AIG Levels Claims Against BoA for Losses Tied to Mortgage Bonds

Image Source: New York Times

American International Group’s lawsuit against Bank of America was widely reported yesterday, as news outlets revealed that the financial firm initiated the suit in an effort to recover more than ten billion dollars in losses resulting from asset-backed securities they purchased from the bank.  According to the New York Times’ financial reporters Gretchen Morgenson and Louise Story, AIG “claims that Bank of America and its Merrill Lynch and Countrywide financial units misrepresented the quality of the mortgages placed in securities and sold to investors,” say inside sources.

As many of you many now know, BoA has faced intense scrutiny over the last several weeks.  A few weeks back, we covered the controversy clouding the bad loan settlement the bank negotiated with investors, in which BoA managed to secure a tremendously favorable outcome.  Just a few days ago, Morgenson penned a follow up piece documenting New York Attorney General Eric Schneiderman’s decision to challenge the settlement.  Apparently, Schneiderman takes issue with a number of the settlement’s terms, particularly those that preclude private litigants who may have suffered from the bank’s troubled loans from making a further claim.

The settlement has prompted other investors, like AIG, to join in on the litigation against the bank.  As Morgenson and Story’s article points out, BoA has encountered 25 suits related to the financial crisis thus far, many more than any other American bank.  Moreover, the journalists correctly tie this ongoing litigation into a broader theme: the federal government’s inability to successfully prosecute members of the banking industry.

Citing legal scholars and the insiders at the Justice Department, the writers imply that the lack of government intervention may be the result of the higher standard of proof necessary to secure a criminal conviction.  This notion has been buttressed by the fact that federal prosecutors were unable to deliver a conviction against Washington Mutual and Countrywide, two banks that have been involved in Justice Department investigations. These failures, unfortunately, create a situation in which investors must regulate the banks through litigation, which is extraordinarily costly and inefficient for all parties involved.

Whether the suit has any merit is a question in and of itelf—BoA rebuts AIG’s claims by arguing that the securities at issue appeared safe to both parties, and that their decline was the result of an unexpected depression in the housing market.  BoA further contends that “AIG is the very definition of an informed, seasoned investor,” and that they fully assumed the risk in purchasing the bank’s potentially high yield securities.

As we have stated several times, the underlying theme that constitently presents itself throughout the media analysis of BoA’s pre-courtroom saga is the lack of regulation in the securities industry.  While it is unclear as to which industry player has the upper hand here, all bear some fault—BoA for marketing the securities in the first place, AIG for creating a market for them, the ratings agencies for ensuring their legitimacy, and perhaps most of all, the government for failing to regulate.  Had these toxic assets not hit the market in the first place, the transaction and subsequent dispute would never had occurred and the economy may be much better off.  Along with it, our clients, many of whom had mortgages resold to Wall Street banks before the crisis, would have been better off, too.

What’s Up with Bank of America’s Bad Loan Settlement??

Late last month, Bank of America, one the nation’s largest mortgage servicers, entered into a settlement agreement with multiple investors, in what has been hailed as one of the most significant settlements involving mortgage-backed, toxic assets since the onset of the financial crisis.  At $8.5 million, the settlement, at least on its face, seems to present an optimistic message for investors, who can now maintain some measure of hope that legal remedies exists for the opaque, sometimes fraudulent securities on which they spent their money.

But a closer look at the agreement reveals a different picture.  While $8.5 million may be a convincing figure to some, the value of the mortgages held by the Bank of America totals at about $172 million, meaning that Bank of America secured a deal in which they were obligated to pay back less than five cents on every dollar.  This statistic has prompted many, including New York Attorney General Eric Schneiderman, to demand more information about the settlement.  Schneiderman and other critics suspect that the deal was put together hastily and unfairly: the New York Times reports that the investors involved in the settlement hold interest in merely one quarter of the 172 million in assets.  Moreover, because of the legal parameters of such a settlement, the deal would have a comprehensive effect, foreclosing claims from investors and individuals that may hold interest in the BoA loans but were not privy to the settlement negotiations.

More specifically, the settlement involves loans held by a BoA subsidiary, Countrywide Financial, which BoA purchased in late 2008 under what was apparently a disaster mitigation circumstance.  While BoA has every incentive to get rid of the Countrywide loans, given their toxicity and total lack of profitability, they neglect to consider the far-reaching policy effects that the deal will have.  Most conspicuously, the settlement will almost certainly accelerate foreclosure processes, which will impose devastating consequences on families.  These foreclosures will have broader economic ramifications.  According to Times columnist Paul Krugman, the settlement:

“would just accelerate foreclosures, and if more families were evicted from their homes, that would mean more homes offered for sale — an increase in supply. An increase in the supply of a good usually pushes that good’s price down, not up. Why should the effect on housing go the opposite way?”

Indeed, as Krugman writes, this settlement presents yet another example of letting bankers of the hook.  Furthermore, the Countrywide mess and the subsequent short sale of the firm to BoA indicates the crucial need for greater regulation of asset-backed securities, the danger of which is now well documented.  The deal will certainly affect our job at here at St. Ambrose, where our foreclosure prevention team negotiates with banks everyday in an effort to stymie foreclosures.  Settlements like this one set a precedent of “going easy on the banks,” as Krugman writes, enabling them to feel that they are beyond legal remedies for honest negotiation.  Such settlement will, in other

Give the Developments a Chance

A Stalled Housing Development (Image Source: Washington Post)

The Washington Post’s new expose that purports to reveal to the public the widespread incompetence affecting the Department of Housing and Urban Development has engendered much controversy. The series ostensibly addresses only a single program within HUD, the HOME Investment Partnership Program, which administers funding to local government and private entities to develop affordable housing projects. In stentorian fashion, the opening sentence of an article titled, “A trail of stalled or abandoned HUD projects,” (part of the multi-article investigative series titled, “Million Dollar Wasteland”), declares, “ the federal government’s largest housing construction program for the poor has squandered hundreds of millions of dollars…and routinely failed to crack down on derelict property developers or the local housing agencies that funded them.” The Post goes onto report that some 700 projects, totaling “nearly $400 million” have been stalled for years, some even for decades, causing widespread blight. The article then lists widespread deficiencies in oversight and accountability within HUD, contending that the agency doles out cash without properly vetting recipients, that money was delivered when projects were only in an inchoate phase, and that HUD should have imposed more regulations on funding recipients, whether they be housing agencies, non-profit organizations, or the partnered developers. Needless to say, we were surprised.

Perhaps the main reason the article surprised us, however, was what appeared to be the intentional misrepresentations of the available housing statistics, most of which were pointed out lucidly by Secretary Donovan. In a response published on June 10, Donovan rebutted the Post by indicating out that HUD has received numerous acclaim in recent years as well introducing his own stats:

Although HUD provided data and information to The Post for more than a year, the paper has not shared with us the list of projects it generated. So after the articles ran, we conducted our own project-by-project review using The Post’s parameters. We determined that more than half of 797 projects that could have been flagged as “stalled” based on The Post’s criteria are finished.

Of the remaining projects, 97 have been canceled and their funding moved to viable projects, while 154 are progressing toward completion. The final 85 properties are experiencing delays, but in the vast majority of cases there is a simple reason for this: the recession.

Donovan goes on to state the conclusions of HUD’s internal study: only four percent of the more that 5,000 Home projects are “delayed” or “cancelled” (employing the metrics used by the Post). Moreover, the Post misleadingly gives the impression that funds were squandered, when in fact HUD policy stipulates that “[if] there are delays, money can be moved to other viable projects or must be returned if it is not used within five years.” Donovan then goes on to defend the decentralized nature of the HUD grants, which give large discretion to local communities and their governments, by suggesting that this framework is a preferable to a “one-size-fits-all” federal mandate.

In addition to what could be blatant misrepresentations or mistakes, the article is unfair in a number of other respects. For starters, it assumes more regulations and requirements are a solution, while ignoring the fact that these could quite possibly further stifle such developments. Moreover, it completely neglects to contrast the HUD programs with the ways in which the private sector has aimed to deliver affordable housing in recent years. While this phenomenon also resulted from public-private partnerships, namely government policies encouraging homeownership and many private entities vying to advantage from government guarantees by engaging in the lucrative process of securitizing credit, the private sector likewise failed, resulting in the financial crisis. The HUD developments, which involve the government to a greater extent than most other housing developments, are one of the few bright spots of economic creation in the housing industry, which many commentators have pointed out is crucial to broader economic recovery. Let’s keep this in mind, and give the developments a chance.

We at St. Ambrose were also particularly chagrined about the fact that the article seemingly attempts to paint the entire Department of Housing and Urban Development in a negative light. The Post does this in part by implying that HUD is a single-faceted organization aimed at the development of new properties for low-income citizens. While it is true that this area comprises a major part of HUD’s activity, the organization also provides other, far different services, many of which remain crucial to mitigating the widespread financial pain incurred by the current financial crisis. These services include both mortgage and foreclosure prevention counseling—we believe that the former type of assistance needs to be implemented on a large scale, as mortgage counseling is often key to ensuring that families understand their commitments, the terms of their mortgages, and what it will take to keep above water over the long term. As for the latter, we know that foreclosure prevention assistance is paramount in enabling families to stay in their homes longer. Take for example our unique study on foreclosure prevention conducted earlier this month, which among other things found that 70% of homeowners that underwent counseling in 2007 reported positive outcomes, and that homeowners who utilized counseling services were 79% more likely to experience a positive outcome. (More insight on the study will appear here next week).

More than anything, in light of Donovan’s straightforward statistics, which serve to debunk much of the Post’s shocking data, we wonder how the Post could have come up with numbers that contrast so sharply with HUD’s. As far as we know, the Post is yet to respond to Donovan, and on this point we think it may be fair to take a hint from one of Baltimore’s great social critics, David Simon. In Season 5 of The Wire, the city’s local paper runs into some problems with balancing sensationalism with thorough, honest journalism. And while we certainly don’t equate the Post series with Scott Templeton, it’s reasonable to suspect that the Post may be guilty of a similar, all too common imbalance.

The Importance of Consumer Protection

President Obama with Elizabeth Warren, Prospective Head of the New Consumer Financial Protection Bureau

To many of us, developing greater consumer protection measures is common sense: every day, we see families foreclosed out of their homes or evicted from their rental units because they did not (or in fact could not) understand the financial product they purchased.  On the lending side, which we see much more commonly at St. Ambrose, these products often come in the form of adjustable-rate-mortgages.  In such a loan, the initial interest rate often starts low but rapidly increases over time, leading the mortgage holder to believe that they are getting a deal at first only to find out later that they will be unable to make payments and may end up in foreclosure.

We’ve come across situations in which homeowners were not told that the interest rates would rise over time or where banks have misrepresented the product entirely, suggesting that the interest rate is fixed.  The latter scenario happens frequently when banks market products to buyers whose first language is not English.  Sometimes, we even see direct credit lenders selling products to low-income, under-resourced clients in order to “help” them purchase a home.  Often times, hidden fees are imbedded in the loan product, whereby the buyer is penalized substantially for late payments.

These stories are common among housing counselors. Beyond the housing world, other industries have long played the same game.  Credit cards, for instance, often fail to clearly disclose the interest rate for buyers intending to pay a lower-end monthly installment.  Rent-to-Own schemes are another classis example. Companies that engage in International Money Transfers—or companies that help Americans transfer money to family members and friends over seas (a multi-billion dollar industry)—often fail to disclose remittance fees, or transaction fees they charge customers.  Likewise, these companies frequently do not notify their customers of the exchange rates on transfers, which, for obvious reasons, can be crucial to the amount of money a customer is willing to send and the commensurate fee they will owe.

These situations are the reason for the creation of the new Consumer Financial Protection Bureau, for which the White House has selected Professor Elizabeth Warren to head.  As the CFPB’s excellent website explains, before the financial crisis, the federal government could not adequately monitor the market for unfair (and perhaps illegal) practices because too many different agencies existed with varying roles; inevitably, cracks emerged, and sleazy companies slipped through them.  The CFPB intends to rectify this problem by functioning as a centralized agency that monitors predatory scams across industries.

Beyond its importance to consumers, the Bureau is crucial on a systemic level.  Perhaps the main cause of the financial crisis was the proliferation of securitized loan products, (many of which were backed mainly by home mortgages).  Investors (and the Wall Street banks that facilitated their purchases) demanded these products highly, incentivizing main street banks to continue to hand out credit, even when buyers were less-than-credit-worthy.  Eventually, this chain, coupled with the lack of government oversight, poor public policy, and failed public-private partnerships, collapsed, leading to the recession.

The CFPB would ensure that products like poor loans do not pervade the market like they once did, which would lead to significant economic consequences.  Moreover, Ms. Warren, a Harvard law professor with an unimpeachable record of standing up for Average Joes, is the woman for the job.

However, Congress must confirm her first, and backed by special interests, the confirmation may not materialize.  (For the latest example of crude opposition, see here). Whatever happens, we know that kick starting the CFPB, a project that his been on the drawing board for years now, would make the job of St. Ambrose and similar non-profits around the country much, much easier.

New Program Brings $40 Million to Maryland for Foreclosure Prevention

Official Logo of HUD, Which Administers the Program

As many of you may know, Maryland recently gained $40 million for foreclosure assistance as part of the Emergency Homeowner Loan Program, signed into law several months ago by President Obama.  Governor O’Malley used these funds to kick off the Emergency Mortgage Assistance Program last week.  On her popular Real Estate Wonk blog, Jamie Smith Hopkins succinctly describes the program’s bullet points:

Borrowers could receive as much as $50,000 in interest-free loans to pay off past-due amounts and to make up to two years of payments. They must have taken an income hit of at least 15 percent, be three to 12 months behind on their mortgage and have a “reasonable likelihood” of being able to get back on their feet.

The emergency help is like loan-to-grant money given to first-time homebuyers: No payments are due for five years, and every year the total is reduced by 20 percent until nothing is owed — as long as the homeowner keeps the property and stays up-to-date on the mortgage during that time.

Ms. Hopkins then asks: “what do you think? Better or worse off than loan modifications?”  While perhaps failing to directly proffer a response, my thoughts are below:

Maryland’s adoption of the new Emergency Mortgage Assistance Program is welcome news, no doubt, but it’s important to temper our optimism with strong caution.  As it stands, the new program delivers cash, not regulation.  And as we’ve seen all too often in our counseling sessions and discerned from our peers across the nation as well as from the news media, cash alone certainly may not result in a tangible step towards mitigating the impact of the foreclosure crisis, which, at least ostensibly, is the goal of this legislation.  Take for example Bryan Sheldon’s recent commentary about a “typical” mediation process, in which Bryan, a veteran counselor, accurately describes some of the common troubles that home-owners face while utilizing HAMP: banks’ ridiculous and erroneous demands for documents unrelated to foreclosure, the government’s inability to enforce program guidelines (and the banks’ inability to comply), and the banks’ illegal practice of commencing foreclosure proceedings while the borrower is under review for HAMP assistance.  Recently, policymakers were forced to draft legislation prohibiting lenders from initiating a foreclosure while the borrower is actively seeking mediation.  While this prospective reform is a breath of fresh air, it should have been totally unnecessary: common sense should prompt one to realize that such a practice is dishonest and unethical.

Frankly, Bryan hits the nail on the button when he writes, “the basic problem with the available government programs is that they have been implemented in the grossly deficient regulatory system which contributed to the foreclosure crisis in the first place.”  Indeed, I’m not convinced that this new program will produce results without robust, broad financial regulation to accompany it.

It’s important to remember that the foreclosure crisis was two-fold.  The predatory lending scams defined stage one, causing massive foreclosures and therefore families without housing, an aggregate loss of equity across the nation, and oddly as well as most consequentially, a crash in the U.S. securities market.  This last consequence led to stage two: large-scale layoffs, which subsequently forced many middle class families to default on their mortgages and eventually face the inevitable.

These victims still exist.  Many are still jobless, even homeless. And while many such people borrowed beyond their means, this trend emerged because of the gaping income inequality and stagnant wages that pervaded the last few decades, obligating many middle-class Americans to borrow more than they could take on.

These problems are now structural, and in addition to emergency benefits like the one’s offered in the new package, a structural fix is likewise necessary. To be sure, The administration has made some good efforts: the Frank-Dodd bill aimed at regulating the financial markets, the concept of a Consumer Financial Protection Bureau, headed by Elizabeth Warren, to name a few. But these development aren’t cutting it, indicated by the continuing prevalence of foreclosures nationwide.

I’m worried that the administration will stop with this initiative and that it will turn into another HAMP, which does not grant the Treasury Department the ability to impose fines on banks, a loophole that the latter group routinely abuses, among other shortcomings.  Along with foreclosure assistance to states, the President Obama needs to return to the drawing board and draft comprehensive financial regulation that 1) includes consumer protection measures, 2) defines and streamlines the process of responding to a foreclosure, while consolidating paperwork, 3) rigorously regulates the trading and development of dangerous securities, and 4) provides stringent enforcement measures.  This last point is crucial, as it had become fairly obvious that the government, all too often, has been plainly unable to administer the rule of law.

Until then, unfortunately, I am not convinced that this measure won’t fall short.  So while the state should welcome the Emergency Homeowner Loan Program with open arms, first and foremost, in order to stymie the foreclosure crisis and ensure it does not reoccur, we must mend “the grossly deficient regulatory system” that caused it.

Will Proposed Reforms in Lending Work?

New Yorker Cartoon Satirizing Wall Street’s Opaque Securitization Chain

Over the last few weeks, considerable reforms have been proposed in the world of mortgage financing.  The most salient has been Iowa Attorney General Tom Miller’s proposal that would, among other things, require banks to terminate foreclosure proceedings while borrowers are actively pursuing a modification.  While Miller’s ideas seem both necessary and commonsensical on the surface, they have run into criticism from all ends of the political and economic spectrum.  The critics, from various vantage points, ultimately posit the same inquiry: will the reforms work?

On one hand, critics from the left argue that the reforms do not go far enough. In a staff editorial a few days back, the New York Times vigorously puts forth this contention, expressing concern that the terms of the reform will provide the banks leeway to avoid the kinds of strong penalties they deserve.  In particular, the Times cites the fact that the proposal does not proffer a way to implement reforms.  Moreover, Miller and his fellow attorneys generals have discussed the possibility of a settlement over the banks illegal practices, like the infamous robo-signing scams and systemic predatory lending—which may function as a prosecutorial shield.

The Times’ also cites a review of the proposal by their staff writer, Gretchen Morgenson.  In addition to outlining the overhaul’s lack of sufficient legal remedies for borrowers, Morgenson also points out what in her estimation appears to be yet another substantive flaw:

the terms severely disappoint in their treatment of second liens, a major sticking point in many loan modifications. The proposal would treat first and subsequent mortgages equally, turning upside down centuries-old law requiring creditors at the head of the line to be paid before i.o.u.’s signed later.

Treating holders of first and second liens alike is a boon to the banks, since so many second mortgages are owned by the nation’s largest institutions; many of the firsts are held by investors in mortgage-backed securities. The banks want the first mortgages to take the hit, leaving the seconds intact. Or at least for them both to share the pain equally.

To some degree, the document presented by Mr. Miller raises more questions than it answers.

As news of the proposal’s substance continues to rapidly unravel, a few thoughts come to mind.  While the proposal is a much needed step in the right direction, it does not seem to address the institutional nature of predatory lending.  We now know that the aggressive marketing of bad loans to uninformed consumers morphed into a systemic problem largely as a result of a perverse incentive structure.  As we’ve outlined in many previous posts, main street banks often possessed an incentive to dole out non-prime loans because of a pervasive securitization chain that linked borrowers, lenders, investment banks, and investors.

While consumer protection reforms are needed, no doubt, attorneys general would fundamentally benefit from a regulatory infrastructure at the federal level that addresses the securities market.  The Frank-Dodd Bill is a start, but as John Cassidy recently pointed out in his much talked about New Yorker article a few months back, asset-backed securities have become the heart of the financial industry, implicating average Joes and Wall Street investors alike.  Without financial regulation that adequately integrates consumer protection measures, Miller and the rest of the state’s attorneys will not gain the legal leverage they need to stymie the broken lending processes that have afflicted far too many of their constituents and thus may be forced to make concessions.

Talk to St. Ambrose Review of Charles Ferguson and Audrey Marrs’s Inside Job

The Film’s Official Poster

Two weeks ago, nearly 38 million Americans tuned in to watch ABC’s coverage of the eighty-third annual Academy Awards ceremony.  While this year’s Oscars delivered the usual Hollywood dose of glitz and glamour, this post highlights merely one slice of the 2011 Oscars: the award-winner for Best Documentary Feature, Inside Job, directed by Charles Ferguson and Audrey Marrs.

Inside Job is relevant to St. Ambrose because it focuses on the origins and implications of the financial crisis, which, of course, are extensively tied to the housing and real estate markets.  Moreover, low and middle-income people have taken a particularly hard hit, as many have lost substantial equity in their homes—and by extension savings for college tuition, healthcare, and retirement—or have undergone foreclosure.

The film, however, doesn’t focus too heavily on everyday folks but instead provides a thorough, didactic chronicle of the public policy and irresponsible financial practices that led to the crisis.  Divided into five parts, Ferguson and Marrs begin their documentary by portraying the situation in Iceland, which, staggeringly, possessed a yearly GDP of $13 billion but found itself $100 billion in debt during the crisis.  Iceland’s troubles culminated in the sort of brutal unemployment with which we in the rest of the Western world are now familiar.  The filmmakers attribute this flabbergasting statistic to the fact that Iceland, in addition to privatizing it’s three largest banks, systematically unraveled its robust regulatory state, as it too was swept by the deregulation fervor that infected most other industrialized nations.  This allowed Icelandic banks to make highly leveraged investments—as in using more borrowed than in-hand capital—that, of course, failed miserably.

From this vantage point, the film explores how domestic deregulatory policy also facilitated U.S. bankers’ identical mistakes. Ferguson and Marrs graphically convey two of the most talked-about yet enigmatic securities that were apparently responsible for bringing down the economy, Synthetic Collateralized Debt Obligations and Credit Default Swaps.  The former refers to the process of banks’ securitizing bundled mortgages, repackaging them and selling them to investors at an inflated price.  The pervasiveness of these kinds of securities created a perverse incentive structure whereby local lenders were under pressure to sell as many loans as possible, even “junk” ones, since they knew that these loans would be purchased, regardless of their quality.  This then led to massive predatory lending.  The latter kind of “security,” if one can even call it that, are the notorious insurance policies that enabled investors to make bets on whether the borrower would sink or swim, get foreclosed or pay off the loan.

In addition to demonstrating the proliferation of both securities, the film, I think, works to dispel a few equally pervasive myths: these securities are complex, sophisticated products that the average Joe couldn’t possibly comprehend, and that the high fallutin’ investment bankers on Wall Street had everyone’s best interest in mind. On the contrary, Ferguson and Marrs show that CDOs and Credit Default Swaps amount to little more than the repackaging of other people’s debt, and rather than rigorously examining the loans that comprise their products, these bankers possessed a lazy tendency to put them on the market with little analysis.  (The directors contrast the financial services industry with the IT sector, for which one actually “needs an education”). They further point out that the perverse incentive structure extended to our three major credit rating agencies, which, having been commissioned by the banks themselves, systematically bestowed upon the banks’ junk loans the same AAA ratings that they gave U.S. Treasury bills.

What the film does best is cohesively weave together this unfortunate maelstrom of events, illustrating the ties between borrowers, lenders, banks, and their investors in a cogent and clear fashion that is lacking in the media.  The filmmakers expose how these ties emphatically reveal a truth recently reiterated by the Financial Crisis Inquiry Commission’s Report, that the catastrophe was avoidable.  To be sure, Inside Job has some setbacks: the directors could have done a better job conveying the human affect of the bankers’ practices.  They could have also further developed some important themes that they mentioned briefly, like the rising cost of college tuition relative to the rate of inflation, which is functioning to preclude more and more middle class kids from college.  Nevertheless, in an hour and twenty minutes, Inside Job manages to be informative, entertaining, and important, and we at Talk to St. Ambrose would welcome any thoughts or comments about the film.