Bank Lawyer's Blog

Borrower Bailout Near?

It appears that all the jawboning that state and federal government officials have been doing with large subprime mortgage loan servicers and investors may be cracking the resolve of those servicers and investors to act in their own best interests and, instead, may be pushing them to bail out subprime borrowers who can make the teaser rate payments but can't hack it at the reset rates. At least, reports out of the nation's capital over the last couple of days give us that impression.

Treasury Secretary Henry Paulson and federal banking regulators are working out the details of a plan to extend lower, introductory interest rates on home loans before they reset at higher levels.

Paulson and the regulators met Thursday morning with loan servicing companies — which collect and distribute loan payments — and other industry executives. A formal agreement had not yet been announced as of Thursday, but could be unveiled early next month.

"We've all agreed that there should be some sort of standardized approach to reaching more homeowners faster," said Treasury Department spokeswoman Jennifer Zuccarelli, who declined to name those at the meeting.

[...]

Federal regulators have developed differing proposals for what to do about the problem. Sheila Bair, chairman of the Federal Deposit Insurance Corp., has been urging mortgage servicing companies to agree to widespread, permanent conversions of adjustable-rate loans to fixed-rate loans for homeowners who are current on mortgage payments but unable to afford loans at higher rates.

However, Bair's proposal met resistance from the industry. Critics say companies would face lawsuits if they permit modifications that are not in the best interest of investors.

Last week, John M. Reich, director of the Office of Thrift Supervision, the federal regulator of the nation's savings and loans, came up with a more modest proposal in which borrowers would get a three-year extension of low initial "teaser" mortgage rates. That plan,would be funded from surpluses in mortgage-backed securities.

Reich, who attended Thursday's meeting was "encouraged with the progress being made toward finding a balanced approach that will help people stay in their home without negatively affecting the markets," said a spokesman for the agency, William Ruberry.

Bair also attended the meeting and was "encouraged with the progress," said spokesman Andrew Gray.

One potential area for compromise would be to allow the teaser rates to be extended for five to seven years. That could give borrowers enough of a breather to shore up their finances and ultimately refinance into traditional, 30-year fixed-rate loans.

Oh, yes. I'm sure an other few years will teach subprime borrowers to get their personal finances in order and to cross the great divide into the land of sweet "primeness." If they don't, they'll have to persuade a new administration and Congress to bail them out of their bad decisions...again.

In an interview published yesterday in BusinessWeek, Paulson expanded on what's motivating him to think big.

Given the scale of the crisis, and the complexity of the ownership of securitized mortgages, only a sweeping plan involving all the industry players is likely to prevent a wave of foreclosures. Paulson, who was scheduled to meet mortgage leaders on Nov. 29, argues that a deal could go a long way toward easing pressures. He says the talks, which involve servicers and investors covering 85% of the market, will give rise to a far speedier and standardized method both for processing such workouts and determining who might be eligible.

Those who can readily pay after their resets won't qualify, of course. Yet neither will those who don't have the financial means to own a home even after refinancing. "We're focusing on the middle bucket," says Paulson. "We'll have broad agreement on criteria that will make it easier to modify mortgages in the volumes we need."

Yeah, that "middle bucket." How much water will leak out of that hole-filled container before the eventual day of reckoning finally arrives, three-to-seven years down the road?

A cynic might opine that all of this is politically motivated by a desire of Democrats to cater to consumer activists and advocacy groups, and by the desire of Republicans to avoid Democrats being able to point the finger at them if the economy slams into a recession next year due to the collapse of real estate values, 2008 being an election year, of course. Speaking of partisan pressure, the BusinessWeek article quotes "experts" from throughout the political spectrum who complain that the Bush Administration is either dragging its feet or moving its feet.

Some complain the feds haven't done as much as they could. Yale University economist Robert J. Shiller and Clinton-era Treasury Secretary Lawrence H. Summers, who both warn that the U.S. housing market could face price declines of 25% to 30% in the next several years, have recently criticized what they see as a too-timid response to the crisis. Shiller says: "When someone's in the emergency room, you've got to give them care right away."

Shiller thinks personal bankruptcy laws should be modified to make it easier for troubled borrowers to stay in their homes. Summers argues that more is needed to keep money flowing to creditworthy home buyers, using the Federal Housing Administration, Freddie Mac (FRE), and Fannie Mae (FNM)—huge government-chartered entities that buy mortgages and package them into securities. He suggests that the government may even need to provide loans directly, or extend tax breaks to stretched families.

[...]

Shiller and others believe more could be done through the FHA. Already, the Bush Administration has backed a program to let the agency expand its loan guarantees to some subprime buyers able to refinance their loans. But Alex J. Pollock, formerly head of the Federal Home Loan Bank of Chicago and now at the conservative American Enterprise Institute (AEI), says the FHA could take on a larger role in helping to ease pressures on subprime buyers whose homes are now worth less than their mortgages.

Pollock argues that the FHA should insure the refinancing of such mortgages at more realistic new prices, with Fannie or Freddie then buying the new loans from the mortgage lender. "What you want is a place where the borrower comes out ahead based on the current value of the home, and the lender comes out ahead compared with foreclosure," he says. This will "prevent the bust from going into a self-reinforcing downward cycle."

So many experts. Only one economy to wreck. What a crying shame.

Personally, we favor the yapping of an old dog, buried in the final paragraph of the article.

A severe housing bust is a scenario unacceptable to Paulson and the Bush Administration, though there is deep aversion among some free-market purists for anything that smells like a bailout. "This is what happens when people make imprudent decisions," says Peter J. Wallison, a Reagan-era Treasury official now at the AEI. He doesn't think the government can do much more to head off a housing-led recession than continue to cut interest rates.

As true as that might be, Pete, you and I both know that reality has never stopped bureaucrats and politicians.

Schumer Criticizes Federal Home Loan Bank For Doing Its Job

Oddly amusing, wasn't it, Chuck Schumer calling on the Federal Housing Finance Board to investigate the loans pledged as collateral to the Federal Home Loan Bank of Atlanta to secure advances made by the Bank to Countrywide's federal thrift subsidiary? This is the same Chuckles the Clown Schumer who's criticized lenders like Countrywide for not disregarding the long-term value of many of these loans and instead engaging in wholesale modifications of subprime ARMs into fixed rate loans at the teaser rate. I suppose Chaz believes that if the Federal Home Loan Banks stop taking subprime loans as collateral, other than those that are fixed rate, he'll succeed in getting Countrywide to engage in that risky blanket loan modification practice.

If he was at all familiar with the collateralization practices of the Federal Home Loan Bank system, he'd have understood that the Federal Home Loan Bank of Atlanta's advances are substantially overcollateralized. As Countrywide's head of investor relations wryly observed yesterday, "[t]he FHLB has some experience in risk management, and they probably have some idea what they're doing in terms of their lending activities." What am I saying? Of course he understood that fact. He simply doesn't give a damn. He needed to issue a press release this week, and the saw an opportunity with another phony issue that he could also use to back-door a favorite cause that he and FDIC Chairman Sheila Bair and other wingnuts, like Conan the Governator of California, have been pushing. Charles in Charge also knew the story would make a one-day splash, and before the FHFB and the FHLB-Atlanta could respond, the main stream press would be on to Stacy Peterson, Lindsey Lohan or Natalee Holloway.

As to Schumer's accusations that Countrywide has treated the FHLB as its "personal ATM," that's the purpose of the Federal Home Loan Bank system: to provide a ready source of credit to its financial institution members when they need it, often in the midst of a credit crunch. And an ATM generally dispenses cash from a checking or savings account, not the proceeds of a secured loan, making Schumer's use of the analogy both inept and inapt. Again, we state the obvious, which, when you're dealing with cynical politicos, is unfortunately necessary.

Speaking of Sheila Bair, my recent claim that's she's "jumped the shark" drew objections from folks inside and outside the FDIC. The gist of their defense of Ms. Bair seems to boil down to three arguments: (1) All subprime borrowers who signed on for 2/28 or 3/27 mortgages must have been "unsophisticated," and, by reason of that fact, are deserving of relief from the consequences of their voluntary actions; (2) Ms. Bair has suggested that lenders only convert performing ARMs (where borrowers are current on their payments at the lower teaser rate); and (3) the teaser rates are not that low, most being in the range of 7% to 9%, so the lender is getting a "fair" or "healthy" rate of return that it should not complain about. I was even pointed to this web page, where there's a CNBC video in which Ms. Bair explains this "reasonable" solution to the subprime crisis. (Warning: you have to suffer through a short E-Trade ad before the sultry Ms. Bair takes center stage, and the video portion works sporadically, although the audio portion works consistently).

I love that fact that government bureaucrats think that they are able to determine which borrowers are "unsophisticated" and, on that basis, deserve to be relieved of the consequences of their voluntary contractual obligations, and what is a "fair" or "healthy" rate of return for a lender or CDO investor to receive, regardless of the bargained for contractual terms. Does anyone catch more than a whiff of nanny-statism in the fetid air inside The Beltway? There's also at play here a marked ignorance of the way these loans, and the securities that are secured by them, were priced. As I've noted many times before, investors' consent is required for such wholesale loan modifications, and investors who are being screwed by such wholesale repricing of the loans don't give a tinker's damn what FDIC bureaucrats think is a "fair rate of return." The CDOs were sliced and priced based upon risk appetite and yield expectations, not on a fixed 7% to 9% per annum for the life of the loan (whatever runoff rate their pricing models assumed). Ultimately, the government may be able to jawbone this policy successfully, but "fairness" determinations rest in some substantial part with the people or institutions who will take the loss and whose consent is legally required before loans are modified. I suppose I ought to be surprised that federal bureaucrats either don't understand how the residential mortgage markets work or, more likely, simply don't care. Sadly, I'm not. Like Schumer, et al., sound business principles have nothing to do with their thought processes. Pure politics and half-baked social justice theories rule.

Predatory Poppycock

While we're not in lock-step with the editorial page of The Wall Street Journal, every once in awhile they hit the nail on the head. Today's editorial entitled "'Predatory' Politics" (paid subscription required) was a fine example of excellent hammering, this time directed at Barney ("I Love You, You Love Me") Frank and the Democratic and Republican quarter-wits in the House who passed the "Mortgage Reform and Anti-Predatory Lending Act of 2007." According to the Journal, the effect of the bill would be "to reduce home ownership."

Chief sponsor Barney Frank boasts that his bill will avoid a recurrence of the subprime lending meltdown. That it might do, but only by exposing mortgage banks to so many new financial penalties and lawsuits that they will refuse to lend to many low- and moderate-income homebuyers. The companies that securitize mortgages -- by packaging and reselling them to investors -- will also have an incentive to abandon the subprime market because the bill makes them liable for any improper actions by the loan originators.

The bill bars banks and securitizers from "steering any consumer to a loan that the consumer lacks a reasonable ability to repay, does not provide a net tangible benefit, or has predatory characteristics." Got that? No one has ever defined what a "predatory" loan is, but rest assured the trial lawyers will try to define it as any loan that a marginal borrower accepts but later can't afford to repay. A legal analysis done for the Consumer Mortgage Coalition concludes that the House bill "will likely generate significant litigation" and that lenders will "rarely, if ever, be able to dispose of even frivolous lawsuits" thanks to the bill's subjective standards. That's probably an understatement.

Not so long ago, we noted that John Hawke, former Comptroller of the Currency, observed that the absolutely worst people in the universe to make determinations like "net tangible benefit" and other "borrower suitability" standards are loan officers. What does he know that Barney and The Boyz don't? Wanna' guess? Yeah, you're right: everything. Not that ignorance slows down a posturing peacock of a legislator, much less stops him or her.

This legislation comes at the worst possible moment for the ailing U.S. housing market. Banks hardly need new incentives to stop lending. A few months ago Wells Fargo Home Mortgage halted all subprime lending because of high default rates. Countrywide Financial, the nation's largest mortgage lender, announced this month that the number of new mortgages it issued this past quarter plummeted by 40% from a year ago. The share of its new loans that are subprime fell to 0.2%. Two years ago subprime loans constituted between 10% and 20% of the new mortgage market.

Now the credit screws are so tight that low-income homebuyers without stellar credit ratings are finding it nearly impossible to get any home loan -- which will further drag down home values. The broader danger is that this lending aversion will limit credit even for higher-income home buyers who have less than pristine credit histories.

That has been precisely the effect of similar "anti-predatory lending" laws at the state level. A recent study by Marcus Cole of Stanford Law School investigated these "consumer protection" laws in Georgia, Illinois and North Carolina, and found a sharp decline in new loans to moderate-income borrowers.

Consider the Illinois "Fairness in Lending Act." That 2005 law required credit counseling and byzantine regulatory requirements on loans made in the Chicago-area to "at risk" communities. The result was a 45% fall in home sales in these neighborhoods. "Instead of protecting hardworking would-be homeowners from predatory lending, the new law protected them from credit," Mr. Cole says. "Within just a few months more than 30 mortgage lenders refused to lend on homes purchased in the targeted zip-codes." He adds that "Home prices plummeted, draining relatively poor people of what little equity they had in their homes." That's fairness for you.

We've also been following the "Fairness in Lending Act" and its impact on affected zip codes in Illinois (most recently here). It's nice to see that a Stanford law professor supports what "boots on the ground" in Illinois have been chirping about since the get-go. Not that statistics make much difference to the bloviating bozos in our nation's capitol. Ideology and the desire to act out in useless, or even harmful, stage plays in the political theater inside The Beltway trump cold, hard reality every time.

Mr. Frank, a partisan Democrat, brought most of his party along on this vote. But the real surprise is that he also managed to persuade Alabama's Spencer Bachus, the ranking Republican on the House Financial Services Committee. Mr. Bachus supported the bill in return for some modestly beneficial changes that would create a federal pre-emption of state law claims against lenders. But Mr. Bachus's support made this bill "bipartisan" and induced some 64 Republicans to vote in favor.

These Republicans may think they're protecting themselves politically by voting against "predatory" mortgage bankers. But they are now on record for supporting a measure that will make it more difficult for the working poor to buy and sell their homes while enriching the trial bar that feeds its windfall to Democrats. A GOP political strategy of making awful bills merely terrible is a good way to stay in the minority for years.

Let me say this about House Republicans: idiots!

Now, back to our regularly scheduled rant

Ironically, these House Republicans are now to the left of Senate Banking Chairman Chris Dodd of Connecticut. Mr. Dodd said last week that he may leave it to the Federal Reserve to issue new regulations to curb abusive lending. That makes far more sense than the House's rush to bludgeon a wobbling industry with new rules and litigation. Distressed homeowners are in enough trouble without the punitive mercy of Messrs. Frank and Bachus.

How does anyone get to the left of Chris Dodd without falling off the face of the flat Earth? The last guy to do that was Mao Zedong, I think. Barney and the Boyz, together with their Republican coattail riders, likely knew all along that Chris Dolt Dodd was going to "ix-nay the ill-bay" (wink wink, nudge nudge). That way, they can tell their constituents that they "tried to do something" but the "Do-Nothing" Senate, where even a minority can thwart the will of "The Peeps," dropped the ball like the asylum full of spastics they are. In other words, the entire exercise by the House was just another pass around the ballroom floor by the dance of the dunderheads.

As we've bloviating about for the last year, these Congressional clowns will soon be yelling about how the poor have been shut out of the residential real estate market. When they do, remember that you heard it here first.

Alphonso Jackson: A New Boss Tweed?

Alphonso Jackson's tenure at HUD continues to ooze slime by the gallon.

Last week, Housing Finance News had an article on the resignation of HUD's assistant secretary for public and Indian housing, Orlando J. Cabrera. The resignation is effective January 9, 2008.

Housing Finance News reporter Andre Shashaty detailed the controversy surrounding Mr. Cabrera's troubles, which dovetail with earlier reports of Jackson's reputed cronyism.

Cabrera’s office is at the center of several very controversial contracting decisions that are now under investigation in Washington, D.C. The HUD Inspector General is looking into allegations that "sweetheart" contracts were awarded by HUD for work on construction and management of public housing in New Orleans and the U.S. Virgin Islands. Published reports also say that a federal grand jury is investigating certain HUD contracts. 

In the case of the Virgin Islands Housing Authority, the investigation centers on the reason for HUD’s decision to award about $750,000 in contracts to Michael R. Hollis of Atlanta to serve as executive administrator of the authority. One contract for $387,102 was awarded in February 2006. A second contract for $360,820 was awarded in July 2006. Each contract is for a six-month period of services as executive administrator. 

There was no bidding process. The first contract was awarded to Hollis without bidding due to "unusual and compelling urgency," according to HUD documents signed by Deborah Hernandez, deputy assistant secretary for public and Indian housing, who served directly under Cabrera at that time. The justification for the sole-source procurement for the second contract, also signed by Hernandez, said no bidding was needed because there was "only one responsible source and no other supplies or services will satisfy agency requirements." 

The HUD documents give no information about the qualifications of Hollis to run a housing authority, but they do say he served as a consultant to another vendor who had been charged with assisting in "the recovery of the Virgin Islands agency," and for that reason, understood its problems. 

A Virgin Islands newspaper reported that he had worked for Smith Real Estate Services, an Atlanta-based real estate firm, at one time. Confidential sources told AFFORDABLE HOUSING FINANCE the contracts are under investigation because Hollis is apparently a personal friend of HUD Secretary Alphonso Jackson. 

In the case of the Housing Authority of New Orleans, as AFFORDABLE HOUSING FINANCE has previously reported, investigators and press reports have raised questions about why a sole source construction contract was awarded to a personal friend of Jackson’s without competition. They have also questioned the fact that Columbia Residential, a firm in which Jackson holds an equity stake, is part of a team chosen to redevelop some of the city’s old public housing. 

The New Orleans and Virgin Islands contracts fall under the program area for which Cabrera was responsible, but it was unclear in mid-November whether he was under investigation for his role in those contracts. The primary focus of the investigations was believed to be Jackson.

As Shashaty also reports, Cabrera is just the latest in a string of HUD officials who have recently resigned under a cloud.

He is the third high-level HUD official to leave Washington this summer and fall under a cloud of suspicion about ethical and legal lapses in contracting. Earlier this year, HUD Deputy Chief of Staff Scott Keller resigned, reportedly after coming under FBI scrutiny.

In October, Lilly Lee, deputy assistant secretary for housing, left her Washington post to relocate to Fresno. Several sources familiar with the case told AFFORDABLE HOUSING FINANCE she is the subject of an investigation into the fact that she has been paid substantial amounts of money for living expenses, in addition to her salary, on the grounds that she claimed to have been on temporary assignment in Washington after previously working in California.

None of this does much good for Mr. Jackson, and even less for HUD. G.W. Bush has a history of not forcing his cronies to resign while they're under the gun. In this case, he should make an exception.

OTS Preemption Bus Hits A Speed Bump

In light of State Farm Bank, FSB vs. John B. Reardon (opinion here), Banking Law Prof Blog asks: Are we headed back to the Supreme Court to resolve the exclusive agent question?   Watch this space!

Fair enough. We will.

Unless the Court of Appeals overturns the District Court's decision, then we're likely to end up in the SCOTUS, eventually. Perhaps, we might end up there even regardless of what the appeals courts do. The last big preemption case, Watters v. Wachovia, was taken up by the Supreme Court notwithstanding the fact that the circuit courts were unanimous in upholding the OCC's preemption authority with respect to national bank operating subsidiaries.

State Farm won a round last year in Connecticut, and now has lost a round in Ohio. (Lenders are not faring well in Ohio, recently, are they?). In our comments on the Connecticut decision, we bemoaned the waste of state resources devoted to losing efforts like Watters v. Wachovia, and this latest effort, to stop the OCC's iity, biity brother, the OTS, from expanding like rogue viruses until they destroy the Tenth Amendment as it applies to the world of banking. It's money flushed down the drain. Resistance is futile. Surrender or die. Whatever you do, don't waste state tax dollars tilting at windmills. Yet, these state rights die-hards just won't quit. God bless 'em.

This fight reminds me in some respects of the futile battles fought by state's rights advocates over the federal preemption of state limitations on the exercise of due-on-sale provisions of deeds of trust by federal savings and loans during the 1970s and 1980s. The Supreme Court's de la Cuesta decision, as well as a number of other state and federal appellate court decisions on the vast preemptive breadth of the Home Owner's Loan Act of 1933, resulted in a pretty nasty outcome for the states. The outcome in this arena is likely to be no less nasty.

The Ohio judge appears to be engaging in wishful thinking when he tries to impose a requirement upon the OTS to adopt preemption opinions by formal regulation subject to notice and comment requirements of the APA. The OTS is not taking an action that results in preemption of  state law, it's merely issuing an interpretation that interprets its own regulations and finds that they preempt the application of state law to federal savings banks' "exclusive agents." The Connecticut determined that where an agency is interpreting its own regulations, as opposed to a federal statute, the court must give deference to that interpretation. The Ohio court disagreed and found that although the OTS might very well have power to preempt state law, it must do so through the formal processes of the APA. I doubt that the OTS will concede that it has to begin adopting preemption regulations that govern each specific state law that it wishes to preempt, rather than doing what it's always done: issue an interpretive letter signed by its Chief Counsel. No other court has imposed such a requirement upon the OTS and before the OTS commences such a practice, I think that it will have to be told to do so by the US Supreme Court.

As much as I'm conflicted about the continued erosion of state banking authority in the face of the continued expansion of federal preemption principles, I see the OTS ultimately prevailing on this issue. At the same time, I have to acknowledge the plaintive cry of one of my correspondents, a former state banking regulator: "Where does this all end?"

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Bank Lawyer's Blog will be on holiday break until next week. Have a great Bird Day!

Tale of Two Judges

Foreclosing lenders in Ohio, displeased by the one-to-two-year backlog of foreclosures at the state court level, have increasingly turned to federal district courts located in that state to foreclose on delinquent residential mortgage loans when they believe that diversity jurisdiction requirements can be met. As reported in last Thursday's The New York Times, foreclosures in federal district courts in Ohio by servicers of residential loans that have been securitized recently hit a snag when federal district court judges balked at the failure of servicers to produce documentation that demonstrated that they were the owner and holder of the note and mortgage as of the date the foreclosure complaint was filed. The court's rules require "an affidavit documenting that the named plaintiff is the owner and holder of the note and mortgage," and the courts have interpreted that requirement to mean more than an affidavit, standing alone. They're requiring that the plaintiff produce an assignment of the note and mortgage dated prior to the date of the foreclosure complaint.

It's a matter of establishing diversity jurisdiction. If you can't show that you are a party that suffered some actual injury, you don't satisfy the requirements of Article III of the U.S. Constitution in this respect. This is all set out fairly concisely and dispassionately in an opinion by Judge Kathleen O'Malley. She observes that the plaintiff either hasn't produced an assignment, or has produced an assignment dated after the date of commencement of the foreclosure action. Therefore, she dismissed the foreclosures without prejudice, which permits the refiling of those actions where an assignment to the plaintiff can be obtained.

The opinion that's received most of the press, however, is that of fellow judge Christopher A. Boyko. Judge Boyko appears to believe that the plaintiff's counsel talked down to him, because one of his footnotes is about as scathing as any I've seen since former federal district court judge Joe Kendall dismissed a government counterclaim against a former client of mine more than a decade ago with the pronouncement "A deal's a deal!" 

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Plaintiff’s, “Judge, you just don’t understand how things work,” argument reveals a condescending mindset and quasi-monopolistic system where financial institutions have traditionally controlled, and still control, the foreclosure process. Typically, the homeowner who finds himself/herself in financial straits, fails to make the required mortgage payments and faces a foreclosure suit, is not interested in testing state or federal jurisdictional requirements, either pro se or through counsel. Their focus is either, “how do I save my home,” or “if I have to give it up, I’ll simply leave and find somewhere else to live.” In the meantime, the financial institutions or successors/assignees rush to foreclose, obtain a default judgment and then sit on the deed, avoiding responsibility for maintaining the property while reaping the financial benefits of interest running on a judgment. The financial institutions know the law charges the one with title (still the homeowner) with maintaining the property. There is no doubt every decision made by a financial institution in the foreclosure process is driven by money. And the legal work which flows from winning the financial institution’s favor is highly lucrative. There is nothing improper or wrong with financial institutions or law firms making a profit — to the contrary , they should be rewarded for sound business and legal practices. However, unchallenged by underfinanced opponents, the institutions worry less about jurisdictional requirements and more about maximizing returns. Unlike the focus of financial institutions, the federal courts must act as gatekeepers, assuring that only those who meet diversity and standing requirements are allowed to pass through. Counsel for the institutions are not without legal argument to support their position, but their arguments fall woefully short of justifying their premature filings, and utterly fail to satisfy their standing and jurisdictional burdens. The institutions seem to adopt the attitude that since they have been doing this for so long, unchallenged, this practice equates with legal compliance. Finally put to the test, their weak legal arguments compel the Court to stop them at the gate. The Court will illustrate in simple terms its decision: “Fluidity of the market” — “X” dollars, “contractual arrangements between institutions and counsel” — “X” dollars, “purchasing mortgages in bulk and securitizing” — “X” dollars, “rush to file, slow to record after judgment” — “X” dollars, “the jurisdictional integrity of United States District Court” — “Priceless.”

None of the foregoing snark is necessary to support the grounds for the dismissal of the foreclosure actions. It is evidence, however, that you had either a condescending plaintiff's counsel, a hypersensitive judge, or both. It also demonstrates, once again, that "He who sits at the right hand of the Father" is not, in federal district court, Jesus Christ, but the district court judge. That's a lesson I learned early in my legal career (by personal observation of another counsel's misfortune). Talking down to a federal district court judge has got to be as dumb a course of action as one could adopt, if that's, in fact, what occurred.

There's been much back-and-forth over the past few days on various discussion boards about these decisions, especially Judge Boyko's. Some assert that this is evidence of massive documentation deficiencies in the mortgage backed securitization arena. As one commentator alleged in the linked New York Times article, notes may have been "assigned" to more than one loan pool, with no actual written "assignment" ever prepared. Other consumer representatives claim that they've seen instances of what appear to be the mass production of fraudulent assignments, with one claiming that "[w"]e have one woman, with VERY unique name, acting as Notary, officer, and various other positions in six different states for over 20 different companies.  Also, dozens of different 'gestations' of her 'mark' which is a simple initial to her first name." That consumer advocate vows that they will wage a scorched earth policy that challenges every bit of evidence of assignment presented, and that "EVERYTHING a lender and their counsel will now do will be questioned in our answers and NOTHING will be accepted as fact until proven up via hard evidence since so many complaints, pleadings, affidavits, and accountings are boilerplate and produced by OTHERS, not the actual LENDER or their servicer, sub servicer or special servicer!"

You think that these foreclosures are generating any hard feelings?

This is obviously a rear guard action to buy time, or create so much difficulty for foreclosing lenders that they'll adopt the "Sheila Bair Method": wholesale modifications of loans at low rates instead of foreclosure. To me, it's merely delaying the inevitable. Sooner of later, the servicers will get an assignment for each loan, and unless the federal district courts want to get bogged down in trivia, which I predict they won't, the threats will turn out to be hollow. If, on the other hand, foreclosing counsel or any servicers are falsifying assignments by the gross, and defense counsel can prove that in only a couple of cases, then pin your ears back, because judges like Boyko are primed to make the lenders pay, and pay dearly.

This one could get nasty.

WSJ To New York Voters: "We Told You So"

Friday's The Wall Street Journal's Editorial Page (paid subscription required) took off on a rant about one of its-and our-favorite punching bags, New York Governor Eliot ("Mess") Spitzer.

When we last checked on New York Governor Eliot Spitzer, he had got himself into an ethics imbroglio over the matter of trying to destroy a political opponent. His descent has continued -- to where a poll this week reports that only 25% of New Yorkers say they'd re-elect him. The other 75% can't say they weren't warned.

That's right, voters of "The Empire State That Has No Clothes." You've been exposed as less than majestic in your ability to "pick 'em." Then again, look at our national leaders and you could say the same about American voters generally.

Mr. Spitzer's most recent setback came this week, when he retreated after being routed by his own party on his proposal to issue drivers licenses to illegal immigrants. In trademark Spitzer style, the Governor presented his proposal in September as a fait accompli. He then moved swiftly into bullying mode, calling one early critic of the plan "factually wrong, legally wrong, morally wrong, ethically wrong."

The waffling by Hilarity Clinton and Barack Hussein Obama during the most recent debate when asked about Spitzer's dead-in-the-water license caused them "collateral damage" that stink-bomb lobbers like Heil Spitzer often engenders. Merely being in the same hemisphere with The Governor of Gloom can ruin an otherwise savvy politico's day.

Also this week, Mr. Spitzer reversed course on a plan to force online retailers like Amazon.com to collect sales tax in New York on purchases delivered to the state. The plan would have violated Mr. Spitzer's explicit campaign promise not to raise taxes as Governor, and he scotched it after the New York Sun exposed the effort.

Remember George H.W. Bush's "Read my lips: No new taxes" proclamation in 1988? Where's Ross Perot when we need him? Oh yeah, he's just back from making another friggin' billion dollars for his shareholders while Spitzer's busy spending another billion for the taxpayers of New York state.

Given Mr. Spitzer's fall in the polls, it's tempting to say New Yorkers have learned something new about the man who said on his inauguration day that, "we must change the ethics of Albany and end the politics of cynicism and division in our state." But the bullying, the arrogance and the focus on destroying anyone who stood his way were on full display when he was Attorney General.

Most of the media chose to overlook these qualities, instead extolling his "crusading" style. Readers of this newspaper knew better, having seen (among other things) how he threatened to destroy John Whitehead, the former Goldman Sachs and State Department official, for daring to defend former AIG CEO Hank Greenberg in public.

The only real difference between Mr. Spitzer now and then is that as Governor he is obliged to govern, as opposed to merely bringing charges amid a PR offensive and then settling before having to prove anything in court. His heavy-handed approach to the drivers license plan shows the limits of such behavior in a job where he actually has to persuade people.

It remains far from clear whether Mr. Spitzer has drawn the right lessons from his recent failures. At Wednesday's announcement on the licensing plan, he said that leadership was "not solely about doing what one thinks is right," a curious formulation. There may be more damaging revelations to come out of Troopergate too. But assuming Mr. Spitzer survives that scandal, he could do worse than enroll in anger management class and take a pledge not to try to ruin everyone who disagrees with him.

Of course, the WSJ doesn't expect Spitzer to learn his lesson and change his spots. He's a congenital punk and bully. The childhood Spitz, a little, ineffectual nerd, is now all grown up, and having acquired power by stage-managing a public persona based solely on using the power of the state, rather than the power of personal persuasion or of the intellectual heft of his ideas, he isn't about to let go of the warped personality that's served him so well. Let's face it, his game plan has propelled him to a life far beyond what he would have achieved based upon his intrinsic worth as a human being. Why would he change?

Speaking of Spitz, my recent posts (here and here) about his sock puppet, Dandy Andy Cuomo (Campaign slogan: "My Dad sure was smart, so I must be, too"), and his accusations that WaMu and other residential lenders improperly pressured third party appraisers to falsify valuations, continue to compel residential appraisers to e-mail me with a couple of consistent opinions: (1) Cuomo's as big a jerk as his mentor, and (2) don't let that fact fool you, because when the dust settles, your eyes are going to bug out in fury at the practices of large lenders and those outside appraisers that big lenders have used to try to insulate them from the consequences of bad appraisals. In other words, those appraisers who are commenting are telling us that Cuomo's accusations are, indeed, merely "the tip of the iceberg."  So, as one corresponded advised me, "Stay tuned!"

When You Wish Upon A Star

The kind of man who wants government to adopt and enforce his ideas is always the kind of man whose ideas are idiotic.
---H.L. Mencken

In today's The Wall Street Journal, columnist David Wessel contends that Congress ought to bail out many of the subprime mortgage borrowers whose 2/28 or 3/27 loans have or are going to reset. He asserts that many of those borrowers will default, resulting in a "tidal wave of foreclosures" (a nice side-step of the overworked "tsunami of foreclosures"), resulting in massive losses to lenders, and damage to "entire neighborhoods" and the "the broader economy."

After acknowledging that many of these loans should never have been made, he nevertheless urges that lenders follow the lead of FDIC chief Sheila Bair and simply engage in wholesale modifications of variable rate loans into fixed rate loans at the low "teaser rate" rather than the much higher reset rate. The "case-by-case method [is] ill-suited to the dimensions of today's problem," according to Wessel. But, wait a minute! "Wholesale" doesn't mean "everyone."

Some folks should lose property if they can't make payments: those who lied on applications or speculated by buying properties for investment (although tenants may deserve help). Temporarily cutting mortgage payments for those who never will be able to afford houses they bought is unwise and doomed to failure.

It's the folks in the middle who need and deserve help from the industry and, if need be, the government: those who are making payments, would have refinanced easily if not for the housing bust and dysfunction of mortgage markets and can't afford the reset payments.

Douglas Elmendorf, a Brookings Institution economist, argues that government "should encourage and subsidize refinancing" for households that can keep their homes "with a modest amount of help," even though "many might not own homes today if risks had been recognized fully" when the mortgages were made.

How would a loan servicer know who's a "liar" or a "speculator" as opposed to "the man in the middle" unless it reviews loans on a "case-by-case" basis? You also have to love the parenthetical "although tenants may deserve help." As if that won't require a case-by-case analysis of every non-owner occupied loan, after, of course, you've first determined who's a legitimate investor as opposed to a "speculator." We hate raising these thorny issues, but if they're obvious enough that even dim-witted hacks like the authors of this post can pick up on them, then they just can't be passed by.

As we say in Texas, "that dog won't hunt," Dave. You can't have wholesale loan modifications and at the same time do justice only to the "deserving." That seems to BLB to be basic logic, although we could be wrong.

Wessel does seem to be slightly sweet on Ms. Bair, because he returns to her again.

There is a loud effort by the Bush administration to cajole the industry into moving beyond case-by-case efforts and to enlist nonprofit groups to reach out to suspicious homeowners. With more vigor and specificity than others (enough to make some officials uneasy), the FDIC's Ms. Bair has urged the industry to extend the two- or three-year initial interest rate permanently for homeowners who are current and whose income indicates they can pay at that rate.

"Public cajoling was needed to bring more pressure to bear, and we decided to come out with a specific example of how to do it," she explains. She says three of 10 top mortgage services are quietly doing what she suggested, although she won't name them.

We hereby take this opportunity to declare that three of the ten smartest people in the world have told us that the authors of this blog are smarter than Steven Hawking (and even more mobile, although, sadly, not as loquacious). Sorry, we decline to tell you who they are.

Sheila Bair has now not only passed her "sell by date," she's officially "jumped the shark."

Wessel is honest enough to note a contrary opinion.

But George Miller, executive director of the American Securitization Forum, an industry group, says the FDIC plan is "neither permitted under the applicable contracts nor does it make economic sense" because "you're likely to be granting windfalls to some borrowers." The industry favors developing better ways to identify groups of borrowers with whom cutting new deals makes sense, but then treating each case individually.

Poor Mr. Miller. He obviously wasn't aware that 30% of the top ten loan servicers have decided "contractual restrictions be damned" and "to hell with the case-by-case" paradigm.

Wessel then ends his column with a wish that reminds us of the prayers of a five year-old niece: wildly improbable of being realized, but causing you to smile and exclaim "God bless the child."

Perhaps some entrepreneurial investor or nonprofit group will buy houses out of foreclosure at low prices and turn them into low-cost rentals.

Yeah, the mythical, mystical Holy Investor will come down from the clouds and save our single-family neighborhoods by turning single-family, owner-occupied residences into "low-cost rentals." Yeah, that's the ticket. Calling George Soros. Mr. Soros, please pick up a white courtesy telephone.

Every now and then when your life gets complicated and the weasels start closing in, the only cure is to load up on heinous chemicals and then drive like a bastard from Hollywood to Las Vegas ... with the music at top volume and at least a pint of ether.
---Hunter S. Thompson

Synthetic Identity Fraud Takes Over The Top Spot

We've been discussing for some time the problem of "synthetic identity fraud" and the fact that data security breach laws, regulations and guidelines that apply to banks focus on the less important aspect of private data: on the access to personal information rather than on the use of such information. Recent reports confirm that when it comes to losses from credit fraud, it's not stolen identities that pose the biggest risk to banks, it's false identities. The Wall Street Journal had a recent article (paid subscription required) that profiled an ingenious scheme by a man named James Rose to create completely false identities and that bilked banks out of $750,000 in two years.

Unlike traditional identity thieves, who purloin people's information to get loans or make purchases, fraudsters like Mr. Rose mix legitimate and phony data to create synthetic identities. This kind of fraud doesn't usually directly affect consumers. The big losers are banks, which get stuck with loan defaults and unpaid credit-card bills that identity thieves leave behind.

There are no reliable figures documenting losses from synthetic identity fraud -- banks are secretive about losses -- but many say the problem is growing. Avivah Litan, a fraud specialist at research firm Gartner Inc., estimates that synthetic schemes constitute at least 20% of credit charge-offs and 80% of losses from credit-card fraud. Banks "are very nervous," she says. Synthetic-identity fraud "is showing up all over the place."

Scams like Mr. Rose's also show how fraudsters can exploit the practices of the three big credit-reporting companies, Equifax Inc., Experian and TransUnion LLC. The companies and the FTC say some inaccuracies and fraud are unavoidable given the bureaus' complex task and lenders' demand for quick access to credit histories.

[...]

Attending credit-bureau seminars, Mr. Rose learned that the bureaus maintain a file for every inquiry lenders make, even if it contains mismatching or erroneous data. The credit bureaus may tell the lender that it couldn't find a match -- a "no-hit" situation -- but they still use the data to create a new file in their databases. Most of these files are legitimate. Some emerge when lenders submit inquiries with misspelled names; others get created when people apply for their first credit card.

Mr. Rose realized he could plant no-hit files within the credit bureaus by applying for credit cards using a mix of real and phony data. Could these files be transformed into seemingly real people with seemingly respectable credit histories, so that lenders would extend credit to them? Mr. Rose experimented with the idea in the late 1980s. A decade later, the Internet had turbocharged the credit-granting process and depersonalized steps needed to make the scheme work on a grander scale.

As expected, the credit bureaus and privacy advocates have differing views on whether the procedures of credit bureaus are sufficient.

All three credit bureaus say their data-management procedures are legal, adequate and continually updated. Meanwhile, each company vigorously markets premium data-screening services to businesses interested in taking extra security steps to weed out identity-theft schemes, including synthetic fraud.

Evan Hendricks, editor of the Privacy Times newsletter, says credit bureaus should better scrutinize data and the FTC should mandate stricter rules. "The credit bureaus are at the epicenter of identity theft and there's no pressure at this point to force them to make changes," he says.

The FTC has estimated that the no-hit phenomenon has created "tens of millions" more files in the credit bureaus' databases than there are actual consumers. It has said the bureaus don't routinely investigate these files, pointing to cost as a factor.

The credit bureaus say they view the automatic creation of such files as a legal requirement. TransUnion says it deletes files containing nothing besides an initial inquiry "within a set period of time," which it won't specify.

Regulators are torn over what, if anything, to do about the problem. Tweaking the system too far in the direction security could slow down credit granting and economic activity. But today's looser approach continues to invite fraud.

Another recent article estimates that most identity fraud is synthetic identity fraud.

Five years ago, this crime was hardly seen but now Stephen Coggeshell of ID Analytics says, "eighty-five to ninety percent of Identity Fraud is really this Synthetic ID Fraud, as opposed to the true name Identity Theft."

If that's the case, then bank regulators and Congress (and the states) have been focusing on preventing data security breaches and the theft of non-public personal information, which account for, at most, 15% of identity fraud and a small portion of credit card losses. Obviously, the reputational and legal harm to banks (and other businesses) that can arise from data security breaches shouldn't be ignored, nor should potential harm to consumers that arises from such breaches (see TJX, for example). No one, least of all BLB, is suggesting weakening the requirements for information security. On the other hand, shouldn't the regulators and Congress (and the states) look at the "no-hit" problem in depth and make certain that the credit bureaus are pulling out all the stops to stop synthetic identity theft?

Just sayin'...

Will There Be A Bank Implode-O-Meter?

A number of large law firms have trotted out "subprime mortgage practice groups" over the last few months, which appear to be nothing more than a marketing ploy. Everyone has litigators and bankruptcy lawyers, so what's the big deal? Now, you can add to the mix bank lawyers expert in representing banks in regulatory enforcement actions and lawyers who specialize in representing buyers of distressed assets from the FDIC. At least, that's apparently the message sent by Forbes magazine's Liz Moyer, who today asked the question, "Are Banks In Danger?"

Worries about the state of the banking system are mounting. Major brokerages report fourth quarter and year-end results soon, and the crystal ball remains cloudy. Investors expect write-downs, stock declines, and perhaps a merger or the ouster of chief executive ouster before the problems are worked out.

"There is a tremendous amount of as yet misunderstood risk in the financial system," says consultant Karen Shaw Petrou. "And that includes the regulators."

Deutsche Bank analyst Michael Mayo estimated banks will write down as much as $70 billion by year end as the value of mortgages and mortgage derivatives continue to plummet. All told the cost of the subprime meltdown could reach $400 billion globally. To put it into perspective, the savings and loan crisis resulted in a $200 billion government bailout almost 20 years ago.

Bank failures are becoming more of a worry, as well. So far this year the Federal Deposit Insurance Corp. reported three failures, two in the last two months. There are 8,000 banks in the U.S. Before this year, however, there hadn't been a bank failure in the United States since 2004, the longest stretch with no failures since the Depression.

Of course the darkest period was the S&L crisis of 1988 and 1989, when one thousand deposit institutions closed up. Credit quality and risk management improved since those days, evidenced by the total lack of failures since 2004, but "the pendulum is swinging back," says Gerard Cassidy, a banking analyst at RBC Capital Markets. He sees two dozen bank failures in the next two years because of deteriorating credit quality conditions.

The magnitude of write-downs, and the market's punishment of shareholder capital in the biggest banks is taking its toll. Meredith Whitney of CIBC Capital Markets, who downgraded Citigroup...shares just before the ouster of chief executive Charles Prince a week ago, reiterated in a note Monday that things for the industry are poised to get worse. She says capital ratios will "drop materially" in the fourth quarter.

Twenty-four failures versus a thousand isn't much of a catastrophe by comparison, although it depends upon the size of the twenty-four who fail. I doubt that any "too big to fail" banks will simply crater. It's more likely that some with a decent deposit franchise will end up absorbed by a steadier institution (or institutions) in "shotgun marriages" arranged by the regulators (I was involved in a few of those in the late 1980s and early 1990s). We also don't know how far the Fed will go in interest rate cutting to avoid a crisis. Regardless, there is definitely going to be plenty of pain spread around the banking system over the next couple of years.

Luckily, I didn't want to retire yet. Looking at the stock and mutual fund portion of my investment portfolio, that's a darned good thing.