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Banks and Government Near Settlement on Mortgages: What Does It Mean?

Monday, January 23, 2012

A fair settlement could facilitate the restart of lending and help accelerate the repair of the housing sector. But if President Obama successfully capitalizes on a deal, banks may be inviting four more years of his anti-Wall Street agenda.

Media reports indicate that banks are poised to reach a settlement with the federal government and state attorneys general over bad mortgage lending practices. Headlines focus on the topline dollars involved—up to $25 billion, according to most accounts. Negotiations have been ongoing for months, and the details are so complex that the implications—legal, economic, and political—can be hard to decipher. Here’s my take:

The political dynamics:

1.    The timing of this deal, so close to the State of the Union, demonstrates its political importance to President Obama. If a deal is reached, expect great fanfare by the White House regarding “billions to be paid by banks” and “millions of hardworking homeowners who will be saved.”

2.    Consumer rights advocates will undoubtedly complain that the banks are not paying nearly enough considering the $700 billion decline in homeowners' equity since the housing market peaked in 2008. But these statistics are irrelevant as banks are certainly not to blame for the entire decline in home prices.

3.    Republican state attorneys general have yet to indicate their support for the proposed plan, and Republicans in Washington have remained relatively quiet. While big banks are unpopular with grassroots conservatives, government shakedowns of private industry do not appeal to business-minded Republicans.

Beyond the politics driving this deal, what matters in terms of the housing market? Three things to consider:

1.    The dollar amount in the deal doesn’t matter that much. The goal is to remove impediments to the housing sector’s recovery. It is the entire package that needs to be evaluated, and it includes:

•    A commitment by lenders to adjust some existing mortgages;

•    Establishment of fair, transparent, and consistent rules for future mortgage issuances; and

•    A commitment by the government to reduce the litigation risk and uncertainty currently facing lenders.

2.    If a comprehensive agreement is reached, only some homeowners will be winners. A $25 billion deal means that perhaps 1 million borrowers will get principal reductions or lower interest rates, but a settlement will also likely accelerate foreclosures. If new “rules of the road” are established for lenders, banks will begin to sell many homes now stuck in foreclosure limbo.

3.    Ultimately, this deal is about establishing some certainty in a very uncertain part of our economy. Banks are willing to pay a handsome fee in exchange for clarity about how they will be allowed to conduct business going forward. A fair settlement could facilitate the restart of lending and help accelerate a repair of the housing sector.

Closing thoughts:

1.    If a deal is reached, it will be the fourth such attempt by the administration to repair the housing market, and its predecessors (HAMP, HARP I, and HARP II) have all demonstrated measly impact. The net effect of this settlement won’t be different.

2.    The long-term politics and economics should not be ignored—if banks cut a deal with President Obama to help jumpstart their business in the near term and the president successfully capitalizes on it, they may be inviting four more years of his anti-Wall Street agenda.

Alex Brill is a research fellow at the American Enterprise Institute.

FURTHER READING: Brill also writes “The Payroll Tax Holiday Is a Bad Bipartisan Idea,” “IRS Bounces on Checks,” “A Victory Celebration and a Wake for Free Trade,” and “Super Committee vs. Fiscal Commission: It's Different This Time.” Joseph Gyourko describes “The Government’s Overleveraged Housing Bet.” Peter J. Wallison contributes “Where No Mortgage News Is Fit to Print” and “A Guaranteed Disaster.”

Image by Rob Green / Bergman Group