Bank of America's $335 Million Settlement Is the Cost of Doing Business

Bank of America agreed to pay the largest award in history for violations of fair housing laws.  Even so, the amount doesn’t come close to the injuries suffered.  I can only hope that the agreement spurs Eric Holder and the Department of Justice onward as opposed to resting on their laurels.

After an investigation of Countrywide Financial that focused on the years 2004-2008, the DoJ found a widespread pattern of blatant discrimination.

Bank of America, which absorbed Countrywide in 2008, agreed to pay $335 million to settle claims that it discriminated against minority borrowers by making them pay higher fees and placing them into costly subprime mortgages when they had the same credit histories as non-Hispanic whites who received prime mortgages.

Because subprime mortgages offered a higher yield, investment banks snapped them up to bundle, tranche and resell them to eager investors.  Countrywide brokers received a higher commission for signing borrowers to subprime contracts and independent brokers contracting with Countrywide were paid even higher commissions than that.

This settlement wasn’t a matter of ideological bias.  It was based on statistics; in other words, counting heads.  The Department of Justice compared the number of minority borrowers with non-Hispanic white borrowers who shared the same proximate credit background:

The odds of a minority applicant being steered into such a loan were more than twice as high as those for a non-Hispanic white borrower with a similar credit rating, the department said.  About 2/3s of the victims were Hispanic and one-third were black, the department said.

If a judge approves the settlement, victims will receive between several hundred and several thousand dollars, with larger amounts going to those who were steered into subprime mortgages despite qualifying for regular loans.

Even though this was by far the largest amount paid by a violator of fair housing laws, the monies paid to aggrieved parties will barely dent their injuries.  Most of the victims were placed in ARMs (adjustable rate mortgages).  As opposed to a fixed-rate mortgage where a borrower paid the same amount of interest over the life of the loan, an ARM started with a low “teaser” rate.   


If it was a 2/28 ARM (a very popular form of subprime mortgage) after two years the interest rate could ratchet up 3-4 times higher.  To give an example, a 30-year 4% fixed-rate mortgage on a $500,000 loan averages out to about $2,400 monthly.  If the ARM jacks up to 10% after two years, the monthly payment becomes $4,220.

Conservatively speaking, using the figures supplied by the Justice Department investigation, 10,000 homeowners were put into subprime mortgages under false pretenses.  According to the above calculations, each borrower paid an excess of $21,840 annually (the difference between 4220 and 2400 [1820] x 12). 


$21,840 x 10,000 homeowners is an eye-popping $218,400,000, 65% of the total settlement.  In other words, the settlement for Countrywide’s malfeasance (now Bank of America’s liability) would barely make the injured homeowners whole for one year.

Countrywide’s criminal practices allowed it to accumulate $200 billion in assets until it collapsed and was taken over by Bank of America for $2.8 billion.  Don’t mean to compare apples with oranges, but while Bernie Madoff’s victims howl to be made whole, management at these mortgage lending criminal enterprises skimmed hundreds of millions off the top and walked away, possibly suffering small fines (the cost of doing business), while their bleeding victims fight desperately to forestall homelessness.

The Big Picture in Housing Is A Tsunami

Financials led the 1st day of 2011 trading, DJIA up 93 points. In Tess Stynes' article , written with help from David Benoit, Alan Zibel and Bob McGoughon on today's Wall Street Journal website, Bank of America is buying back $3 billion in bad loans from Fannie Mae and Freddie Mac. Is that a sliver of sunshine peaking through the clouds? Or is it just a miniscule drop in the bucket?

Bank of America bought Countrywide Financial, which originated many of the worst mortgages imaginable. Such as, you only have to pay a low teaser rate for a few years then-BOOM-! the interest rates double. Or you pay less than the interest rate (known as negative amortization). Every payment adds to the principal, so you end up owing more at the end than you did in the beginning.

So what are these entitities, Fannie Mae and Freddie Mac? They're government-sponsored entities (GSEs). Fannie Mae was created back in the FDR administration to expand the secondary mortage market by securitizing mortgages in the form of mortgage-backed securities. I've written a lot about mortgage-backed securities (MBS) in the 3 years I've worked on whereiscassandra.

Anyway, by securitizing the loans the GSEs provided more money to lenders, increasing the number of lenders in the mortgage market.

These were good, solid entities for decades. They provided conservative underwriting standards and guarantees that principal and interest would be paid.

But something is rotten in the state of housing cognitive dissonance. Could be due to the hybrid nature of Fannie & Freddie. They are an unholy mixture of implicit (not explicit) government backing of affordable home ownership, which allows them a place at the Fed table for cheap money but they are also answerable to private shareholders. That's not their only conflict: its mission is to provide affordable housing, yet when competition came in the form of private label securitization, they lowered their underwriting standards to keep competitive.

In 2004, the government allowed high-risk loans to count toward affordable housing. The concept was that Fannie and Freddie would police its underwriting standards across the board.

As of 2008, Freddie and Fannie guaranteed 56.8% of the United States $12 trillion mortgage.

But they have HUGE problems. They're zebras pretending to be thoroughbreds. Private label securitization paralyzed them by stealing market share and took them on the wrong path. Let me illustrate with a little graph:

Fannie/Freddie Securitization
Conservative Underwriting Standards-30-year Fixed Rate Mortgages (FRM).

Private Label SecuritizationAnything goes: liar loans, toxic waste, let's get out of here before the house of cards collapses.
Adjustable Rate Mortgages (ARM).

Fannie/Freddie altered its strict underwriting standards to please its private shareholders.

Then the sh***t really hit the fan. People could not pay subprime, predatory mortgages. They couldn't even understand what the fast-talking broker was selling them. Many who were put in subprime ARMs could have qualfied for prime fixed rate mortgages but weren't given that option because the lenders made more with the riskier loans.

Housing prices plunged and depreciated. The unemployment rate went to double digits and is stubbornly staying there. Since Fannie/Freddie guaranteed payment of interest and principal and the money owed on the mortgages they owned was greater than the equity in the house, losses grew and are growing for the GSEs.

In a 7/8/08 article in the New York Times, the dire state of affairs had just begun:

Fannie Mae and Freddie Mac are the nation's largest buyers of home mortgages and traditionally, the government's backstop for the housing economy. But with Monday's plunge, each of these giants has now lost more than 60% of its market value this year. The declines, along with a falling stock market and growing unease about the possibility of more red ink at big banks, reflect a growing conviction consensus among investors that the current housing slump will last longer, and prove more severe, than initally feared.

Representives of Freddie Mac and Fannie Mae declined to comment on their stocks' performances on Monday. Freddie Mac closed at $11.91, the company's lowest [rce soce 1994. Fannie fell to $15.74, its lowest level since 1992.

At end of trading today, 1/3/11, a share price of Fannie Mae was $0.32. That's right, 32 cents. They were delisted from the major exchange in June 2010.

Freddie and Fannie are eager to get banks to repurchase their horrible loans that they sloughed off on F & F. They're poring over their legal guidelines, looking for ways to pressure financial institutions to repurchase the bad loans they orginated and to all intents and purposes insured with F & F.

On the Mortgage Lending News website post "Fannie Mae and Freddie Mac Up Against Bankers' Stubborn Refusal to repurchase Home Loans," Fannie and Freddie are trying new tactics. No more mister nice guy:

Fannie Mae and Freddie Mac are putting into effect agreements calling for banks to repurchase loans that did not comply with the government's underwriting regulations. Byy the end of September, lenders had yet to react to these calls to buy back $13 billion in loans. Freddie Mac has already begun the process to impose penalties for the bad loans, 1/3 of which are 4 months old and older.

But the math will kill you. Fannie and Freddie are costing the taxpayers hundreds of billions in conservatorship. They can dream about getting maybe 5% back. Meanwhile, they're collapsing under the weight of all those bad loans, for which no one took responsibility. which are unaccounted for and which could be utterly worthless. And F & F guarantee 56.8% of the U.S. $12 trillion mortgage market.

What's the endgame? Stop all government spending? Privatize (sell-off) everything? Keep printing money? Is it impossible or desireable to find out through some sort of mark-to-market accounting how many mortgages are dead in the water? Investors in MBS must have some idea. This is asymmetrical information, folks. Some people have a lot of answers and react accordingly. Others are in the dark surrounded by their meager possessions and rapidly dwindling hope. Is it possible to move the process along, with class action lawsuits, etc.?

*Invaluable help from Wikipedia re: GSEs.

The Financial System's Maze to Defeat You

I don't have automatic bill paying through my bank because I don't trust banks. My last bank, Washington Mutual, failed. Many people had great difficulty extricating themselves from their automatic bill paying with WaMu, and as a consequence, their bills remained unpaid until they were way past due.

I pay the old way: writing a check, putting it in an envelope, and pasting on a stamp (now 42 cents, will be 44 in May). Generally I send out it out days before it's due. For instance, I paid for my el cheapo, desperation bid Daily News subscription on 3/5/09. Due date 3/8. Because they didn't get it until 3/10, they sent out a past due invoice immediately. My check was cashed 3/12. In other words, there is no way to pay bills on time the old-fashioned way. Yet if you trap yourself with automatic bill paying through a possibly zombie bank, you may get hung up with the over-burdened FDIC (527 banks on the watch list and counting) and the difficulty extricating yourself.

The Post Office is cutting back one day a week and raising the cost of its first class stamps in order to remain in business. Those measure impair its service. On the other hand, banks are failing and wise heads say don't connect your account with your creditors.

So what happens? If you have an arbitrage thinking financial company, they will dart out a past due notice with late fees and finance charges eagerly attached without a breather. There's no way they can lose. They're betting against the post office and you can't prove them wrong. I mean, the Daily News is telling me they got my check a week after I mailed it. Imagine what Bank of America could do to leverage the calendar? Their BoA credit card is the only one I use. I have a large credit line and I've invested the card with sentimental value (it's granted through my alma mater). And BoA is first out of the gate. The instant my check leaves my burning fingers, BoA has cashed it. I don't know how they do it. Maybe they've cracked the time-space continuum.

I try not to use my credit card at all. I'm not going to pay extra and risk my credit score. How does this system of logic help stimulate the economy?