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 saw 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 United States 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 the national 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 Wall Street 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 path of typical single-family homes located in each metropolitan area provided.” Standard & Poor’s Press Release, Record Declines in Home 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 United States Congress, The U.S. Housing Bubble and the Global Financial Crisis: 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 New York 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, Business 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