Homeowners who kept up on their payments would lose while those who fell behind would win under an apparent deal between big banks and state governments, banking analyst Dick Bove said.
The agreement, expected to be worth at least $26 billion, would compensate both victims of alleged foreclosure fraud and underwater homeowners whose debt exceeds the value of their properties.
While the agreement is being hailed in some circles as justice for those duped into buying overvalued homes, Bove, the vice president of equity research at Rochdale Securities, thinks the deal is misguided.
"Those people lucky or smart enough to stop making payments on their homes may get their loan balances reduced," he said. "Other beneficiaries of the agreement may be homeowners who have seen the value of their houses drop below the size of their mortgages. They get a freebie that other homeowners who have paid their mortgages down will not get."
Begun in 2010 as an investigation into foreclosure practices, discussion between state attorneys general across the country and the banks evolved into trying to find ways to help underwater borrowers as well.
The deal is believed to include some $20 billion in mortgage refinancings and principal writedowns to discourage struggling homeowners from walking away from their obligations.
But Bove, who called the agreement "the mortgage deal from hell," said doing so will help those who bought homes with little money down and who either fell behind on payments or stopped paying their mortgages altogether.
Those who brought down their principal with 20 percent down payments and who kept up on their obligations would not benefit, and ultimately could suffer if the mortgage modifications and principal writedowns drag down neighborhood property values.
"The government has selected a small minority of homeowners to get this benefit (1 million of 75 million or 1.3 percent of the total)," he wrote in an analysis. "Homeowners who made large down payments on their homes or made the terrible mistake to pay down the principal on their mortgages do not qualify. Homeowners who made minimal or no down payments will get the windfall benefit of a lower principal repayment or a cash payment."
The agreement appears headed towards approval with the last of the holdout states — California and New York among them — having signed on.
Principals involved hope the final tally for principal reduction actually could grow to $40 billion, even though Goldman Sachs economists recently estimated that the total homeowners helped could be just 520,000.
Inability to make benefits widespread enough to help the broader housing market have hindered the Home Affordable Mortgage Program, or HAMP, from being effective. Originally designed to assist up to four million homeowners, actual refinancings have been closer to one million.
In the meantime, banks have had to take billions in writedowns to account for an anticipated settlement from the foreclosure cases. Investigators charge that banks used so-called robo-signers — employees who processed foreclosures rapidly, often under fraudulent circumstances — to clear the huge backlog of cases.
"It is important to note that the government is not alleging that the banks took homes away from homeowners who were making payments," Bove said. "Nor is the government arguing that the banks profited from these foreclosures. The basis of offering the benefit to the 1.3 percent winners in this lottery is that the government is unhappy about the way the foreclosures took place."
As a practical matter, Bove said the institutions involved — Bank of America , JPMorgan Chase , Wells Fargo , Citigroup and Ally Financial — likely won't suffer any more material losses as they already have set aside cash or written down mortgages in anticipation of the settlement.
However, he said the precedent is disturbing.
"There is no sanctity of contracts in the United States," Bove said. "Only fools meet their financial commitments. The non-payers are the truly enlightened."