FORTUNE -- Over the past several months regulators have finally noticed what consumer attorneys have been saying for years: the big banks have routinely committed fraud in their foreclosure filings and their records of how much people owe are too often wrong. And the mortgage modification process, which was meant to help homeowners, has been exposed as an abject failure.
Salvageable mortgages are being foreclosed because the banks, wearing their "mortgage servicer" hats, find it more profitable to foreclose than modify loans. And even when the banks sincerely try to modify loans, they often seem incompetent.
In early March, a settlement proposal surfaced claiming to represent what the 50 states' attorneys general think the big banks should do to fix the problems. Although not all of the AGs are in agreement yet – some think it's too harsh and others too weak – it was the first peek inside the settlement negotiations. The proposal mostly amounted to saying "thou shalt obey the law and not abuse borrowers." One term was "sworn statements shall not contain information that is false or unsubstantiated." That is, "Thou shalt not commit perjury."
Given how basic the term sheet was, it was hard to imagine how the big banks could make a good faith counter-proposal that was significantly weaker. And yet a recently leaked document shows they did.
The banks' counter-proposal, dated March 28th, rewrites the "banks can't commit perjury" term as the banks "shall implement processes reasonably designed to ensure the factual assertions made in…sworn statements…are accurate and complete…" and "sworn statements shall not contain information that is false or unsubstantiated in any material respect."
Translation: It's not perjury if we make a reasonable effort not to lie under oath and we don't consider the lie to be important.
What kind of lie in a sworn statement isn't "material?" What about a small detail, like the date? Well, consider documents Bank of America and Wells Fargo filed in a case brought by homeowners in Hawaii -- the securitized trusts trying to foreclose on the loans were supposedly given the mortgages before the trusts existed. Are those dates material?
Wells Fargo, responding to a request for comment, did not address the impossible date issue: "The borrowers lost their home following a protracted judicial foreclosure, the issues raised in their petition [i.e. the claim that documents were fraudulent] were argued and ruled upon by the courts twice already and the most recent petition was actually denied by the Hawaii Supreme Court on March 17." Bank of America (BAC) did not respond to a request for comment. The attorney for the homeowners, Gary Victor Dubin, disputes Wells Fargo's (WFC) characterization.
Bottom line: Wells filed a document to give a trust a mortgage before the trust existed. Would the banks' proposed settlement language make that okay?
Or perhaps the banks are suggesting that they could be wrong about precisely how much a borrower owes. If the borrower is in default, they might say, we're right to foreclose. Does it really matter if our math is precisely correct? Well, yes. For starters, the bad math might mean the borrower shouldn't be facing foreclosure.
For example, the Matthews family of Missouri would not be facing foreclosure if JPMorgan Chase (JPM) hadn't collected some $3,000 for an insurance policy the Matthews didn't need -- the Matthews already had insurance -- and if Chase's computer system would acknowledge the Matthews' payment should be $1,216, not the $1,611 Chase started charging to pay for the insurance.
When asked about the Matthews' account, a Chase spokesman responded: "The customer's account has been corrected, reducing the payment back to the proper amount, and we are reaching out to the customer to resolve the past issues. In the meantime we will amend her credit and remove foreclosure actions from her record." However, the Matthews countered that it remained unresolved.
Again, the bottom line: Chase's computer system had the wrong payment in place and that caused the Matthews to face foreclosure wrongly.
A mess of records
Like the language regarding perjury, the attorneys general and the banks have a different view of the banks' need to keep accurate records of what people owe. The attorneys' general term sheet says the banks "…shall maintain procedures to ensure the accuracy and timely updating of borrowers' account information…" The banks' counter offer again inserts the weasel words "reasonably designed," as in "procedures reasonably designed to ensure accuracy…"
One theme running through the banks' counter proposal is their unwillingness to be responsible for their employees' actions.
For example, the AG term sheet flatly says "Servicer's employees shall not instruct, advise or recommend that borrowers go into default in order to qualify for [a mortgage modification]." The banks' counter offer says "Servicer shall instruct its employees not to advise …"
Inserting that "shall instruct" is all about plausible deniability: Look, we told our employees not to tell borrowers to default, who cares if we were winking and nodding when we told them that?
Telling people to default before a modification can be considered is insidious, because it triggers many preventable foreclosures. As it is, during trial modifications when the borrowers promptly make the full, modified payment -- the only payment they're supposed to make -- the banks consider the payment late because it's less than the original amount, and charge a late fee. If the borrower is already three months delinquent when he starts the mortgage modification, the fees have grown so much that the borrower ends up in a big hole.
The bank then starts on the foreclosure path while considering the modification -- the so-called "Dual Track" -- and the borrower ends up foreclosed on.
I've spoken to many borrowers who were told to default. Most recently, I've been chatting with Joe, a homeowner in Georgia who works in the financial industry. Joe and his family have been struggling with SunTrust Bank (STI) since 2009. At that time, they wanted to refinance their house. The couple's credit was stellar, rates were low, they had a long and deep relationship with the bank, and they were willing to pay closing costs. Seemed like a no-brainer.
Unfortunately they owed more than the house was worth, so the bank wouldn't do the deal. Instead, in January 2010 the bank told him to seek a mortgage modification. When an appropriate program became available in July, Joe submitted his application package. But SunTrust didn't reply at all until December, and in January 2011, it told him he didn't qualify for a modification because he was still current on his mortgage.
Meanwhile, the family blew through their life savings. Joe's income was reduced, his wife fell ill and could no longer work, and her medications were expensive. But they stayed current on their mortgage through December 2010.
Despite that heroic effort to stay current, Joe is now facing foreclosure. The bank told him to default in January, and it's now made a modification offer that reduces his payment by a mere $250 a month -- not enough for him to be able to save his house, and half of what he could have saved by doing the 2009 refi. And if the refi had gone through, they would still have their life savings, and their credit would still be great.
Joe has asked SunTrust to explain its math in calculating what kind of modification he qualifies for, but it refused. The AG proposal would solve this problem, but the banks' counteroffer wouldn't. In fact, most recently, SunTrust demanded that Joe give it some $7,000 -- three months of trial payments. But SunTrust wouldn't tell him how the money would be applied, whether for fees, principal, or interest, until it decided -- if it decided -- at the end of that time to give him a permanent modification. Nor would it tell him what the terms of a permanent offer would be if it were made. SunTrust refused to put anything in writing. Joe wouldn't pay on that basis, of course.
Joe recorded his conversations with SunTrust, which he shared with Fortune. SunTrust said: "While we are not at liberty to discuss a specific client relationship or our internal policies and procedures, generally speaking we work with clients on a case-by-case basis regarding potential loan modifications taking into account investor guidelines and the fact that every situation is different."
The AGs must not lose sight of people like Joe, a former marine who served during the first Gulf War, and condemn troubled borrowers as unsympathetic "deadbeats." The banks are relying on that stereotype to carry the day for them.
If the banks won't deal, throw the book at them. Just like it's been thrown at baseball great Barry Bonds for his comparatively trivial alleged perjury. If we can prosecute Bonds but not the banks, what kind of country are we?
by Abigail Field CNNMoney.com April 7, 2011
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