Most of what I’ve read so far on the multistate attorneys general mortgage servicer settlement involves analysis of what homeowners "get" or "don’t get," with the inevitable conclusion being that whatever consumers will "get" isn’t enough. All of which should surprise exactly nobody.
What I'm going to do, instead, is give some new perspective on what this settlement really accomplishes. Participating banks appear to have given up far more in this settlement than many want to give them credit for. Two items in particular stand out to me:
1. The settlement is a clear signal of large banks’ acquiescence to state AGs as their new de-facto regulators, effectively ushering in the end of an era of federal pre-emption.
2. Discovery obtained in the foreclosure settlement process by state AGs can and will be allowed to have broad applicability to future lawsuits that have nothing to do with servicing.
The idea that state AGs are gaining newfound regulatory power and importance is something the industry is now waking up to in the wake of this settlement announcement. It will force a sea change in how banks see their mortgage operations. A great post by Jeremiah Buckley with BuckleySandler over at American Banker’s BankThink blog sums this up nicely, and is worth a read. But this settlement effort is just the start: under Dodd-Frank, state AGs gain new enforcement powers relative to rules promulgated at the federal level by the Consumer Financial Protection Bureau.
As for discovery, I’m told by those much closer to the settlement that the AG investigation uncovered plenty of new skeletons in the closet — but most of it not directly tied to servicing practices. The fact that New York AG Eric Schneiderman (along with a group of other state AGs) is now leading a federal task force newly empowered by the Obama administration to pursue these other issues should be your first clue.
The fact that discovery from the foreclosure investigation will be allowed to apply to future litigation removed from this particular settlement effort should also signal that the state AGs feel they found larger fish to potentially try to fry.
Both of these concessions are far more important than many commentators seem to realize, since the general consensus I’ve read thus far seems to be that the "banks gave up nothing." The question we really ought to be asking, instead, is this: What made the banks agree to give up so much?
Finding an answer in the FHA
For the answer to that question, you probably don’t need to look much further than the Federal Housing Administration itself. As HousingWire reported, Bank of America [stock BAC][/stock] agreed to pay $1 billion to settle claims of harm involving the FHA, with $500 million of that total going directly to the agency in a cash payment.
Other banks participating in the settlement thus far have driven the total direct payments to FHA up to $1 billion — which not only helps offset the agency’s dwindling mutual mortgage insurance fund that garnered so much press attention as of late, but also resolves FHA’s claims against the lenders themselves.
Nearly everyone outside the industry, and even many of those professionals within it, aren’t aware of the arcane-but-important details of how the FHA really does business when it comes to mortgages.
In particular, two words matter: treble damages.
Let me explain. The FHA, which insures mortgages issued by federally qualified lenders, essentially serves as a de facto lender of last resort for the low- to moderate-income borrower who cannot afford a sizable down payment. It’s been chronically understaffed, and lacks the technology to perform in-depth underwriting reviews and servicer reviews. In addition, the FHA has often been the trash can for loans no one else wants, or is willing to underwrite. It’s not popular to say, but it is the truth — especially historically.
Because of this, originators selling loans to the FHA for a Ginnie Mae wrap, for example, are required to make all sorts of attestations regarding loan quality, servicing practices and so forth (for example, here’s a final rule from HUD on loss-mitigation procedures and treble damages for failure to follow them, from early 2005).
The punishment for breaching any of these rules is designed to be extraordinarily harsh. The idea here is that by making the punishment severe enough, lenders will abide by the given requirements out of fear of what could happen if they don't; especially since the FHA doesn’t have the resources to actively audit everything.
In practice, however, the FHA rarely pursues major lenders under its treble damages authority. In fact, unlike Fannie Mae and Freddie Mac, it’s my understanding the FHA has yet to make a major push for loan buybacks due to fraud and misrepresentation of loans sent its way — and it’s also my understanding that at least some misconduct violating the FHA’s servicing requirements was uncovered during the state AG investigation.
Teddy Roosevelt once famously said, “Speak softly and carry a big stick.” That logic would seem to apply to HUD Secretary Shaun Donovan’s thus-far underappreciated role in compelling the nation's largest banks to the table to negotiate with a group of state AGs that for years prior had been told to pound salt by banks that didn't feel they needed to answer to a state-level litigator — and it explains a lot about why the banks were willing to make the sort of concessions that seem to go against much of the industry’s core M.O. for the better part of two decades now.
A few sources have suggested to me that if the FHA were to push for full treble damages relative to the violations uncovered, the amount of money involved would have put the banks into an undercapitalized state. Which is, of course, a very bad thing in a world comprised of SIFIs. But I can imagine pretty easily that it made for a very interesting game of high-stakes poker behind the scenes.
So my take on the deal? The banks gave up plenty more than most seem to recognize, but in return were able to clear a large contingent liability off of their books. If we are to believe that a well-capitalized banking system is critical to overall economic health — surely, a debate for another day — then perhaps the multistate AG settlement will yet end up accomplishing more than its critics have so far been willing to recognize.
Paul Jackson is the CEO at HousingWire. The views expressed here represent his own personal views, and do not reflect the opinion of HW or any of its affiliated business entities.