.)
We're not against databases (in fact we used to design them). We're anti-deception. An effective settlement must require banks to stop using "MERS Inc." or any other shell company to conceal the true holder of a loan from legal scrutiny. With today's database technology it's very easy to scan physical documents and attach them to a digital file. That includes papers that are filed in local courthouses in accordance with all relevant law, which would ensure that borrowers and courts are always able to track down the true holder of a loan.
This requirement wouldn't just stop fraud. It would also have the added benefit of slowing down the trading of mortgages. It would make it just a little less tempting to treat houses as if they were virtual gambling chips in a digital casino. After all, people live in those houses.
Grade: Unclear. Nothing's been said about the procedural issues, but they're at the heart of the case. And the silence isn't a good sign. Systemic change should be at the heart of any smart proposal.
Grading on a curve
The greater the penalty for fraud, the lower the likelihood it will happen again. What's more, financial sector profits are artificially high right now because underwater homeowners are paying more for their mortgages than they should. The victims are subsidizing their predators, bolstering their already-high profits and contributing to those billion-dollar bonuses.
A bold plan to reduce the principal on those mortgages would transfer some of those unproductive profits back into the general economy, where it would be used to purchase goods and services. That would lead to more jobs and a quicker recovery for everybody, not just Wall Street.
Unfortunately, neither the president nor Congress has shown the willingness to do what needs to be done. While all the details aren't in, all the signs indicate that this is a good deal for the banks and not for anybody else.
This deal may -- may -- be better than nothing. But that's grading it on a pretty steep curve. The administration can and must come up with a better proposal.
UPDATE: If this this report in the New York Times is correct, the Administration is saying exactly the right things and articulating the real nature of the problem quite well. So why are they starting the "bidding" so low, both in dollar terms and in the scope of the fix? (That may be a rhetorical question ...)
- The Proposed Foreclosure Fraud Bank Settlement, Part 1: Journalistic Failures
- The Proposed Foreclosure Fraud Bank Settlement, Part 2: A Leadership Vacuum
- Pictures Of MERS, Part 1
Richard (RJ) Eskow, a consultant and writer (and former insurance/finance executive), is a Senior Fellow with the Campaign for America's Future. This post was produced as part of the Curbing Wall Street project. Richard also blogs at A Night Light.
He can be reached at "email@example.com."
Website: Eskow and Associates