Deutsche Bank, the DOJ and how $4B in aid to distressed homeowners evaporated

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In the waning days of the Obama administration, Deutsche Bank made a series of unusually frank admissions in a U.S. court filing.

The German bank acknowledged that during the housing boom it made intentionally false representations to buyers of its mortgage-backed securities, concealing the actual risks from purchasers of the bonds. It lied, for example, about borrowers’ credit scores. It also lied about the amount of equity that borrowers held in their homes.

Banks typically do not fess up to deliberate wrongdoing, and when they do, their language is usually more equivocal than it was here. So the Department of Justice, which extracted the confession, took credit.

“Our settlement today makes clear that institutions like Deutsche Bank cannot evade responsibility for the great cost exacted by their conduct,” Attorney General Loretta Lynch said in a January 2017 press release.

The Justice Department also said that the $1.77 trillion-asset bank had agreed to pay $7.2 billion, more than half of which would come in the form of aid to consumers who were harmed by its misconduct. “Specifically, Deutsche Bank will provide loan modifications, including loan forgiveness and forbearance, to distressed and underwater homeowners throughout the country,” the DOJ’s press release stated.

But that claim, like many statements that Deutsche made to mortgage bond investors a decade earlier, proved to be false.

The multibillion-dollar settlement did not actually require Deutsche to offer any loan modifications; they were merely one option on a menu of choices available to the bank. And after initially pledging to provide modifications, Deutsche Bank recently backed out of that plan, saying that it would instead fulfill its settlement obligations by financing new mortgages, some of which have gone to wealthy borrowers.

So far, Deutsche has received $1.5 billion in credit for new mortgage originations. These loans — ostensibly made for consumer relief purposes — do not need to have any connection to the borrowers who were harmed a decade ago. The homebuyer merely has to reside in one of 18 U.S. states in which more than half of the nation’s population lives in order for Deutsche to receive credit.

Critics of Deutsche Bank say that many distressed homeowners would be able to stay in their homes if their monthly payments were lower or their loan principal were reduced and that the bank is doing nothing to help them.

“The thing that was most needed is the thing that they seem to be walking away from,” said Kevin Stein, deputy director of the California Reinvestment Coalition.

The Department of Justice, which did not respond to requests for comment, claimed in 2017 that its settlement with Deutsche would provide $4.1 billion in consumer relief. But the agreement is now expected to provide no assistance to homeowners who are struggling to pay their mortgages.

The bank’s about-face serves as a fitting coda to President Obama’s foreclosure prevention efforts, which failed to stem the sharp nationwide increase in vacant homes. It also illustrates how one particular Obama-era program was creatively repurposed by lawyers, who found a way to give banks settlement credit for funding new mortgages that likely would have been made anyway.

‘Deutsche’s conduct was among the worst'

On the eve of the financial crisis, Deutsche Bank was the world’s third-largest issuer of residential mortgage-backed securities. The bank later admitted that it knew the U.S. housing market was on the verge of collapse even while it was injecting tens of billions of dollars into the sector.

Deutsche’s list of confessed misdeeds was long. The bank knowingly misrepresented to investors that mortgages had been reviewed to ensure borrowers’ ability to repay them. It intentionally securitized loans that were originated based on fraudulent appraisals. And it knowingly disregarded evidence that significant numbers of loans would not comply with the bank’s representations to investors.

The bank’s motive was simple: There was a lot of money to be made as long as the housing boom continued. In 2006, a supervisor in Deutsche’s due diligence department predicted that the mortgage machine would keep whirring until rising defaults began affecting profits.

“I can say very clearly that Deutsche’s conduct was among the worst,” said a former federal prosecutor with direct knowledge of the case. “We took the view that their conduct was pretty egregious. They had to be held accountable for it.”

The Justice Department investigated the mortgage securitization practices of numerous big banks in the wake of the financial crisis, and subsequent negotiations led to settlements with varying punishments. During the Obama administration, they typically included a mix of fines and so-called consumer relief, which gave the banks monetary credit for taking steps to help homeowners.

Since President Trump took office, banks accused of bad conduct before the financial crisis have not had to provide any redress to consumers at all. Mortgage bond settlements reached last year with Barclays Capital, HSBC, Nomura, Royal Bank of Scotland and Wells Fargo did not include consumer relief provisions.

In the Deutsche case, negotiations heated up in 2016. That September, the bank confirmed that the Justice Department was seeking a $14 billion settlement, while also stating that it had no intention to resolve the claims for anywhere that amount.

The German lender was facing pressure to resolve the matter quickly, as market concerns swirled about its ability to absorb a massive settlement.

But a couple of subsequent developments appear to have weakened the DOJ’s hand. First, Donald Trump was elected president, which seemed to portend that more industry-friendly officials would soon be installed at the Justice Department.

Second, the settlement talks raised the uncomfortable possibility that a large penalty could wipe out most of the bank’s capital cushion. In September 2016, Deutsche’s market capitalization was around $18 billion.

German Chancellor Angela Merkel’s government denied that state aid was a possibility, but the bank’s precarious financial condition gave her administration a stake in the outcome of the U.S. talks.

On Dec. 23, Deutsche announced that it had reached a settlement in principle with the Justice Department, which included a $3.1 billion civil money penalty and $4.1 billion in consumer relief. “The consumer relief is expected to be primarily in the form of loan modifications and other assistance to homeowners and borrowers, and other similar initiatives to be determined,” the bank stated.

In earlier settlements, the Justice Department had allowed banks to get some credit for originating new mortgages, but it had also established minimum thresholds for loan modifications.

For example, JPMorgan Chase was required under a 2013 settlement to obtain at least $2 billion in credit for modifications that included either principal write-downs or forbearance. The following year, a DOJ settlement with Bank of America established a $2.15 billion minimum for modifications that provided first-lien principal reductions.

By contrast, the Deutsche Bank settlement included no minimum requirement for loan modifications. If the bank so chose, it could fulfill all of its purported consumer relief obligations by financing new loans to any homebuyer in California, Florida and other states designated as hardest-hit areas.

‘Things did not need to be this bad’

Even before he took office as president, Barack Obama was feeling political pressure to provide substantial aid to borrowers who were on the verge of losing their homes. The law that authorized a $700 billion bank bailout — passed just a month before Election Day — had not earmarked any money for homeowners.

Within weeks of Obama’s inauguration, the Treasury Department set aside $75 billion in bailout funds to encourage loan servicers to modify distressed borrowers’ mortgages. The plan was touted as a way to help 3 million to 4 million at-risk homeowners by reducing their monthly payments.

“By making these investments in foreclosure prevention today,” Obama said in a speech announcing his plan, “we will save ourselves the costs of foreclosure tomorrow.”

But Treasury proved unable to get the money out the door quickly. One year later, only 169,000 loan modifications had been finalized, which was fewer than the number of homeowners who were receiving foreclosure notices each month.

“Things did not need to be this bad,” Julia Gordon, a Washington-based housing advocate, testified in 2010. “If the Bush administration had moved quickly back in 2007, or if the Obama administration and Congress had acted more forcefully in early 2009, we could have significantly limited the breadth and depth of the foreclosure crisis.”

In February 2010, the Obama White House tried another approach, allocating $1.5 billion to state housing finance agencies in California, Florida, Arizona, Nevada and Michigan. The Hardest Hit Fund later grew to $9.6 billion, as 13 more states plus the District of Columbia became eligible to receive money.

The program was meant to encourage state-level experimentation in foreclosure prevention, but it’s been plagued by episodes of mismanagement. A government watchdog in 2016 and 2017 identified $11 million in wasteful and unnecessary spending that included a Mercedes Benz lease, employee parties, free parking for employees and gym memberships.

“Ultimately every misused dollar is one less dollar for homeowners,” Christy Goldsmith Romero, the special inspector general for the Troubled Asset Relief Program, testified at a May 2018 congressional hearing.

The Hardest Hit Fund had been created to provide funding to states that suffered large home price declines and high unemployment rates. But eventually the "hardest hit" designation was seized upon by lawyers who were negotiating multibillion-dollar settlements between banks and the federal government.

The settlements enabled banks to earn credit for making new mortgage loans to borrowers in hardest-hit places, regardless of the particular borrowers’ economic circumstances. Under the early agreements, eligible loans were restricted to specific distressed census tracts, and the amount of credit that banks could get for those loans was capped.

One example was JPMorgan Chase’s November 2013 settlement over pre-crisis mortgage securities. Of the $4.06 billion in consumer relief credit that was eventually granted under that settlement, 17% was for loans to borrowers in hardest-hit areas, while 42% was for loan modifications that included principal forgiveness.

‘The change in plans … may disappoint distressed homeowners’

But then came the Deutsche Bank settlement. Under that agreement, in order to be eligible for hardest-hit credit, new loans did not have to be targeted to specific census tracts.

So new loans to borrowers in posh parts of San Francisco, Palo Alto and Santa Monica were eligible for credit — since California was one of the 18 states designated by the federal government as hardest hit. The same was true for pricey suburbs such as Wilmette, Ill., Short Hills, N.J., and Lake Oswego, Ore.

Wealthy borrowers with high-priced mortgages were also eligible. Last year Deutsche sought credit under the settlement for loans as large as $982,000. The borrowers reported as much as $500,000 in annual income.

After the settlement was reached, Deutsche took preliminary steps toward providing loan modifications. The bank, which has virtually no direct involvement in the U.S. mortgage servicing industry, entered into financing arrangements with two loan servicers.

But then the bank reversed course, informing the lawyer who is charged with monitoring its compliance with the settlement that it planned to satisfy its entire $4.1 billion obligation by financing the origination of new mortgages. Under the settlement, Deutsche gets credit of $10,000 to $11,500 for each eligible mortgage that it finances.

“The bank’s strategy of focusing solely on new loan originations is permitted by the agreement,” the monitor, Michael Bresnick, noted in a report published in February. “The change in plans, however, may disappoint distressed homeowners and others, including the many individuals who have reached out to the monitor over the past two years, hoping to receive different types of consumer relief from the bank.”

Bresnick declined to comment for this article.

A Deutsche spokesman declined to say what prompted the bank’s reversal. In a written statement, the bank said that its consumer relief program has provided financing to more than 190,000 homeowners.

“As reported by the monitor, we have decided to focus our efforts on helping people purchase homes as the most efficient and effective way of delivering consumer relief given current market conditions and our financing expertise,” the bank’s statement read.

Of the $1.5 billion in consumer relief credit that Deutsche has received, more than half of that amount has been for loans to borrowers in hardest-hit states. The bank also gets credit for financing loans to first-time low- and moderate-income homebuyers in any state.

Data about the mortgages that Deutsche submitted for credit in the second and third quarters of 2018 suggest that many were the kind of plain-vanilla loans that can usually find funding in the market.

The vast majority of the Deutsche loans were 30-year fixed-rate mortgages. All of them met credit underwriting criteria established by Fannie Mae, Freddie Mac, the Federal Housing Administration, the Department of Veterans Affairs or the U.S. Department of Agriculture.

Nationwide housing prices have risen by 53% in the last seven years, according to the S&P/Case Schiller index. But the recovery has been uneven, with high levels of underwater mortgages still dogging many low-income and minority communities.

During the fourth quarter of last year, 18 mortgages were either seriously delinquent or in the foreclosure process for every one mortgage that was modified, according to data collected from seven large banks by the Office of the Comptroller of the Currency.

By deciding not to offer loan modifications, Deutsche Bank is putting its own interests ahead of what is best for consumers, said Scott Astrada, director of federal advocacy at the Center for Responsible Lending. He compared the German bank’s decision-making to its bad conduct before the housing crisis.

“I think it was the same kind of mentality — in a different context — that was the whole problem in the first place,” Astrada said.