American Banker has a smart story on “How Not to Make a Mortgage Servicing Settlement,” taking a look at the failed attorneys general settlement with Countrywide in 2008:
The servicer conflict with second mortgages rears its head again here:
The Countrywide settlement covered first-lien loans that B of A serviced, but it did not cover the second-lien loan portfolio that B of A inherited from Countrywide. And although B of A has the largest portfolio of second liens in the country, it owned only 12% of the first-lien loans covered by the Countrywide settlement.
According to the Nevada suit, B of A has financial disincentives that stand in the way of its commitment under the Countrywide settlement to modify loans. “Bank of America earns substantial late fees and other default-related fees, which operate as disincentives to modify mortgages so that borrowers can afford to remain current on their obligations,” the suit states. “The fact that Bank of America and other servicers hold second-lien loans on many of these mortgages may explain their reluctance to pursue certain modifications involving principal forgiveness, which would require them to recognize losses on these second liens.”
Despite the various alleged conflicts of interest that B of A had in servicing the loans covered by the National Homeownership Retention Program, the Countrywide settlement left the administration of the program largely up to the bank.
For example, according to the settlement, a loan mod offer made by B of A in its role as servicer could be turned down if the investor or group of investors that actually owned the mortgage failed to approve the modification. But B of A was in charge of securing investor approval for the loan modifications.
The conflicts of interest are incredible in the mortgage servicer world. Hard to imagine how anything gets fixed without directly solving that problem, as the Banker says in its kicker:
For any future settlement to work, Franklin said, it is essential to get the servicing decisions out of the control of the big banks. “If you have the same old people doing the same old things, you can pretty much expect a bad outcome,” he said. “What makes the AGs think that they can trust these guys any more than they could last time?”
— Yves Smith points to a research note by Institutional Risk Analytics’ Chris Whalen that looks at the private mortgage insurers and asks if Fannie Mae and Freddie Mac are hiding tens of billions of dollars in losses by not making claims on defaulted loans.
Why not? Well, if the GSEs did put in claims, the PMIs would quickly go bust and Fannie and Freddie would report losses. So the failure to put in claims is yet another variant of “extend and pretend”.
Smith comes to a rough $100 billion number on how much these GSE losses might be.
And this is interesting, to say the least:
Given the prevalence of PMI insurance, their thin capitalization, and the big wipeout in home values, they should be as dead as the monolines. But they aren’t. That’s because they are engaging in insurance fraud, namely, refusing to pay out legitimate claims.
It seems like we haven’t seen very much reporting on these private mortgage insurance companies. How much have they paid out? How are they still in business? Are they refusing to pay legitimate claims? Are the GSEs indeed hiding losses, with the at least tacit approval of their regulators, presumably, by not filing claims on PMI?
— Georgeown Law prof Adam Levitin riffs off Smith’s piece and makes the GSE-private mortgage insurance story even more interesting:
There’s a further twist, however, that Yves post didn’t capture. A lot of PMI is reinsured. And guess who does about half of PMI reinsurance? The captive reinsurance affiliates of the large banks.
While most large banks have reinsurance capitves, the captives of the big 4 banks get about 1/3 of all PMI reinsurance premiums, which probably translates to something like 1/3 of the exposure…
What this all means is that if the GSEs are forbearing in making claims on their PMI policies, it not only hides the GSEs’ losses. It also means we’re seeing another quiet bailout of the banks.
Leviting further says the banks get reinsurance business as a sort of kickback from PMI companies:
The lender selects the PMI carrier based on the amount of business the PMI firm will cede to the lender’s captive reinsurance subsidiary. And therein lies a regulatory capital game, as captive reinsurers aren’t required to hold much regulatory capital at all, as there is jurisdictional competition for charters.
Needless to say, we need more reporting here.
Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR’s business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum.