Memo to Banks: You are Toast

The big banks are reporting that profits are up. Citigroup is celebrating a 46% gain in share prices and net income of $1.31 billion. Wells Fargo just reported strong profits.Yet there are many reasons to doubt the good news. As I've said before, it is more likely that they are toast. First, the income reports result in large part from reductions to loan loss reserves. Yes, banks are partying like it is 1999—everything is hunky-dory so there is no reason to sock away reserves against possible defaults. Heck, no one is going to default in 2011. Right? Move those reserves into the profits column. Banks are not making any money in traditional lines of business—that is, by making loans. No one wants loans. The economy is down for the count. Other than pulling money out of loan loss reserves, banks can only make profits by revaluing assets. The write-downs of trashy mortgages need to be reversed. Banks trade trash with each other at higher prices, recording profits. They sell trash to the government at inflated prices—more on that below. And they jack up late fees on homeowners, credit card users, and other debtors. Even though none of those borrowers can actually pay the late fees, the banks book the revenue now. But here is the much bigger problem: the banks are getting sued from here to Pluto by homeowners, soldiers and sailors, Fannie and Freddie, PIMCO, the NYFed, and just about anybody with access to a lawyer. And, increasingly, the banks are losing. JPMorgan-Chase was caught stealing homes from military personnel. The bank admitted 14 outright thefts—improper foreclosures. It is illegal to foreclose on active duty personnel. But illegal activity is routine business practice at the big banks. They flaunt the laws. They then claim they had some paperwork problems. Oh, you know, banking is such a complex business, you never know whose home you are taking. Widow, Orphan, Military Personnel. What the heck. Who keeps track, anyway? The bank also admitted that it overcharged 4000 active duty personnel—jacking up their mortgage interest rates to 9 or 10 percent even though those serving our country are supposed to get 6% rates (6? How generous is that?). The bank now says it feels their pain—“we feel particularly badly about the mistakes we made here” said bank officials in a statement. Because they got caught, of course. Routine overcharges are the business model at the big banks. Then they pile on late fees when families cannot afford the overcharges. Finally, they take the homes and throw the owners out onto the streets. Paperwork problems, you know. No prison terms for theft of homes by bank officials. At best, the bank says it is sorry and promises it will do better in the future. It would be interesting if bank robbers were allowed to pursue the same strategy. Ok, next problem on the docket. Citigroup is still selling trash—to Freddie, no less. A recent audit has disclosed that 15% of the mortgages Citi sold to Freddie in 2010 were frauds. Folks, these are not the old trash Citi originated in the heyday of fraudulent loans back in 2004-06. No, these were all new originations, “underwritten” between February and May of 2010. I put “underwritten” in quotes, because it is clear Citi is not checking credit-worthiness. These are loans that are rated “not acceptable quality” by Freddie. They've got missing documents, the properties were not properly appraised, the incomes of homebuyers did not meet requirements, and the homes did not qualify, either. In other words, they had the same litany of problems that all the junk mortgages had back in 2005. Citi has learned no lessons from the fiasco it helped to created. Indeed, Sanjiv Das, CEO of CitiMortgage (that originates loans for Citi) argued that with “only” a 15% rate of fraudulent mortgages, that qualifies as “one of the most outstanding stories” of Citi's business model; it represents a “fantastic job” he claimed. True, it is down from a 30% fraud rate in the fourth quarter of 2009. And, who knows, maybe this really is the least fraudulent business the big banks have going on right now—compared with money laundering, drug running, and who knows what else, this might really be the shining example of good citizenship on Wall Street. So, fantastic improvement, Citi. The bank has cut its fraud rate in half. Still, just about one out of every seven mortgages it sells is a fraud. Just what kind of business can stay in business with a fraud rate like that? Oh, a big “too big to fail” sort of bank. Experts say that “the percentage of acceptable quality loans should be in the high 90s”—not down around 85%. This is a bank that received massive bail-outs by government, and is still screwing government by selling trashy garbage to Freddie. Vikram Pandit, currently the darling of the financial press because he manufactured presumably fake profits at the bank, declined to comment. That is quite a surprise. Meanwhile, Citigroup upped its reserves to cover buybacks to $952 billion. Credit Suisse reckons it will need between $2.2 billion and $4.3 billion for defective mortgages it sold between 2005 and 2008. But like all estimates of the size of this catastrophe, that will prove to be orders of magnitude too small. In the third quarter of 2010 there were over 2000 repurchase agreements from Citigroup mortgage buyers demanding that Citi take back the junk it sold. In a similar scam, Bank of America agreed to settle with Freddie and Fannie. Countrywide (taken over by BofA) had faced $127 billion in buyback claims for faulty securities it sold. Again, the problem was that the underlying mortgages did not meet the “reps and warranties” the bank had provided. It paid Freddie $1.28 billion and Fannie $1.52 billion—a measly 2+% of the value of the fraudulent mortgages the bank sold. Four Democratic members of Congress rightly objected—how could this settlement represent “the best possible recovery of funds available to taxpayers”? Meanwhile, Freddie posted 5 straight quarters of losses, receiving $63 billion in aid from the Treasury to cover its bad deals with banks like BofA. Apparently the deal with BofA was pushed through by Treasury Secretary Geithner, who continues to protect his Wall Street benefactors. But as Yogi said, it ain't over until it's over. BofA will be sued again and again over these fraudulent mortgages, by those with deeper pockets who are not subject to Timmy's will and access to Uncle Sam's purse. Courts continue to chip away at the justifications banks and their Frankenstein creation, MERS, have created for theft of homes. MERS was manufactured by the industry to evade proper recording of property sales in county recorder's offices. This will sound overly dramatic, but there is no other way to accurately state it: MERS was from inception a criminal conspiracy designed to cheat counties out of recording fees, the US Treasury out of taxes, and homeowners out of their homes. That conspiracy will have to be proven in the courts, but everyday and everywhere courts are ruling against MERS. The fiction perpetrated by MERS is that it is simultaneously a nominee of the true owner of the mortgage debt and at the same time it is the mortgagee of the security instrument. (You cannot simultaneously be the party of interest and the nominee, of course.) It also disclaims any financial interest in the mortgage and has no claim on the mortgage payments. But it claims that it can operate as the agent of unnamed owners of the mortgage instrument, unknown owners who—since they are unknown—have never designated MERS as agent. I won't repeat my earlier missives: you must have a clear chain of title, demonstrating proper assignment of the mortgage at every step. It looks like none of MERS's mortgages meet that—which is what the Massachusetts Supreme Court ruling was all about. Judges are waking up to the multiple scams. In Utah, judges are allowing homeowners to pursue a “quiet title action”. The owner seeks clear title to property free of lien by lenders or others. Typically, in a home purchase, the homebuyer signs a promissory note (note) held by the lender and a deed of trust (mortgage) that is recorded at the county recorder's office. The holder of the note has the right to receive mortgage payments; the mortgage provides the right to foreclose. In US law, the “mortgage follows the note”—the note holder who has the mortgage can foreclose if the payments are not made. In a quiet title action, the owner takes advantage of the fact that MERS purposely separated notes and mortgages, listing itself on the trust deeds as the beneficiary of the note. Utah courts have recognized that as a fraud. MERS—with no financial interest in the mortgage—cannot be beneficiary. It is just a data registry. It makes no loans. It has virtually no employees. It does not receive mortgage payments. It was designed to defraud counties and the IRS. Hence, homeowners can go to court without any notification to MERS, serving legal papers only to the legal owners of the title to the property. This is usually some title company, that is supposed to be the trustee of the trust deed (mortgage). In cases in Utah, these title companies either did not respond at all, or they simply said that they didn't “know who the beneficiary of the trust deed is” and denied any interest in the deed. The judges then handed the deeds over to the homeowners. While they can still be sued for the mortgage payments they owe, the homeowners got their homes free and clear. In other words, no one can foreclose on them. Their debts are unsecured. MERS has screwed up the records so badly that in many or most cases no one knows who holds the notes, who is entitled to receive mortgage payments, and who has got the deed. What we used to call “mortgage backed securities” are probably mostly unsecured. It is not clear that any of the securitizations of home mortgages were done properly. In that case, the securities are not mortgage backed. Mortgage servicers do not have the right to foreclose, and neither do the securities holders. Homeowners can follow the example in Utah because, apparently, all states have a similar provision to allow “quiet title action”. The mortgage debts are not secured by homes. The homeowners can keep their homes and tell the banks to take a flying leap. And that makes the banks toast. Forget anything you read about their income, their profit rates, their recovery. They've got to take back the unbacked mortgage securities—they do not meet the “reps and warranties”. And there is no property behind them, so foreclosure is out of the question. They can pursue homeowners in court—but homeowners lost their jobs and in any case could not afford the houses the lender fraudsters put them into. Yet, they get to stay in the homes, can claim their titles, and can negotiate for better terms with banks that are failing. The next several years will be fun. Bet on the lawyers. L. Randall Wray is a Professor of Economics, University of Missouri—Kansas City. A student of Hyman Minsky, his research focuses on monetary and fiscal policy as well as unemployment and job creation. He writes a weekly column for Benzinga every Thursday. He also blogs at New Economic Perspectives, and is a BrainTruster at New Deal 2.0. He is a senior scholar at the Levy Economics Institute, and has been a visiting professor at the University of Rome (La Sapienza), UNAM (Mexico City), University of Paris (South), and the University of Bologna (Italy).