Editor's Note: In his 2012 State of The Union address, President Obama spoke of American homeowners abused by unscrupulous banks and financial institutions. Have they gotten justice? What follows is the first in a new series examining foreclosure settlements and the disturbing patterns of incomptency, malfeasance, and conflicts of interest which have marked their execution. Yves Smith of Naked Capitalism takes a deep dive into the mire of America's mortage industry and investigates the continued suffering of the public at the hands of greedy predators.

On January 7, 2013, ten servicers entered into an $8.5 billion settlement with the Office of the Comptroller of the Currency and the Federal Reserve, terminating a foreclosure review process which was set forth in consent orders issued in April 2010. Borrowers who had had foreclosures that were pending or had completed foreclosure sales in 2009 and 2010 could request an investigation by independent reviewers, selected and paid for by the servicers but subject to approval by the OCC.

Some experts argued that the 2009 and 2010 time range was too narrow and excluded many borrowers who had been treated improperly. These professionals also questioned whether the investigators would operate independently and fairly. Nevertheless, the reviews were touted as delivering a measure of justice to abused homeowners, since any found to be have suffered wrongful foreclosures were to receive sizable monetary awards, and smaller payments would be made to those who experienced other forms of abuse. As HUD Secretary Shuan Donovan proclaimed:

For families who suffered much deeper harm — who may have been improperly foreclosed on and lost their homes and could therefore be owed hundreds of thousands of dollars in damages — the settlement preserves their ability to get justice in two key ways. First, it recognizes that the federal banking regulators have established a process through which these families can receive help by requesting a review of their file. If a borrower can document that they were improperly foreclosed on, they can receive every cent of the compensation they are entitled to through that process. Second, the agreement preserves the right of homeowners to take their servicer to court. Indeed, if banks or other financial institutions broke the law or treated the families they served unfairly, they should pay the price — and with this settlement they will.

Yet the foreclosure investigation was halted abruptly, with the OCC and the Fed failing to identify any methodology for how the portion of the settlement allotted to cash awards, $3.3 billion, would be distributed to homeowners who might have been harmed in 2009 to 2010, an astonishing lapse that will almost certainly result in small payments being made to large numbers of borrowers, irrespective of whether they deserved vasty more or nothing at all.*

But except from its hamhandedness, this outcome was no surprise to astute observers. The OCC consent orders had been launched in an unsuccessful effort to render the ongoing 50 state attorney general/Federal negotiations moot. Critics described how these orders were regulatory theater, with Georgetown law professor Adam Levitin comparing them to promising in public to spank a child, then taking him indoors and giving him a snuggle. Leaks during the course of the reviews confirmed these concerns, revealing deep-seated conflicts, limited competence among the review firms, half-hearted efforts to reach eligible homeowners, and aggressive efforts by the banks to suppress any findings of harm.

As grim as this sounds, the conduct was worse than the leaks suggested. After extensive debriefing of Bank of America whistleblowers, we found overwhelming evidence that the bank engaged in certain abuses frequently, in some cases pervasively, in its servicing of delinquent mortgages. This is particularly important because Bank of America has been identified in previous settlements as far and away the biggest mortgage miscreant, paying over 40% of last year’s state/federal mortgage settlement among the five biggest servicers.

This settlement, as intended, was yet another significant bailout to predatory servicers. As we will demonstrate over our upcoming series of posts, conservative estimates of damages due to borrowers under the consent order who suffered improper foreclosures from Bank of America exceed $10 billion. That contrasts with the cash portion of the settlement amount for Bank of America of $1.2 billion.** The amount owing for other abusive practices would have increased this total further.

The OCC gave two rationales for shutting down the reviews. The first was that they were costly to Bank of America and other serivcers, potentially diverting funds from borrowers. This argument is spurious. Those expenses were always contemplated as being in addition to compensating borrowers for the considerable damage they suffered. Moreover, as we will demonstrate, the high price tag for undertaking the reviews was due not only to fragmented and poorly documented borrower records and the servicers’ long-standing disregard for legal requirements, but significantly to an inefficient, poorly designed review process. The fees to the major firms engaged to conduct the reviews are so patently out of line that Caroline Maloney, a senior member of the House Financial Services Committee, has launched an inquiry.

Professional service firm clients, particularly ones as powerful as major banks, when faced with such egregious levels of cost overruns, would normally demand significant reductions in the bills from their vendors. Instead, the Fed and the OCC let Bank of America make its cost problem their cost problem.

The second reason given for shutting down the reviews is that the regulators claim few borrowers were harmed by impermissible foreclosure practices. A recent American Banker article quoted Morris Morgan of the OCC, who was overseeing the reviews from the regulators’ side:

“Do I think there were a significant number of people who were foreclosed on where the banks did not have a legal right to foreclose on them? At this point in time I don’t think that was a significant number,” he said. “But I would go further to say a very few number, and you could even argue one of those, is too many.”

This is both disingenuous and as we will demonstrate over our series, patently false. Borrowers could suffer wrongful foreclosures due to predatory or negligent foreclosure practices for reasons well beyond the servicer not having the “legal right to foreclose”. Moreover, the servicers were ordered to look well beyond that issue. The whistleblowers saw ample evidence of abuses of that could and typically did result in the loss of home within the scope of the reviews they performed. Moreover, they also presented evidence of persistent, sometimes pervasive, impermissible conduct at Bank of America which was simply not addressed in the tests or captured in related information gathering, yet clearly fell within the scope of the consent orders. As we will discuss, some of these abuses would likely result in an impermissible foreclosure or serious borrower harm.

Turn the issue around: why would the banks be willing to down the reviews if indeed they were finding so little in the way of damage to borrowers? They would be well served to spend a few billion dollars to be able to say that with a fair and exhaustive process, hardly any borrowers were harmed. If this claim was true, the costs of finishing the reviews still would have been lower than the cost of the settlement plus the expenses of the reviews to date.

The settlement is also a bailout for the “independent” foreclosure reviewer, Promontory Financial Group, which also played this role for Wells Fargo and PNC. Promontory occupies a unique role in Washington, DC. The firm, headed by former Comptroller of the Currency Gene Ludwig, is heavily staffed with former senior and middle level banking and securities regulators. For instance, former OCC chief counsel Julie Williams (who Ludwig hired when he was at the OCC) has just joined Promontory, and her replacement, Amy Friend, came directly from Promontory.

As we will demonstrate in later posts in this series, even making the most generous interpretation possible of the role played by Promontory, Promontory’s review at Bank of America completely omitted significant categories of borrower harm that were explicitly discussed both in the OCC consent order and Promontory’s engagement letter with Bank of America.

Scope of Our Investigation

We interviewed five contract workers at the largest Bank of America site where the foreclosure review work took place, Tampa Bay, Florida. All had worked on the project from relatively early on, and all had considerable knowledge of mortgage and foreclosure processes and documentation, with the least experienced having worked five years as a paralegal in small real estate-focused law firm. The majority had over ten years of relevant experience. Together they performed significant tests on over 1600 borrowers in a “live” mode, and ran preliminary versions of the tests on hundreds of additional borrower files (actual customer records from Bank of America systems, not dummied-up data) in the attenuated start-up phase.

The reviewers also provided comprehensive documentation from some of the major tests designed by Promontory and operated on its CaseTracker software program as well as other documents provided by Bank of America. We provide a brief overview of the various roles in the Tampa Bay and other Bank of America locations at the end of this post, in Appendix I, and a description of the major tests in Appendix II. We have reviewed the information and documents presented by the whistleblowers with recognized legal experts in foreclosures and securitizations, and have also reviewed relevant OCC materials and Bank of America disclosures.

Overview of Findings

The foreclosure reviews showed persistent, widespread efforts by Bank of America to avoid any finding of borrower harm. These efforts were supported and enabled by Promontory. The whistleblowers, all told their role would be to act as investigators and help borrower get compensation they deserved, described the review process as seriously flawed. Yet even with those obstacles, they saw abundant evidence of serious damage to borrowers.

We asked our five whistleblowers to estimate the amount of borrower harm they saw for the borrowers whose cases they reviewed, and what portion of that was serious harm (all reviewers will be described as male irrespective of gender):

Reviewer A: 90% harmed, with 30% to 40% suffering serious harm Reviewer B: 30% harmed, including instances of serious harm; described multiple instances of serious harm on other tests performed on his borrowers but could not readily quantify Reviewer C: 67% harmed on his test; like B, saw multiple instances of serious harm in the borrower history not captured on his test as harm; could not readily quantify but specific examples cited during interviews alone exceed 10% Reviewer D: 95% harmed, with 30% to 40% suffering serious harm Reviewer E: 100% harmed, with 80% suffering serious harm

This level is consistent with the findings of a never-published GAO report on the foreclosure reviews that the rushed settlement appeared intended to terminate. The GAO review selected a random sample of foreclosure files and found an 11% error rate. The files the reviewers saw came (depending on the reviewer) at least 80% and in most cases 100% from borrower requests for review through the IFR process or an executive request for review. One would expect to see a markedly higher level of serious problems in these files.

As we will describe in detail, these estimates considerably understate the actual harm suffered due to defects in the test design, active efforts to suppress findings of harm, and major gaps in Bank of America records. As one reviewer stated:

I really kind of went into it very naively, I guess, as a lot of us did, that we were actually there to do good and were being welcomed there to do good for people….I mean, I had gone from pretty gung ho to, “Hey, you guys need to knock this crap off. You guys are just – you’re, just, you’re turning this into a sham.”

Note that Bank of America and Promontory are likely to claim, as they did late last year when ProPublica published an article questioning the independence of the foreclosure reviews, that Promontory was doing the reviews and the contractors employed in Tampa Bay and other locations were simply doing document retrieval. In later posts, we will discuss in depth why this claim is ludicrous in light of how the organization was structured, how Bank of America managers interacted with the reviewers, and how the tests were designed and the reviewers were trained.

Overwhelming evidence of widespread, systematic abuses . No interviewee estimated harm as occurring in less than 30% of the files they reviewed; one put serious harm at 80%. The interviewees did not simply describe individual borrower suffering in graphic terms (as one put it, “I saw files that would make your stomach turn.”) Multiple interviewees would describe widespread, sometimes pervasive patterns of impermissible conduct. The reviews confirm what both servicing experts and foreclosure defense attorneys have seen since the crisis: Bank of America’s servicing standards were poorly designed and thus unable to handle the deluge of troubled borrowers (suspense accounts, modifications, bankruptcy, etc.). In addition, BofA had a low level of competence in their servicing area and, as a result, the problems with their servicing was made worse. For instance, reviewers gave examples of types of behavior where Bank of America practices were clearly contrary to the law, yet the banks’ personnel confidently maintained that they were proper OCC’s badly flawed review structure compounded by complex, chaotic, and undermanaged implementation by Promontory. By delegating so much of the review process to “independent” firms (many of whom had little or no experience with servicing and foreclosure), the OCC doubled down on the same incompetence and poor standards that Bank of America and the other servicers already had in their servicing departments. Many of the flaws in the review process (compartmentalized reviews, conflicted supervisors, poor senior review for issues or disputes) were mirror images of the problems at the servicer. These problems were made worse by a bizarre management structure and frequent changes to test content and directives. Concerted efforts to suppress finding of harm. The organizational design, the way the reviewers were managed, the elimination of areas of inquiry, and evidence of records tampering with Bank of America records all point to a multifacted, if not necessarily well orchestrated, program to make sure as much damaging information as possible was not considered or minimized. To give one example: state law issues were eliminated from the in G test, which covered loan modifications (see Appendix II below), reducing it over time from 2200 questions to 500. Dubious role of Promontory. Promontory was a poor choice to perform the review. It had virtually no internal expertise in serivcing, provided little or no supervision, and, either by design or incompetence, managed to politicize the review process rather than make it independent. Promontory’s recent accomplishments include telling MF Global’s board that it had “robust enterprise-wide risk management” five months before it failed and finding only $14 million of Standard Chartered wire transfers in a money laundering investigation to be out of compliance, when the bank eventually admitted the amount was $250 billion. That is no typo, that is an over four order of magnitude difference. Why does Promontory prosper despite such implausible, indeed, embarrassing performances? It’s because financial firms are eager buyers of extreme management-flattering positions that are seldom subjected to scrutiny thanks to Promontory’s roster of former regulators. Indeed, Promontory occupies a position no firm holds in any other heavily regulated space, that of being the dominant shadow regulator. As we will demonstrate in later posts, the claims made by Promotory about the review process as to its independence and completeness are at odds with considerable evidence on the ground.

We will present the evidence supporting each of the findings in successive posts in this series.

Bank of America Foreclosure Review Appendix I by

Bank of America Foreclosure Reviews Appendix II by

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* While the OCC maintains that some borrowers may still receive the maximum payment under the foreclosure reviews, $125,000, the abrupt termination of the foreclosure reviews at Bank of America and other banks and the dismissal of trained staff indicate that not further investigation will be made. That, in combination with the efforts we will describe to show how evidence of harm was not considered, minimized, or suppressed, suggest that the only people who might receive that level of payout will be ones that suffered not just egregious but easily identified harm and were also fortunate enough to get through the review process before the settlement was finalized.

** We attribute very little value to the “required other amount of assistance” of $1.6 billion, which Bank of America can satisfy by extremely low cost actions, such as writing off deficiency judgments on foreclosed borrowers. A deficiency judgment occurs when, after a foreclosure, the borrower is still liable for the difference between the amount owed on the mortgage when it exceeds the amount recovered in the foreclosure sale. People who undergo foreclosures are almost always under severe financial stress (we have discussed elsewhere that the incidence of “strategic defaults”, ex on second homes, is greatly exaggerated). Banks historically have not pursued deficiency judgments; the cost of going after the borrower greatly exceeds what they might collect. At best, Bank of America might be able to sell them to debt collectors for a few cents on the dollar.