Great Deal For Servicers But Lousy For Investors And Pension Funds

The government’s deal with banks over their foreclosure practices after 16 months of investigations is cheap for the loan servicers while costly for bond investors including pension funds, according to Pacific Investment Management Co.’s Scott Simon.

In what the U.S. called the largest federal-state civil settlement in the nation’s history, five banks including Bank of America Corp. (BAC) andJPMorgan Chase & Co. (JPM) committed $20 billion in various forms of mortgage relief plus payments of $5 billion to state and federal governments yesterday.

“This was a relatively cheap resolution for the banks,” said Simon, the mortgage head at Pimco, which runs the world’s largest bond fund. “A lot of the principal reductions would have happened on their loans anyway, and they’re using other people’s money to pay for a ton of this. Pension funds, 401(k)s and mutual funds are going to pick up a lot of the load.”

Asset managers are frustrated with the deal because, in addition to the debt the banks own, it gives credit to the lenders for changes to loans they hold no interest in and oversee for investors. That “treats people’s 401(k)s and pensions,” which hold mortgage securities, “like perpetrators as opposed to victims,” Simon said. Investment firm Angelo Gordon & Co. said yesterday that bondholders should consider banding together to protect their rights.

Protecting Investor Capital

The deal comes after all 50 states announced a probe into foreclosures in 2010 following disclosures of faulty documents used to seize homes, costing bondholders as liquidations of bad debt were delayed.

“Think about this, you tell your kid, ‘You did something bad, I’m going to fine you $10, but if you can steal $22 from your mom, you can pay me with that,’” Simon said yesterday in a telephone interview from Newport Beach, California.

Government officials say the costs will be “funded primarily by the banks, not third-party investors,” according to a statement posted yesterday on a website created for the settlement. The five banks will get different amounts of credit for various types of borrower aid, with loans in government- backed mortgage bonds exempted.

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