The $25 billion mortgage-abuse settlement between the states and five top banks that was announced Thursday won’t solve the nation’s housing crisis. Far from it.
It will not restore the housing market. The money involved is a fraction of the amount that would make a dent in that.
It will not provide direct assistance to the vast majority of distressed homeowners. Most owners aren’t eligible for its most valuable provision ― principal reduction ― because loans guaranteed by the government-controlled Fannie Mae and Freddie Mac are excluded from the deal.
This settlement engineered by the attorneys general in 49 of the 50 states picks winners and losers. Among people whose homes are worth less than they owe ― “underwater” homeowners ― it favors those who aren’t paying their mortgage on time over those who are. So about 1 million owners will see the amount of their loans reduced by an average of $20,000. More than 90 percent of underwater homeowners won’t be helped at all.
There is less here than meets the eye.
The architects of this settlement give the impression that something truly game-changing has occurred. Keep in mind, however, that the agreement stems from a relatively minor chapter in the mortgage mess. The original impetus was to hold banks to account for engaging in robo-signing.
During the mortgage boom and bust, financial-industry workers cut corners by signing thousands of documents without verifying the information. That was a shamefully sloppy business practice, and it tainted mortgage loans coast-to-coast. Bad as it was, however, it was a mere handmaiden to the easy credit and eager borrowing that led to financial disaster. Robo-signing marred the foreclosure process at the heart of the settlement. But by itself, it didn’t cost anyone his or her home and savings.
It is remarkable that the attorneys general managed to squeeze $25 billion out of a rather dry stone. They got far more from the banks than any reasonable estimate of the actual damage done by the specific practice they initially targeted.
The key part of Thursday’s settlement is up to $17 billion set aside for principal reduction and other loan modification relief nationwide.
Some advocates for distressed borrowers consider principal reduction the most effective method to help people who are at risk of losing their homes. A lender agrees to reduce the amount of an outstanding mortgage loan. So instead of owing $100,000 on a house, a borrower might owe $80,000. The difference is simply written off by the lender. That reduces the monthly payment and gives the owner greater ability and incentive to stay and pay off the mortgage.
Banks can modify loans in more than one way: They can give a borrower 40 years to pay instead of the traditional 30, for instance, or reduce the interest rate. Both those steps result in lower monthly payments. Banks also can give forbearance, suspending monthly payments for a time on part or all of a loan. There are different options available to avoid throwing people out of their homes who have a reasonable chance of hanging in there if they can get a break.
The limited scope of this deal is likely to draw complaints about fairness. A small number of winners, and not necessarily the homeowners who have the greatest claims that they were victims of banks.
The proponents hope that this solution will snowball. The structure of Thursday’s deal gives banks a special incentive to favor principal reduction ― and not by accident. The attorneys general, including Illinois’ Lisa Madigan, expect that as additional principal reductions occur under terms of the deal, lenders will become more comfortable offering them on loans outside the settlement’s scope.
Up to now, for many lenders, principal reduction has been a last resort. This deal seeks to prove that it should be a more routine practice. Madigan and her peers across the country evidently want Fannie and Freddie to follow suit.
By itself, this deal is no game changer. Its reforms to mortgage servicing standards, in particular, strike us as too little, too late. It does have the potential to punch beyond its weight, but no guarantees. We’re skeptical that principal reduction should be favored over other forms of modification.
The nation needs to work off excessive mortgage loans that continue to slow the economic recovery. This settlement will help, but only on the margins.
