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What Is This Mortgage Settlement Anyway?

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Mike Kemp | Getty Images

Has anyone figured out what this mortgage settlement floated in the Wall Street Journal today is supposed to be?

Here’s how it is introduced in the WSJ:

The Obama administration is trying to push through a settlement over mortgage-servicing breakdowns that could force America's largest banks to pay for reductions in loan principal worth billions of dollars.

Terms of the administration's proposal include a commitment from mortgage servicers to reduce the loan balances of troubled borrowers who owe more than their homes are worth, people familiar with the matter said. The cost of those writedowns won't be borne by investors who purchased mortgage-backed securities, these people said.

If a unified settlement can be reached, some state attorneys general and federal agencies are pushing for banks to pay more than $20 billion in civil fines or to fund a comparable amount of loan modifications for distressed borrowers, these people said.

I can kind of squint at those words and see an attempt to do something truly constructive: instead of issuing a fine—whose revenues would go to the US government—for foul play in foreclosures, the government would require mortgage lenders to forgive billions of dollars of principal in mortgages.

This could bring many borrowers out from underwater on their mortgages. That’s very important because the fact that so many borrowers are underwater is contributing to a lot of economic stagnation. Many homeowners cannot refinance because banks are loathe to make new loans when the loan-to-value ratio is upside down. They cannot sell their houses because they cannot afford to pay off the difference between the sale price and the mortgage overhang. This means workers cannot move to find new jobs, increasing the unemployment problem.

Felix Salmonis cautiously optimisticabout the settlement proposal.

On the other hand, Yves Smith at Naked Capitalism is calling it “HAMP 2.0”—named for the Obama administration’s first—failed—attempt at getting banks to modify mortgages. Indeed, it seems that the loan modification program in the settlement would rely on banks to administer it—exactly the same sort of thing that failed so badly in HAMP.

Joseph Mason, a professor of banking at Louisiana State University and a senior fellow at the University of Pennsylvania's Wharton School, also thinks the program will fail. He points out on the editorial page of the WSJ that roughly half of those borrowers who obtain mortgage modifications become delinquent again in six months. The problem is that “loan modification programs cannot help borrowers without means,” Mason writes.

My worry is different. I’m afraid this is really an attempt by banks to get off easy. We do not know what the settlement is supposed to include. But if it includes, for instance, amnesty from put-back claims from investors in mortgage-backed securities, this could be a huge giveaway to the banks. I’ve been saying for months that I accept the government would attempt to avert a put-back apocalypse with some sort of legal forgiveness. Is this it?

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