FDIC's Loss-Share Agreement Scam is killing America

Noelle Nikpour of the Sun Sentinel wrote in November 2011 of issues involving "Loss-Share" agreements with banks buying the assets of failed banks.  

In essence the Loss-Share agreements insure the loans acquired by the purchasing bank, but require prudent business judgment in the treatment of the loan.  In other words, if the loan were in the bank's own portfolio, it must treat the insured loan in the same manner.  Many banks write a portion of a loan down so as to keep a performing loan, to prevent taking back a burdensome and costly property, and to otherwise cut losses to a minimum.  That is prudent business.  Why take back property that you have to maintain, pay taxes on and try to sell or lease?  You don't if the buyer can pay on better terms.  You change rates, extend amortization schedules, waive interest, or even hold some principal in abeyance to keep the borrower on the property as they are in the best positions to be hands on and run the property.

Not with Share-Loss agreements.  The bank just takes the loan, goes through the motions and collects its money from the FDIC.  What is disturbing is that some banks have used TARP funds to purchase the assets of troubled banks for the sole purpose of collecting on the FDIC money.  This is the equivalent of insurance fraud.   

As Noelle wrote:

The FDIC uses loss-share agreements to encourage lenders to buy the loan portfolios of failed banks. The loans are sold at discounts of up to 65 percent and deals are "sweetened" with loss protection guarantees of up to 95 percent (including legal fees). "Losses," however, are not based on the discounted price paid for the loans, but on their original value.

For instance, let's say the FDIC transfers a $350,000 home loan to Bank A at a 30 percent discount ($245,000) with a 90 percent loss-share guarantee. Bank A then sells the home at foreclosure for $150,000. According to the FDIC, Bank-A's "loss" is $200,000 ($350,000 minus $150,000) and a check for $180,000 is cut to cover 90 percent of the "loss."

With sale proceeds of $150,000 and loss reimbursement of $180,000, Bank A just made $85,000 by foreclosing on an American family with taxpayers paying the expenses and much of the profit.

If a lender can make $85,000 by foreclosing without regard to costs, there remains little incentive to deal with the uncertainty and negotiating pains of a short sale and zero incentive to modify loans. In other words, the exploitation of loss-share turns traditional collection practices upside-down.

Loss-share agreements do strive to prevent exploitive tactics as lenders are permitted only to incur expenses with the same degree of care that would be exercised in the absence of FDIC protection. The unscrupulous lender, however, exploits the lack of contractual oversight and pursues foreclosure even when costs and risk would dictate the pursuit of a short sale or loan modification.

This abuse is harming families and depressing real-estate markets as conventional sellers are forced to compete with an artificially high foreclosure rate, which results in artificially low sales prices. Unless these practices are exposed and the unintended consequences of loss-share are addressed, the problem is going to get worse.

Between 1991 and 1993 the FDIC entered into 16 loss-share agreements. By 2009, the number jumped to 94. Today, 269 loss-share agreements guarantee losses of $160 billion. Many banks have been paid hundreds of millions, and some have received more than $1 billion from the FDIC.

With payouts expected to exceed $21 billion by 2014 and an FDIC insurance fund balance of negative $20 billion, one wonders where money will come from.  Perhaps the FDIC will crack down on exploitive lenders or maybe they will simply draw on their$500 billion line of credit from the U.S. Treasury, also known as the U.S. taxpayer.

You can follow Noelle on Twitter at @noellenikpour, and communicate with her at letters@sun-sentinel.com.