Opinion

Alison Frankel

What happens if AG mortgage deal falls through?

By Alison Frankel
October 7, 2011

With the news Wednesday that Massachusetts Attorney General Martha Coakley has “lost confidence” in the multistate AG talks with five big banks and is revving up to sue, coupled with last week’s announcement by California AG Kamala Harris that she’s also dropping out of talks and launching her own investigation, I’ve been wondering what shape an AG suit against mortgage lenders would take. I reached out to both the New York and Delaware attorneys general offices, since they were the first to start talking about filing their own cases. They didn’t return my calls. But according to the bank lawyers I talked to (caveat emptor), there’s a huge gap between the wrongs the states will be able to show and the relief for troubled homeowners that they say they want.

“There’s a fundamental disconnect between what they want and they claims they might have,” one bank lawyer said.

Let’s put aside securities fraud claims the states may have for troubled mortgage-backed securities, since those have nothing to do with the robosigning revelations that led all 50 states to enter talks with Bank of America, JPMorgan Chase, Wells Fargo, Citigroup, and Ally Financial a year ago. The basis of the talks has been deficiencies in the foreclosure process. Mortgage servicers took all sorts of shortcuts as they pushed an unprecedented surge of homeowners into foreclosure beginning in 2008. It’s pretty much undisputed that foreclosure law firms filed untold numbers of false certifications and deficient affidavits with the courts in states that require foreclosures to be approved by a judge.

There are also myriad problems with mortgage documentation, as MBS investors have discovered when they’ve reviewed underlying loan files. The chain of ownership is another potential area for AG claims. The Mortgage Electronic Registry System, a database set up to facilitate mortgage loan trading, has spent the last two years fending off all sorts of homeowner claims that it has either engaged in a conspiracy to force homeowners into foreclosure or else is responsible for administrative fiascos.

These are not trivial claims. It’s a big deal to submit a false affidavit to a judge. Most states have criminal or civil laws (or both) barring false certification. State AGs could certainly fashion unfair or deceptive acts cases against mortgage servicers, and they could assert big money demands, based on statutory damages for each robosigned document. Bank lawyers are skeptical that damages based on deficiencies in the foreclosure process would net the states the $20 billion the banks are reportedly willing to pony up in the multistate settlement. (The banks, of course, want releases beyond their liability for foreclosure deficiencies, which is both why they’re willing to pay that much and why some AGs say the proposed deal is letting them off too easily.)

The state AGs could also claim that the behavior of mortgage servicers in the foreclosure process amounts to systemic fraud or racketeering. “I’m sure they could come up with a creative theory,” one bank lawyer told me. “I would look forward to kicking their ass if they do.”

What this lawyer and several others I talked to said is that none of the potential claims the AGs have would actually bring relief — in the form of loan modification or reduced principal — to homeowners who can’t pay their mortgages. “They can get all sorts of things that will cause pain to servicers, but it’s not clear what the benefit will be to borrowers,” said one.

The genius of the multistate AG campaign against the banks was that with the help of the Obama Justice Department, the attorneys general were able to leverage technical deficiencies in the foreclosure process into billions of dollars in loan modifications. (I’ve been told that as much as two-thirds of the settlement money would go to helping homeowners in trouble.) That was a masterstroke by regulators. Banks were on the defensive about robosigning, so even though robosigned documents and even false affidavits didn’t really affect homeowners’ ability to pay their mortgages, the DOJ and AGs managed to conflate the issues.

If, on the other hand, AGs are forced to litigate alleged false certifications one mortgage at a time, bank lawyers said, they’ll be able to tell judges that technical problems in loan files have nothing to do with defaults: If a homeowner isn’t paying the mortgage, it doesn’t matter whether a document was robosigned or not. Banks will also argue that until 2010, robosigning was an industrywide practice and judges knew about it, so the AGs can’t show intent. “It’s hard to obtain damages in the form of penalties or criminal convictions for something widely perceived as the industry norm,” said one lawyer.

The multistate AG deal could still happen. In the alternative, New York’s Eric Schneiderman and Delaware’s Joseph Biden III could be right that banks are liable for many billions for the wrongs they committed in mortgage-backed securitizations. I just hope that however this plays out, someone other than litigators winds up a winner.

For more of Alison’s posts, please go to Thomson Reuters News & Insight

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