NCPA - National Center for Policy Analysis

The Investor's Case against the Mortgage Settlement

March 27, 2012

Mortgage-backed securities (MBS) investors are upset after details on the $25 billion national mortgage settlement emerged recently.  The settlement confirmed that they might have to forfeit $17 billion to $20 billion to pay for most of the deal.  As was long suspected, the headline figure of banks paying $25 billion for their robo-signing of foreclosure documents is false, and banks may only wind up paying $5 billion in cash of the overall deal, says Anthony Randazzo, the director of economic research at the Reason Foundation.

It is understandable that MBS investors are upset about this, but do they have a case in court?

  • The first complaint from MBS investors will be that they were ignored.
  • The second complaint from MBS investors will be that they are innocent of any wrongdoing in this matter -- MBS investors have no authority over how foreclosures are processed or whether the right fees are being charged.

Then there's the third point investors will make: the national mortgage settlement wrongly incentivizes banks to modify private securitized mortgages before modifying loans on their own balance sheets.

  • While only one-fifth of the mortgage settlement is cash payments from the banks to a trustee, $20 billion of the settlement is "consumer relief" efforts including writing down principal, refinancing loans and funding short-sales.
  • The settlement draws up a "menu" of different ways that banks can get "credits" toward their portion of the consumer relief efforts.
  • For example, banks will get a $1 credit for every $1 of principal reduced on mortgages in their own portfolio and a $0.45 credit for every $1 of principal reduced on an investor owned mortgage.

The structure was intended to incentivize banks to favor their own mortgages for principal, but it turns out that the incentive structure suggests that banks would prefer to write down more than double the amount of investor principal for the same credits while strengthening their own balance sheets and avoiding increased losses.

Collectively, these arguments would give MBS investors a credible case that the national mortgage settlement unjustly excluded their participation in the talks, that it unfairly asks them to pay for robosigning failures they had nothing to do with, and that it improperly incentivizes banks to pass losses on to them rather than bite the bullet themselves.

Source: Anthony Randazzo, "The MBS Investor's Case against the Mortgage Settlement," Real Clear Markets, March 22, 2012.

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