William K. Black is an Associate Professor of Economics and Law at the University of Missouri-Kansas City. He is a white-collar criminologist and was a senior financial regulator. He is the author of The Best Way to Rob a Bank is to Own One.
L. Randall Wray is a Professor of Economics at the University of Missouri-Kansas City and Research Director with the Center for Full Employment and Price Stability as well as a Senior Research Scholar at The Levy Economics Institute and author of Understanding Modern Money.
This is the second installment of a two-part series. Read the first here.
Note also that while we have supported a moratorium on foreclosures, this is only to stop the foreclosure frauds — the illegal seizure of homes by fraudulent means. We do not suppose that financial institutions can afford to maintain toxic assets on their books. The experience of the thrift crisis of the 1980s demonstrates the inherent problems created by forbearance in the case of institutions that are run as control frauds. All of the incentives of a control fraud bank are worsened with forbearance. Our posts on the Prompt Corrective Action (PCA) law (which mandates that the regulators place insolvent banks in receivership) have focused on the banks’ failure to foreclose as a deliberate strategy to avoid recognizing their massive losses in order to escape receivership and to allow their managers to further loot the banks through huge bonuses based on fictional income (which ignores real losses). We have previously noted the massive rise in the "shadow inventory" of loans that have received no payments for years, yet have not led to foreclosure:
As of September, banks owned nearly a million homes, up 21 percent from a year earlier. That alone would take 17 months to unload at the most recent pace of sales, and doesn’t include the 5.2 million homes still in the foreclosure process or those whose owners have already missed at least two payments.
Bank of America’s response admits how massive its contribution to the shadow inventory has been. Mairone implies that the bank delays its foreclosures for years out of a desire to help homeowners, but common sense, and their own data show that the explanation that makes most sense is that the bank is hiding losses and maximizing the senior officers’ bonuses by postponing the day that the bank is finally put into receivership.
We did not call for a long-term foreclosure moratorium. Our proposal created an incentive for honest lenders to clean up their act quickly by eliminating foreclosure fraud. We will devote a future post to our proposals for dealing with the millions of homes that the fraudulent lenders induced borrowers to purchase even though they could not afford to repay the loans.
Bank of America’s data add to our argument that hundreds of thousands of its customers were induced by their lenders to purchase homes they could not afford. The overwhelming bulk of the lender fraud at Bank of America probably did come from Countrywide, which was already infamous for its toxic loans at the time that Bank of America chose to acquire it (and also most of Countrywide’s managers who had perpetrated the frauds). The data also support our position that fraudulent lenders are delaying foreclosures and the sales of foreclosed homes primarily in order to delay enormous loss recognition.
The fraud scheme inherently strips homeowners of their life savings and finally their homes. It is inevitable that the homeowners would become delinquent; that was the inherent consequence of inducing those who could not repay their loans to borrow large sums and purchase homes at grossly inflated prices supported by fraudulent inflated appraisals. This was not an accident, but rather the product of those who designed the "exploding rate" mortgages. Those mortgages’ initial "teaser rates" induce unsophisticated borrowers to purchase homes whose values were inflated by appraisal fraud (which is generated by the lenders and their agents) and those initial teaser rates delay the inevitable defaults (allowing the banks’ senior managers to obtain massive bonuses for many years based on the fictional income). Soon after the bubble stalls, however, the interest rate the purchasers must pay explodes and the inevitable wave of defaults strikes. Delinquency, default, foreclosure, and the destruction of entire neighborhoods are the four horsemen that always ride together to wreak havoc in the wake of epidemics of mortgage fraud by lenders.
Out of these millions of fraudulent mortgages, Bank of America claims to have modified 700,000; of these, 85,000 are under HAMP. Still, the Treasury says that the bank has another 375,000 mortgages that already meet HAMP terms. In other words, Bank of America has been shockingly negligent in its efforts to modify mortgages. The Treasury reports that the bank’s performance is far worse than that of the other large banks. Alternatively, Treasury could be wrong about the mortgages; Bank of America may be refusing to modify mortgages for homeowners who appear to qualify for the HAMP terms because it knows the data Treasury relied upon is false. Their unusually low rate of HAMP modifications could be the result of the extraordinarily high rate of mortgage fraud at Countrywide.
Bank of America has admitted that HAMP’s "implicit" purpose is to help the banks that made the fraudulent loans — not the borrowers. That goal was the same goal underlying the decision to extort FASB to gimmick the accounting rules — delaying loss recognition. For example, as reported by Jon Prior
BofA Merrill Lynch analysts said critics of the program aren’t yet vindicated on their calls that HAMP is a failure. "While the increased re-default rates will provide more ‘fodder to those in the camp’ that regards HAMP as a failure, we do not think the story is so simple," according to the report. The analysts said the revised re-default rates are in line with what they expected. While the "explicit goal" of HAMP to help 3m to 4m homeowners "appears unattainable at this point," its "implicit goal" to stall the foreclosure process and provide some order to the flow of properties into REO status has been achieved, according to the report. "In our view, the implicit goal has been one of the key reasons for the stabilization in home prices," according to the BofA Merrill Lynch report.
HAMP’s parallel goal is funneling more money to the banks that induced the fraudulent loans. Data indicate that neither the HAMP modifications nor those undertaken independently by the banks actually benefit homeowners. Most debtors eventually default even on the modified mortgage and end up in foreclosure. Further, many reports indicate that banks encourage homeowners to miss payments so that they can qualify for HAMP, then use the delinquencies as an excuse to evict homeowners. Most importantly, as we reported, half of all homeowners are already underwater in their mortgages, or nearly so. Bank of America representative Rebecca Mairone does not report how many of these mortgages undergoing mods are underwater, but given the massive lender fraud that included overvaluation during the property appraisal process (in other words, even before property values fell these mortgages were probably underwater), it is likely that most are. Since the modification merely lowers the monthly payment but leaves the balance unchanged, the homeowners remain underwater. What this means is that homeowners are left with a terrible investment, paying a mortgage that is far larger than the value of the home. Because most modifications will lead to eventual default, all they do is to allow the bank to squeeze more life savings out of the homeowner before taking the home. Bank of America wants to be congratulated for such activity.
Meanwhile, Bank of America expects to receive billions of dollars for its participation in HAMP. The top three banks (JPMorgan Chase and Wells Fargo being the others) will share $17 billion because HAMP pays servicers, investors and lenders for restructuring. These top 3 banks service $5.4 trillion in mortgages, or half of all outstanding home mortgage loans. Yet, as Phyllis Caldwell, Treasury’s housing rescue chief has testified, there is no proof that these banks have any legal title to the loans they are modifying and foreclosing. In Bank of America representative Rebecca Mairone’s response to us, she does not respond to, let alone contest, the fact that her bank, as well as other banks, has been illegally foreclosing on properties — illegally removing people from their homes. Instead, she lists characteristics of those homeowners on which Bank of America might be illegally foreclosing: they are unemployed, they have not made payments in many months, a third no longer occupy their homes, and so on. It is interesting that she completely ignores all the important issues at hand with respect to the "deadbeat" homeowners. How many of these homeowners were illegally removed from their homes so that they became vacant?
Does Bank of America hold the "wet ink" notes on any of these homes, as required by 45 states? How many of these homeowners were unemployed or otherwise financially distressed when the loans were originally made? How many of the mortgages were fraudulent from the very beginning: low docs, no docs, liar loans, NINJA’s (all specialties of Countrywide)? Without addressing these questions, Bank of America cannot claim to have demonstrated that the foreclosures were appropriate, no matter how many years borrowers might have been delinquent.
Unfortunately, the non-response to the crises caused by Bank of America’s frauds exemplifies their response to our reporting. It does not engage the points we made. It is a pure PR exercise. Bank of America also wants praise for having "stepped up" to purchase Countrywide, and asserts that if it had not done so, the "failure of [Countrywide] would have been devastating to the economy, the markets, and millions of homeowners." We have explained why this was not true of Countrywide or Bank of America. Receiverships of fraudulent banks preserve, not destroy, assets. Countrywide and its fellow fraudulent lenders and sellers of toxic mortgages "devastat[ed] the economy, the markets, and millions of homeowners," as Citicorp’s response put it. A receiver would have fired Countrywide’s fraudulent senior leaders. Bank of America, by contrast, put them in leadership roles in major operations, including foreclosures, where they could commit continuing frauds.
Bank of America did not purchase Countrywide for the good of the public. It purchased a notorious lender to feed the ego of their CEO, who wanted to run the biggest bank in America rather than the best bank in America. They certainly knew at the time of the purchase that is was buying an institution whose business model was based on fraud, and it had to have known that a substantial portion of Countrywide’s assets were toxic and fraudulent (since Bank of America’s own balance sheet contained similar assets and it could reasonably expect that Countrywide’s own standards were even worse). The response does not contest the depth of the bank’s insolvency problems should it be required to recognize its liability for losses caused by its frauds.
Here is how current CEO explained the decision to acquire Countrywide:
The Countrywide acquisition has positioned the bank in the mortgage business on a scale it had not previously achieved. There have been losses, and lawsuits, from the legacy Countrywide operation, but we are looking forward. We acquired the best mortgage servicing platform in the country, and a terrific sales force.
Bank of America’s response to our articles ignores its foreclosure fraud, which we detailed in our articles. News reports claim that the bank sent a 60 person "due diligence" team into Countrywide for at least four weeks. The Countrywide sales staff were notorious, having prompted multiple fraud investigations by the SEC and various State attorneys general. The SEC fraud complaint against Countrywide emphasized the games it played with the computer system. Countrywide had a terrible reputation for its nonprime lending. Nonprime loans were already collapsing at the time of the due diligence, the FBI had warned about the epidemic of mortgage fraud, and the lending profession’s anti-fraud firm had warned that liar’s loans were endemically fraudulent. Is it really possible that Bank of America’s due diligence team missed all of this and that the CEO thought even months later that the Countrywide lending personnel and Countrywide’s computer systems were exceptionally desirable assets?
The obvious questions we have for Bank of America about the due diligence are:
How did you determine the losses in Countrywide’s assets?
- How large were the market value losses at that time?
- How large are the market value losses now?
- Which members of the due diligence team were assigned to determine the incidence of fraud in various loan categories? What did they find?
- What actions did BofA take in response to finding the incidence of mortgage and accounting/securities fraud?
Even Bank of America now acknowledges that Countrywide’s computer system and personnel were defective:
After buying Countrywide, Bank of America decided to adopt the Calabasas, Calif., company’s homegrown mortgage-servicing technology. For more than a year, though, the combined company used two core systems that didn’t communicate with each other. The company’s resources were strained by the integration, the need to roll out new loan-modification programs and rising delinquencies. "We knew it would be challenging," says one executive involved in the integration. Bank of America soon discovered that information was missing from many Countrywide loan files, making it more difficult to communicate effectively with borrowers. "You would shake your head and say: How can that be?" this executive says.
It didn’t help that many Countrywide executives were let go during the integration, with Bank of America installing its own employees in key posts. Such moves are routine in corporate acquisitions. Former Countrywide executives ran the servicing operation until recently, says Dan Frahm, a company spokesman.
Bank of America says no home-loan servicer could have anticipated the crushing workload caused by economic turmoil, falling home prices and the foreclosure epidemic. The bank did its "best" in "difficult and an unforeseen set of circumstances," says Mr. Mahoney, the head of public policy.
We explained in our initial posts why accounting control frauds typically have very poor record keeping. They are wrong to claim that no "servicer" could anticipate that making fraudulent loans would cause severe losses. Countrywide was perfectly poised to know how extensive fraud was in nonprime lending and the sale of nonprime paper. Indeed, its CEO predicted disaster.
Bank of America’s computer problems aligned with its senior officers’ interest in hiding its losses, as reported by Michael Powell:
The bank instructs real estate agents to use its computer program to evaluate short sales. But in three cases observed by The New York Times in collaboration with two real estate agents, the bank’s system repeatedly asked for and lost the same information and generated inaccurate responses. In half a dozen more cases examined by The New York Times, Bank of America rejected short sale offers, foreclosed and auctioned off houses at lower prices. But less obvious financial incentives can push toward a foreclosure rather than a short sale. Servicers can reap high fees from foreclosures. And lenders can try to collect on private mortgage insurance. Some advocates and real estate agents also point to an April 2009 regulatory change in an obscure federal accounting law. The change, in effect, allowed banks to foreclose on a home without having to write down a loss until that home was sold. By contrast, if a bank agrees to a short sale, it must mark the loss immediately.
Any competent due diligence team would have seen obvious warning signs within hours of entering Countrywide’s offices. Countrywide openly violated the law on record keeping with impunity. Gretchen Morgenson reported on such practices on August 26, 2007:
Independent brokers who have worked with Countrywide also say the company does not provide records of their compensation to the Internal Revenue Service on a Form 1099, as the law requires. These brokers say that all other home lenders they have worked with submitted 1099s disclosing income earned from their associations. One broker who worked with Countrywide for seven years said she never got a 1099. "When I got ready to do my first year’s taxes I had received 1099s from everybody but Countrywide," she said. "I called my rep and he said, ‘We’re too big. There’s too many. We don’t do it.’ " A different broker supplied an e-mail message from a Countrywide official stating that it was not company practice to submit 1099s. It is unclear why Countrywide apparently chooses not to provide the documents. More than 85% of the bank’s 1.3 million mortgage customers now at least 60 days behind on their payments got their loans through Countrywide. The $4 billion deal also saddled Bank of America with technology problems, paperwork glitches and cultural tension. The servicing unit now has its fourth leader in roughly two years.
Is it too much to expect of Bank of America’s due diligence team that it might have looked at publicly available reports?
As we explained, fraud begets fraud. Bank of America created over $4 billion in "goodwill" and placed it on its books as an asset when it paid money to acquire Countrywide at a time when it was deeply insolvent on a market value basis. Instead of acquiring an asset, they got thousands of fraudulent employees and officers, a failed computer system and catastrophic losses. So, we have a question for Bank of America, its auditors, and the SEC: why haven’t you written off that entire goodwill account?
Given the fact that we have obtained B of A’s attention (and that of the some administration officials), we ask the following questions that the public needs to make intelligent policy decisions.
- Has Bank of America conducted a review of the bank’s assets that AMBAC reviewed and found a 97 percent rate of false reps and warranties?
- If so, who conducted the review, and what rate of false reps and warranties did they find? Does Bank of America agree that liar’s loans have extremely high fraud rates?
- Does Bank of America agree that an honest secured lender would never seek to inflate an appraisal?
- Does Bank of America agree that a competent, honest secured lender would prevent others from frequently inflating appraised values?
- Does Bank of America agree that appropriate home mortgage underwriting can minimize adverse selection and produce a positive expected value to home lending?
- How many fraudulent mortgage loans made by Countrywide has Bank of America identified?
- What is Bank of America’s procedure when it finds suspicious evidence of a fraudulent loan?
- How many fraudulent mortgage loans, by year, since 2000, have Countrywide and Bank of America identified.
- How many suspicious activity reports (SARs) did Bank of America file concerning mortgage fraud, by year, for the period 2000-to date? What are the position titles of the three most senior Bank of America managers that were a subject of the SARs filed by the bank?
- How many SARs did Countrywide file, by year, for the period 2000 on?
- How many mortgage loans or securities did Countrywide and Bank of America sell under false reps and warranties?
- What was the allowance for loan and lease losses (ALLL) (aggregate amount and relevant ratios) provided by Countrywide and by Bank of America, each year from 2000 on for mortgages and mortgage securities? If it varied by type of mortgage provide the ALLL for each type.
- Which years does Bank of America consider Countrywide’s ALLL to be adequate?
- Has Bank of America reviewed Countrywide’s nonprime loans for fraud incidence, fraud losses, and the incidence of lender fraud and fraud by the lender’s agents? Please provide the results.
- What has Bank of America done to remedy the injuries that borrowers suffered through loan or foreclosure fraud by them or Countrywide?
- Does Bank of America agree that Countrywide’s nonprime lending was often conducted in a manner that was unsafe and unsound?
- Does Bank of America agree that Countrywide’s record keeping was not adequate and required substantial improvement?
- At current market value of its assets, just how insolvent is Bank of America
- How much can the bank sell its toxic assets for in today’s market?
- What is the value of mortgages and mortgage backed securities held by Bank of America for which it has no clear title?
- How many MBSs has the bank sold to investors for which it does not hold the notes that are required?
- What is the bank’s current estimate of losses it will suffer in court due to lawsuits by investors?
- The top four banks are holding434 billion in second liens (good only if the first lien — the mortgage — is paid), and carrying these on their books at 90% of face value. What are Bank of America’s reasonably expected losses on second liens against properties that are delinquent, in foreclosure, or likely to go into foreclosure?
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- How large a sample of subprime and liar’s loans did BofA’s due diligence team review?
- What likely mortgage fraud incidence did BofA’s due diligence team discover? What did they report to BofA with regard to fraud incidence? What changes in lending and personnel did BofA implement in response to these findings?
- Bank of America has not responded to Bill Black’s prior requests that it terminate the services of its openly racist chief advisor in Germany: Hans-Olaf Henkel. We request a response.
Professors Wray and Black also blog at New Economic Perspectives, the UMKC economics blog, and at the Huffington Post where this post first appeared.