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A Highly Unjust Mortgage Settlement

Whatever justice may appear to have resulted from banks shelling out a few billion dollars, it should not come at the expense of those mortgage investors or taxpayers who did nothing wrong or the economy at large.

It's a tale of political extortion Hollywood couldn't write and one your neighborhood association wouldn't believe:  

Three families buy identical homes all on the same block in the summer of 2005. The Andersons put 20 percent down, the Bakers 3 percent, and the Carters get a 105 percent loan-to-value mortgage so they can have some cash to go on family vacations. By 2008, after housing prices collapsed, the Carters stop making payments because they didn't want to "throw their money away" on a home that has high negative equity. Though their bank is justified in foreclosing, the mortgage servicer gets sloppy with the paperwork and robo-signs the foreclosure notice, along with a slew of others.  

Four years later a group of states attorneys general win a battle against these mortgage servicers with a settlement agreement that awards the Carters a $2,000 check from their bank because it skirted the law via robo-signing tactics. Curiously, the same settlement offers to reduce the principal of the Bakers' underwater mortgage by $22,000. The Andersons still have to pay the full amount of their mortgage though, since the equity they put into their home means the value of their home is worth more than they still owe on the mortgage.

And this is the process that the Department of Housing and Urban Development says is holding banks "accountable."

It is not just a hypothetical, it is a very real representation of the $26 billion mortgage settlement reached two weeks ago between state attorneys general, federal regulators, and the nation's top five mortgage servicers.

The obvious question is: why did the Bakers get money for their mortgage via the Andersons' pension fund, especially when it was just the Carters who had their foreclosure processed incorrectly?

The answer boils down to the fact that the mortgage settlement was nothing more than political extortion.

Only six percent of the $26 billion settlement has been set aside to provide restitution to households that were robo-foreclosed on. The rest of the settlement is a mix of political favors, like mortgage modifications and refinances. Playing the part more of headline seeking politicians than defenders of the public, the attorneys general sought after a large sum of unrelated, politically controversial housing ideas to pad their bottom lines as they attempted to create the illusion they were doing something to help the housing market.

But rather than helping the housing market, all the attorneys general wound up accomplishing was pushing aside justice in lieu of political grandstanding.

The mortgage settlement lacked what should have been basic procedure for investigating claims of misconduct at financial firms. There should have been evidence collected, executives deposed, the facts presented, and restitution paid to those who were wronged.

But this did not happen in any meaningful sense - only a "small number" of cases were found where robo-signed foreclosure notices were served on households making their payments. And had the attorneys generals' case against mortgage services been taken to court, there would have been little evidence to persuade a judge or jury that $26 billion payout was due.

This is not to suggest that banks should not be held responsible for breaking the law in signing off on foreclosures without review. But the nature of the investigation acted as if the foreclosing on homeowners in default was itself a crime.

Preliminary documents from the settlement suggest that foreclosed homeowners won't even have to prove they were robo-signed. As long as you were foreclosed on between 2008 and 2011 by one of the five mortgage servicers in this agreement, then you can apply to get a check.

That is a pretty wide scope for providing justice to those "wronged" and needing restitution. But if the AGs had stopped there, this deal may not have been so bad. Instead the settlement pushed for principal modifications and forced refinancing ofmortgages.

These ideas are, obviously, highly controversial. There is no definitive proof that principal write downs provide a net benefit, and substantial evidence suggests that a majority of principal modifications merely delay foreclosure (just look at the quarterly reports from the TARP inspector general on the effectiveness of HAMP which can currently claim only a 42 percent success rate).

And even if modifications and refinancings were somehow related to robo-signing, the deal would have an ironic sense of justice since mods and refi costs are typically borne by the underlying mortgage-backed security investor. How is transferring money from mortgage investors - pensions, insurers, 401(k)s - to homeowners underwater providing justice to robo-signed victims? Imagine our fictional Bakers getting their principal write-down paid for by the Anderson's pension fund!

The mortgage settlement also failed to address all mortgage liability claims pending against the banks. Ideally this agreement would have been narrowly focused on just the robo-signing issue, but since the scope was broadened the deal could have at least dealt with all claims associated with origination deception, mortgage note mishandlings, and fraudulent fees. This would have allowed banks to move forward faster with foreclosures, liquidating properties, and cycling the new capital back into new mortgage lending instead of being tied up in zombie loans.

Instead, the foreclosure process is still uncertain, the housing market bottom is blocked off, and attorneys general are promising more lawsuits to come.

Since the settlement has yet to be approved by a judge, it is still possible this "landmark" deal could be dismissed. The arbitrary $2.5 billion slush fund state attorneys general got in the deal should be grounds enough for a judge to reject this (ala Jed "Dread" Rakoff). The unjust treatment of mortgage investors being linked to a non-germane robo-signing case is even more substantial grounds for refusal.

The fact that the deal hurts the economy by continuing to drag out the foreclosure crisis and keep the housing market in legal limbo is the knockout punch. Whatever justice may appear to have resulted from banks shelling out a few billion dollars, it should not come at the expense of those mortgage investors or taxpayers who did nothing wrong or the economy at large.

Anthony Randazzo is the Director of Economic Research at the Reason Foundation. This article first appeared at RealClearMarkets.com on February 23, 2012. 

Anthony Randazzo is Director of Economic Research





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