By Elizabeth MacDonald
The new housing bailout bill would let mortgage lenders off the hook for sour mortgages, as it would let the Federal Housing Administration assume the risk for these bad debts, shifting the burden to taxpayers and bond investors.
However, two “discussion documents” about a potential housing bailout bill, both of which are stamped “confidential and proprietary” that Bank of America (BAC: 24.59, -0.22, -0.88%) authored and circulated among Congress, shows that the legislation now making its way through the corridors of Washington, DC is almost word for word what Bank of America wanted.
And in a revealing disclosure, the Bank of America documents state that “we believe that any intervention by the federal government will be acceptable only if it is not perceived as a bail-out of the bond market.”
The first Bank of America document is dated February 11, and is entitled “Federal Homeownership Preservation Corp.” The second is dated March 11, 2008, and is entitled “FHA Housing Stabilization and Homeownership Retention Act of 2008.”
It is not unusual for companies to weigh in on legislation affecting their industries, and elected officials have historically turned to industry insiders to craft legislation (most elected officials are lawyers, which is why we are dealing with a top-heavy, conflicted bureaucracy, but that is a discussion for another day).
However, the first of Bank of America’s “discussion” documents came within a month of its announcement that it would buy Countrywide (CFC: 4.42, -0.01, -0.22%), the nation’s biggest mortgage lender by volume, for $4 bn, a deal value that’s now worth about $2.8 bn, according to its terms.
Countrywide has been accused by state attorneys general of making tens of thousands of dodgy loans that are now being put on the backs of taxpayers with the new housing bailout bill. At the same time, the Federal Bureau of Investigation is investigating Countrywide, among other regulatory bodies.
The Securities and Exchange Commission is also investigating stock sales made by Countrywide chief executive officer Angelo Mozilo, which he has attributed to a pre-existing executive plan under securities laws (elected officials want the SEC to probe whether the bank broadened the plan so Mozilo could unload more shares. Unload bad loans onto taxpayers. Unload bad stock onto unwitting investors. You with me?)
The Examiner’s Tim Carney has been on this story, as well as the National Review. A source close to the situation disclosed the documents to me.
The chairman of the Senate Banking Committee, Sen. Christopher Dodd (D-Conn.), has helped shepherd the housing bill, and according to Douglas Weber, an analyst with the Center for Responsive Politics, has received about $107,800 in campaign contributions–nearly 50% higher than initially thought–from Bank of America’s employees and political action committee since 1989.
A call to Bank of America was not returned.
The new housing bailout would help borrowers unload tens of billions of dollars worth of bad mortgages onto taxpayers. It would let borrowers get their debt forgiven and also allow them to get cheaper mortgages via refinancings at lower rates backed with federal loan guarantees.
Bank of America’s “discussion” documents are revealing. Watch how Bank of America drops certain important language between the two reports as the legislation, too, evolved.
In the March discussion document, Bank of America says that “the program works by letting investors realize the losses on the existing mortgages” as the program takes “advantage of the Government’s unique ability to provide low cost financing for the replacement mortgages.”
Although the February document says that the program’s “mandate” would be to “minimize taxpayer cost,” among other things, there is no further discussion of how taxpayer costs would be minimized, and the March report drops that language.
Both reports talk about how the current securitized US mortgage market is about $2.6 tn, that about “$339 bn or 13%” of all mortgages are at “high risk of default over the next five years due to payment shock from rate reset or payment reamortization loans,” with about $739 bn, or 28%, “at moderate to high risk of default over the same period.”
Both BofA reports note that it expects “$400 bn, or 43% of subprime mortgages to default in the next five years.” Neither of the reports cite Countrywide’s role in approving these loans to borrowers who could not afford them.
Here’s where BofA advises Congress how to structure the legislation so it’s not perceived as helping Wall Street–meaning, money managers, pension funds, endowments, insurance portfolios and money market funds around the world that bought this landfill backed by bad loans, many of them from Countrywide.
And here’s where BofA starts to ask for the taxpayer’s help. As the current housing bill has it, the FHA would back adjustable rate loans that are refinanced through the program into fixed-rate loans. The FHA-backed refinancings would pay off the earlier ARMs.
The documents state:
“As a number of public and private individuals have suggested, the government can mitigate the social and economic costs of massive numbers of foreclosures by establishing a program with the mandate to:
“Determine an acceptable short payoff amount based on the current appraised value of the home for eligible loans in imminent risk of default (Translation: the short payoff amount would be used to pay off the earlier ARM).”
The document goes on to say that the FHA-backed refinancings would support new mortgages with, among other things, “current loan to value ratios less than or equal to 90%, reductions in monthly payment of at least 30%, along with certifications of willingness to pay, and a soft second mortgage that protects the government’s investment in the property along with an agreement that lets the government share in future appreciation of the property.”
The documents say that to be eligible, the home must be occupied by the borrowers as their principal residence and that the borrower and lender “must certify borrower’s need to refinance and ability and willingness to make payments on the replacement mortgage.”
Question: Certifications of willingness to pay. Does that include a pledge of allegiance to Countrywide? And does yet another piece of paper really stop borrowers from dumping loans back onto taxpayers?
The documents say the program would “insure replacement mortgages through FHA,” and would have them repackaged into securities backed by Ginnie Mae.
Now which bond investor is going to buy those Ginnie Mae securities, after BofA has effectively told the government to stick it to bond investors who bought these asset-backed securities in the first place?
The March document says: “bondholders and portfolio lenders will experience virtually the same losses as they would have without government intervention since the short payoff amount is based on the current value of the property and is economically equivalent to the value that would be recovered in a foreclosure–thus no bailout of the bond market.”
Duly noted, despite the pointed language. The program could help bond investors if it stops borrowers from going into foreclosure. Better to have bond investors get the scraps of what’s left over if the program does stop foreclosures.
The loan balance, the documents add, “must be reduced by at least 10%” and the “new loan payment must be at least 30% lower than the existing payment.”
Translation: cutting the loan to value ratio to, say, 90% from 100% means that the lender and bond servicers take the 10% hit here, they have to foot the bill for that 10% swing in the borrower’s reduced risk.
And in a revealing section entitled “high level concerns,” Bank of America suggests ways to surmount “significant legal and regulatory hurdles” in the new program.
For instance, it notes a future accounting strategy for lenders ready to dump sour loans by shoving them off the lenders’ balance sheet. The move would make further use of controversial off-balance sheet vehicles, which investors have already been blindsided with in the Enron debacle and in the recent structured investment vehicles used by banks such as Citigroup to house these bad asset-backed securities that went belly-up in the credit crisis.
The Financial Accounting Standards Board, which sets accounting rules used by publicly traded companies to book their profits and losses, are now forcing banks to wipe out these vehicles which house these mortgage-backed assets, forcing lenders to put them back on their balance sheets, wrecking important debt to capital ratios.
Inside Mortgage Finance, a mortgage industry publication, says the new rule could force lenders to place an astonishing $5 tn worth of off-balance sheet securitized assets back on their books under a plan by accounting standard-setters to eliminate qualifying special purpose entities, or QSPEs.
The BofA documents suggest that “although selling loans out of trusts can cause FAS 140 consolidation concerns (NOTE: see explanation of FAS 140 below), servicers can accept short payoffs without jeopardizing QSPE status.”
In the earlier February report, BofA notes that “the chief accountant of the SEC has provided an interpretation of FASB (sic) 140 that contemplates more elaborate modifications of subprime mortgage loans to address this issue in part.”
Translation: BofA is saying that the SEC may bend the rules here, as rules are being massaged right and left, given the guardrails fell off a long time ago, so what’s wrong with a little more rule-bending?
Here’s the deal.
Last summer, Rep. Barney Frank (D-Mass.), chairman of the House Committee on Financial Services working on the housing legislation, to SEC chairman Christopher Cox. In it he asked about the potential impact of relaxing accounting rules that guide securitizations when mortgage lenders modify loans to avoid default.
When a lender securitizes a loan, it puts them into an off balance sheet vehicle and it is not allowed to change the loan’s terms.
But as the subprime crisis went viral and lenders starting modifying loans en masse, lenders got nervous about having to take those loans back onto their books, as the rules require. The SEC has since said that lenders modify these loans if a default seems likely, without having to take those asset-backed securities back onto their balance sheets.
Back to the BofA documents. The March document adds another “high-level” concern, that the refinancings “must be tax neutral to the borrower,” and asks that the tax code as of December 2007 be amended.
It notes too that banks that securitized these loans subject to the new program “will be focused on minimizing any liability they may have from participating in his program,” but that those worries can be best addressed through industry associations such as the American Securitization Forum, to develop market guidelines.”
In a section entitled “avoiding unintended borrower behaviors” BofA notes a “concern” in the report, that the program “could encourage other borrowers to stop making their monthly payments.” Question: Why didn’t BofA put this issue under its section called “high level concerns”?
BofA says that issue can be fixed by forcing borrowers in the program to give the government 10% of the appreciation of the home if it is later sold, for example, if a borrower sells a house 10 years later for $450,000, if the appraised value as of the date of entry into the program is $250,000, the borrower would then have to give the government $20,000.
Question: Who does the borrower write the check out to? Joe or Jane Q Citizen Taxpayer?
Furthermore, the March document drops language used in the February report that would have forced borrowers to behave more responsibly if they want to be eligible for the new housing bailout program.
The February report suggested that possible remedies could include “reporting the existing loan as a default to credit bureaus when it is refinanced” through the program, and “making the new loan non-dischargeable in bankruptcy.”
In the end, the program, the BofA documents say, would keep “eligible borrowers in their homes,” and slow the “decline in house prices by reducing the increase in unsold housing inventories.”
And slow the pain to Countrywide from its bad lending practices–while maximizing the potential pain to taxpayers.