The Breakdown

Explaining Southern California's economy

You call that a mortgage settlement?

U.S. Attorney General Eric Holder and U.S. Housing and Urban Development Secretary Shaun Donovan announce that the government and 49 state attorneys general have reached a $25 billion settlement agreement with the five largest mortgage lenders to redress foreclosure abuses, in Washington, February 9, 2012.
U.S. Attorney General Eric Holder and U.S. Housing and Urban Development Secretary Shaun Donovan announce that the government and 49 state attorneys general have reached a $25 billion settlement agreement with the five largest mortgage lenders to redress foreclosure abuses, in Washington, February 9, 2012. Reuters/Gary Cameron

UPDATE: California Attorney General Kamala Harris wasted no time in leaping ahead to a provision of the deal that could up the settlement to $45 billion, with California homeowners getting $18 billion. The U.S. Department of Justice says $7 billion, and adds that "[s]ervicers that miss settlement targets and deadlines will be required to pay substantial additional cash amounts." Maybe she doesn't like the size of the stated number all that much, either?

We have a mortgage settlement at last between the big banks and the states. California and New York, the two staunchest holdouts, have signed on. But then there's the actual number: $25 billion (initially reported as $26 billion). It just isn't that much. And although the news of the settlement has been greeting positively, for the most part, it's far from clear that it will ultimately turn the housing market around.

This is from the New York Times:

The settlement money will be doled out under a formula that gives banks varying degrees of credit for different kinds of help. As a result, banks should be motivated to help harder-hit borrowers with homes worth far less than what they owe.

Mortgages owned by the government’s housing finance agencies, Fannie Mae and Freddie Mac, will not be covered under the deal, excluding about half the nation’s mortgages.

About one in five Americans with mortgages are underwater, which means they owe more than their home is worth. Collectively, their negative equity is almost $700 billion. On average, these homeowners are underwater by $50,000 each.

A recent estimate from the settlement negotiations put the average aid for homeowners at $20,000.

That's where underwater homeowners stand in all this. At Reuters, Felix Salmon considers the settlement from the banks' side:

[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 last part is critical: defending themselves from prosecution was going to cost the banks big time, absent a settlement. This is why bringing California in particular into the deal (there would have been no deal without the Golden State). Some analysts were speculating last year that it was potential litigation costs that could force Bank of America into bankruptcy, quite apart from the bad loans on its books.

MORE: California and Nevada team up to make the housing crisis last forever

So I both agree and disagree with Felix. I agree because we can't let this thing drag on forever. At some point, the banks need to get their balance sheets in good enough shape to enable a real housing recovery. I disagree because the settlement is so paltry. For perspective, the government spent around $50 billion bailing out General Motors, and of course close to trillion, depending on how you add it up, bailing out the banks. When you put it on the private sector, the numbers just go down, down, down. How's that for a robust free market?

Freddie Mac and Fannie Mae, meanwhile, aren't involved in the settlement. Which is a good thing, because the two loan giants have argued that it would cost them $100 billion to get into principal reductions for underwater borrowers.

MORE: How long does the government expect borrowers to stay underwater on mortgages?

This is a bargain settlement that does move the needle in the right direction. But $20,000 per underwater borrower isn't going to radically change the foreclosure situation. That said, it does set us up to have healthier banks. But given how dodgy lending practices were before the crisis, $2,000 for each borrower who did get foreclosed is cold comfort.

Follow Matthew DeBord and the DeBord Report on Twitter.

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