The Mortgage Settlement Is Fine

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When people who hate banks and love homeowners are full of wild rage about this here mortgage settlement, and when people who love banks and hate homeowners are full of equal and opposite rage, that is pretty good evidence that the mortgage settlement is sort of meh and compromise-y and not that interesting, so let's not talk about it. Oh, fine, let's. You could go read all sorts of explanations and FAQs and diagrams and "top n things to know" (n = 3, 5) but I will give you a list of only one most important thing to know about it, which is that it will not reduce my mortgage so it's all just noise. When will politicians start sticking up for me?

There is one sort of interesting thing that is probably most cogently explained here:

[Twenty of the $26bn nominal settlement amount is] to come in the form of $3 billion in refinancings and $17 billion in principal reductions, deeds in lieu, short sales, anti-blight measures, etc. The banks receive variable credit for these actions, depending on whether these measures are taken for loans owned by the banks or owned by others and serviced by the banks. Basically, it’s full credit if the bank owns the loan, and half credit if the bank merely services the loan. Because of this formulation, the $17 billion in principal reductions, DILs, short sales is anticipated to result in $32 billion in actual relief. In other words, it is expected that the banks will modify the loans owned by others rather than the loans they themselves own. And when a second lien loan owned by the bank is involved, it only has to be written down pari passu (at the same percentage) as the first lien loan. So from absolute to relative priority, which is a major handout to the big banks, which have large underwater second lien positions.

Or put differently, $32 billion of the settlement is being financed on the dime of MBS investors such as pension funds, 401(k) plans, insurance companies, and the like—parties that did not themselves engage in any of the wrong-doing covered by the settlement.

Here is a math problem. If you came to me and were like "I will give you one gold star for every dollar that you take out of your wallet and light on fire, and I will also give you one gold star for every two dollars that you take out of Bess's wallet and light on fire," and I liked gold stars and had as my aim to accumulate a certain fixed number of them, say 17 gold stars, how many of my dollars would I light on fire, and how many of Bess's dollars would I light on fire?

If you said "zero of yours and 34 of Bess's," you would be right, as far as me. As far as banks you'd be ... like, really close to right, no? The answer appears to be "$1 of their money and $31 of someone else's," give or take. That is terrible if the point of the mortgage settlement is to maximize the amount of pain suffered by the evil servicer banks that robo-signed all those robo-signatures. It is ... well, optimal, actually, if the point of the mortgage settlement is to maximize the amount of benefit provided to underwater homeowners for a given supply of gold stars.

Felix Salmon, like me, seems to think that universal noises of disapproval just have to indicate that this settlement is basically okay:

[W]hat’s happening here is that the mortgage settlement is at heart largely just encouraging banks to bring their balance sheets closer to reality — which is something they’d have to do sooner or later in any case. Indeed, insofar as principal reductions can increase the value of a mortgage, this deal is actually making banks money, over the long term.

So think of this as that rarest of settlements, one which really is a win for all sides. The attorneys general get a big deal, homeowners who got foreclosed upon get $2,000 apiece, and the banks get to do the kind of principal reductions they probably have wanted to do for a while, but while getting significant immunity from prosecution at the same time.

That appears to be accurate for, like, the financial system, but not necessarily for the banks - because the writedowns seem to come almost entirely from mortgages not held by the banks. As Yves Smith puts it, "That $26 billion is actually $5 billion of bank money and the rest is your money," because "you" are a beneficiary of the pension funds or whatever who own RMBSeses.

But "you" are also an owner of the banks, either because you're in index funds or because you're a taxpayer and, let's face it, you're gonna bail them out again one day, especially if BofA wakes up tomorrow with a seven hundred billion dollar mortgage judgment against it. And Felix is probably right about the basic mechanism at work here: writing down principal doesn't really "cost" anyone nearly as much as the headline amount, because a lot of that principal is unrecoverable anyway and the writedown here just brings accounts closer to reality. Over the last few years many people have pointed out that a central problem of the housing market is that mutually beneficial loan modifications are hard to achieve when borrowers, servicers, and dispersed MBS investors can't or won't coordinate with each other to write down loans.

Those dispersed MBS investors did not, of course, engage in any of the wrongdoing covered by this settlement. The banks did. But that wrongdoing is - well, the New York Times story doesn't get around to describing it until paragraph 23, which runs in its entirety:

In the agreement’s expected final form, the releases are mostly limited to the foreclosure process, like the eviction of homeowners after only a cursory examination of documents, a practice known as robo-signing.

Now you could quite reasonably say that the robo-signing abuses were more than "eviction of homeowners after only a cursory examination of documents," and call it something more like criminal forgery. But that shouldn't prevent you from signing on to one point that Dick Bové makes: "It is important to note that the government is not alleging that the banks took homes away from homeowners who were making payments. Nor is the government arguing that the banks profited from these foreclosures." However bad or not bad the servicers' conduct was, it's hard for me to see the $26 billion worth of actual damages to homeowners from robo-signing.

So I'm kind of with Felix Salmon that this is a win-win of coordination. Those who don't want to know anything about this colossally boring corner of the world (have the right idea and) can be told "homeowners got some relief and banks got punished for causing the mortgage crisis." Those who do want to know the details may figure out that banks didn't really get punished that much - but they may also figure out that this settlement has basically nothing to do with what caused the mortgage crisis (which is, I suppose, still to come in securities fraud and reps & warranties suits). And the fact that this settlement takes advantage of the mortgage servicers' nasty-looking but economically not-all-that-harmful misdeeds to impose an economically helpful solution to the mortgage coordination problem seems like an actual win for everyone.

Mortgage Plan Gives Homeowners Bulk of the Benefits [NYT]
Felix Salmon: The positive mortgage settlement [Reuters]
Adam Levitin: The Servicing Settlement: Banks 1, Public 0 [Credit Slips]
Yves Smith: The Top Twelve Reasons Why You Should Hate the Mortgage Settlement [Naked Capitalism]
Matt Taibbi: RAAARRRRR! HULK SMASH! [Taibblog]