After more than four years, the U.S. Justice Department is finally bringing to justice the banks responsible for the mortgage-backed securities scheme that triggered the 2008 real estate and financial crises.
Or is it really?
For its part in misleading investors over the true risk of the toxic mortgages it was packaging, J.P. Morgan Chase and Co. (NYSE: JPM) settled on charges laid by the Justice Department last month, admitting to guilt and accepting $13 billion worth of fines and penalties, $4 billion of which is destined to compensate investors for their losses.
And the Justice Department has vowed it won’t stop there. “We have a number of investigations that are coming to a head at the same time,” U.S. Attorney General Eric Holder announced to Reuters yesterday. Not yet prepared to name names, the next big banks in the Justice Department’s cross-hairs have already been contacted. “It is my hope that the next round of these cases will be filed soon after the new year,” Holder informed of his department’s readiness to fight them all.
But is the DOJ really bringing the big banks to justice for their perpetration of such a devastating deception, which not only brought the nation’s housing market to its knees but also froze its credit market, triggering a global credit crisis that caused the gears of nearly every economy on Earth to grind to a halt?
Or is it simply putting on a show as part of a public relations campaign to placate the people’s demand for justice? The big banks certainly seem to be carrying on as though nothing has happened.
The Justice Department’s Hit List
Beginning in 2012, the U.S. Justice Department initiated lawsuits against more than a dozen banks for misrepresenting the risks of the mortgage securities they were selling, including Bank of America (NYSE: BAC), Citigroup (NYSE: C), Goldman Sachs (NYSE: GS) JP Morgan Chase (NYSE: JPM), Credit Suisse (NYSE: CS), and a number of their subsidiaries.
BofA has elected to fight its charges, and it promises to be a long drawn out battle given the bank’s expectation of further charges next year, including an upcoming New York Attorney General’s suit against the defunct Merrill Lynch investment bank, which BofA bought in 2008.
Citigroup and Goldman Sachs are cooperating with Justice Department requests for documents, with expectations of increased liabilities through legal fees, fines, and penalties.
One of the first victories for the DOJ during this campaign was scored late in 2012, when JP Morgan and Credit Suisse agreed to fines of $296.9 million and $120 million respectively. The most recent tackle was made just last month when JP Morgan agreed to pay the $13 billion fine noted above.
Actions Betray Lack of Remorse
Yet despite repeated lawsuits, fines, penalties, outraged public protests, and scathing editorial exposés, the banks’ actions throughout the Justice Department’s crusade against them shows that they are really not afraid and that they really haven’t learned any lessons at all. They are still neglecting their fiduciary obligations to their customers, and they are still defying the DOJ's authority.
In early 2012, 49 state Attorneys General joined the federal Attorney General in a suit against five major banks – which included BofA, Citigroup, JP Morgan Chase, Wells Fargo (NYSE: WFC), and GMAC, renamed Ally Financial – resulting in $25 billion worth of compensation to distressed home owners foreclosed upon, as well as to state and federal governments.
What was the basis of the charge? “The agreement settles state and federal investigations finding that the country’s five largest mortgage servicers routinely signed foreclosure related documents outside the presence of a notary public and without really knowing whether the facts they contained were correct,” explains the National Mortgage Settlement’s webpage. “Both of these practices violate the law.”
But more violations continued. Joseph A. Smith, who oversees the N.M. Settlement, revealed yesterday that BofA, JP Morgan, and Citigroup “each failed at least two of 29 metrics that measure standards over how to provide relief to homeowners under threat of foreclosure,” the Wall Street Journal transcribed Smith’s report. “In total, the three banks failed on seven metrics in the first half of 2013.”
This follows failures on three other metrics by JP Morgan, Citigroup, and Wells Fargo in the second half of 2012.
“The banks still have additional work to do in their efforts to fully comply with the National Mortgage Settlement and to regain their customers' trust,” Smith put it rather mildly in his report. “I am hopeful that the corrective action plans and the new metrics will result in meaningful improvement in how the servicers treat their customers.”
But how hopeful can anyone be when after so many lawsuits, fines, and outcries, the banks are still carrying on business as usual? Taking the diplomatic approach, Smith deemed that “most of the failures are systems-related,” and he is satisfied “that the servicers have all implemented plans to address these failures.”
Until now, it seems the U.S. Justice Department’s bark has had no bite. It remains to be seen if next year’s batch of lawsuits finally pierces the banks’ thick skin.
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Too Big and Getting Bigger
But some question what good any such fines will do when the big banks just keep getting bigger, and any fines and penalties are quickly recouped. To them, it’s just the cost of doing business, spurring little need for change.
Remember, too, that federally-backed mortgage agencies Freddy Mac and Fanny Mae keep buying mortgages from the banks, as does the U.S. Federal Reserve. This means the largest banks can collect revenues and service fees from closing new mortgages and quickly get their money from federal agencies to start the process all over again with new clients.
The banks are churning out mortgages without locking up their capital in the process. A fine or two means very little when the banks can generate revenues without tying up their money. Any money lost through fines would have been locked up in mortgages for 30 years anyway. The bank will make it all back quicker this way than they would if they had to wait 3 decades for homebuyers to return their capital in full.
Thickening their skin into a protective armor are new regulations due to take effect January 10th, 2014 under the 2010 Dodd Frank law requiring mortgage lenders to lower the cost of their loans. While the intent was to make mortgages more affordable to home owners, it may result in making the big banks even bigger and more resistant to fines and penalties.
The new regulations will make it tougher for smaller mortgage providers to survive. Jeff Taylor, co-founder of Digital Risk, a provider of risk management services, expressed his fear to CNN Money that these new regulations are coming at the worst possible time, right at the end of the rebounding phase of the housing market. “Now that the [refinancing] boom is over,” Taylor predicted, “we'll see a lot of small banks fading away”.
“My concern,” David Stevens of the Mortgage Bankers Association voiced his worry to CNN Money, “is that we're going to be in an environment where some lenders are too small to comply.”
And that would make the big banks too big to comply… with the Justice Department’s punishments. With less competition comes greater market share and larger revenues for the big boys, making any fines levied progressively less consequential.
Home Owners and Investors Must Prepare
While a repeat of the last housing collapse will likely not be repeated in similar magnitude, home owners would be wise to prepare for anything. Very few people saw the last crisis coming, and very few will see the next one ahead of time either.
Purchasing mortgage insurance from the Federal Housing Administration or other providers would give home owners peace of mind knowing that their mortgage payments would be covered – in whole or at least in part – should they lose their jobs or should interest rates rise sharply, as they are expected to when the U.S. Federal Reverse begins reducing its accommodation.
Investors also need to take some precautions of their own, knowing that several upcoming lawsuits against the major banks may cause their stocks to take a hit as the fines cut into banks’ revenues – even if it is just a little in some cases. This might be a good time for regional banks to outperform, as they are spared the recapitalization burdens of the Basel III accord requiring the larger banks to keep more of their cash in unused reserves.
But examine very carefully any mortgage provider firm you are considering investing in, as next year’s Dodd Frank regulations may weed many of them out of business. Watch out for those mortgage REITs, too, since higher interest rates in coming years will limit capital gains or even crush their stocks.
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