Denial in the Mortgage Industrial Complex

I just came back from the AmeriCatalyst conference in Austin, which was a packed two days focused on the state of the housing and securitization market. The panels were very informative, and it was also good to see some of the people I’ve read or heard about, in particular the leading analyst, Laurie Goodman of Amherst Securities. She gave a talk where she went through a very persuasive (and conservative) analysis that there are 8.3 to 10.3 million more foreclosures baked given how underwater borrowers are. And she had some striking bits of information. One is if you take out the homes where no one has made a mortgage payment in a year or more, homeownership in the US is 61%. In addition, Judge Annette Rizzo discussed a successful program she had developed in Philadelphia to do remediation. The success rate on modifications that come out of her court is 85% after 18 months.

I had quite a few people come and commend me on my comments. I think the main reason was that the viewpoint presented on this blog, that there are deep seated problems resulting from chain of title issues, and that servicers have engaged in a lot of abuses, was sorely underrepresented. I don’t blame the organizer, Toni Moss, who has an exceptionally well organized and prepped effort; I think this reflects the nature of who has expertise in this industry. The overwhelming majority of knowledgeable people will be insiders, and whether they can admit it to themselves or not, their first loyalty will be to their meal ticket. Put it another way: why would you have to go outside the industry to find someone (and a blogger to boot) to raise issues that come directly out of recent court decisions and the gridlock in foreclosure courts if you could find people with institutional credentials? (In fairness, there were other skeptics, such as Adam Levitin and Josh Rosner, but that was a minority viewpoint).

But I don’t mean to attribute to the panelists or industry defenders of mendacity. Instead, it has much more to do with both loyalty to their industry, and a distressing lack of understanding of the legal issues involved. By happenstance, I’m reading a book by an award-winning academic psychologist, David Tucker, Minding the Markets, and it includes a good summary on the state of the art of group processes. As W.R. Bion wrote,

I know of no experience that demonstrates more clearly that a basic assumption group experience is active [colloquially known as groupthink] that ‘the dread with which a questioning attitude is regarded’ and particularly towards the group itself.

I’ve been at conferences in the past where denial was a palpable subtext, in particular, the 2008 Milken conference, which took place the month after Bear Stearns collapsed. There was a whistling in the dark quality to it, but there was also aggressive enforcement of a “ne’er a bad word will be said” policy (see here and here for details).

By contrast, here the hope was to mix it up a bit, yet there was a lot of unanimity. For instance, the six members of one panel were asked where housing prices would be a year from now. One said they’d bottomed, one said they’d bottomed but would bump sideways for a very long time. The others projected very modest declines (with the usual caveat that real estate is local), typically 2%, with the maximum 5%. Given how far housing prices have fallen, it would not seem crazy to expect things not to deteriorate much further. But given the severity of the chain of title mess and the high odds of a European banking crisis, which would wind up impacting the US economy, I found it telling that no one was willing to hedge their views with a consideration of a downside scenario.

But the biggest undertone was the “borrowers are deadbeats” meme. In the first panel I was one, one of the other speakers went on about borrower fraud in the widely criticized HAMP program. I had trouble containing myself in my response. Each table in the audience had a keyboard that allowed comments and questions to be displayed (both to people at the table and the speakers (a clever way to direct the texting temptation into the conversation). In a later panel I was on, on litigation, there were a lot of “shoot the messenger” remarks (among other things, I was accused of being an anarchist, and it was also interesting to see how some of my remarks were either distorted or misunderstood. For instance, I made a general remark about the use of allonges (a preferred form of fabrication to solve the little problem of failure to convey the mortgage notes as required on time), and a written comment charged me with being wrong about Kemp v. Countrywide, when I had just mentioned that case for a different reason). It was pretty clear that the American Securitization Forum party line, that these were mere errors or sloppiness, is widely shared. Too few are willing to accept the point made by Levitin:

To raise the “it’s just paperwork” argument in the context of securitization, however, is unreal. Securitization is all about legal fictions and paperwork. Why on earth would anyone every bother with the complex legal structures of securitization (typically involving two shell entities) other than to take advantage of legal fictions?

As I’ve noted in other venues, securitization is the legal apotheosis of form over substance, and the basis on which this is legally tolerated is the punctilious observance of formalities. Failure to do so can result in a securitization failing to be bankruptcy remote or to lose its off-balance sheet accounting status or lose its pass-thru tax status, any of which are disasterous. Securitization deals were so heavily lawyered precisely because the paperwork matters. They aren’t like a sale of a used sofa over Craigslist.

The “it’s just paperwork” argument quickly proves too much. Is the borrower’s signature on the loan “just paperwork”? How about a co-signor’s? If it’s just paperwork, why bother to have the borrower or co-signor sign, especially as it can create federal Equal Credit Opportunity Act issues when a spouse is involved.

So it isn’t surprising that a lawyer who represents investors made an impassioned plea for servicers to wake up and smell the coffee, that he’d rather work with them and negotiate a deal, but he was too often left with no other option than to sue. And that means that this battle will continue to play out in the courtroom.

The good news at least some of the media gets it. The New York Times was early to support attorney general Eric Scheiderman’s efforts. The Grey Lady provided another editorial covering his back, this one on his and other AGs like Delaware Beau Biden’s opposition to the direction the multi-state settlement talks have taken. Key points:

The administration says a settlement today would quickly deliver relief to needy borrowers. That’s true as far as it goes, but it doesn’t go far enough. Early word of the proposed settlement indicates that banks would reduce the balances on a million or so underwater loans by $17 billion to $20 billion. They would put up $5 billion to $8 billion to help pay for refinancings, counseling, legal services and other aid to homeowners. And they would have to adhere to tougher standards for loan servicing and foreclosures. That would be better than now but paltry compared with the potential extent of bank misconduct and with the scale of the mortgage debacle. At present, 14.5 million borrowers — and the broader economy — are drowning in some $700 billion of negative equity.

The administration also believes federal and state officials could effectively pursue investigations of unexamined issues after a settlement. We doubt that. The government’s history on challenging banks and holding them accountable does not inspire confidence. And for banks — threatened by crushing legal challenges for their conduct — the whole point of settling is to restrict legal claims.

The proposed settlement reportedly would prevent the states from pursuing claims against banks relating to fraud or abuse in the origination of loans during the bubble. (In some states, the statute of limitations has expired for bringing challenges for faulty originations but not on all loans in all states.) It would also prevent states from pursuing claims for foreclosure abuses, like improper denial of loan modifications. And it would prevent them from pursuing banks’ misconduct in their dealings with the Mortgage Electronic Registration Systems database, or MERS, a land registry system implicated in bubble-era violations of tax, trust and property law…

In effect, the legal waivers being contemplated would let the banks pay up to sweep wrongdoing under the rug…

The best outcome would be for government officials to do what they should have done all along: develop the strongest possible legal case by fully investigating the banks’ conduct during the bubble and since the crash and then — and only then — talk settlement. In the meantime, the public is being well served by attorneys general who are willing to say that the deal currently on the table is not nearly good enough.

The industry seems not to understand that it does need a global resolution, but not a fake one that will be undermined as the gridlock in the courts gets worse, but a real one that seeks to come to some equitable solution and put the industry on a sounder footing. Until then, they are holding the housing market and the economy hostage.

This post originally appeared at naked capitalism and is reproduced with permission.