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<a href="http://www.nytimes.com/"><img src="http://graphics8.nytimes.com/images/misc/nytlogo153x23.gif" alt="The New York Times" align="left" border="0" hspace="0" vspace="0"></a>
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<div class="">February 17, 2013</div>
<h1>The Second-Mortgage Shell Game</h1>
<h6 class="">By
<span><span>ELIZABETH M. LYNCH</span></span></h6>
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<p>
IN January, federal regulators announced an $8.5 billion <a title="Board of Governors of the Federal Reserve System, Jan. 7, 2013 press release" href="http://www.federalreserve.gov/newsevents/press/bcreg/20130107a.htm">agreement</a>
with 10 mortgage servicers to settle claims of foreclosure abuses,
including bungled loan modifications and the wrongful evictions of
borrowers who were either current on their payments or making reduced
monthly payments. </p>
<p>
Under the deal, announced by the Federal Reserve and the Office of the
Comptroller of the Currency, the mortgage servicers will pay $3.3
billion to borrowers who went through foreclosure in 2009 and 2010 and
an additional $5.2 billion to reduce the principal or the monthly
payments of borrowers in danger of losing their homes. </p>
<p>
Those numbers might look impressive, but the deal is far too modest to
be a credible deterrent to reckless foreclosure practices. </p>
<p>
Consider the last big mortgage settlement. Last February, the federal government and 49 state attorneys general reached a <a href="http://www.nytimes.com/2012/02/09/business/states-negotiate-25-billion-deal-for-homeowners.html">$25 billion deal</a>
with the country’s five largest mortgage servicers — Bank of America,
JPMorgan Chase, Wells Fargo, Citibank and Ally Financial (formerly
GMAC). They promised to help <a title="NY Attorney General Eric T. Schneiderman, Feb. 9, 2012." href="http://www.ag.ny.gov/press-release/ag-schneiderman-secures-136-million-struggling-new-york-homeowners-mortgage-servicing">save homeowners</a> from unnecessary foreclosure. </p>
<p>
A year later, it’s clear that the settlement hasn’t worked as planned.
Banks have dragged their feet in modifying first mortgages, much less
agreeing to forgive part of the principal on homes that are underwater.
In fact, the deal contained a few flaws. It has allowed banks to push
homeowners into short sales, an alternative to foreclosure whereby the
distressed homeowner sells the property for less than the debt that is
owed. Not all short sales are bad — some homeowners are happy to walk
away with the debt cleared — but as a matter of social policy, the
program has failed to keep people in their homes. </p>
<p>
A lesser-known but equally grave problem is that banks have been given a
backdoor mechanism to continue foreclosures at the same pace as before.
</p>
<p>
The problem involves <a title="Link to Furman Center essay on second mortgages, Aug. 2012" href="http://furmancenter.org/files/publications/Essay_Sticky_Seconds_--_The_Problems_Second_Liens_Pose_to_the_Resolution_of_Distressed_Mortgages.pdf">second mortgages</a>,
which millions of homeowners took out during the housing bubble. It’s
estimated that as much as a quarter of all mortgage debt in the United
States is in the form of second mortgages. Some of these loans were
taken out to finance home improvements; others were part of a subprime
product known as an “80/20 mortgage,” in which 80 percent of the
purchase price was covered by a first, adjustable-rate mortgage, and the
remainder by a second mortgage, often with a much higher interest rate.
</p>
<p>
The second mortgages have given the banks a loophole: each dollar a bank
forgives goes toward fulfilling its obligation under last year’s
settlement. But many lenders have made it a point to almost exclusively
modify secondary loans while all but ignoring the troubled, larger
primary mortgages. </p>
<p>
It’s a real problem: when it comes to keeping your home, it’s the first mortgage that counts. </p>
<p>
Take Tiberio Toro, a Queens resident who took out an 80/20 mortgage in
2006 when he purchased his home, and who now owes far more to the bank
than his house is currently worth. Recently, Wells Fargo told him that
it completely forgave his second loan. But at the same time, it declined
to modify his first mortgage — an adjustment Mr. Toro needs to get his
monthly payment to a level he can afford. </p>
<p>
Why would a bank forgive a second mortgage completely but move forward with foreclosure on the first mortgage? </p>
<p>
Surprisingly, such a tactic often makes sense for banks. When a lender
forecloses on a first mortgage, the house in question is typically sold
at auction. If the house is worth less than the loan amount, the bank
gets only part of its money back. But after the sale, of course, there’s
no asset left to pay off <em>any </em>of the second loan. The holder of
that second loan — which has lower priority than the holder of the
first — gets nothing. </p>
<p>
So a lender can forgive a second mortgage — which in the event of
foreclosure would be worthless anyway — and under the settlement claim
credits for “modifying” the mortgage, while at the same time it or
another bank forecloses on the first loan. The upshot, of course, is
that the people the settlement was designed to protect keep losing their
homes. </p>
<p>
The five banks covered under last year’s settlement are wiping out
second mortgages in record numbers. In New York State, for example,
during the first six months of the settlement period, three times as
many homeowners received <a title="Office of Mortgage Settlement Oversight, Nov. 19, 2012" href="https://www.mortgageoversight.com/wp-content/uploads/2012/11/Continued-Progress_11.19.12.pdf">second-mortgage forgiveness</a> (2,933) as received permanent modifications on first mortgages (967). </p>
<p>
In New York State, 36.2 percent of the banks’ credits under the
settlement have been related to second loans, compared with only 18.2
percent for first mortgages. </p>
<p>
In 2011, the five banks that are subject to last year’s settlement sent
230,678 pre-foreclosure notices to New York State homeowners, according
to data I obtained from the Finance Department through the Freedom of
Information Law. </p>
<p>
As is well known, many of those at greatest risk of losing their homes
are African-American or Latino. Under the settlement, banks get more
credit for forgiving mortgages that they own (“portfolio loans”) than
those they sold to Wall Street and currently only service. These
portfolio loans are largely conventional loans; those sold to Wall
Street were subprime. It was these notorious subprime loans that were <a title="The New York Times, Oct. 15, 2007" href="http://cityroom.blogs.nytimes.com/2007/10/15/subprime-mortgages-concentrated-in-citys-minority-neighborhoods/">marketed</a>, often through <a title="The New York Times, Oct. 15, 2012" href="http://www.nytimes.com/2012/10/15/business/aclu-to-sue-morgan-stanley-over-mortgage-loans.html">predatory lending</a> practices, to <a title="The New York Times, July 12, 2012" href="http://www.nytimes.com/2012/07/13/business/wells-fargo-to-settle-mortgage-discrimination-charges.html">black and Latino borrowers</a> during the housing bubble. </p>
<p>
There is a lesson to be learned from the deficiencies of the National
Mortgage Settlement. And the new deal reached by the Fed and the
comptroller of the currency provides an opportunity to get right what
the 49 attorneys general got wrong. At a Senate Banking Committee
hearing on Thursday, Senator Elizabeth Warren, Democrat of
Massachusetts, called on regulators to take tough enforcement actions
and not settle for negotiated agreements with banks. </p>
<p>
To do that, the government must clearly require that relief be given in
the form of first-mortgage modifications. In addition, the settlement
should direct the banks to provide relief in the ZIP codes hardest hit
by predatory lending. </p>
<p>
Finally, we need real transparency to monitor the new settlement. That
means that the public should easily be able to determine who is getting
relief, and how. Until that’s done, as we’ve seen, banks are likely to
keep playing the same old shell game. </p>
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<p>Elizabeth M. Lynch is a lawyer at <a href="http://www.mfy.org/about/about-mfy/">MFY Legal Services</a>, a New York City organization that provides free civil legal aid. </p> </div>
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