Posted on Monday, November 22, 2010
KUDOS to the Congressional Oversight Panel for publishing a thoughtful and thorough report last week on the mortgage documentation mess. It argued that, yes, in fact, these paperwork problems may have significant implications for banks, investors and the stability of the financial system.
Since mortgage paperwork flaws became front-page news this fall, the banks caught in the glare have characterized the problems as technicalities that are easily remedied.
Their responses sound a lot like Mike Wazowski, the assistant scarer in “Monsters, Inc.,” who is reprimanded for not turning in his daily reports. “Oh, that darn paperwork,” he tells his supervisor. “Wouldn’t it be easier if it all just ... blew away?”
But the mortgage paperwork problems aren’t blowing away, and the panel report analyzes their implications in fine detail. It also questions the view, held by some overseeing the Treasury Department’s loan modification effort, that mortgage documentation errors have no impact on the program.
Phyllis Caldwell, chief of the Treasury’s Homeownership Preservation Office, articulated the Treasury’s view in her testimony before the panel, according to the report. She said false affidavits and other processing flaws weren’t problematic for the government’s modification plan, known as the Home Affordable Modification Program or HAMP.
Because loan modifications don’t require physical production of a mortgage and note, the Treasury has not been examining whether document flaws have an impact on its efforts, she said.
Ted Kaufman, the former Delaware senator who leads the panel, saw it differently on Thursday. “Financial institutions all say everything is fine, but prudence would dictate that we make sure,” he said. “Not that we don’t trust the banks, but let’s take a hard look at this thing.”
In an interview on Friday, Tim Massad, acting assistant Treasury secretary for financial stability, clarified his agency’s position. “We weren’t saying these problems aren’t serious,” he said. “They are extremely serious, they are clearly widespread, they do pose dangers and they need to be fixed. But based on the evidence today, we didn’t see a systemic risk to financial stability.”
STILL, the oversight report points out problems that arise if servicers modify mortgages under HAMP when they don’t actually have the right to do so.
First, the report said, borrowers may either be granted or denied modifications improperly. And paperwork errors may mean the government is paying modification bounties of $1,500 a mortgage to the wrong banks.
Treasury officials told the oversight panel that if ownership of the mortgage was not properly transferred, the government could claw back incentives paid to the wrong institution.
But such a solution may not be feasible, the report concluded. And even if the Treasury chased down a loan servicer to return the incentive money it received in error, the government would have essentially handed that bank an interest-free loan for the period it kept the funds.
Given the size and the ambitions of HAMP, all of these problems loom large. As of October, the program had generated about 520,000 active permanent loan modifications.
The report also said a lack of concern at the Treasury over paperwork flaws might lead borrowers to conclude that HAMP traffics in double standards. After all, borrowers have to provide reams of documents before receiving a modification — even though servicers don’t have to prove ownership of the note underlying a property, the report said.
But the meat of the report comes in its analysis of the threats that false loan documentation may pose to banks’ balance sheets and to financial stability in the broader economy. These perils are related to the possibility that banks will have to buy back loans from investors if they were based on false documentation, or if the proper records required when setting up mortgage securities trusts were not kept, the report said.
“There are scenarios whereby wholesale title and legal documentation problems for the bulk of outstanding mortgages could create significant instability in the marketplace,” the report stated.
Litigation from investors in mortgage-backed securities is likely, the report concluded. “Claimants will contend that the securitization trusts created securities that were based on mortgages which they did not own,” the report said. “Since the nation’s largest banks often created these securitization trusts or originated the mortgages in the pool, in a worst-case scenario it is possible that these institutions would be forced to repurchase the M.B.S. the trusts issued, often at a significant loss.”
Consider a lawsuit in the United States Bankruptcy Court in Camden, N.J. It involves a Countrywide loan and a note that was supposed to have been deposited in a mortgage pool issued by the lender in 2006.
In an opinion published last Tuesday, the chief judge, Judith H. Wizmur, cited testimony from an executive at Bank of America, which bought Countrywide. The lender’s practice, the executive said, was “to maintain possession of the original note and related loan documents.” Countrywide did this even though the pooling and servicing agreement governing the mortgage pool that supposedly held the note required that it be delivered to the trustee, the court document shows.
If Countrywide’s practice was to hold onto the note, then investors in this pool and others may question whether the security was constructed properly and legally and may be able to require Bank of America to buy back their securities.
Larry Platt, a partner at the law firm K & L Gates in Washington, spoke on behalf of Bank of America on Friday. He said the New Jersey decision did not constitute a basis for broad mortgage repurchase requests.
“We believe the loan was sold to the trust even if there wasn’t an actual delivery of the note,” he said. “The risk of repurchase is going to depend on the unenforceability of the loan and we think the loan is enforceable. We think this is an aberration; Countrywide’s practice was to deliver the notes.”
While it is hard to assess the damage that suits like these could cause, the authors of the Congressional report estimated $52 billion.
The bulk of that would be shouldered largely by the four largest banks — Bank of America, JPMorgan Chase, Citigroup and Wells Fargo. The panel arrived at this estimate using analysis provided by investment firms and taking into account possible loan losses, an assessment of successful put-back rates and assumptions of losses to be borne by the banks on mortgages they are forced to repurchase.
Those banks have already reserved almost $10 billion for expenses related to buybacks, in addition to $11.4 billion in costs they have already incurred, the report said. “It is not inconceivable that the major banks could recognize future losses over a 2-3 year period,” it said.
ONLY time will tell if the panel’s estimates are low, high or right on the money. The report is painstakingly temperate.
But financial burdens for big banks are not all that’s at stake here. Perhaps even more significant are the social costs associated with mortgage paperwork improprieties and any attempt to brush them under the rug.
“If the public gains the impression that the government is providing concessions to large banks in order to ensure the smooth processing of foreclosures,” the report contends, “the people’s fundamental faith in due process could suffer.”
And along with it, their faith in the government.
By GRETCHEN MORGENSON
New York Times