Bank Settlements and the Arc of Justice

Ron Cogswell

MLK Memorial in DC

Martin Luther King, Jr. said that the “arc of the moral universe is long, but it bends towards justice.” A recent report by SNL Financial (available here, but requires a lot of sign-up info) offers us a chance to evaluate that claim in the context of the financial crisis.

SNL reports that the six largest bank holding companies have paid over $132 billion to settle credit crisis and mortgage-related lawsuits brought by governments, investors and other financial institutions.

In the context of the litigation over the Fannie and Freddie conservatorships, I had considered whether it is efficient to respond to financial crises by allowing the government to do what it needs to do during the crisis and then “use litigation to make an accounting to all of the stakeholders once the situation has stabilized.” (121)

Given that the biggest bank settlements are now in the rear view window, we can now say that the accounting for the financial crisis comes in at around $132 billion give or take. Does that number do justice for the wrongs of the boom times?  I don’t think I have my own answer to that question yet, but it is certainly worth considering.

On the one hand, we should acknowledge that it is a humongous number, a number so big that that no one would have considered it a likely one at the beginning of the financial crisis. This crisis made nine and ten digit settlement numbers a routine event.

On the other hand, wrongdoing (along with good old-fashioned boom mentality) during the financial crisis almost sent the global economy into a depression.  It also wreaked havoc on so many individuals, directly and indirectly.

I look forward to seeing metrics that can make sense of this (ratio of settlement amounts to annual profits of Wall Street firms; ratio to bonus pools; ratio to home equity lost), but I will say that I am struck by the lack of individual accountability that has come out of all of this litigation.

Individuals who made six, seven and eight figure paychecks from this wrongdoing were able to move on relatively unscathed.  We should think about how to avoid that result the next time around. Otherwise the arc of justice will bend in the wrong direction.

 

This Is What Bad Faith Looks Like

Silas Barnaby

A New York judge ruled in Federal National Mortgage Assoc. v. Singer, 2015 NY Slip Op. 51038(U) (July 15, 2015 Sup. Ct., New York County) (Moulton, J.) (unpublished opinion), that two lenders will forfeit more $100,000 in interest payments on two mortgages because they did not act in good faith in negotiating a mortgage modification, as required by New York law. There is a lot of choice language in the opinion, but it is useful to read the judge’s summary of what the borrowers went through in trying to get the modification.

The judge disagreed with the lenders’ “positive assessment of the negotiations” as it was “belied” by the facts:

Fannie Mae delayed filing of Action No. 1 (filed on June 14, 2011) 17 and 1/2 months after the date of default. Counsel then delayed filing the RJI [Request for Judicial Intervention] for another three months after the answer was filed. The first settlement conference, scheduled on March 14, 2012, had to be rescheduled to May 2, 2012 due to Fannie Mae’s non-appearance, a one and one-half month delay. It took Fannie Mae and its counsel another five and 1/2 months to provide an explanation for why the two mortgages could not be merged or consolidated, and only after wasting time at two conferences in June and July attended by attorneys without knowledge of the case or settlement authority and only after my court attorney probed for answers. Thereafter, the Singers submitted the requested documentation for a loan modification of the 400-Mtge., despite confusing and conflicting requests by the Rosicki firm, by August 3, 2012. When that application became “stale,” the court directed the Singers to update the information and, finally, after another two-month delay, Seterus offered the Singers a trial modification plan on or about October 11, 2012. When the Singers received the permanent loan modification papers from Seterus in January 2013, they objected to the payment of $63,632.21 in accrued interest and the $5,605.23 accrued interest. It took many months for Seterus to admit its mistake on the escrow deficiency, and only after much prodding by the court for status updates. Seterus did not offer the Singers a new loan modification agreement until the very end of October 2013 — a whopping nine-month delay. Finally, it took Fannie Mae’s counsel another five months to reject the Singers’ January 1, 2014 counteroffer to pay $18,000 of the accrued interest.

Accordingly, the court holds that Fannie Mae and/or its counsel have acted in bad faith and have unreasonably delayed a resolution of this foreclosure action. As a result, interest should be tolled on the note and mortgage in the amount over and above 2% annually, for the period from September 30, 2011 (one month after Singers’ filing of their answer in Action No. 1) through the date of this Decision and Order. (10-11, footnotes omitted)

It is hard to really get how crazy the modification process can be in the abstract, so sitting with facts like these is a useful exercise. And this seems like the right result on these facts.

I have blogged before about the Kafkaesque struggles that borrowers face. Some deny that lenders behave this badly in general but the cases and the large scale settlements “belie” this too. What will it take to give borrowers a consistent and reasonable experience with mortgage modifications?

What’s Behind Rising Mortgage Bond Issuance?

GlobeSt.com quoted me in What Else Is Behind Rising Mortgage Bond Issuance, Demand?. It opens,

Investor demand for mortgage bonds, both that have agency backing and not, is quite high these days.

Last week Bloomberg reported that issuance of home-loan securities that don’t have government backing reached more than $32 billion this year, compared to $18 billion a year ago, citing data compiled by Bloomberg and Bank of America Corp. These securities include rental-home bonds, a relatively new asset class that developed after the recession.

Agency and GSE securities are also in high demand, as a recent report from the Mortgage Bankers Association indicates. The level of commercial/multifamily mortgage debt outstanding increased by $40.4 billion in the first quarter of 2015 — a 1.5% increase over the fourth quarter of 2014. Said Jamie Woodwell, MBA’s Vice President of Commercial Real Estate Research with the report’s release: “Multifamily mortgages continued to grow even more quickly than the market as a whole, with banks increasing their portfolios by $8 billion and agency and GSE portfolios and MBS increasing their holdings by $10 billion.”

There are a number of economic-based drivers behind the demand for mortgage bonds of course: the fundamentals in the real estate space and the low interest rates that have driven investors to consider all manner of securities to eek out yield.

However, there is another possibility to consider as well and that is that the changing financial regulations are driving both issuance and investment.

On one hand, mortgages and private-label mortgage backed securities are much more regulated per Dodd-Frank and its Qualified Mortgage and Qualified Residential Mortgage rules, according to David Reiss, professor of Law and research director of the Center for Urban Business Entrepreneurship (CUBE) at Brooklyn Law School. On the other, post-crisis rules put in place for mortgage bonds have made these securities far more attractive for banks to hold as various news reports suggest.

For example, new rules have made ratings on mortgage bonds less crucial, allowing US lenders to use an alternative approach to calculating capital requirements, according to another recent article in Bloomberg. In essence, these rules allow lenders to reduce the amount needed for junk-rated mortgage bonds that are trading at discounts.

In addition, banks are finding that “treasury debt and MBS pass-throughs meet regulators’ standards much more easily than other assets”, according to a report by Deutsche Bank analysts Steven Abrahams and Christopher Helwig, per a third recent article in Bloomberg.

Two Opinions

With these facts in mind we turned to two experts to see how much of an impact new regulations are having. As it turned out, they are driving some of the change – but what is actually moving the needle in terms of demand is yet another trend. Read on.

For starters, there are some caveats. It can be misleading to throw the new rental home bonds in the mix in such a comparison, Reiss tells GlobeSt.com. “They are a post-crisis product when Wall Street firms saw that single-family housing prices were so low that they could make money from buying them up in bulk and then renting them out,” he says.

“They are not regulated in the same way as private-label MBS.”

Meanwhile issuers are still navigating Dodd-Frank’s Qualified Mortgage and Qualified Residential Mortgage rules, he says. They “are still trying to figure out how to operate within these rules — and outside of them, with the origination of non-QM mortgages. The market is still in transition with these products.”

As he sees it, the surge in issuance is a reflection of market players trying to understand how to operate in a new regulatory environment. They “are increasing their issuances as they get a better sense of how to do so.”

Reiss on SCOTUS Junior Lien Decision

US-Supreme-Court-room-SC

Bloomberg BNA quoted me in Nagging Economic and Credit Questions Dampen Bankruptcy Victory for Bankers (behind paywall). It reads, in part:

The U.S. Supreme Court delivered an important bankruptcy ruling for bankers that doesn’t, however, do anything about still-struggling homeowners (Bank of Am. N.A. v. Caulkett, 2015 BL 171240, U.S., No. 13-cv-01421, 6/1/15); (Bank of Am. N.A. v. Toledo-Cardona, 2015 BL 171240, U.S., No. 14-cv-00163, 6/1/15).

In a June 1 decision, the court said Chapter 7 debtors cannot void junior liens on their homes when first-lien debt exceeds the value of the property, as long as the senior debt is secured and allowed under the Bankruptcy Code.

The decision is a victory for Bank of America, which held both junior liens in the two related cases, and for banking groups that said a different result could have destabilized more than $40 billion in commercial loans secured by similar liens.

But Brooklyn Law School Professor David Reiss June 2 said the case highlights the need for a broad remedy for homeowners who have continued to struggle to make payments since the financial crisis.

“The bank’s position as a legal matter is a very reasonable one, but from a policy perspective we needed and still need a bigger and more systemic solution to the problems that households face,” Reiss told Bloomberg BNA.

*     *     *

[S]ome said the ruling highlights economic questions on several levels.

Reiss, who coedits a financial blog, June 2 said the case shows the federal government’s inability to deal head-on with the impact of financial turmoil in 2008 and 2009.

“Not enough is being done to move households beyond the crisis, and it’s bad for households and it’s bad for the financial sector,” Reiss said. “Here we are seven or eight years later and we’re sitting here with these valueless second mortgages. We’re just slogging through the muck and we’re not coming up with any good solutions to get past it.”

AG Lynch on Wall Street

Loretta_Lynch_US_Attorney

Institutional Investor quoted me in Will New Attorney General Loretta Lynch Shake up Wall Street? It opens,

Those unhappy with the lack of personal accountability for the 2008–’09 financial crisis are running out of time to see justice served: In the U.S., the statute of limitations for many bank-related criminal charges is ten years. But the recent appointment of Loretta Lynch as the first black woman to the post of attorney general could present a window of opportunity.

Given mounting public frustration over the failure to punish financial executives who helped push the world to the brink of another Great Depression, Lynch may be well positioned to act where her predecessor, Eric Holder, was unsuccessful. The U.S. Department of Justice has often talked up its efforts to hold individuals responsible for crimes they may have committed, but there hasn’t been much progress. Last year, however, saw an uptick in the size of bank settlements related to the crash, including a $16.65 billion deal with Bank of America Corp. and a $7 billion agreement with Citigroup.

Some industry observers believe Lynch, who turns 56 on Thursday, could use this momentum to target people. “If she does anything differently [than Holder did], she may push her folks to try to make those cases against individuals higher up the corporate ladder,” says Glen Kopp, former assistant U.S. attorney in the Southern District of New York and a New York–based partner in the white-collar practice at law firm Bracewell & Giuliani.

Lynch’s critics have griped that she may be not be strict enough with Wall Street. They point to her 1980s stint with law firm Cahill Gordon & Reindel, which has counted among its clients BofA, Credit Suisse Group and HSBC Holdings, and to a spell early last decade at Hogan & Hartson (now Hogan Lovells), where she practiced white -collar criminal defense.

Detractors say both positions, as well as her tenure at the Federal Reserve Bank of New York from 2003 to 2005, have compromised her ability to prosecute big banks by establishing relationships that she may not wish to jeopardize as attorney general. During Lynch’s lengthy confirmation process, Republicans criticized her for being too soft on HSBC in a 2012 settlement; the British bank agreed to pay $1.92 billion in a money-laundering case after New York and federal authorities decided that criminal charges might bring down the institution.

But many in the legal community believe the more likely outcome will be somewhere in the middle.

“The financial industry will be dealing with an extremely well-informed AG who will seek to balance the competing concerns that arise when investigating and prosecuting large enterprises like those that dominate Wall Street,” says David Reiss, a professor at Brooklyn Law School with expertise in property, mortgage lending and consumer financial services matters.

FHFA’s $500MM Win

Bloomberg quoted me in Nomura, RBS Defective-Bond Suit Loss Seen Spurring Deals. It reads, in part,

Nomura Holdings Inc. and Royal Bank of Scotland Group Plc may face $500 million in damages for what a judge called an “enormous” deception in the sale of defective mortgage-backed securities, a ruling that may spur other banks to settle similar claims tied to the 2008 financial crisis.

Nomura and RBS were excoriated in a 361-page opinion by U.S. District Judge Denise Cote in Manhattan, whose ruling followed the first trial of claims that banks sold flawed securities to government-owned mortgage companies. After a three-week trial, Cote said they misled Fannie Mae and Freddie Mac and set a damages formula that may result in the government winning about half its original claim of $1 billion.

“The offering documents did not correctly describe the mortgage loans,” Cote, who heard the case without a jury, wrote Monday. “The magnitude of falsity, conservatively measured, is enormous.”

Before the trial, FHFA had reached $17.9 billion in settlements with other banks, including Bank of America Corp., JPMorgan Chase & Co. and Goldman Sachs Group Inc. The ruling against Nomura and RBS may encourage other banks to settle mortgage-related suits brought by regulators and private investors rather than face the bad publicity and cost of an adverse judgment, said Robert C. Hockett, a professor at Cornell Law School.

“They look pretty bad,” Hockett said in an interview. “They look like the strategy has blown up in their faces.”

Cote ordered the Federal Housing Finance Agency, which filed the case, to propose how much the banks should pay as a result of her ruling.

*     *     *

Cote rejected the banks’ claim that the housing crash, and not defects in the loans, was responsible for the collapse of the mortgage-backed securities.

David Reiss, a professor at Brooklyn Law School, called Cote’s ruling “incredibly thorough.” The judge included detailed factual rulings that may make it difficult for Nomura and RBS to win on appeal, he said.

Foreclosures and the Fair Debt Collection Practices Act

Bloomberg BNA quoted me in Third Circuit Says Foreclosure Complaint May Serve as Basis for Claims Under FDCPA (behind a paywall). The article opens,

A foreclosure complaint may form the basis of a Fair Debt Collection Practices Act (FDCPA) claim, the U.S. Court of Appeals for the Third Circuit held, saying foreclosure meets the broad definition of “debt collection” under the statute (Kaymark v. Bank of Am. N.A.2015 BL 97853, 3d Cir., No. 14-cv-01816, 4/7/15).

Dale Kaymark filed a class suit against Bank of America and Udren Law Offices, P.C., a Cherry Hill, N.J., law firm, including in its claims an allegation that Udren violated the FDCPA by listing in a foreclosure complaint not-yet-incurred fees as due and owing.

Kaymark also said the firm violated the statute by trying to collect fees not authorized by the mortgage agreement.

A district court dismissed those and other claims by Kaymark, but the Third Circuit reversed April 7, allowing all but one of his FDCPA claims against Udren.

According to the court, a 2014 Third Circuit ruling on debt collection letters also applies to foreclosure complaints.

“We conclude that a communication cannot be uniquely exempted from the FDCPA because it is a formal pleading or, in particular, a complaint,” Judge D. Michael Fisher said. “This principle is widely accepted by our sister Circuits,” he said.

Wide Impact Seen

Udren Law Offices did not immediately respond to a request for comment on the case. In separate briefs filed in August 2014 and December 2014, lawyers for the firm predicted that application of the FDCPA to foreclosure complaints might allow any state foreclosure action to spark an FDCPA suit, with ill effects for legal practice.

A Bank of America spokeswoman April 8 declined to comment on the ruling. The FDCPA claim was directed only at the law firm, not the bank. Lawyers for Kaymark also did not immediately respond to a request for comment.

Brooklyn Law School Professor David Reiss, the Research Director of the Center for Urban Business Entrepreneurship, said the decision highlights increased judicial sensitivity in some areas of the law.

“It’s a well-reasoned ruling that clarifies application of the statute in the foreclosure context and that will affect contacts that lawyers have with alleged debtors,” said Reiss, who maintains a real estate finance blog. “In terms of practical effects, it won’t necessarily mean thousands of new lawsuits, but it does mean that lawyers will have to be very careful about how they communicate fees and estimates. It’s going to mean, to some extent, a cleaning-up of informal practices in the foreclosure bar, such as treating not-yet-accrued costs as accrued costs,” Reiss told Bloomberg BNA.