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COUNTRYWIDE: THE MULTI-STATE FRACTURED

ROBERT CONN

INTRODUCTION

In October 2008, America’s largest mortgage lender Countrywide Financial

Corporation (and affiliated companies) reached a settlement with 11 state attorneys general to provide up to $8.4 billion in loan relief to 400,000 borrowers, as well as additional funds for foreclosure relief and relocation expenses for a total of $8.7 billion.1 The agreement settled state claims relating to a host of alleged deceitful practices in the subprime mortgage market. The settlement was reached during the depths of a housing crisis caused in large part due to problems originating in the subprime mortgage market. The Countrywide settlement was the latest in a series of predatory lending settlements by state attorneys general who have been fighting predatory lending practices for years. In 2002, 20 state attorneys general settled with Household International for $484 million, and in 2005

Ameriquest settled with 49 states for a total of $325 million.2 While both the Household and Ameriquest cases were coordinated multi-state, multi-agency operations involving both attorneys general and state banking regulators, the Countrywide case was different. 3

The time pressures created by a nationwide foreclosure crisis and other factors posed unique challenges and resulted in the Countrywide case playing out differently from previous predatory lending cases. This paper will explore the progression of the

Countrywide case, the strategies adopted by the various parties, the lessons that can be learned, and the implications it has for the future of the multi-state litigation process.

ECONOMIC CONTEXT OF THE COUNTRYWIDE CASE

1 Testimony of Lisa Madigan, Attorney General of Illinois, before the U.S. Senate Financial Services and General Government Appropriations Subcommittee, December 4, 2008 (hereinafter “Lisa Madigan Testimony”). (Available at http://www.illinoisattorneygeneral.gov/pressroom/2008_12/Attorney_general_testimony.pdf). 2 Daniel Schmitt, Ameriquest, January 2008 (hereinafter “Schmitt”), p. 7. 3 Id.

1 The second half of 2006 the beginning of a substantial downturn in the US housing market. The Standard & Poor’s/Case-Shiller metro 20 composite index peaked in

July 2006, and had fallen 23.4% by November 2008.4 This statistic belies both the severity of the decline within certain regions hit especially hard, as well as the greater losses incurred by borrowers due to the effects of mortgage leverage. Accompanying this decline, hundreds of thousands of U.S. homeowners have their homes to foreclosure. In 2007,

405,000 homes in the were foreclosed on and more than 1% of all homes in the US were in the process of foreclosure. 5 2008 was even worse; by November there had been over 800,000 foreclosures.6 In that month alone, foreclosure filings were reported on

259,085 U.S. properties.7 California was hit even harder than most states with “1 in every

218 housing units [receiving] a foreclosure filing” in November 2008, more than double rate.8 The crisis resulted from a real estate bubble caused by a combination of factors including U.S. monetary policy, unrealistic investor expectations, and the easing of

4 Case Schiller Price Index Jan 1987-July 2008. (Available at http://www2.standardandpoors.com/spf/pdf/index/CSHomePrice_History_093042.xls); Sudeep Reddy, House Prices Declined at Record Pace in October, The Journal, December 31, 2008. (Available at http://online.wsj.com/article/SB123064533193442343.html). “The S&P/Case-Shiller Composite of 20Home Price Index is a value-weighted average of the 20 metro area indices which are constructed to accurately track the price of typical single-family homes located in each metropolitan area provided.” Standard & Poor’s Press Release, Record Declines in Prices Continued in 2008 According to the S&P/Case-Shiller Home Price Indices, March 25, 2008 (Available at http://www2.standardandpoors.com/spf/pdf/index/CSHomePrice_Release_032544.pdf). 5 Les Christie, Foreclosures Up 75% in 2007, CNNMoney.com, January 29, 2008. (Available at http://money.cnn.com/2008/01/29/real_estate/foreclosure_filings_2007/index.htm). 6 U.S. Foreclosures Index: October Foreclosures Drop Dramatically to Near 2008 Lows, ForeclosureS.com Press Release, November 10, 2008. (Available at http://www.marketwatch.com/news/story/US-Foreclosures-Index-October- Foreclosures/story.aspx?guid={2C6502F0-3845-46E7-B56B-6F551AFD8B32}) 7 Foreclosure Activity Decreases 7 Percent in November, RealtyTrac Press Release, December 11, 2008. (Available at http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=5543) 8 Id.

2 mortgage lending terms due to both insufficient regulation and by the transfer of risk allowed by the securitization of mortgages.9

Securitization is a process by which income-generating assets are transferred into a trust which issues securities backed by those assets.10 Securitization of mortgage debt began in the 1980’s at Saloman Brothers.11 “Salomon realized that investors were interested in buying securities backed by a large diversified group of mortgages on single family homes, as opposed to directly investing in individual mortgages.”12 Pooling mortgages in complex structures allows the creation of financial products with a higher credit rating than the underlying assets.13 High credit ratings made mortgage-backed securities attractive to investors such as insurance companies and pension funds who are limited to investments possessing certain credit ratings.14 In its brief history, securitization has grown to become a $7 trillion industry.15

9 Joint Economic Committee , The U.S. Housing Bubble and the Global : Housing and Housing-Related Finance, May 2008. (Available at http://www.house.gov/jec/news/Housing%20Bubble%20study.pdf).; The Bursting of the US house price bubble, Trésor-Economics (prepared under the authority of the French Tresury), No. 40, July 2008. (Available at http://www.dgtpe.minefi.gouv.fr/TRESOR_ECO/anglais/pdf/2008-014-40en.pdf). 10 First Amended Complaint for Restitution, Injunctive Relief, Other Equitable Relief, and Civil Penalties, The People of the State of California v. Countrywide Financial Corporation, Case No.: LC081846, Superior Court of the State of California For the County of Los Angeles County Northwest District, July 17, 2008 (Hereinafter “California Complaint”), p. 7. (Available at http://www.consumerlaw.org/unreported/content/n1588_firstamendedcomplaint.pdf). 11 John J Healy Jr, Patricia R Healy, Eric R Lindner, Emerging trends in commercial mortgage securitization, Real Estate Issues, August 1994 (hereinafter “Healy, Healy, and Lindner”). (Available at http://findarticles.com/p/articles/mi_qa3681/is_/ai_n8713726) 12 Id. 13 Id. 14 Adam B. Ashcraft and Til Schuermann, Understanding the Securitization of Subprime Mortgage Credit, Federal Reserve Bank of Staff Reports, no. 318, March 2008 (hereinafter “Ashcraft and Schuermann”), p.10. (Available at http://www.newyorkfed.org/research/staff_reports/sr318.pdf) 15 Robert Berner and Brian Grow, They Warned Us About the Mortgage Crisis, Week, October 9, 2008 (hereinafter “Berner and Grow”). (Available at http://www.businessweek.com/print/magazine/content/08_42/b4104036827981.htm).

3 The securitization process begins with an originator who underwrites, services, and funds a loan.16 Countrywide became the largest subprime originator in the U.S. in 2007 with a subprime loan volume of 7.8 billion.17 The originator receives fees paid by the borrower, and also profits by selling portfolios of loans at a premium over their principal balances.18 An arranger/issuer purchases a pool of mortgages from the originator, or the originator can serve this function itself, which Countrywide often did as the largest U.S. subprime mortgage-backed security issuer by 2006.19 The arranger is responsible for performing due diligence on the originator including examining underwriting standards.20

When securitizing its own loans through subsidiaries, Countrywide avoided having an outside party perform such due diligence.21 The arranger/issuer is also responsible for enforcing representations and warranties made by the originator; as the Illinois

Countrywide complaint mentions as an aside, it is unclear how such enforcement would occur in a case where the same company is acting as both originator and arranger/issuer.22

The arranger forms a trust which purchases the mortgages and issues securities to investors underwritten by the arranger.23 Ratings agencies provide credit ratings on these securities and “calculate the amount of credit enhancement that a security requires in order for it to attain a given credit rating.”24 These agencies “only conduct limited due diligence on the

16 Ashcraft and Schuermann at p. 5. 17 Lisa Madigan Testimony. 18 Ashcraft and Schuermann at p. 5. 19 Id. at pp. 4-5. California Complaint at p. 7. 20 Ashcraft and Schuermann at p. 5. 21 Complaint for Injunctive and Other Relief, The People of the State of Illinois v. Countrywide Financial Corporation, Case No. 08CH22994, In the Circuit Court of Cook County, State of Illinois, County Department – Chancery Division, June 25, 2008 (hereinafter “Illinois Complaint”) at pp. 17-18. (Available at http://www.illinoisattorneygeneral.gov/pressroom/2008_06/countrywide_complaint.pdf). 22 Id. at p. 18. 23 California Complaint at p. 7. 24 Ashcraft and Schuermann at p. 7.

4 arranger and originator.”25 A servicer is employed by the trust to collect and remit loan payments, perform accounting, perform borrower customer service, hold escrow funds, supervise foreclosure, and provide other services.26 The servicer receives fees from the trust in the form of a percentage of outstanding loan principal, and is paid first before any payments are made to investors.27 Countrywide was the largest subprime mortgage servicer by 2006.28 For loans under 90 days delinquent, the servicer must typically advance interest and other payments, and in the event of foreclosure must pay all expenses until the foreclosure is completed.29

While prior to securitization, originators of mortgages would typically hold them to term, in today’s market originators sell or securitize pools of mortgages and then use that capital to originate new mortgages. 30 This shift created an increase in liquidity which spurred a rise in homeownership in the U.S.31 A consequence of the trend towards securitization of mortgages is that by dispersing a large portion of the risk of loan default to a wide group of investors, the process fundamentally altered the incentives of mortgage originators. In a pre-securitization world, originators had a strong incentive to ensure that borrowers could afford loan payments, and that loan-to-value ratios would be sufficient to secure loans in the event of foreclosures. Securitization, however, gives originators far fewer incentives to ensure loan affordability or safe loan-to-value ratios, because their

25 Id. 26 Id. 27 Id. at p. 8. 28 Id. at p. 4. 29 Id. at p. 8. 30 “[A] large and increasing fraction of both subprime and Alt-A loans are sold to investors, and very little is retained on the balance sheets of the institutions who originate them.” Id. at p. 2. 31 Eric S. Rosengren, President & Chief Executive Officer Federal Reserve Bank of Boston, Subprime Mortgage Problems: Research, Opportunities, and Policy Considerations, Speech at The Massachusetts Institute for a New Commonwealth, December 3, 2007, p.2. (Available at http://www.bos.frb.org/news/speeches/rosengren/2007/120307.pdf).

5 profits are driven not by holding mortgages to term, but rather by selling the mortgages off to investors. As Iowa Attorney General Tom Miller stated in testimony before the House

Committee on Financial Services:

“Securitization separated the origination of a loan from its consequences by dramatically changing the distribution of risk and incentives for mortgage market participants … creat[ing] incentives for lenders to make loans without appropriate regard to a borrower’s ability to repay the loan,” leading to “weak underwriting, and in some instances fraud, and to borrowers being placed in loans they could not afford.”32

The moral hazard created by the separation of underwriting from default risk was further exacerbated by information asymmetries between the borrower and originator, and between the originator and security investors. Unsophisticated borrowers, typically those in the subprime market, often did not understand complex loan terms, and could be led to take out loans which were not in their best financial interest (Morgan defines predatory lending as “welfare-reducing provision of credit” through which lenders profit by

“tempt[ing] households into…overborrowing and delinquency”).33 Once a loan is securitized, borrowers can be stripped of many of their legal defenses on the mortgages such as fraud and unconscionability by the “holder in due course” doctrine.34 The result, as put by Kathleen Keest, a former Iowa assistant attorney general with the Center for

Responsible Lending, was that “nobody along the chain (including Wall Street) had …

32 Testimony of Tom Miller, Attorney General of Iowa before the U.S. House of Representatives Committee on Financial Services, Progress in Preventing Foreclosures, Nov. 2, 2007, p. 4. (Available at http://www.house.gov/apps/list/hearing/financialsvcs_dem/htmiller110207.pdf) 33 Donald P. Morgan, Defining and Detecting Predatory Lending, Federal Reserve Bank of New York Staff Reports, no. 273, January 2007. (Available at http://www.newyorkfed.org/research/staff_reports/sr273.pdf). 34 Sally Peacock, How the Household Settlement Uncorked a Law Enforcement Bottleneck Household, December 2002 (hereinafter “Peacock”) at p. 19. (Available at http://www.law.columbia.edu/center_program/ag/Library/studentpapers)

6 legal accountability.”35 Security investors suffer from information asymmetries with regard to the borrower’s ability to pay the mortgage. 36 Originators could “collaborate with a borrower in order to make significant misrepresentations on the loan application;” In

Countrywide’s case, such misrepresentations almost always happened without the borrower’s knowledge.37 This is where the ratings agencies came in; as Roger Lowenstein put it:

“Who owns the property? What is his or her income? Bundle hundreds of mortgages into a single security and the questions multiply; no investor could begin to answer them. But suppose the security had a rating. If it were rated triple-A by a firm like Moody's, then the investor could forget about the underlying mortgages.”38

Although rating agencies were supposed to reduce these information asymmetries and assist investors in assessing risk, “[t]he rating agencies are paid by the arranger and not investors for their opinion, which creates a potential .”39 The high fee rates received by ratings agencies in mortgage securitization transactions and the importance of these deals to the ratings agencies’ balance sheets raises serious doubt about the ability of these agencies to provide objective opinions.40

35 , Politicians, lobbyists, shielded financiers, The Seattle Post-Intelligencer, October 10, 2008. (Available at http://seattlepi.nwsource.com/business/382707_mortgagecrisis09.html) 36 Ashcraft and Schuermann at p. 5. 37 Id. ; , Countrywide to Set Aside $8.4 Billion in Loan Aid, , October 6, 2008. (Available at http://www.nytimes.com/2008/10/06/business/06countrywide.html). 38 Roger Lownstein, Triple-A Failure, The New York Times, April 27, 2008. (Available at http://query.nytimes.com/gst/fullpage.html?res=9900EFDE143DF934A15757C0A96E9C8B63). 39 Ashcraft and Schuermann at p. 10; In fact, long after it became evident that “rising delinquencies and foreclosures, coupled with higher interest rates on adjustable mortgages and declining home appreciation, would undermine the market for mortgage securities,” the three major ratings agencies (Moody’s Investors Service, Fitch Ratings, and Standard & Poor’s) did not respond by “reviewing and lowering ratings” on mortgage-backed securities until mid-July 2007. Joshua Rosner, Stopping the Subprime Crisis, The New York Times, July 25, 2007. (Available at http://www.nytimes.com/2007/07/25/opinion/25rosner.html). 40 Ashcraft and Schuermann at pp. 10-11.

7 Proper regulation and enforcement could have reduced these systematic risks in the mortgage market, however this has not happened, due to federal policy choices and the unique regulatory scheme that exists for banks. Financial institutions can either be chartered by states, or alternately by one of two federal agencies: the Office of the

Comptroller of the Currency (OCC), and the Office of Thrift Supervision (OTS).41 It is mostly at a bank’s discretion which it will charter with, and thus who will regulate it.42

Under the George W. Bush administration the OCC and OTS have aggressively pre-empted

(blocked) state regulation of federally chartered banks.43 Federal laws on predatory lending and consumer protection are weak, and the federal agencies in turn lack authority to enforce state consumer protection statutes.44 The result is a classic regulatory race to the bottom between the states and federal government. For example, in 2006 and 2007 when Iowa

Attorney General Tom Miller proposed stronger state lending laws, he was rejected by the state legislature because “[s]tate-chartered banks insisted that tougher rules in Iowa would put them at a competitive disadvantage with federally chartered banks overseen by the

OCC.”45 As former Iowa Assistant Attorney General Kathleen Keest characterized it,

“[s]tate institutions…wanted a level playing field, which was a playing field with no rules.”

At the federal level the OCC and the OTS are funded almost entirely by fees paid by the institutions they charter, leading to competition among these agencies by design.46 “They

41 Eric Nalder, Mortgage system crumbled while regulators jousted, The Seattle Post-Intelligencer, October 11, 2008, (hereinafter “Nalder”). (Available at http://seattlepi.nwsource.com/business/382860_mortgagecrisis11.html) 42 Id. 43 Id.; Berner and Grow. 44 Nalder, supra note 41. 45 Berner and Grow. 46 Berner and Grow; Nalder, supra note 41.

8 are competing with each other for the business,” as stated by Keest, “it is the only place I know of where regulated entities get to pick their regulators.”47

The intent of federal preemption is to provide for uniformity of laws, so that regulated entities avoid conflicting dual regulation schemes.48 However, as applied in the area of predatory lending, the result of preemption has been a near absence of regulation and regulatory enforcement. The OCC oversees 1,700 banks, controlling two-thirds of all

U.S. commercial bank assets--yet between 2000 and 2006 it brought only one enforcement action relating to subprime mortgages.49 Together, the OCC and OTS together have initiated roughly 18 enforcement actions against financial institutions for “unfair and deceptive practices” in the entire decade, whereas states made 3,694 such enforcement actions in 2006 alone.50 In 2007 the Supreme Court upheld the exclusive right of the federal agencies to regulate federally chartered banks in Watters v. Bank,

N.A., 550 U.S. 1 (2007).51 Although Wachovia Mortgage was not itself a federally chartered bank, it was a wholly-owned subsidiary of federally chartered Wachovia.52

Within a year of the decision, Wachovia’s subprime lending practices led to its demise.53

OCC head John D. Hawke Jr. (a former banking industry lawyer) argues that the blame lies in great part with mortgage brokers and originators, many of whom are regulated by states.54 However enforcement against these operators can be difficult as many are small operations and because often, “mortgage mills arranged to be acquired by nationally

47 Nalder, supra note 41. 48 Id. 49 Berner and Grow. 50 Nalder, supra note 41. 51 Berner and Grow. 52 Id. 53 Id. 54 Id.

9 regulated banks and in the process fended off more-assertive state supervision.”55 When

Georgia passed a law in 2002 providing "assignee liability" which would have eliminated the holder in due course doctrine for mortgages, allowing borrowers to retain claims such as fraud arising out of mortgages, the OCC ruled not only that the law was preempted with respect to national banks and subsidiaries of national banks, but also that the law did not apply to state-chartered mortgage brokers and lenders “if the loans they handled were funded at closing by a national bank or its subsidiary.”

The federal pre-emption campaign in the lending market accelerated in 2002,

“about the time subprime and nontraditional mortgage lending was beginning an astounding climb, from $267 billion in originations nationally to more than a trillion by

2005.”56 As North Carolina Attorney General Roy Cooper stated, the OCC “took 50 sheriffs off the job during the time the mortgage lending industry was becoming the Wild

West.”57

The combination of weak regulation and the offloading of risk allowed by securitization fostered predatory lending practices. Kathleen Engle and Matricia McCoy define predatory lending as lending that involves one or more of five “problems”: “(1) loans structured to result in seriously disproportionate net harm to borrowers; (2) harmful rent seeking; (3) loans involving fraud or deceptive practices; (4) other forms of lack of transparency in loans that are not actionable as fraud, and (5) loans that require borrowers to waive meaningful redress.”58 Engel and McCoy flesh out these problems with specific

55 Berner and Grow. 56 Nalder, supra note 41. 57 Berner and Grow. 58 Kathleen C. Engel and Patricia A. McCoy, A Tale of Three Markets: The Law and Economics of Predatory Lending, 80 TEX. L. REV. 1255, 1260 (2002).

10 examples including “loans to borrowers whom the lender knows cannot afford the monthly payments,” “pushing borrowers to take on more debt than they need, steering prime- eligible borrowers to subprime loans,” “refinancing low-interest loans into costlier loans,”

“fees and interest rates that are exorbitant compared to the risk that the borrowers present,”

“charging prepayment penalties and points without a corresponding cut in the interest rate,”

“inflated appraisals,” “false promises to refinance loans down on better terms,” and “withhold[ing] information from borrowers.”59 Many of these practices were alleged to have been committed in the Countrywide complaints.

COUNTRYWIDE’S ALLEGED LENDING PRACTICES

On June 25, 2008, California and Illinois filed state court complaints against

Countrywide Financial Corporation (CFC) (and a few affiliate corporations and officers) over its lending practices. The California complaint alleges Countrywide violated the

California Business and Professions code by engaging in unfair competition and making or causing to be made untrue or misleading statements to induce people to enter loans.60

The Illinois complaint alleges that Countrywide violated the Illinois Consumer Fraud and

Deceptive Business Practices Act by engaging in unfair and/or deceptive acts or practices in originating loans, and violated the Illinois Fairness in Lending Act by engaging in

“equity stripping” (defined as assisting in making loans for the primary purpose of obtaining fees when the loan decreases the borrower’s equity in their principal residence and the financial institution does not reasonably believe the borrower will be able to make

59 Kathleen C. Engel and Patricia A. McCoy, Turning a Blind Eye: Wall Street Finance of Predatory Lending, 75 Fordham Law Review 2039, 2043-2044 (2007). 60 California Complaint at pp. 42-44.

11 their payments).61 The complaints flesh out these allegations in great detail (the Illinois complaint totals 81 pages, and the California complaint, 46 pages) and are very similar in their descriptions of Countrywide’s alleged business practices. The basic allegations are that Countrywide engaged in misleading marketing, deceiving consumers into taking out loans that that either: 1) they could not afford; and/or 2) posed an unnecessarily high risk of foreclosure or loss of home equity; and/or 3) were unnecessarily more expensive than alternatives.62

The California complaint alleges that Countrywide “sold the vast majority of its loans on the secondary market” and aimed to produce as many mortgages to sell as possible, “originating loans with little or no regard to borrowers’ long-term ability to afford them and to sustain homeownership,” and creating “a high-pressure sales environment” that encouraged its employees to achieve this result through improper means.63 The complaint details several of the loan products Countrywide marketed.

Countrywide aggressively marketed payment option adjustable rate mortgages (Pay

Option ARMs) after 2003.64 Pay Option ARMs made up 19% of Countrywide-originated loans by 2005.65 According to the California complaint, these loans featured teaser rates as low as 1% which lasted only one to three months, at which point the loan would become an adjustable rate loan with an increasing interest rate; borrowers could make a specified minimum monthly payment (the rest of the amount due would negatively amortize) which after one year would increase by 7.5% for four years.66 After the fifth year, the payment

61 Illinois Complaint at p. 80 62 Id. at pp. 71-77 63 California Complaint at pp. 5-7. 64 Id. at p. 10. 65 Id. at p. 13 66 Id. at p. 11.

12 would become fully amortizing, massively increasing the monthly payment.67 Due to the negative amortization, refinancing would be difficult or impossible unless the home had appreciated at a commensurate rate, and there were often prepayment penalties for one to three years.68 The California complaint cites as an example of a typical bad Countrywide mortgage, a loan with an initial principal balance of $460,000 and initial payments of

$1,479 per month for the first year; by the fifth year, the payments would be $1,975 per month for the first 9 months of the 5th year, after which they would jump to $3,747 per month for the remaining 25 ¼ years.69 By the time of the payment jump, the principal on the loan will have increased to $523,792.70

Another common Countrywide loan product was the Hybrid ARM loan, which featured a “fixed” interest rate for a period of 2, 3, 5, 7, or 10 years with an adjustable interest rate for the remainder of the term.72 As with Pay Option ARMs, these loans subjected borrowers to “payment shock” (dramatic increases in monthly payments).73

Countrywide allegedly deceived borrowers as to the period for which the interest rate was fixed, the ease of refinancing, and existence of prepayment penalties.74

Countrywide also allegedly pushed Home Equity Lines of Credit (HELOCs) which would bring borrowers’ homes up to or above a 100% Loan-to-Value ratio, and which featured a 5-10 year period of interest-only payments followed by fully amortized payments for 15 years.75 Countrywide allegedly “did not provide borrowers with any

67 Id. 68 Id. at pp. 12-13. 69 Id. at p. 12. 70 Id. 72 Id. at p. 16. 73 Id. 74 Id. at pp. 17-18. 75 Id. at p. 19.

13 documents or other materials to help them calculate … payments that would be due after the draw or interest-only period,” and many borrowers were subjected to a double shock when both their first mortgage and HELOCs reset at higher payment rates; this was usually hidden from or not explained to borrowers.76

Additional alleged misleading practices in relation to Countrywide’s loan products include: failure to disclose negative amortization, one month teaser rates while failing to adequately disclose the manner in which those rates would increase, representing to borrowers that they would be able to refinance before payments became unaffordable, obfuscating interest rates by shifting focus to monthly payments, and misleading customers into believing that they could trust in Countrywide to get them the best possible terms for their loans.77

In an effort to originate as many loans as possible, Countrywide allegedly lowered and ignored its underwriting standards (e.g. credit score, loan-to-value ratio, debt-to- income ratio, and other requirements).78 The vast majority of Hybrid ARMs and Pay

Option ARMs were reduced or no documentary loans, used to qualify borrowers for loans they could not afford.79 Furthermore, Countrywide allegedly underwrote loans on the basis of the borrower’s ability to afford initial interest rates and initial or minimum payments, without regard to whether the borrower could afford payments or rates after they reset to higher levels.80 Countrywide employees would allegedly inflate stated income on applications, usually without the knowledge of borrowers, to qualify borrowers for loans

76 Id. 77 Illinois Complaint at p. 74. 78 California Complaint at p. 10. 79 Id. at p. 20; Illinois Complaint at p. 71. 80 California Complaint at p. 22.

14 they could not afford.81 Where income was not inflated and where borrowers would be perfectly able to document their income Countrywide employees allegedly sold borrowers reduced documentation loans anyway, because they were more expensive.82

Additionally, Countrywide allegedly “encouraged serial refinancing…in order to constantly produce more loans for sale to the secondary market”, by 1) misrepresenting the benefits of refinancing to borrowers and 2) “creating a perpetual market for its refinance loans” by selling loan products structured to result in enormous jumps in required monthly payments.83 Countrywide’s loans were allegedly designed “not for long-term viability but for short term refinancing.”84

These lending practices were encouraged from the top down through the use of “a compensation structure that incentivized broker and employee misconduct and failed to exercise sufficient oversight.”85

PRIOR PREDATORY LENDING SETTLEMENTS

The $484 million 2002 settlement between Household International and 20 state attorneys general was at the time “the largest direct restitution amount ever in a state or federal consumer case.”86 “More revolutionary,” according to Peacock, “was the fact that the negotiating team was composed of attorneys from the consumer protection and civil rights divisions of State Attorneys’ General offices and state banking regulators.” By working together with state banking regulators, the team was able to increase its muscle in

81 Illinois Complaint at p. 72. 82 Id. at p. 73. 83 California Complaint at pp. 28-29. 84 Illinois Complaint at p. 72. 85 Id. at p. 76. 86 Schmitt at p. 2.

15 states where Unfair and Deceptive Acts and Practices (UDAP) laws do not apply to financial instruments (in such states, “legislators had reasoned that lending institutions are already regulated – through licensing – by state banking agencies”).87 Banking regulators can have significant leverage due to the fact that many states view revocation of a license in another state to be grounds for revocation in their own state.88 According to Kathleen

Keest, who at the time an Assistant Attorney General (AAG) for Iowa, this led to greatly increased leverage compared to a traditional Attorney General-only multi-state litigation.89

Additionally, banking regulators used their knowledge of how the industry works to help

“keep Household honest.”90 As evidence of the benefits of increased multi-state leverage in Household, Peacock notes that “before the multi-state team had formed, the state of

Minnesota negotiated a $200,000 consent order with Household. In comparison, Minnesota borrowers received $5.5 million under the multi-state settlement.”91 Peacock also describes the involvement of the non-governmental organization (NGO) the Association of

Community Organizations for Reform Now (ACORN) as an “outside agitator” which helped document patterns across states, making it clear that Household’s practices were not merely those of a “rogue office.”92

The Household negotiation team was made up of Attorneys General and financial regulators, and was led by Tom Miller (Iowa AG), Christine Gregoire (Washington AG),

Roy Cooper (North Carolina AG), and Elizabeth McCaul (New York Superintendant of

Banks).93 The multi-state team structure featured an “executive committee” with

87 Peacock at p. 23. 88 Id. 89 Id. 90 Schmitt at pp. 2-3, citing Kathleen Keest Interview, Jan 3, 2008. 91 Peacock at pp. 34-35 92 Id. at pp. 24, 27-28 citing Kathleen Keest, interview, November 14, 2002. 93 Id. at p. 29.

16 “responsibility to negotiate the case on behalf of the states” as well as attempting to “build consensus among the ‘full group’ and negotiate among the states where there are divergent interests.”94

Household settled quickly with the states, due in part to stock market pressures.

“With each state added to the multi-state team and each new article discussing its lending practices, Household witnessed yet another drop in its market capitalization. Rather than face this continued financial disaster, the company ‘wanted universal peace,’ rather than brokering piecemeal settlements with different states.”95 Another contributing factor may relate to the fact that Household was acquired by HSBC on Nov 14, 2002, a little over a month after the Household settlement.96 It is unknown for sure whether or to what extent the sale to HSBC contributed to the settlement.97

In addition to the $484 million in monetary relief to borrowers, Household agreed to:

 “Limit prepayment penalties on current and future home loans to the first

two years of a loan.

 Ensure that new home loans actually provide a benefit to consumers.

 Limit up-front points and origination fees to 5%

 Reform and improve disclosures to consumers.”98

 “Eliminate ‘piggyback’ second mortgages.”99

94 Schmitt at pp. 7-8. 95 Peacock at p. 29, quoting Kathleen Keest, interview, November 14, 2002. 96 Peacock at p. 29. 97 Id. at 31. 98 States Settle With Household Finance: Up to $484 Million For Consumers, Iowa Office of the Attorney General Press Release, October 11, 2002. (Available at http://www.iowa.gov/government/ag/protecting_consumers/2002_news/10_11_2002.html). 99 Id.

17 Peacock argued that the Household case could serve “as a template for future multi- state, multi-agency Attorney General action against both predatory lenders and other violators.”100 Not surprisingly, several of the main figures in the Household case also had prominent roles in Ameriquest, including Kathleen Keest (Iowa AAG), David Huey

(Washington AAG), and Patrick Madigan (Iowa AAG).102

The FTC began investigating Ameriquest in the late 1990’s, but dropped its investigation after Ameriquest settled a suit with ACORN by agreeing to make $360 million in “low-interest, low-fee loans” to customers in areas with large minority populations and to reform its lending practices.103 Nonetheless, from 2000-2004, the FTC received over 3 times as many customer complaints for Ameriquest than for its two biggest competitors combined.104 In January 2004 the Department of Banking

“sought to bar Ameriquest from doing business in the state for allegedly charging excessive fees and repeatedly violating a state law aimed at preventing loan flipping.”105 Separately, the Connecticut Banking Commissioner settled with Ameriquest for re-soliciting customers too soon for refinancing, with Ameriquest paying “$603,552 of refunds, … $500 to each borrower (totaling $62,000), and a $5,000 civil penalty.”106 A Feb 4, 2005 Los

Angeles Times article reported allegations of former employees that Ameriquest ran boiler rooms at which employees “forged documents, hyped customers’ creditworthiness and

100 Peacock at p. 1. 102 Id. 103 E. Scott Reckard and Mike Hudson, Workers Say Lender Ran ‘Boiler Rooms,’ , Feb 4, 2005 (herinafter “Reckard and Hudson”). (Available at http://articles.latimes.com/2005/feb/04/business/fi-ameriquest4) 104 Id. 105 Id. 106 Erick Bergquist, Under Scrutiny, Ameriquest Details Procedures, , June 30, 2005 (hereinafter “Bergquist”).

18 ‘juiced’ mortgages with hidden rates and fees.”107 Alleged Ameriquest business practices included deceiving borrowers as to loan terms, falsifying borrower income information in order to qualify borrowers for loans they could not afford, forging documents, and falsifying appraisals, and loan flipping (promoting unnecessary refinances in order to earn fees and commissions).108

State attorneys general began investigating Ameriquest in 2003.109 Prentiss Cox in the Minnessota Attorney General’s office led the group initially and Patrick Madigan led the group from June 2005 onwards.110 Like the Household case, Ameriquest was multi- state, multi-agency operation involving both attorneys general and banking regulators, as well as a few district attorneys.111 As with Household, the multi-state nature of the team was effective in countering the “rogue office”/”bad apple” defense, because the team was able to draw on evidence of the similar practices across state lines.112 In summer 2004

Ameriquest disclosed in a bond filing that it was under investigation by a group of attorneys general, however this went mostly unnoticed until American Banker reported in March

2005 that 25 attorneys general were investigating the company’s lending practices.113 By

June 2005 several more AGs had joined the effort.114

107 Reckard and Hudson. Former employees even stated that they were told to watch the movie Boiler Room as part of their training. 108 Schmitt at p. 5; State of Iowa v. Ameriquest Mortgage Company, Petition, Equity No. EQCE-53090, In the Iowa District Court for Polk County, at pp. 4-6. (Available at http://www.iowa.gov/government/ag/images/pdfs/Ameriquest_Pet.pdf). 109 Lisa Madigan Testimony. 110 Miller: Ameriquest Will Pay $325 Million and Reform its Lending Practices, Iowa Office of the Attorney General Press Release, Jan. 23, 2006 (hereinafter “Miller Press Release”). (Available at http://www.iowa.gov/government/ag/protecting_consumers/2006_news/1_23_miller.html). 111 Schmitt at p. 7. 112 Id. at p. 8. 113 Bergquist. 114 Id.

19 Iowa’s Patrick Madigan led the negotiations, but the attorneys general of California,

New York, Washington, and Illinois as well as the New York State Department of Banking and district attorneys in California were also involved in negotiating the agreement.115 The executive committee also included the attorneys general of Minnesota, Arizona, ,

Massachusetts, New , and Connecticut and financial regulators in Washington,

Nebraska, New Hampshire, and Florida.116 This executive committee worked differently than in Household; in Household the committee negotiated with the company and also attempted to reach a consensus among the full group of states, while in Ameriquest, “full power to … settle was given to the executive committee – it did not need to seek prior approval of the states – it would just reach the settlement it found prudent, and would then allow other states to join if they wanted.”117 There were three negotiating sessions from

February through April 2005 involving the full executive committee, in which the parties discussed monetary relief, terms, and the nature of the case the states had against

Ameriquest. 118 Part of the process, explained Patrick Madigan, was “to make them understand our view of their behavior.”119 Over the summer, the parties moved past the idea that it was a case of “a few bad apples,” explains Madigan “they came to accept our view of the situation.”120

115 Miller Press Release. 116 Id. 117 Schmitt at p. 8. 118 Interview with Patrick Madigan, Assistant Attorney General of Iowa, January 9, 2009 (hereinafter “Patrick Madigan January Interview”). Mr. Madigan had a prominent role in both the Ameriquest and Countrywide cases. 121 E. Scott Reckard and Kathy M. Kristof, Ameriquest Prepares to Settle States’ Probe, Los Angeles Times, July 29, 2005. (available at http://articles.latimes.com/2005/jul/29/business/fi-ameriquest29). 121 E. Scott Reckard and Kathy M. Kristof, Ameriquest Prepares to Settle States’ Probe, Los Angeles Times, July 29, 2005. (available at http://articles.latimes.com/2005/jul/29/business/fi-ameriquest29).

20 In July 2005 Ameriquest stated that it had earmarked $325 million to resolve what was by that point a 30 state investigation; the task force of attorneys general said that they

“do not disagree” with this estimate of liability.121 For the final negotiations, the executive committee, which had grown over time, created a smaller negotiating team.122 In the fall of 2005, Patrick Madigan led three more negotiating sessions to finalize stipulated injunctive relief.123

One significant difference between the Ameriquest and Household settlement processes was that as a publicly traded company, Household felt pressure to settle quickly to minimize share price damage caused by uncertainty regarding the investigation. As a private company whose founder was its sole shareholder, Ameriquest was not subject to the same scrutiny and pressures as a publicly traded company.124 Although private companies also need to keep their cost of capital low by avoiding large decreases in bond prices, the attorneys general investigation did not affect Ameriquest’s bond prices, perhaps due to the relative security of bonds compared to common stock.125 Ameriquest was however subject to a unique factor which created settlement pressure; on July 28, 2005, the same day Ameriquest set aside $325 million for settlement expenses, President George W.

Bush nominated Ameriquest’s billionaire chairman, sole owner, and Bush contributor, to the tune of $6 million, Ronald E. Arnall as U.S. ambassador to the .126 Senate

121 E. Scott Reckard and Kathy M. Kristof, Ameriquest Prepares to Settle States’ Probe, Los Angeles Times, July 29, 2005. (available at http://articles.latimes.com/2005/jul/29/business/fi-ameriquest29). 122 Patrick Madigan January Interview. 123 Schmitt at p. 9; Patrick Madigan January Interview. 124 Bergquist. 125 Id. 126 Id.

21 Democrats held up Arnall’s confirmation vote, and Senators on the Foreign Relations

Committee encouraged Arnall to resolve the state investigation.127

On January 23, 2006, 49 states and the District of Columbia (Ameriquest did not operate in Virginia) announced a $325 million settlement with Ameriquest, with $295 million for consumer restitution, and $30 million to reimburse the states for legal fees.128

Under the settlement, 240,000 borrowers would receive a minimum of $600 each, with a possibility that as many as 485,000 additional borrowers would be compensated.129

Ameriquest denied all the states’ allegations.130

Patrick Madigan, says that the injunctive relief was by far the most important part of the settlement.131 The settlement required Ameriquest to:

 “Provide full, clear disclosure of interest rates, discount points, prepayment

penalties, and other loan refinancing terms.

 Remove branch office and sales personnel from appraiser selection.

 Charge the same rate and points to similar customers.

 Cap prepayment penalty periods on variable-rate mortgages.” 132

 Refrain from refinancing solicitation in the first two years of a loan.133

127 Kirstin Downey, Mortgage Lender Settles Lawsuit: Ameriquest Will Pay $325 Million, Washington Post, January 24, 2006 (hereinafter Downey). (available at http://www.washingtonpost.com/wp- dyn/content/article/2006/01/23/AR2006012301523.html); E. Scott Reckard, Ameriquest Settles Claims, Los Angeles Times, January 21, 2006. (Available at http://articles.latimes.com/2006/jan/21/business/fi-ameriquest21) 128 Downey; Miller Press Release; Schmitt at p. 7. 129 Downey. 130 Id. 132 Schmitt at p. 9. 132 Schmitt at p. 9. 133 Miller Press Release.

22  Refrain from encouraging borrowers to misstate income information.134

 Refrain from incentivizing salesmen to “include prepayment penalties or

other fees or charges in mortgages”135

 Protect whistle-blowers and facilitate reporting.136

The Household and Ameriquest cases demonstrate the effectiveness of the multi- state, multi-agency platform for achieving monetary and injunctive measures in predatory lending cases. At the same time, however, Peacock notes that the benefits on increased leverage through multi-state coordination come at the cost of increased difficulty in reaching a consensus and differing needs in terms of relief across the different parties.

“It often ‘proved more difficult to get a consensus among the fifty states than to deal with Household.’137 For example, New York law prohibits prepayment penalties after the first year of a loan. The New York representatives did not wish to compromise monetary relief in exchange for a two-year prepayment penalty limit that would not provide additional protection to its constituents. Yet states without predatory lending laws needed the Household settlement to fill that legislative gap.”138

In the Ameriquest case, these issues were dealt with by: 1) breaking the executive committee down into an even smaller negotiating team; and 2) reaching a consensus among the executive committee and presenting that to the states as a “join if you want” option so that the executive committee did not have to reach a consensus among the full group of states. Nonetheless, this structure was able to achieve participation by all 49 states which

Ameriquest operated in. In the case of Countrywide, the way the case played out fractured

134 Id. 135 Id. 136 Id. 137 Peacock quoting Sandra Kane, Civil Rights attorney in the Arizona Attorney General’s Office, December 20, 2002. 138 Peacock at 34.

23 the playing field of states, making the Household/Ameriquest multi-state/multi-agency model infeasible.

THE COUNTRYWIDE CASE AND SETTLEMENT PROCESS

On November 27, 2007 Illinois Attorney General Lisa Madigan sued One Source

Mortgage, a Chicago mortgage broker alleging that it had promised borrowers low interest rates without telling them that their required payments would jump greatly after a short time.139 Countrywide was One Source’s primary lender, and the One Source inquiry led

Illinois to begin investigating Countrywide Financial’s lending practices in September

2007.140 Lisa Madigan’s attention to the issue no doubt stemmed partly from the fact that from 2004-2006 Chicago had the highest number of subprime loans sold to homeowners of any metropolitan area in the country.141 In addition to Illinois, a few other states were investigating Countrywide and had subpoenaed it for information, each working individually.142 In early 2008, financial problems at Countrywide appeared to be leading it towards bankruptcy; in the first six trading days of 2008 alone Countrywide’s stock fell

139 Gretchen Morgenson, Countrywide Subpoenaed by Illinois, The New York Times, December 13, 2007 (hereinafter “Morgenson”). (Available at http://www.nytimes.com/2007/12/13/business/13lend.html?n=Top/Reference/Times%20Topics/People/M/ Madigan,%20Lisa) 140 Id.; Lisa Madigan Testimony. 141 Morgenson. 143 Ruthie Ackerman, Countrywide, BofA Could Team Up, .com, January 10, 2008. (Available at http://www.forbes.com/2008/01/10/countrywide-bankofamerica-buyout-markets-equity-cx-ra- 0110markets40.html).

24 43%.143 On January 11, 2008 announced that it planned to buy the company.144

Countrywide Financial Corporation’s shareholders approved the buyout on June

25, and on the same day California and Illinois filed complaints against the company. 145

The merger was intended to close on July 1, and the suits were timed in part to avoid a preemption issue posed by the buyout of Countrywide by a nationally chartered bank.146

On the same day the state of Washington announced that it was fining Countrywide Home

Loans $1 million and was seeking to revoke Countrywide’s state license.147 Florida followed with a 12 page complaint filed June 30, 2008.148 Connecticut filed a roughly 18 page complaint on August 6, 2008.149 West Virginia filed suit on August 12, followed by

Indiana on August 25.150

“Traditionally in multi-state you don’t necessarily sue, you try to negotiate and get a deal,” notes Madigan, “but this one started differently.”151 (As with the Ameriquest case,

143 Ruthie Ackerman, Countrywide, BofA Could Team Up, Forbes.com, January 10, 2008. (Available at http://www.forbes.com/2008/01/10/countrywide-bankofamerica-buyout-markets-equity-cx-ra- 0110markets40.html). 144 David Ellis, Countrywide rescue: $4 billion, CNNMoney.com, January 11, 2008. (Available at http://money.cnn.com/2008/01/11/news/companies/boa_countrywide/index.htm). 145 Martha Graybow and Gina Keating, Countrywide sued for unfair lending, buyout approved, June 26, 2008. (Available at http://uk.reuters.com/article/marketsNewsUS/idUKN2547219720080625) 146 Id.; Patrick Madigan December Interview. 147 Gov. Gregoire announces alleged discriminatory lending by Countrywide Home Loans, Governor Chris Gregoire Press Release, June 25, 2008. 148 Complaint for Injunctive Relief, Damages, and Other Statutory Relief, Office of the Attorney General, Department of Legal Affairs, State of Florida v. Countrywide Financial Corporation, Case No. 0830105, In the Circuit Court of the Seventeenth Judicial Circuit, In and For Broward County, Florida, June 30, 2008. (Available at http://myfloridalegal.com/webfiles.nsf/WF/MRAY- 7G5G7L/$file/CountrywideComplaint.pdf) 149 Complaint, State of Connecticut v. Countrywide Financial Corporation, Superior Court, Judicial District of Hartford, July 28, 2008. (Available at http://www.mortgagefraudblog.com/images/uploads/CTcountrywidesuit.pdf). 150 Sarah K. Winn, W.Va. AG files suit against mortgage lender, The Charleston Gazette, August 12, 2008. (Available at http://sundaygazettemail.com/News/Business/200808121236); Jonathan Stempel, Indiana sues Countrywide over mortgage practices, , August 25, 2008 (Available at http://www.reuters.com/article/gc06/idUSN2525887320080825). 159 Id.

25 Patrick Madigan ran the Countrywide case for the Iowa AG office.) In addition to the preemption issue, Madigan cites the unprecedented housing crisis as the reason states moved quickly to file suit instead of taking the traditional multi-state process. “[W]e’re in an unprecedented foreclosure crisis – the longer this took, the more people would lose their homes due to foreclosure – there was more of a time pressure than in previous cases.”152

Bank of America Counsel John Beisner, a litigation partner at O’Melveny & Myers LLP, agrees, noting “this is an issue that hit disproportionately among the states - the crisis with people actually losing homes was more pronounced in a few jurisdictions. The need to go quickly led these groups to work separately.”153

As counsel for Bank of America, the O’Melveny & Myers team did not become involved until the after acquisition occurred.154 Beisner’s characterization of Bank of

America’s response to the case is “from day one the approach was that we wanted to solve the problem.”155 “It was different from most of the other investigations I’ve been involved in because we never talked about what the allegations were all that much – we went to the meetings saying we need to find a solution here – we've got a national emergency, both with people losing their homes, and also the impact on communities.”156 Countrywide

“had new managers, who were taking over responsibility and were therefore able to say we don't know what happened, we just want to find a solution.”157

One major difference between this and previous multistate actions against unscrupulous lenders was that public sentiment regarding subprime loans had changed

159 Id. 159 Id. 159 Id. 159 Id. 159 Id. 159 Id.

26 drastically. At the time of the Ameriquest investigation, “the subprime market was going gangbusters; this was seen as a good thing, as ‘the democratization of credit,’” explains

Iowa’s Madigan.158 “People accused us of being activist attorneys general, just trying to make a name for ourselves.”159 However by the time of the Countrywide case, there was a consensus that this was an important issue that needed immediate action. This was reflected in the way Bank of America handled the case. “Bank of America very much wanted to be part of the solution and be viewed as part of the solution,” says Beisner.160

On July 2, the day after the Bank of America buyout deal closed, Bank of America called Iowa Attorney General Tom Miller, whose office had provided leadership on the

Household and Ameriquest cases, to discuss making a deal.161 Iowa was working with a few states it had existing relationships with from prior predatory lending cases:

Massachusetts, Ohio, Texas, Arizona, and Washington (although Massachusetts later dropped out from the group).162 This became informally known as the “Iowa group.”163

“What developed is there were two groups – the states that had sued, and the Iowa group.”164 Both groups met with Bank of America in July.165 According to Beisner, Bank of America attempted to encourage the states to work together as a single group in order to reach an agreement quicker.166 “From a defendant's perspective, there are a lot of advantages from a multi-state… you are dealing with a single group of AGs, many of whom

159 Id. 159 Id. 160 Beisner Interview. 161 Patrick Madigan December Interview. 162 Id.; Patrick Madigan January Interview. 163 Patrick Madigan December Interview. 164 Id. 165 Id. 166 Beisner Interview.

27 have different views, but the differences get resolved within that group. You're [as the defendant] hearing them speak with a single voice.”167 This case was different than a traditional multi-state, because “several states sued right out of the box.”168 According to

Beisner, “the fractured nature of the case meant it took a lot longer.”169 “We were splintered right from the start, not to say that that’s good or bad, but it was a different circumstance,” says Madigan.170 According to Beisner, “no one seemed to be responding to our call to get everyone in the room at the same time,” so Bank of America told the Iowa group that it would focus on negotiating with California and Illinois first, “in part because of their status with their investigation,” and also because those states were “among the top states with Countrywide exposure in terms of number of homes with Countrywide loans.”171 According to Beisner, negotiating with California and Illinois first was not a strategy choice. “We didn’t know how to do it any other way.”172

Patrick Madigan believes that negotiating separately was a result of the circumstances of how the case arose, and not a conscious strategy on Bank of America’s part.173 Another senior assistant attorney general who was involved in the negotiations agrees, characterizing the approach: “My is [Bank of America was] just playing catch-up once they bought Countrywide, they didn’t know what was going on [initially]. I don’t think they had any strategy at all except to resolve it as quickly as possible.”174 On the

167 Id. 168 Id. 169 Id. 170 Patrick Madigan December Interview. 171 Beisner Interview. 172 Id. 173 Patrick Madigan December Interview; Patrick Madigan January Interview. 174 Interview with a senior Assistant attorney General who was involved in the negotiations, April 1, 2009 (hereinafter “Senior Assistant Attorney General Interview”).

28 effectiveness of a strategy of separate negotiation, this assistant attorney general argues that “picking off states is not a good strategy because then you [as another state] know what the minimum you’re going to get is. If you’re a state and you know they’re talking to other states you’ll never sign anything that won’t protect your attorney general from criticism.”175 One way to do this is with what is known as a “Most Favored Nation clause,” where the negotiating state will get at least as favorable terms as are given to any other state.176 However, the assistant attorney general agreed that “if they called your bluff” a state lacking the resources to litigate a case would have decreased bargaining power going it alone.177

While Bank of America negotiated with California and Illinois, the Iowa group continued investigatory discovery work.178 Then in September 2008 things started happening very quickly. “We were notified in September that Bank of America had cut a deal and had a proposed settlement with California and Illinois and they wanted to run it by our group. It wasn’t take-it-or-leave-it, this was a chance for us to influence the deal, but they made it clear that there was no time to reinvent the wheel.”179 The proposed settlement was given to the Iowa group on September 22nd, and Bank of America wanted a completed deal by October 1st.180 The Iowa group decided to take a shot at working on the proposed deal. “We dropped everything and negotiated with them over a two week period and made a lot of changes to the deal.”181 The Iowa group was able to add another

$55 million in restitution above what California and Illinois had negotiated, in addition to

175 Id. 176 Id. 177 Id. 178 Patrick Madigan December Interview. 179 Id. 180 Id. 181 Id.

29 making a number of changes to the injunctive terms of the settlement.182 Unlike in

Household and Ameriquest which involved smaller negotiating groups, the Iowa group was small enough that everyone was at the negotiating table.183

It was very important to Bank of America that there be a consensus among the states as to the key terms of the agreement, despite the fact that the states were fractured. “We made very clear that we did not want to have separate deals with the separate states; the main reason for that was that a lot of what we are doing is modifying loans and agreeing with certain protocols. Investors own most of those mortgages, and we need to treat the investor pools similarly in terms of doing these modifications.”184 One way the parties dealt with this was to create some options in the agreement with respect to compensation, for example, “whether they're going to send money directly to mortgage owners or use it directly.”185 The loan modification part of the agreement is identical in every settlement, however.186 In order to achieve this uniformity, the O’Melveny team engaged in “shuttle diplomacy.”187 “As we heard from one group of states we need to change this or that, we had to go to the other group of states and make sure they were ok with that. This was more of an issue with modification issues as opposed to increasing the amount of money – no state would disagree with that.”188

The speed at which Countrywide was settled required the involvement of fewer parties. The Iowa team was kept only to states with prior working relationships on

182 Id. 183 Patrick Madigan January Interview. 184 Beisner Interview. 185 Id. 186 Patrick Madigan January Interview. 187 Beisner Interview. 188 Id.

30 subprime issues.189 Another result of the short time frame was that banking regulators had no role in the Countrywide settlement.190 Nor was there any involvement by NGOs.191

While district attorneys in California were involved in the Ameriquest case due to their consumer protection jurisdiction, they were not involved in Countrywide.192 “It went from

June 24th until October 6th when it was announced – this was extraordinarily fast.

Ameriquest took about a year and a half.”193 “When [the] deal was announced, many of the states didn’t know about it, and they were surprised – because all the other big cases had been handled as multi-states.”194 At that point, “we had to do a multi-state after the fact.”195

On October 6, 2008 a settlement was announced with 11 states: California, Illinois,

Arizona, Connecticut, Florida, Iowa, Michigan, North Carolina, Ohio, Texas, and

Washington. “At that point it became apparent that those other states were out there and there was a need to create a master template for everyone else,” says Madigan, who helped hammer out the “master template” over six weeks after the main settlement was reached.196

Beisner referred to this as a “reverse multi-state.”197 Beisner believes that eventually Bank of America might get almost all the states to join the master template settlement.198 An

October article in the Pittsburgh Tribune-Review illustrates the public pressure attorneys general will face in deciding whether to join the settlement. The article discusses

189 Patrick Madigan December Interview; Patrick Madigan January Interview. 190 Patrick Madigan December Interview. 191 Id. 192 Id. 193 Id. 194 Id. 195 Id. 196 Id.; Beisner Interview. 197 Beisner Intereview. 198 Id.

31 Pennsylvania’s non-participation in the 11-state settlement, quoting a spokesperson for

Pennsylvania Attorney General Tom Corbett saying that they are in discussions with Bank of American and trying to determine whether to “sign on to the deal -- or pursue something more.”199 The article notes that “10,000 Pennsylvania residents…could benefit from the settlement,” and says that “the lack of action could delay getting help with problem loans to homeowners.”200 It quotes a local ACORN director saying that Corbett should have already signed on: "I think that's a failure on their part."201 The political pressure from constituents who want immediate help coupled with the fact that a state attempting to litigate would have to do so without the benefit of a large multi-state team seem to make it likely that most or all states will sign on to the deal.

A major difference between Countrywide and prior subprime cases was that the purpose behind the injunctive relief was different, due to the fact that Countrywide had been bought out by Bank of America. “Normally the idea behind injunctive relief is to punish you for what you’ve done in the past and to make sure you don’t do it again in the future.202 The injunctive relief in the Countrywide settlement was completely different because we were dealing with Bank of America, a company that didn’t do the bad acts, so there wasn’t a need to do that.”203 The second reason was that there was a jurisdictional issue due to the fact that Bank of America is nationally chartered. “Bank of America is a national bank, and that played a role in how far we were able to go.”204 As a result, the focus was more on devising assistance to current borrowers than on controlling future

199 Ron Daparma, State not included in deal to aid subprime borrowers, Pittsburgh Tribune-Review, October 9, 2008. (Available at http://www.pittsburghlive.com/x/pittsburghtrib/business/s_592357.html). 200 Id. 201 Id. 202 Patrick Madigan January Interview. 203 Id. 204 Id.

32 lending behavior.205 “This allowed us to a lot faster.”206 The resulting settlement was very different from the Household and Ameriquest settlements. Explains Madigan, “a whole lot of the settlement is a loan modification program, which wouldn’t have been possible to do in Ameriquest, and there’s not as much emphasis on consumer restitution in terms of money, sending someone a check – there’s a roughly $150 million fund, but it doesn’t have the prominence that it had in other cases and this was the appropriate focus in this case.”207 Beisner noted that the Household and Ameriquest settlements were both reached at times when housing prices were still increasing, and thus were not good models for a solution that would work to “keep people in their houses today.”208

Although the greatly different circumstances under which the Countrywide case arose meant that the Household and Ameriquest multi-state, multi-agency model was not applicable, the experience of working on those cases nonetheless proved valuable. Patrick

Madigan notes that attempting to finalize a settlement in two weeks would have been nearly impossible for the Iowa group had it not been for prior experience in the subprime arena.209

“This is a very complicated issue, what you could achieve in terms of falling interest rates, the cost of foreclosure etc.,” says Beisner, “I was phenomenally impressed with the way the AGs engaged in the process.”210

TERMS OF THE COUNTRYWIDE SETTLEMENT

205 Id. 206 Id. 207 Patrick Madigan December Interview. 208 Beisner Interview. 209 Patrick Madigan January Interview. 210 Beisner Interview.

33 The nationwide settlement with Countrywide was announced on October 6,

2008.211 Under the settlement, Countrywide will identify mortgages for modification and offer modification to borrowers who qualify under a specified affordability equation, with options including reduction of principal, lowered or capped interest rates, and interest-only periods.212 Countrywide was required to offer at least 50,000 modifications by March 31,

2009.213 Countrywide will at its discretion make relocation assistance payments to borrowers who are unable to keep their homes in exchange for them voluntarily surrendering the property.214 Countrywide will also make a total of $150 million in payments to certain borrowers who had their homes foreclosed on.215 The settlement also includes reporting requirements to the states.216

While the focus of the settlement is not on restricting future practices, Countrywide does make some broad, unspecific compliance commitments. “CFC shall ensure that, (a) to the extent it resumes subprime lending, it will design and implement an effective compliance management program to provide reasonable assurance as to the identification and control of consumer protection hazards associated with subprime lending activities, and (b) to the extent of its own lending activities (if any), it will create appropriate consumer safeguards to avoid unfair or deceptive activities or practices arising in

211 Patrick Madigan December Interview. 212 Final Judgment and Consent Decree, People of the State of Illinois v. Countrywide Financial Corporation, Case No 08CH40569, Cook County Circuit Court, State of Illinois, Oct 31, 2008 (hereinafter “Illinois Consent Decree”). Stipulated Judgment and Injunction, The People of the State of California v. Countrywide Financial Corporation, Case No. LC083076, Superior Court for the State of California For the County of Los Angeles Northwest District, October 20, 2008 (hereinafter “California Stipulated Judgment”). 213 Id. 214 Id. 215 Id. 216 Id.

34 connection with its interaction with brokers and other third parties.”217 These requirements expire on June 30, 2012, as with most of CFC’s obligations under the consent decrees.

While beyond this, the settlement does not restrict future practices, it notes that for the

Bank of America has stopped these practices for the near term. “In connection with the acquisition, Bank of America Corporation announced that it would suspend offering subprime or higher-priced mortgages or nontraditional forward mortgages that may result in negative amortization, such as Pay Option ARMs. Bank of America also stated that it would place restrictions on offering “low documentation” and “no documentation” mortgage loans and set limits on mortgage broker compensation.”218

ANALYSIS OF THE COUNTRYWIDE SETTLEMENT TERMS:

One notable characteristic of the mortgage modification plan is that the affordability equation only calls for modifications of mortgages where modifying the mortgage would create a net increase in value for the securities investors who own the underlying mortgages (or at least is neutral in economic effect). This leaves the program open to the criticism that the modification program only requires Countrywide to do something that ought to happen on its own anyway, because it’s in the investors’ best interest to modify loans where doing so would create a net increase in value for them.

However, as the foreclosure crisis has played out, this has proven to not be the case. The explanation is that the servicer, not the investors, is responsible for making loan modifications, and it is not in the servicer’s best interest to do so. Servicers are reimbursed for the costs they incur in a foreclosure; however they are rarely compensated for

217 Illinois Consent Decree. 218 Id.

35 modifications.219 “Loan loss mitigation is labor intensive and thus raises servicing costs.”

220 This “creates a bias for moving forward with foreclosure rather than engaging in foreclosure prevention,” regardless of whether investors would be better off if actions such as modification were taken.221 A second reason servicers haven’t been widely modifying mortgages is that servicers are concerned about being sued by investors.222 “While most

Pooling and Servicing Agreements (PSAs) provide adequate authority to modify loans, these modifications may cause disproportionate harm to certain tranches of securities over other classes,” which presumably might expose the servicer to liability. Additionally,

“some PSAs limit what servicers can do by way of modification … [limiting] the number or percentage of loans in a pool that can be modified.”223 In Bank of America’s case, it

“can modify about 75% of the loans at issue based on ‘delegated authority’ in its contracts with investors.”224 A final reason why banks have not been modifying mortgages on their own volition is because of complications posed by junior liens on property. “[O]ne-third

[to] one-half of the homes purchased in 2006 with subprime mortgages have second mortgages, and many more homeowners have open home equity lines of credit secured by

219 Testimony of Martin D. Eakes, Self-Help and Center for Responsible Lending, before the U.S. Senate Committee on Banking, Housing and Urban Affairs, November 13, 2008 (hereinafter “Eakes Testimony”). (Available at http://banking.senate.gov/public/_files/EakesTestimony111308final.pdf). 220 Larry Cordell, Karen Dynan, Andreas Lehnert, Nellie Liang and Eileen Mauskopf, The Incentives of Mortgage Servicers: Myths and Realities, Federal Reserve Staff Working Paper, Finance and Economics Discussion Series, 2008-46, at p. 15. (Available at: http://www.federalreserve.gov/pubs/feds/2008/200846/200846pap.pdf). 221 Id. 222 Countrywide was in fact sued by a group of investors in December 2008 over the settlement agreement. Lisa Madigan Testimony. 223 Eakes Testimony; See also Vikas Bajaj and Barry Meierome, Hedge Funds Argue Against Proposals to Modify Mortgages, The New York Times, October 23, 2008. (Available at (http://www.nytimes.com/2008/10/24/business/24modify.html). 224 Ruth Simon, Investors Hit BofA Loan Modifications, , November 18, 2008 (hereinafter “Simon”). (Available at http://online.wsj.com/article/SB122696804303735525.html).

36 their home.”225 A first mortgage-holder won’t want to make a modification if that money is just going to go to pay off “a formerly worthless junior lien.”226 “But as reports, ‘it is often difficult, if not impossible, to force a second-lien holder to take the pain prior to a first-lien holder when it comes to modifications,’ thereby dooming the effort.”227

Thus, due to servicer incentives to favor foreclosure, servicer fear of liability, and complications due to junior lien holders, such voluntary modifications have not been occurring. The Countrywide settlement requires the modification of at least 50,000 loans by March 31, 2009 regardless of those concerns; providing that modifications will be evaluated and made without regard to the presence or absence of junior lien holders, so presumably Bank of America will take this factor out of its decision-making; it can limit potential investor liability by working with investors or by choosing 50,000 loans to modify with the most favorable servicer agreements (in fact, Bank of America owns 48,000 of the loans at issue anyway, so it could simply modify those first).228

Another potential criticism of the settlement is that the parties paying for most of the estimated $8.4 billion in loan relief are the investors, not Bank of

America/Countrywide. Some investors have been making this argument, claiming:

“Bank of America is moving much of the cost of the settlement to investors when it should be paying those costs itself. These investors said that they don't oppose modifying loans when it will increase investor returns while keeping borrowers in their homes. But they said that many of these loans violated representations and warranties made when the mortgages were packaged into securities. As a result, they said, Bank of America should repurchase the loans before modifying them. ‘This is literally an attempt to

225 Eakes Testimony. 226 Id. 227 Id. 228 Simon; Bank of America has apparently already received permission for modifications from the vast majority of investors it needs permission from. E. Scott Reckard, Countrywide plan may cut mortgage rates for 395,000 borrowers, Los Angeles Times, October 24, 2008 (hereinafter “Reckard”). (Available at http://articles.latimes.com/2008/oct/24/business/fi-countrywide24).

37 settle a dispute with state attorneys general on predatory lending claims with someone else's money,’ said one money manager. ‘In 10-plus years in the market, I've never seen anything as outrageous as this.’”229

Patrick Madigan characterized such criticisms as fringe arguments. “Good modification helps the investors and produces a greater revenue stream than foreclosures – this idea that doing the modifications hurts the investors is ludicrous. Some of the investors have raised other concerns that are legitimate and have led to tweaks to the program.”230 The counterargument is that the loan modifications in the settlement insure a greater net revenue for the pool of mortgages as a whole – but not necessarily for every individual investor.

“Modifications … can benefit some bondholders at the expense of others. Reducing a borrower's loan balance, for instance, may hurt holders of the riskiest piece of a mortgage securitization more than investors who bought securities that had higher credit ratings.”231

Nonetheless, it is not true that investors are bearing all the costs of modifications, because

Countrywide will bear both the administrative costs of modifying loans as well as expose itself to potential liability from mortgage security investors.

Another question raised by the settlement is whether fixing the problem was the proper end goal of the Countrywide case as opposed to retribution and/or enforcement.

Arguably, Countrywide is just helping to clean up the mess it made, receiving nothing in the way of punitive measures. As state officers charged with protecting the public interest, however, attorneys general have to consider the broader context of their actions. The settlement reflected the unique circumstances under which it was negotiated, including the urgent time pressure to achieve results that would help homeowners, the fact that the states

229 Simon. 230 Patrick Madigan December Interview. 231 Simon.

38 were fractured, and the jurdisctional issues created by Countrywide’s buyout by a national bank. Further, 2008 saw the collapse of Bear Sterns, the bankruptcy of Washington

Mutual, the $85 billion bailout of AIG, the buyout of Lynch by Bank of America, the placement of and in conservatorships, and the need for large capital infusions at and . In this climate, the failure of another bank would benefit no one. In Schmitt’s Ameiquest paper, he notes that reasonable minds can disagree “whether state attorney generals should be concerned with whether a potential settlement might end up destroying a company,”232 Under the economic environment in 2008, this was no longer the case for a large financial company, and thus it was proper for the states to focus their energies on getting as much help for homeowners as possible.

The oft-cited $8.4 billion in loan relief figure relies on the assumption that

Countrywide meets its eventual goal of 400,000 modifications; that “every eligible borrower and investor participates.”233 However the only hard number in the settlement is the required modification of 50,000 loans by March 2009, beyond which the settlement is more vague as to how many modifications will eventually be made. CFC is required to

“[i]dentify and contact borrowers who are having or may have trouble making their payments, and do an individualized evaluation of whether alternatives to foreclosure are feasible,” and must “offer loan modifications or other workout solutions to delinquent borrowers who desire to remain in their homes and who can afford to make reasonable

232 Schmitt at p. 9. 233 Attorney General Brown Announces Landmark $8.68 Billion Settlement With Countrywide, Office of the Attorney General Press Release, October 6, 2008. (Available at http://ag.ca.gov/newsalerts/release.php?id=1618)

39 mortgage payments…subject to applicable investor guidance and approvals.”234 “Subject to the foreclosure avoidance budget…the eligible borrower will be offered a loan modification that produces a first-year payment…equating to 34% of the eligible borrower’s income.” Countrywide is also required to ensure that loan modification offers

“are made to eligible borrowers, on average, no more than 60 days after such eligible borrowers make contact with the applicable CFC servicer and provide any required information concerning a possible modification.” Further, CFC must commit 3,900 employees to assist borrowers with modifications and other foreclosure avoidance measures until July 2009. Madigan explains that it was important to keep some details of the modification program vague in order to respond to changing circumstances.

“[M]odifications are a very dynamic … [so] it’s necessary to have a certain amount of flexibility.” 235 Countrywide has said that the “ultimate goal is to modify 395,000 loans.

Even if participation by states and qualified borrowers and investors is on the low end of the possible range, the settlement cost to Countrywide will be in the same ballpark as Ameriquest and Household, with the potential that costs could go higher than either of those two cases. However, by targeting this money towards achieving loan modifications, there is a much great multiplier effect in the effect this money can have on borrowers and on the state as a whole. In terms of pure -for-buck, the Countrywide settlement seems to be a step forward in how to approach predatory lending settlements.

Aside from the modification program, Countrywide has agreed to “waive late fees of $79 million and prepayment penalties of $56 million… A foreclosure relief fund will be

234 Illinois Consent Decree (emphasis added). 235 Interview with Patrick Madigan, Assistant Attorney General for Iowa, April 21, 2009 (hereinafter “Patrick Madigan April Interview”).

40 created with $150 million from Countrywide to help borrowers who are four months or more behind on their payments or whose homes have already been foreclosed on.” 236

Countrywide will also make payments to assist borrowers in move to rental housing. The relocation assistance payments are to be made entirely at the “discretion of CFC or its delegate according to its or their assessment of the individual circumstances of the

[b]orrower.” The settlement states that “CFC projects that, from October 1, 2008, through

December 31, 2010 [payments] will be made to 35,000 borrowers in total amount of more than $70,000,000 on a nationwide basis.” This “cash for keys” program is an industry practice that would happen on some level without the settlement, but Madigan notes that

“there’s a difference between saying you’ll do something and signing agreements with attorneys general.”237 The $150 million in foreclosure relief is a hard number, broken down on a state by state basis in the individual settlements, and dependant only upon how many states agree to the settlement. This number is apparently calculated “to pay an average of

$2,000 to borrowers who have lost their homes – or who will lose them because they don’t qualify for the program.”238

The affordability equation ensures that the people who receive modifications are the people who are on the borderline of being able to afford their mortgages; if a modification fitting within the cost cap created by the “affordability equation” would not bring a borrower to a point where payments become affordable, their loans will not be modified. This is a good thing as it ensures that money spent on modifications is spent on people who really need the help, and where modifications will have the greatest chance of

236 Gretchen Morgenson, Countrywide to Set Aside $8.4 Billion in Loan Aid, The New York Times, October 6, 2008. (Available at http://www.nytimes.com/2008/10/06/business/06countrywide.html). 237 Patrick Madigan April Interview. 238 Reckard.

41 success. This is an important consideration, because borrowers after modification are still at high risk of default: “In one preliminary analysis (of loan modifications), roughly 23% of borrowers who received a principal reduction were at least 60 days delinquent eight months after their loans were modified, though 80% were seriously delinquent before the modification.”239

The settlement has been generally met with widespread praise. The Los Angeles

Times reported that consumer advocates are “hailing” the deal.240 A spokesman for U.S.

Rep Barney Frank (D-Mass.)(who has been very active on the issue of predatory lending) called the program “the first truly comprehensive plan we’ve seen from the private sector”

(for dealing with the foreclosure crisis).241 In fact, Representative Frank “gave 10 other major mortgage-servicing companies an ultimatum to adopt programs similar to the

Countrywide plan. If the servicers don’t comply, ‘we’ll write legislation that does it or them,’ said…a spokesman for the lawmaker.”242 Naming the Countrywide deal as the model for future action by servicers and/or legislation by Congress is a pretty strong endorsement of the Countrywide modification program. “We were happy with the settlement,” said a Senior Assistant Attorney General interviewed for this paper.243

The Countrywide settlement has the potential to help many borrowers stay in their homes and stem the tide of foreclosures. If the settlement is taken as a model and applied by or to other servicers, the efforts of the state attorneys general will have achieved an even greater effect. Compared against the alternative of protracted litigation with a chance of

239 Ruth Simon, States Call for Adoption of Mortgage-Loan Help, The Wall Street Journal, October 8, 2008. (Available at http://online.wsj.com/article/SB122342048455713109.html). 240 Reckard. 241 Id. 242 Id. 243 Senior Assistant Attorney General Interview.

42 receiving more money years from now, this settlement will be far more effective at helping solve the current economic crisis. The Countrywide settlement is a demonstration of great flexibility on the part of the attorneys general who negotiated it in responding appropriately to a new kind of challenge, instead of simply treating Countrywide like enforcement actions of the past. While one effect of this was that the multi-state process was fractured, and states may have lost some ability to coordinate and maximize leverage, at the same time, the attorneys general still worked together indirectly; The Iowa team made a strong contribution to improving the initial settlements negotiated by California and Illinois, and the Iowa team also worked to do a “multi-state after the fact,” to get more states on-board with the agreement. AAGs like Patrick Madigan responded dynamically to the unprecedented circumstances of the Countrywide case. The settlement is also a reflection of the leadership of state attorneys general in Illinois and California who began the process by filing suit against Countrywide before the Bank of America merger, and in Iowa, where

Tom Miller’s prior leadership in the area of predatory lending positioned him to be able to coordinate among the other states.244 While it is too early to judge the effectiveness of the

Countrywide settlement, it has great promise of helping tens if not hundreds of thousands of Americans avoid losing their homes.

EPILOGUE: ATTEMPTS TO BRING THE COUNTRYWIDE PROGRAM TO OTHER SERVICERS

In 2007, Iowa Attorney General Thomas Miller formed a task force of attorneys general and banking regulators from 10 states in an effort to work with mortgage servicers and investors to restructure more subprime loans and thus decrease foreclosures (The group, the State Foreclosure Prevention Working Group is composed of Miller, AGs from

244 Patrick Madigan April Interview.

43 CA, Arizona, Texas, Illinois, Ohio, North Carolina, Colorado, and Massachusetts, and banking regulators from North Carolina and New York, and a representative form the

Conference of State Banking Supervisors.).245 After Countrywide Settled, Miller sent a letter on behalf of this task force to the nation’s largest subprime-mortgages-servicing companies, urging them to “follow Bank of America Corp.’s lead and embark on a broad- based loan-modification program.”246 Miller suggested he would consider litigation if the discussions do not achieve results. Barney Frank also threatened to legislate to bring a modification program similar to the one in the Countrywide settlement to the other servicers, if they do not create such programs voluntarily. In February 2009, President

Obama announced a $75 billion program to help 3-4 million homeowners avoid foreclosure, which has changed the mortgage modification landscape.247 On the effect of the State Foreclosure Prevention Working Group’s efforts, Madigan says he believes that the dialogue they engaged in with services “greatly influenced the debate on loan modification and servicing.”248

One AAG interviewed expressed a broader concern over other participants in the market who he believes engaged in, or were complicit in, deceiving home-buyers. “The buyer is being misled [throughout the process]. He buys a house, and the realtor gets a commission, the developer gets to [book the sale], the appraiser gets a cut, the mortgage broker gets his cut, and the mortgage company slices it up and sells it to [an investment

245 Ruth Simon, Task Force Will Seek More Loan Revisions, Wall Street Journal, September 8, 2007. (Available at http://online.wsj.com/article/SB118921051749421243.html) 246 Ruth Simon, States Call for Adoption of Mortgage-Loan Help, The Wall Street Journal, October 8, 2008 (Available at http://online.wsj.com/article/SB122342048455713109.html) 247 A. Fletcher and Renae Merle, Obama Proposes Package to Stave Off Foreclosures, , February 19, 2009. (Available at http://www.washingtonpost.com/wp- dyn/content/article/2009/02/18/AR2009021801081.html?sid=ST2009030401759) 248 Patrick Madigan April Interview.

44 bank]. And the appraiser and the mortgage broker get each another cut every time they refinance – so there’s an incentive to encourage people to overextend themselves in an up market. And when we reach bottom and start going up again, all those incentives are still in place.”249 These other players, he noted, “walked away rich.”250 The AAG noted, however, that these other market participants are outside the realm multistate litigation.251

249 Senior Assistant Attorney General Interview. 250 Id. 251 Senior Assistant Attorney General Interview.

45 APPENDIX: TERMS OF THE COUNTRYWIDE SETTLEMENT

Below is an overview of the main terms of the settlement: 252

Enhanced Home Retention Practices: Until June 30, 2012, CFC will:

 Identify and contact borrowers who are having or may have trouble making their payments, and do an individualized evaluation of whether alternatives to foreclosure are feasible.

 Offer loan modifications or other workout solutions to “delinquent borrowers who desire to remain in their homes and who can afford to make reasonable mortgage payments…subject to applicable investor guidance and approvals.”

 Monitor delinquency characteristics to identify borrowers that may be appropriate for loan modification campaigns; report these characteristics to the state.

 Commit at least 3,900 employees through July 1, 2009 “to assist borrowers with loan modifications and other foreclosure avoidance measures.”

Loan Modifications for Delinquent Borrowers – Until June 30, 2012, CFC shall be responsible for ensuring that CFC servicers:

 Consider each “eligible borrower” with a “qualifying mortgage” for “a range of affordable loan modification options…subject, as applicable, to approval of the investor who owns the qualifying mortgage consistent with the ‘affordability equation.’”

 “Eligible borrowers” are defined as those with “qualifying mortgages” with a first payment date on or before 12/31/07 in an owner occupied 1-4 unit residential property serviced by a CFC servicer.

 “Qualifying mortgages” are defined as:

o Subprime 2, 3, 5, 7, and 10 Hybrid ARMs with delinquent or seriously delinquent borrowers (those 60 days or more delinquent or those subject to an imminent recast which is likely in of the servicer to cause them to become 60 days or more delinquent before the termination date) with loan to value (LTV) ratios of 75% or more;

252 Except where otherwise noted, the sources for all bullet points and quotes of terms below are: Illinois Consent Decree; California Stipulated Judgment. The California and Illinois settlement agreements are very similar.

46 o Pay Option ARMs where the eligible borrower is delinquent or seriously delinquent with an LTV ratio or 75% or more;

o Other Subprime First Mortgage Loans where the borrower is seriously delinquent with an LTV ratio of 75% or more.

 Loan modification options – CFC is required to consider at least the options below, subject to investor approval and consistent with the affordability equation (which establishes a cap on the cost of loan modification as explained below). The options for each type of qualifying mortgage are broken down for each type of qualifying mortgage below:

o For Hybrid ARMs, Pay Option ARMs, and other qualifying subprime loans:

. “To the extent the Hope for Homeowners Program is available, an FHA refinancing under [this program]”

. Note: The Hope for Homeowners Program “in effect requires a lender to cut the principal to 87% of the home’s current value so the borrower can receive a smaller long-term, fixed-rate loan.”253

o For Hybrid ARMs:

. An unsolicited restoration of the introductory rate for 5 years; or

. “A streamlined fully-amortizing loan modification subject to the affordability Equation, consisting of” a reduced interest rate for 5 years (with another possible two years of reduced rate financing) “with automatic conversion to a fixed rate mortgage at the higher of the introductory rate or the Fannie rate; or

. “A streamlined loan modification subject to the affordability equation consisting of: A) modification of the qualifying mortgage to include a ten-year interest-only period; B) reduction of the interest rate;” and “C) “an interest-rate cap for the remaining, fully-amortizing term.”

o For Pay Option ARMs:

. “A streamlined loan modification subject to the affordability equation consisting of: A) elimination of the negative amortization feature; B) optional introduction of a ten-year interest-only period on the loan; C) reduction of the interest rate” with a cap of 7%;

253 Reckard.

47 and D) a write down of the principal in certain cases to achieve a 95% loan-to-value ratio.

o For other, non-Hybrid ARM/Pay Option ARM subprime loans:

. “A streamlined loan modification within the limits of the affordability equation consisting of: A) optional introduction of a ten-year interest-only period on the loan; B) reduction of the interest rate;” with an interest rate cap; and C) an interest rate cap for the remaining term.

 Affordability equation: “establishes a foreclosure avoidance budget that is a cap on the cost of loan modification.”

o The “foreclosure avoidance budget “is at any time the difference between (i) the likelihood and severity of the projected loss in a foreclosure sale; and (ii) the likelihood and severity of the projected loss in the event that there was a loan modification with respect to the Qualifying Mortgage and a later foreclosure sale.

. Note: Here is a plain English example of how the foreclosure avoidance budget would work. Borrower X has a 50% chance of foreclosure, and if that borrower is foreclosed upon, the projected loss will be $300,000; if there is a loan modification for Borrower X, there will be only a 10% chance of foreclosure with a projected loss of $300,000. The foreclosure avoidance budget would be [(50% * 300,000) – (10% * 300,000)] = 120,000.

o “Subject to the foreclosure avoidance budget, if tax and insurance escrows are maintained … the eligible borrower will be offered a loan modification that produces a first-year payment of principal (if applicable), interest, taxes, and insurance equating to 34% of the eligible borrower’s income or as close to 34% of the eligible borrower’s income as the foreclosure avoidance budget permits without exceeding 42% of eligible borrower’s income.”254

. In plain English, this says that the servicer will use the money in the foreclosure avoidance budget (e.g. the $120,000 from our example above) to offer the borrower a modification that will bring his or her first-year payment to as close to 34% as is possible (with a maximum of 42%) within the cap on the cost of the

254 The modification program “follows a template laid down this summer by the Federal Deposit Insurance Corp. after it took over IndyMac Bancorp,” in which “modifications are designed so that mortgage-related payments don’t exceed 38% of gross income.” Ruth Simon, States Call for Adoption of Mortgage-Loan Help, The Wall Street Journal, October 8, 2008. (Available at http://online.wsj.com/article/SB122342048455713109.html).

48 modification provided by the foreclosure avoidance budget. If it is not possible to bring the borrower’s total payments down to at least 42% of his or her income, they may not be offered a modification.

. If tax and insurance escrows are not maintained, the aim is to produce a first-year payment of principal and interest that equates to 25% of income without exceeding 34%.

o “There is no obligation to offer loan modifications with respect to qualifying mortgages if the eligible borrower cannot be qualified under the affordability equation. Such eligible borrowers may be eligible for a relocation assistance payment or a payment under the foreclosure relief program.”

o However, CHC must offer at least 50,000 loan modifications nationwide by March 31, 2009. Additionally, CFC will ensure that loan modification offers “are made to eligible borrowers, on average, no more than 60 days after such eligible borrowers make contact with the applicable CFC servicer and provide any required information concerning a possible modification.”

 Additional terms of the loan modification program

o Modifications will be made “without consideration of second or junior liens on mortgaged properties. CFC does not expect that the presence of second or junior liens will impede [borrowers] from receiving a loan modification offer.”

o “Any late/delinquency fees associated with overdue loan payments remaining unpaid…will be waived.” “Eligible borrowers will not be charged loan modification fees.” “Prepayment penalties will be waived in connection with any payoff or refinancing…of a qualified mortgage” meeting certain criteria.

o Borrowers will not be required to release claims against CFC or its affiliates to receive loan modifications.

o The consent decrees include restrictions on initiation or advancement of foreclosure process for eligible borrowers “for the period necessary to determine such eligible borrower’s interest in retaining ownership and ability to afford the revised mortgage terms as well as the investor’s willingness to accept a loan modification.”

49 Relocation Assistance Program:  Until June 30, 2012, Countrywide will provide borrowers with residential loans serviced by CFC or its affiliates as of June 30 2008 who are unable to keep their homes will be offered to receive monetary relief to assist with relocating to a new residence, in exchange for voluntarily surrendering their residence at time of foreclosure.

 The amount of any payment offered to any borrower is at the “discretion of CFC or its delegate according to its or their assessment of the individual circumstances of the [b]orrower.”

 “CFC projects that, from October 1, 2008, through December 31, 2010 [payments] will be made to 35,000 borrowers in total amount of more than $70,000,000 on a nationwide basis.”

Foreclosure Relief Program:

 Countrywide will make payments to borrowers who 1) were foreclosed on; or 2) “were 120 days or more delinquent in making mortgage payments soon after their loans were originated or after an interest rate reset” as of the settlement date.

 To be eligible, borrowers must be in owner-occupied property, must have made their first payment between January 1, 2004 and December 31, 2007, and must have made six or fewer payments on their loan (Illinois can expand or limit eligibility requirements to a certain extent).

 California will receive $27,950,101; Illinois $8,481,307. The total amount of the program for all states will be $150 million.255

 Borrowers must release CFC and affiliates from all claims in order to receive funds; borrowers who have not yet been foreclosed will be given at least three months to decide whether to accept the deal.

 Recipients may also be eligible to receive relocation assistance funds.

Additional Terms:

 The consent decrees include a number of reporting requirements to the states.

 The settlement stipulates that if Countrywide settles with other states on more favorable terms the consent decree will be amended to the more favorable terms.

255 Gretchen Morgenson, Countrywide to Set Aside $8.4 Billion in Loan Aid, The New York Times, October 6, 2008. (Available at http://www.nytimes.com/2008/10/06/business/06countrywide.html).

50  Countrywide agrees to fully cooperate with attorney general prosecution of and David Sambol.

 Countrywide will pay $1.7 million each to Illinois and California to cover attorney’s fees and investigative costs.

Countrywide denied all of the states allegations.256

256 Illinois Consent Decree

51