John Vogel is an adjunct professor at Dartmouth's Tuck School of Business.
$26 billion is a big number. If the five banks who settled with the State Attorneys General would write a check for that amount and give it to someone as smart as Shaun Donovan, the secretary of Housing and Urban Development, I am confident that he could find ways to help homeowners and stabilize the housing market. Unfortunately, that $26 billion does not come in the form of a check and is largely an illusion.
Most of the settlement comes from banks promising to modify existing mortgages. In a typical example, the bank might have a mortgage on its books for $200,000 for a house that is now worth $150,000. Were they to sell that mortgage to an investor, the investor would probably pay them less than $150,000 for that mortgage. In fact, the bank has probably set aside a $60,000 reserve against that mortgage to account for the fact that it is only worth $140,000. What the settlement requires the bank to do is go back to the homeowner and offer to reduce the principal on the mortgage from $200,000 to $180,000.
From the bank's perspective, offering to reduce the mortgage balance by $20,000 might be a sensible thing to do whether they were required by the settlement agreement to do it or not. If the homeowner pays the mortgage under this modified agreement the bank comes out $40,000 ahead. If the homeowner defaults under the modified mortgage, the bank is no worse off than they were before they modified the loan.
Multiply this $20,000 loan modification or principal reduction by a million homeowners and you have $20 billion. The government can claim that they received a big settlement from the banks and are doing something about the housing crisis. However it is hard for me to see how this $20 billion will do much for anyone other than make the revised mortgages a bit closer to what they are actually worth.
The other part of the settlement is even worse. Robo signing is a nice euphemism for fraud. People signed documents using names that were not their own and attested to things they had not done. The settlement says that the penalty for committing fraud is that about 20 percent of the people who lost their homes will get a $2,000 check. If the goal is to stop corporate fraud, one probably needs to do more than impose a $2,000 fine.
The housing crisis continues to be a drag on the economy, a tragedy for the millions of families who have lost their homes and a blight on communities across the country. Solving this problem will not be easy or painless. What is disheartening about this settlement is that it is a distraction and promises more than it can deliver.