Will Government Bank Mortgage Deal Help or Hinder Prosecutions?
Yves Smith: How can Obama Admin. settle before they have fully investigated the fraud - February 9, 2012
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Yves Smith has written the popular and trenchant financial blog "Naked Capitalism" since 2006.
Yves has spent more than 25 years in the financial services industry and currently heads Aurora Advisors, a New York-based management consulting firm specializing in corporate finance advisory and financial services. Prior experience includes Goldman Sachs (in corporate finance), McKinsey & Co., and Sumitomo Bank (as head of mergers and acquisitions). Yves has written for publications in the United States and Australia, including The New York Times, The Christian Science Monitor, Slate, The Conference Board Review, Institutional Investor, The Daily Deal and the Australian Financial Review. Yves is a graduate of Harvard College and Harvard Business School.
PAUL JAY, SENIOR EDITOR, TRNN: Welcome to The Real News Network. I'm Paul Jay in Washington.In President Obama's recent State of the Union speech, he announced he wanted to create a commission to investigate fraud and bad behavior by the financial institutions in and around the 2008 crisis/crash. Well, that sounds like a good thing, doesn't it?Well, joining us now to talk about that is Yves Smith. Yves is the publisher of nakedcapitalism.com and also the author of the book ECONned. Thanks for joining us, Yves.YVES SMITH, NAKEDCAPITALISM.COM: Thanks so much, Paul.JAY: And I should mention you're coming in just by audio. So what's your take on this? He wants to establish this commission. At the same time, I understand, there's negotiations going on for some kind of big deal on the issue of the mortgages, a deal with the financial institutions. What's the relationship of these two things?SMITH: Well, it looks a little bit peculiar, because if you were serious about investigating, you wouldn't be settling. I mean, one of the basic rules of prosecution is that you investigate first, you see what the cases might look like, and then you have at least a rough idea of what you might sue on, or you even file a lawsuit; then you negotiate a settlement. That's the normal procedure.I mean, for example, readersâyour viewers have probably seen a number of discussions of various settlements by the Securities and Exchange Commission. Many of them have been controversial because they think the dollar amounts are too small. But nevertheless, those settlements came, actually, because cases were filed. The whole procedure of having a settlement with no case development is just highly irregular.JAY: Now, there is one caseâat least one; maybe there's more. But in Missouri, the attorney general has actually filed a case now about these robosignings. And the robosignings are a big part of this whole issue, aren't they?SMITH: Well, in fact, that's actually what the settlement's supposedly about. There have been various leaks as to what is going to be exempted from the settlement, and one of the things that's supposedly exempted is criminal prosecutions. He launched a criminal case, so supposedly that type of case would be exempted. It's kind ofâit's funny that actually nobody hasâup until yesterday, has decided to call this robosigning what it isâforgery. I mean, in many cases people forgedâthere were actual what they call "surrogate signer". I love that these terms [incompr.] they make up, "surrogate signers", people signing in other people's names. I mean, that's justâyou know, some of the practices are just astonishing.JAY: Now, just quickly for people that haven't followed this, this is banks hiring companies to do signings of documents that are essentially forgeries, claiming that people had signed these things, because the actual paper trail of all this derivatives market and these mortgages was so bad that when it came time to foreclose, they couldn't prove they owned the places. Have I got that right?SMITH: Well, more or less, I mean, 'cause the issue is that much of this isâyou're correct that much of this stems from the fact that mostânot all, but most of the loans made in the, you know, 2003 to 2007 period were securitized. And the parties that set up these deals had to create fairly complicated procedures because there were a number of legal requirements they had to satisfy. And the effect was that the mortgages would be transferred multiple times through different parties before they got to the trust. The trust is kind of aâthink of it as a legal box in which all the mortgages sit. Basically, it looks like, you know, on a large-scale basis, if not endemically, they just didn't do that. You know, they just acted as if they'd done the transfers, but they didn't. And, you know, normally it's not a big deal to sign a mortgage, but not the way these contracts were set up. These contracts make it very difficultâthey basically make it legally impossible to fix things retroactively. They're extremely rigid contracts.JAY: Okay. So the attorney general of Missouri has filed an actual case. This negotiations are going on, and President Obamaânegotiations for a settlement with the banks, and President Obama says he wants to create a commission that involves the attorney general. So what's wrong with all that?SMITH: Well, the fact is, as Charles Ferguson said in an op-ed, let them eat task forces. I mean, what was the Financial Crisis Inquiry Commission supposed to accomplish? You know, we had a whole year of investigations, and, you know, it turned up that everybody was to blame, therefore no one was to blame. This effort, first thingâ. And similarly, all the people who are on this commission all have the power to investigate independently. So why have we waited on a crisis that ended in 2007 to 2012, when the statutes of limitation on many issues have already expired, to form a commission?I mean, and some of the people on the commissionâ. For example, Schneiderman is only the cochairman. Two of the people on the commission are from the Department of Justice, which has been missing in action on this. The other one is the head of the SEC's enforcement, Robert Khuzami. Khuzami was the general counsel of Deutsche Bank. Deutsche Bank was one of the worst actors in the CDO space. He's got serious conflicts here. You know, I mean, you know, justâand if you look at the people on the commission, it's just not credible. I mean it's just not. And Schneiderman is onlyâyou know, Schneiderman has a full-time day job. It's not as if he's going to be physically in D.C., able to do bureaucratic infighting. Similarly, there've even been disagreements among the people whoâabout the staffing. The DOJ has only something like 50 people, which is inadequate. Schneiderman has said hundreds. I mean, soâand even hundreds is less than they had in the S&L crisis, which was a much smaller crisis. They had 1,000 FBI agents on that.JAY: Now, the commission is notâwho's conducting negotiations on the settlement? Is that a separate process than what this commission is?SMITH: That'sâthe settlement is completelyâis separate. That has beenâand that's a bit misbranded in the public too, because it keeps being spoken of as an attorney general settlement. And they are trying to get attorneys general to sign on, but this is being led by the Obama administration with an attorney general from Iowa, Tom Miller, as the lead actor on the attorney general's side of these negotiations. So that'sâ.JAY: Yeah. So your point: why are you creating an inquiry over here and you're doing direct negotiations over there, and it's all really about the same issue?SMITH: Well, it's about the same sort of set of issues. Now, the argument in favor of the settlement negotiations which I have a lot of trouble with is that, oh, you know, weâsupposedly they've narrowed the release down, and there are a whole bunch of things that are going to be excluded from the release. But the point is that, you know, normally when you doâfor example, when you doâwhen you go after any kind of bad activity, youâone of the best ways to start is to go after the most obvious misbehavior and use that as a basis to do discovery and see what other misbehavior you find. And so they're giving up the clearest path to finding other abuses in the settlement. This is why the banks are so keen to do that. And another very bad feature of the settlement is that the banks are really not going to be paying any kind of serious money for this.JAY: Well, thatâI was about to ask you about that. On one of your blogs on nakedcapitalism.com, you're saying it's not just about the liability of the issues in terms of misbehavior, but this is actually a form of another bailout. What did you mean by that?SMITH: Exactly. Well, the way this negotiation evolved, originally it was going to be $25 billion. Well, then it turned out, no, the banks are going to be given credit for modifying mortgages. But earlier in the discussions it was only going to be mortgages they modified on their own. Now the way the deal stands is they're going to pay a portion in cash. And I've never seen a number bigger than $5 billion forâI think the latest I saw was something like $4.4 billion, but that's kind of a moving target, because it depends whether California is in or out. But basically they're going to pay less than $5 billion among all these, you know, big banks in cash, and the rest are going to get credit for modifying mortgages.JAY: What does that mean, credit for modifying mortgages?SMITH: Wellâbutâwell, so let's say they reduce the principal of a mortgage fromâyou know, it was originally 100,000âor let's say $200,000, and they reduced it to $185,000. They'll get a $15,000 credit. But they are now permitted to modify mortgages that they don't own, which means they don't bear that cost; the investors bear the cost. And the reason this can help the banks is, as I mentioned earlier, the banks own almost all of the second liens, which are typically home equity lines of credit.Normallyâand there's a very clear creditor hierarchyâyou would expect to wipe out the second lien before you'd even touch the first lien. In a bankruptcy, the second lien would beâor in foreclosure, you pay the first lien first, and anything that's left over goes to the second lien. And these houses are so underwater there's nothing left.I mean, there'sâyou know, this isâyou know, so the secondâand the banks haveâagain, among them, have hundreds of billions of dollars in secondâthe four biggest banks, Bank of America, JPMorgan Chase, Citibank, and Wells, have hundreds of billions of mortgage second liens among them. And if you write down the first lien, that gives the borrower more money to pay the second lien. That makes theâall this does is take money from investors to make second liens better, when in fact it's the second liens that should be wiped out before you even touch the first liens. And these mayâyou know, it may still be that you should modify first liens. I mean, I'm not saying these first liens shouldn't be modified, but the second lien should be modified before you touch the first.JAY: And in terms of this settlement, they're getting credit for that writedown of the first, even though they're picking it up, the same amount of money, more or less, by getting the second paid. That's what you're saying.SMITH: Yeahâwell, before the investors. They're basically able to get a credit when they misbehaved. They misbehaved, and they are getting investorsâ. Oh, and by the way, who is the biggest investor in this stuff? Fannie and Freddie. So it ultimately is the taxpayer: Fannie, Freddie, pension funds, and insurers are the ones who are going to be paying for this.JAY: So take it another notch of explanation why this is a bailout, then. How does thisâwhat is the value to the banks?SMITH: Well, again, the banksâif you were to write these second liens down severely, mostâthose big banks would be very seriously undercapitalized. So if you write down the first lien, that means that the second lien is worth more, because [inaud.] has more money left to pay the second lien. The second lien is what should be wiped out before you even touch the first lien.JAY: So a lot of this is just to make the books of the banks look more solvent than the banks really are.SMITH: That's correct.JAY: Now just one anecdotal experience I have. I've been talking to some real estate agents in Baltimore, and they're talking about how they can't get the banks to actually sell properties they're sitting on, either that have been foreclosed or that have beenâare in what they call short sales, where essentially they're about to foreclose but they haven't actually done the process yet, and they allow the buyerâI should say, the individual owner to sell without screwing up their credit rating if the bank approves the deal. And the real estate agents are telling us they can't get banks to approve these dealsâthey're just sitting on these properties; they don't seem to want to sell them.SMITH: Yeah. Well, we've been hearing this around the country. I mean, I've heard in Los Angeles people literally have to advertise "no short sale" because brokers won't talk to them, it's become so common for banks not toâit's so widely known that banks aren't processing short sales. One of the reasons is thatâwell, one of the reasons, of course, is the second liens, right? If the bank has a related second lien, if it finally processes a foreclosure, it's going to have to write down the second. So that's one reason, you know, the banks are dragging their feet on foreclosing.The second is that the longer they draw out the process, if it's a mortgage, if they don't own the mortgageâ. Remember, most of these are securitized. That means they can keep collecting servicing fees and they can keep charging late fees. So they have an incentive, you know, to drag this process on as long as possible.JAY: So what should be done? I mean, if you could actuallyâif you could suggestâassuming President Obama would listen, what should be done now to actually move a realâa process of actual accountability?SMITH: Well, the first is that, you know, we're so late in this game that there should be real investigations and there should be real prosecutions. And the one who's going about this most seriously seems to be Catherine Cortez Masto of Nevada, which isâeven though she'sâyou know, has a veryâI would assume that in a small state she has a small staff, but it's so deeply underwater thatâthose houses are so deeply underwater that it's a huge issue for that state.But she has targeted one firm, Lender Processing Services, which is the platform for about half the industry. They actuallyâthe banks, remarkably, outsource a lot of the foreclosure activities to Lender Processing Services, and about half of the industry's foreclosures are processed by them in some fashion, and they've been accused of all kinds of abuses. You can establishâif she can get her hands on LPS's software, she could conceivably establish that this is systematic and that the banks couldn't not have known. I mean, it would be a very efficient way of demonstrating all kinds of bad behavior across all the banks, because so many of the banks used LPS.JAY: So your fear or concern about President Obama's commission is that instead of facilitating actual prosecutions by state attorney generals, it might actually slow them down, being involved in this inquiry.SMITH: Exactly, that this is justâ. I mean, Obama clearly just wants some talking points for the election. I mean, this isâto think that he has any interest in a serious effort is, you know, counter to the entire history of his administration. You just have to look at all the people he's got inâyou know, he still has Geithner in place; you know, Walsh, who's the head of the OCC. I mean, that's an astonishingly bank-friendly regulator. I mean, it's justâI mean, it's not evenâto even call it a regulator is a bit of a stretch, it so prostrates itself to what the industry wants. So, you know, there's nothing convincing here toâ.And even Richard Cordray has said some things that are shockingly disappointing. For example, there's beenâthe new head of the Consumer Financial Protection Bureau. For example, he was before Congress, and he was asked about a very clear violation of the Service Members Civil Relief Act, where you're not supposed toâamong other things, you're not supposed to foreclose on the homes of active-duty serviceman, and yet the banks were doing that. And, you know, Cordray just said, oh, well, you know, it looked like it was mistakes, and, you know, the banks said they've stopped doing this. Well, how do you know it's mistakes unless you investigate? I mean, this is just ridiculous. They were going to take an industry that has this bad of a historyâ. You know, I mean, they've all so piously swore they stopped robosigning, and, you know, Reuters and a couple of other news reporters found evidence six months later that they were still doing it.JAY: Right. Thanks very much for joining us, Yves.SMITH: Thank you.JAY: And thank you for joining us on The Real News Network.
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