Prudent or Petty: The Government’s Settlement Strategy

Attorney Erik Gunderson's voice shakes a little when he recalls the homeowner who broke down weeping in open court.

The attorney with Palm Dale-based Charlton says the nurse, a mother to two kids, saw a cutback in her hours at work during the recession. She came up short for the mortgage she and her disabled husband had taken out with a stated income loan. Gunderson laments what happened next: sheriffs escorting the woman from property that now belonged to his clients.

He is less sympathetic when it comes to the nation's largest servicers, recently parties to several landmark multibillion-dollar settlements that keep setting new precedents. Federal officials made Bank of America the largest and most recent example of these in August when the mortgage giant agreed to pony up some $16 billion in pre-tax consumer relief.

When it came to signing off on the mortgages and securitized loan pools that precipitated the Great Recession, he says. "They should have said, 'The risk of this loan is not justified by the collateral.'"

It was a tough climate to work within. The same government that is now demanding that the banks pay record penalties related to the sale of faulty RMBS was then pressuring the financial institutions to relax their threshold of acceptable risk so as to expand homeownership to a larger pool of citizens.

Some servicers like Bank of America are on the hook not necessarily because of their own misdeeds, but for the roles many of their acquisitions, like now-infamous Countrywide Financial, played in buying and selling securitized loans for properties that homeowners couldn't afford.

That isn't stopping the Justice Department and other officials from extracting a combined $40 billion in separate settlements with Bank of America, Citi, Goldman Sachs, JPMorgan Chase, and Wells Fargo—none of which even includes the $25 billion some of these banks paid out under 2012's national mortgage settlement, or the various billion dollar shareholder derivative suits and securities payouts from the last few years.

Critics say the expensive deals will help a few with direct relief but only at the cost to many in the sense that it will discourage risk taking on the parts of these institutions. Further, these penalties will eventually be passed along to consumers in the years to come in the form of higher interest rates and increased fees. The entire industry is paying for the sins of a few.

"On the one hand, we want banks to be healthy," says Brian Mahany, a self-described whistleblower attorney whose own estimates bring settlement totals from the financial crisis onward to $161 billion. "The fines are taking their tolls."

Crunching $65 Billion

Each successive mortgage settlement seems to set a new precedent. Now, adding in 2012's $25 billion from four of those banks plus Ally, the total settlement payout for the nation's six largest servicers—just from the past few years—approaches a neck-cramping $65 billion.

All those zeroes make for some headline-grabbing press releases, with U.S. Attorney General Eric Holder praising Bank of America's $16-billion settlement in August for offering "$7-billion in relief to struggling homeowners, borrowers and communities." He went on to call the commitment "appropriate given the size and scope of the wrongdoing at issue" in a statement.

But that's just a little more than half of what the mortgage giant agreed to pay in August to settle Countrywide's misdeeds. Much of the rest is headed straight back to the federal government, which will use it to repay executive agencies that lost big on the acquired unit's securities. Other amounts will exchange hands just to satisfy investors in Treasury debt and government-backed enterprises like Fannie Mae, Freddie Mac, and Ginnie Mae.

Under the Financial Institutions Reform, Recovery, and Enforcement Act—a centerpiece of the government response to the savings and loans crisis, the last "big one"—the Treasury Department plans to help itself to about $5 billion from that settlement in the form of civil penalties. Two other agencies, the FDIC and Federal Housing Administration, will shore up their capital reserves with infusions of more than $1 billion and $800 million, respectively. Another billion dollars will flow through the offices of state attorneys general for California, Delaware, Illinois, Kentucky, Maryland, and New York.

And that's just the recent landmark settlement with Bank of America.

Paying for the sins of Bear Stearns and Washington Mutual, its own acquisitions, JPMorgan Chase agreed to fork over a then-unprecedented $13 billion, with just less than a third of it earmarked for homeowner relief, a sixth or so for Treasury, and an eighth for compensation to national associations and executive agencies.

Treasury also sopped up more than half of Citi's $7 billion in July, leaving just $2.5 billion for direct consumer relief. For its part, Goldman Sachs will pay $3.15 billion to buy back mortgage-backed securities the Federal Housing Finance Agency said helped tank Fannie and Freddie during the crisis.

Those multimillion dollar increments can go a long way toward helping quasi-executive agencies like the FDIC and FHA replenish their emergency funds, handy in a crisis like the Great Recession and sorely depleted in the fallout. It's worth noting these agencies maintain their funds not with federal income tax dollars, but fees collected from litigation activities, including actions against criminally negligent bank owners and mortgages insured for low-income homeowners.

Experts say the agencies played critical roles in stabilizing the housing market—and paid the price. The FHA reportedly received its first $1.7-billlion taxpayer-funded infusion from the federal government last year after stepping up to back more than a third of all mortgages during the financial crisis. The FDIC itself hovered near first-time bailout territory for a few years as it oversaw liquidations for nearly 400 failed banks between 2009 and 2011.

‘Not Insurmountable’

Despite the amounts that have been earmarked in each settlement, critics have it correct when they say it's difficult to judge when crimped homeowners will see government payouts from mortgage settlements.

Federal housing aid programs have been less than reliable. Of the hardest hit states slated for relief, California homeowners counted only 20 percent of their $2 billion due in aid disbursements from the Troubled Asset Relief Program (TARP) last year.

In July, Peter Wallison, the former Reagan White House lawyer, now senior fellow for financial policy studies with the conservative American Enterprise Institute, opined in The Wall Street Journal that "uncertainties, costs and restrictions . . . have sapped the willingness or ability of the financial industry to take the prudent risks" needed for a faster recovery.

He is correct about uncertainty. Citigroup reported just $181 million in second quarter net income earlier this year, quite a notch down from $4.2 billion. Citi CEO Michael Corbat attributed their lower earnings to the "significant impact" of the $7 billion settlement it negotiated with officials.

Critics say liability fears can scare up a contagion. Fearing litigation and costs needed to meet new regulatory thresholds, many banks have chosen to sell off or close down their divisions rather than continue to buy home loans in the correspondent channel. The past two years alone saw staples like Ally, MetLife, and Citi draw down their home loan programs, with each one more or less echoing Wallison's claims about market uncertainty.

But others disregard any negative impact from the settlements for the industry's long– term economic outlook. Paul Ashworth, chief U.S. economist with Capital Economics, a firm specializing in economic risk analysis, dismisses notions that any of the recent deals will "reduce risk taking" by large lenders and servicers.

"I can't see any evidence of it," he says. "The fines are large, but they’re not insurmountable."

If nothing else, recent profits show servicers are staying afloat. Without accounting for its standout settlement, in July Bank of America reported $2.3 billion in second quarter net income on revenue of $22 billion. Wells Fargo's was $5.7 billion, up from last quarter, on $21.1 billion. JPMorgan Chase saw $6 billion in earnings, down a little from $6.5 billion, on $25.3 billion in revenue, and Goldman Sachs reported some $2 billion on $9.13 billion.

Little reason, then, why The Journal ran a headline in January this year that proclaimed the largest financial institutions had returned "from the brink" with first quarter profits.

Still, if another function of the recent settlement payouts was to deter risky lending, the California attorney says they haven't done their job.  Gunderson admits to seeing the same high risk loans possibly leading to a "second wave of defaults."

Borrower Relief?

Fanfare aside, billions of dollars in historic payout may not actually cast that wide of a net for homeowners in distress, at least not comparatively.

That $20 billion or so in direct relief under the national settlement, for which payments began trickling down to borrowers in June last year, reached only approximately 600,000 homeowners—a curiously low fraction of the millions who lost tens of trillions of dollars in home equity, life savings, and retirement accounts as a result of the financial crisis.

Asked whether the homeowner aid really amounts to much, Iowa Attorney General Tom Miller, a key mover in the 2012 settlement, doesn't leave much room for doubt on where he stands.

"For those people, this has been a big deal," he tells us. "Nobody else has done anything else like this in this area."

Sasha Werblin, economic equity director with the Greenlining Institute in Berkley, believes that the settlements with the largest banks should be more focused on aid to homeowners, especially when it comes to minority neighborhoods and those in which English isn't the first language.

"What's unfortunate about the settlement process at the moment is that it's not really intended for homeowners affected by the crisis," she says. "There really hasn't been an instrument to make individual homeowners whole."

Numbers from the Alliance for a Just Society, a Seattle-based nonprofit, give fresh urgency to her claims. According to a report titled "Wasted Wealth" it released last year, ZIP codes in which people of color were the majority counted 17 foreclosures for every thousand residences in 2012, with a loss of $2,000 on average for every household in these hardest hit communities.

The study called for more principal reduction programs, estimating $7,710 in savings for every underwater homeowner nationwide and a $101.7-billion bump to the economy with the creation of 1.5 million new jobs. But other numbers tell different stories about the financial crisis—not one about lost jobs or vanquished home equity.

Publishing their results in the British Journal of Psychiatry this year, researchers with the University of Oxford and a London medicine school showed definitively that more than 10,000 people committed suicide across Canada, Europe, and the United States as a result of the financial crisis and over fears about financial ruin.

Numbers like those continue to breathe new life into calls for civil and criminal prosecution, with some state and federal officials reportedly relying on that anti-fraud law from the savings and loans era, FIRREA, in litigation against culpable C-suite executives.

Asked whether state and federal officials should pursue a harder line against bank execs, Miller demurs, calling it a "rule of law" issue that deserves closer scrutiny only if liability can be proved.

"It’s hard to say that [bank executives] knew what was bad when they were jeopardizing the future of the banks themselves," the Iowa attorney general said.

Prison bars and orange jumpsuits may be a stretch, but those wanting more than fines against banks don't have to look far. Bloomberg reported in August that the U.S. attorney's office in Los Angeles is prepping a civil suit against Angelo Mozilo, the discredited former CEO of Countrywide, and perhaps 10 other high-level employees formerly associated with Bank of America's notorious purchase.

Gunderson counts himself among those who think the mortgage settlements are just half measures. "I believe these settlements are failing to deter matters sufficiently and protect the economy from the danger of another real estate bubble," he said.

In light of their ineffectiveness in preventing another downturn in housing and their possible contribution to the slowness of the housing recovery, the question then becomes whether the imposition of penalties by the federal government, while "not insurmountable," is really in the best interest of the American consumer. Are they prudent or just petty? The recovery of the greater economy, which largely hinges on how quickly the housing industry can fully recover, hangs in the balance.

This select print feature originally appeared in the October 2014 issue of DS News magazine.