Mortgage Crisis

Not only does the foreclosure deal add up to peanuts compared to the $350 billion tobacco settlement, but it also pales before the size of the problem that it is theoretically supposed to address. The amount of negative equity held by Americans in their homes is currently calculated at around $700 billion. As a result of the foreclosure settlement around 750,000 Americans who lost their homes to foreclosure will receive checks of around $2,000 and another million homeowners will see the size of their outstanding loans reduced by an estimated average of around $20,000. Sure, any additional stimulus will be sorely appreciated in today’s demand-constrained U.S. economy, but a $2,000 check isn’t going to make up for a foreclosed home, and it is silly to think the banks will feel more than a slight pinch. The banks have already reserved enough capital to cover the checks that they are going to have to cut (around $5 billion). Compared to the damage caused to American families by both the financial crisis and the rush to foreclosure, the banks are getting off easy.

Obama may be technically correct to say that the settlement “will deliver some measure of justice for some families who have been victims of abusive practices,” but it’s wrong to treat the news as any kind of real payback for bank misdeeds. It’s just nibbling around the margins.

So is it a sellout — “another raw demonstration of who wields power in America,” as Naked Capitalism’s Yves Smith, — undoubtedly the harshest critic of the Obama administration on housing policy and bank reform — argues? That’s a little harder to say, and a lot depends on the future course of events.

Some defenders of the settlement are arguing that the size of the deal is smaller than it might otherwise be because the government has retained the right to sue the banks for a wide variety of mortgage-related bad behavior stretching beyond the fraudulent processing of foreclosure paperwork at the heart of this deal. In particular, the states attorneys general of New York and California can continue their own separate investigations. As Felix Salmon writes, “other big-money lawsuits over securitization can and almost certainly will still be brought — which means that the big banks all still have significant litigation risk hanging over their heads.” As if to punctuate this point, on Wednesday night, the Wall Street Journal reported that federal regulators plan to sue some of the largest banks on charges of fraud related to the dodgy securitization of mortgages in 2007 and 2008.

The proof of this theory will only come when we see how hard the Obama administration and states like California go after the banks in the future. Given the track record of this administration, that may be doubtful. (Although, it may be worth noting that at least one conservative critic of the settlement, Douglas Holtz-Eakin, bases his critique precisely on the fact that banks still can’t put the whole crisis behind them. The administration can’t leave well enough alone, complains Holtz-Eakin, or “resist the political temptation to rouse its base with finger-pointing and lawsuits.”)

A more interesting question to consider, however, is how the housing relief contained in this settlement fits into other administration housing policy efforts currently in the works.

First off, government negotiators are still working on roping another nine mortgage providers into the deal, which could raise the overall settlement total from $26 billion to around $40 billion. In March, the rejiggered HARP refinance program will kick in, presumably allowing hundreds of thousands of homeowners to refinance at currently rock bottom mortgage rates. There is also strong pressure coming from the Federal Reserve and the White House to convert currently unoccupied foreclosed homes owned by the Fannie Mae and Freddie Mac into rental properties, a step that would remove excess inventory from the housing market.

Each individual nibble here is unlikely to make a profound difference, but taken together, all these initiatives add up to the most concerted effort the Obama administration has taken to date to bring relief to the housing sector. It’s also worth noting that it’s all happening without any help whatsoever from Congress. The approach does not address the desire for punishment that so many would like to see meted out upon the banks, but it will likely help spur additional economic growth. At a point when the economy already seems to have solid momentum toward recovery, every extra bit of help is gravy.

These securities were sold pursuant to registration statements, including prospectuses and prospectus supplements that formed part of those registration statements, which contained materially false or misleading statements and omissions. Defendants falsely represented that the underlying mortgage loans complied with certain underwriting guidelines and standards, including representations that significantly overstated the ability of the borrowers to repay their mortgage loans.

To most people who have followed the mortgage crisis closely from the beginning, the FHFA would seem to have a slam-dunk case. As Felix Salmon pithily summarizes: “These banks lied to investors when they put together mortgage securitizations.” The evidence is simply overwhelming — the only real question here is why the government hasn’t moved more quickly to call the banks to account.

But listen to the industry response! Paul Miller, a former bank examiner now working as an analyst for FBR Capital Markets & Co., declared in a research note that it was time to “stop punishing banks.” Demanding that the banks make restitution for the losses would hurt the economy, he argued.

The Federal Housing Finance Authority is “reacting in their own self-interest as opposed to that of the broader U.S. economy,” Miller wrote. Their claims “drain capital from the banking system, and they cause banks to overly tighten credit standards, which pushes potential home buyers onto the sidelines.”

Securities analyst Richard Bove warned that the lawsuits proved that the U.S. government “is committed to breaking up the banking industry.”

The audacity! Talk about your all-purpose, gilt-edged get-out-of-jail-free cards! The U.S. government should refrain from punishing the malefactors who brought down the economy, because doing so would negatively hamper the economy! And even better, the Obama administration, which helped to inspire Tea Party anger and alienated its own left-wing base by moving heaven and earth to keep the banking industry intact, is now supposedly “committed” to breaking up the banking industry.

If only!

The economy argument simply doesn’t hold water. First of all, banks have already tightened their credit standards and are reluctant to make loans. If they wouldn’t make loans when their profits were high, the government needn’t worry over much about the effect that draining more capital from the banking system might have. But secondly, there is no way that legal action on this scale will be resolved in any kind of short-term time frame. Goldman Sachs, Citigroup and Bank of America will have access to the best legal teams money can by, and any resolution will likely take years, by which point, one hopes, the economy will be on sounder footing, and the banks will be able to pay their fines without causing undue economic sabotage.

And then there’s the reasoning offered by FHFA itself, in a note released Tuesday clarifying the rationale behind the suits:

Some have claimed that these suits will disrupt economic recovery, or endanger the targeted banks, or increase their cost of capital. While everyone is concerned with these important issues, the long-term stability and resilience of the nation’s financial system depends on investors being able to trust that the securities sold in this country adhere to applicable laws. We cannot overlook compliance with such requirements during periods of economic difficulty as they form the foundation for our nation’s financial system. Therefore, through these lawsuits, FHFA turns to the courts to adjudicate the violations that it has alleged in its complaints.

Of course, it’s probably also worth noting that nothing particularly economically advantageous is likely to happen, in the short term, as a result of the FHFA’s move, aside from some modest deficit-reducing benefits in the event that some of the losses the government was forced to eat bailing out Fannie Mae and Freddie Mac are offset by any restitution from the banks.

Which brings us to one final observation. Could this have been managed any less effectively, from a political point of view? After bailing out the banks, and becoming widely perceived as more concerned about Wall Street than Main Street, the feds waited three years to aggressively confront the banking industry, and then buried the news of their action on a Friday before a three-day weekend. More people probably remember the score of a college football game played Saturday than what the FHFA did on Friday.