There were two major mortgage-backed securities settlements this week. The larger by far was by Bank of America. The broad outline of the settlement had been discussed for the past month.
There is a reason this particular settlement took so long. It is the most complicated bank settlement I have ever seen. There are 17 legal entities on the bank’s side of the deal, including not just the bank and its operating subsidiaries, but also Countrywide Financial and Merrill Lynch. Most of the troubled mortgages were at Bank of America itself. In 2006 and 2007 the bank was waiving its home mortgage underwriting guidelines for almost half of the mortgages it issued, while telling investors that it was adhering to its underwriting guidelines. Some problems in the bank’s handling of mortgages continued through 2012. There were documents that showed intent to defraud, so the bank had little choice but to admit culpability and make a payment to settle the claims.
The bank is paying $1 billion to 26 failed banks that purchased the bad securities. In a few cases the banks failed just because of the mortgage-backed securities. Some of the banks had filed the claims before they went under; the rest were filed by the FDIC as receiver. The deal includes compensation for state pension funds and some other investors. Another $1 billion is divided among six states. The largest payment, $5 billion, goes to the U.S. Treasury. In all, the bank is paying nearly $17 billion. It is one fourth of the $65 billion the bank has paid on mortgage problems to date.
The $17 billion penalty is huge by almost any measure. It is roughly one fourth of one business day of U.S. GDP — that is, the whole country would have to work for two hours to pay a penalty this large. But investors in the bank feel that they got a pretty good deal. The bank’s stock surged 6 percent after the settlement was announced. If that seems puzzling, look at it this way: if the bank had dealt honestly with its mortgages it would have been, at least, an additional $30 billion in the hole at the end of 2008. It almost certainly would have gone under. By cheating its customers all around during the crisis and compensating them later, the bank bought time at a fairly attractive effective interest rate around 11 percent. That would be a high interest rate for a stable, profitable business to pay, but it is an astonishingly low rate for a business in crisis that is secretly bankrupt. Given that context, it is highly doubtful that this latest penalty, as high as it is, will have any deterrent effect. On the contrary, the bank and future banks in similar situations will surely see this kind of fraud as the path of least resistance for a bank in crisis.
A much smaller, but still large, settlement comes from Goldman Sachs. In a settlement with Federal Housing Finance Agency (FHFA), Goldman Sachs has agreed to repurchase $3 billion in bad mortgage-backed securities it sold to Fannie Mae and Freddie Mac. The securities have an estimated market value of $2 billion, so the settlement is valued at $1 billion.
Rounding out this week’s major banking penalties was a new $300 million penalty for money laundering lapses at Standard Chartered Bank. The bank had previously settled its money laundering activities but had failed to change its ways as required under the 2012 settlement. Since then it had been routing money-laundering transactions through Hong Kong and United Arab Emirates in an attempt to avoid detection. More significant than the monetary penalty is a one-year ban on dollar clearing at the bank.