Whether the U.S. government’s settlement with Bank of America goes far enough or achieves the right goals, the $ 16.65 billion settlement is important not only because of its historic size, but because all Americans – directly or indirectly – were affected by the financial crisis triggered. through risky loans. And many Americans are still struggling under the weight of bad mortgages.
What was Bank of America’s role in the housing crisis?
Bank of America made this clear in its statement on Thursday, pointing to residential mortgage backed securities (RMBS) and secured debt securities (CDOs).
To understand what it is and how Bank of America got into legal trouble, we need to review the housing crisis, and for that we turn to the Safe Making Sen $ e.
As Making Sen $ e already explained, homebuyers no longer borrow from banks like Jimmy Stewart’s Bailey Building and Loan in “It’s a Wonderful Life”. Instead, a Wall Street company buys a mortgage and a bunch of other mortgages, which are pooled. They then sell slices of this pool to investors as mortgage-backed securities. This is because home buyers borrow from investors.
A secured debt instrument groups – or securitizes – mortgages unevenly. As the Baseline Scenario blog describes: “Some tranches are entitled to the first payments that arrive each month, and are therefore the safest; some installments only get the last payments that come in each month, so when people start to default it’s the slides that lose money first.
There was little fear that the real estate market would stop growing; housing was the asset that kept giving, Americans not even buying houses to live in, but simply to return for a higher return. The competition among lenders for borrowers was so competitive and unregulated that lenders reduced the percentages required for a down payment. “Some buyers,” as Paul Solman explained in 2008, “were only responsible for securing the loan – their home.
“It was an industry where sober people had crazy thoughts,” Karl Case, Wellesley professor emeritus, co-creator of the Case-Shiller Housing Index, told Making Sen $ e Thursday. Case’s poetic reflection on the housing market, of which just a stanza and a half is below, remains one of the best explanations of the crisis.
Fannie and Fred were always ahead,
Then Countrywide entered the fray.
Then Lehman and Merrill and Goldman Sachs
Couldn’t be kept away.
You can guess that MBS
Helped to make trading fast.
Investors believed that the paper they were buying
Was decided with a well-measured risk.
To that, add leverage and default swaps,
And then when house prices fell,
The “smart boys” got hosed down as the risks were exposed,
And that was the closing bell.
Bank of America’s risk as a bank and mortgage lender increased dramatically in 2008 when it bought Countrywide, a private mortgage company that had grown by offering subprime mortgages to aspiring home buyers. . They got really good at writing paper that made those mortgages affordable, Case said. Later that year, Bank of America also acquired Merrill Lynch.
Borrowers, many of whom could not afford their mortgages, were duped. “It’s a bit like going to your neighborhood grocery store to buy milk advertised as fresh, only to find that the store workers knew that the milk you were buying had been left on the loading dock, unrefrigerated, all the time. the day before, but they never told you, ”Assistant Attorney General Tony West said at Thursday’s press conference.
By the time Bank of America arrived, said John Taylor of the National Community Reinvestment Coalition, it was too late. Regardless of what they knew about Countrywide’s poor quality loans at the time of purchase, Bank of America inherited a mess of mortgages that quickly went sour.
Prosecutors are preparing a separate civil case against Angelo Mozilo, the former chief executive of Countrywide Financial. Mozilo took “an extraordinary risk,” Case said, but he doubts Mozilo intended to crash the market or thought the collapse was likely. “Even the people who were underwater,” Case added, “were used to being able to wait for him. [the housing market] to recover.”
But it doesn’t – and the collapse sent millions of Americans into foreclosure. Meanwhile, Bank of America, Taylor said, is paying the costs of their acquisition from an unregulated predatory lender.
How does the regulation affect shareholders?
So how will the regulation affect consumers, taxpayers, homeowners and the rest of Wall Street?
For ordinary consumers – the millions of Americans whose children get lollipops at one of Bank of America’s 5,000 branches or deposit their paycheques at one of 16,000 ATMs – the settlement of 16, $ 65 means little in a practical sense. The Federal Deposit Insurance Corporation insures depositors ‘accounts, so it’s not as if the bank can use its customers’ money to pay their obligations.
For shareholders, that’s another story. In announcing the settlement, Bank of America expects it will reduce Q3 2014 pre-tax profit by $ 5.3 billion, or about $ 0.43 per share after tax. So yes, shareholders are expected to suffer, and some would argue that they deserve this as a payback for the loot resulting from overruns on risky loans, not to mention the government bailout money.
But shareholders don’t have much control over the governance of banks, said Anat Admati of Stanford Business School. In fact, there is no other industry where shareholders have as little control over governance as in the banking sector, said Simon Johnson, former IMF chief economist and co-author of several books on governance. financial crisis.
You just can’t buy enough stocks to have that kind of hold on a bank; So yes, the settlement will be a small tax on shareholders, Johnson said, but there is a big gap between the role played by shareholders and executives, which many detractors of the settlement complain of getting away with without scotch. .
Shareholders don’t seem too upset, however, as the bank’s shares rose 4% on Thursday after the settlement was announced. Bank of America CEO Brian Moynihan said in a statement Thursday that the bank believes the settlement, “which resolves the significant remaining mortgage exposures, is in the best interests of our shareholders and allows us to continue to focus on the future “.
“It’s a good deal for Bank of America,” said Johnson, who would have liked to see criminal prosecutions against high-level people within the bank and believes a settlement helps the bank to hide more than it does. does not reveal about his wrongdoing. Admati agrees that the settlement is largely symbolic.
And yet, added Karl Case, there is an important balance to be struck between not letting Bank of America run away with unfair profits and not ruining them as a lending institution. “The company has an interest in keeping Bank of America alive,” he said.
The fact that the Department of Justice has repeatedly chosen big financial settlements over criminal prosecution may be a concerted strategy dating back to what is now known as the “holder doctrine”. As Deputy Attorney General, Eric Holder issued a 1999 memorandum outlining the long-term consequences of criminalizing a bank, such as loss of jobs.
Lynn Stout of Cornell Law School, however, told Hari Sreenivasan on Thursday at NewsHour that the regulations would punch out because they “hit the business where the business hurt, and that’s his wallet.” .
Tackling the executives, she added, would not get to the heart of the bank’s guilt. “It wasn’t the CEOs and senior executives, many of whom found it easy enough to look away and not know what was going on,” she told NewsHour. Shareholders, she said, were responsible for the incentives that encouraged bad behavior. “I don’t mind to think that the shareholders are going to pay part of the settlement.”
Consumer Relief: Help for Americans, but too little pain for the bank?
The settlement has two parts: only $ 9.65 billion is a cash penalty, while the remaining $ 7 billion will be in the form of consumer aid, which will go to homeowners struggling with unrealistic mortgages and demolition. of the “urban scourge”.
But as the New York Times reports, these consumer relief efforts may not hurt the bank as much as the headline figure suggests. For example, one of the primary ways Bank of America plans to help struggling homeowners is through capital write-downs. It just means that they will reduce the principal owed by the borrower on a mortgage. And it is certainly necessary for many distressed borrowers, especially those who cannot afford to refinance, said Taylor of the National Community Reinvestment Coalition.
However, these impairments do not necessarily have a direct cost for the bank. In other words, by reducing the principal owed, the bank does not spend additional money on this part of the settlement; they just don’t absorb that much. It’s the reduction in principal (in dollars) that counts for the $ 7 billion in consumer assistance.
In addition, as the Times reports, some of the loans that would be impaired have already been taken over by investment firms and are no longer in the hands of Bank of America. The tax deductions could also reduce the amount Bank of America owes six states and a handful of federal agencies, as Better Markets’ Dennis Kelleher explained Thursday to NewsHour.
But while some critics don’t think consumer relief is enough, most agree it’s an important part of the settlement. “I think it’s going to be very helpful,” Taylor told Making Sen $ e, when it comes to helping people stay at home. The case was more measured. “It won’t hurt them,” he said, “but it won’t get them out of the water.”
The most important thing about regulation, Taylor said, is the message that “regulation matters”. With better regulators, Countrywide might not have gotten away with such predatory loans, and Bank of America might not have bought the private mortgage company, he said. “The wise thing to do,” Taylor concluded, “is to avoid putting ourselves in these positions” in the first place.
