You are herePro Publica: In Proposed Mortgage Fraud Settlement, a Gift to Big Banks

Pro Publica: In Proposed Mortgage Fraud Settlement, a Gift to Big Banks


March 16, 2011- Lurking in a proposed mortgage fraud settlement with the state attorneys general is a clause that could be worth billions for the big banks.

Yes, I mean the settlement that might extract the supposedly large sum of $20 billion [1] from the banks to settle foreclosure fraud. The one denounced as a "shakedown" [2] by Sen. Richard Shelby of Alabama.

Despite such rhetoric, the settlement might let the banks avoid tens of billions of write-downs, thanks to a clause with a biblical flavor: the last shall be first.

The proposed agreement -- which is preliminary and subject to intense negotiations being led by Tom Miller, the attorney general of Iowa -- would allow banks to treat second mortgages, like home equity lines of credit, just like the first mortgages. Under the proposal, when a bank writes the principal down on the first mortgage, the second should be written down "at least proportionately to the first."

Suddenly, the banks would be given license to subvert the rules of payment hierarchy, as Gretchen Morgenson pointed out [3] in The New York Times on Sunday. Yes, the clause says the other alternative is to wipe out the second's value entirely, but given a choice, the banks would be extremely unlikely to do that.

So how is this a gift? Because when the principal on the first mortgage is reduced, the second lien is typically wiped out. The first lien holder has the first right to any money recovered, and the second lien holder has to wait its turn.

The proposal "seems astonishingly generous to the second-lien holders," said Arthur Wilmarth, a law professor at George Washington University. "And who are those? Of course, they are the big mortgage servicers."

And who owns the big mortgage servicers? The biggest banks. Throughout the financial crisis, we have heard plenty of intoning about the sanctity of contracts. But this suggests that the banks, with the authorities' tacit approval, think contracts are for thee and not for me. The price to get the banks to do the right thing contractually with mortgage modifications and foreclosure is to allow them to not do the right thing elsewhere.

FULL STORY HERE:

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