AG Settlement's Falls Short

Tomorrow, the AGs of the 50 states are supposed to reveal the great settlement that is going to impose upon the largest lenders some burden for the short cuts that helped deepen this recession.  The problem that some have found with this is that the AG's solution may actually lengthen the time that underwater properties plague our economy.  Some have gone so far as to find their own economists to attack the settlement because it may cause higher costs than what the lenders are actually going to give up ($25 billion in mortgage principal writedowns). Whether you think its good or not, or if you just don't agree with the banking industry, you will find supporters aplenty (counter argument-if you can call it that)

In some respects, I can understand the hand wringing because I too don't see the AG's settlement as a positive move.  I remember in 2008, when GM was on the verge of financial collapse and the government stepped in to save it, Mitt Romney wrote an op-ed for the New York times.  In that piece, he explained that the GM should be allowed to go into bankruptcy.  It was likely the fastest way of curbing the executory contracts with its labor force and salvaging its beneficial intellectual, real, and personal properties so that they could be put to the best effect.  I agreed with Romney at the time he wrote that piece, and hindsight shows that the government intervention did little to alter the outcome, only delaying the inevitable restructuring of a failed enterprise. 

The difference though, in that Governmental-hand-of-god save of GM as compared to what the AGs are trying to with home owners, is that there isn't really any save.  In a blog post a couple of weeks back, I looked at the number of homes to be repossed this year alone, 1.2 million, and if all the principal writedowns were to go to those homeowners alone, it would only amount to $20,833 per home.  Considering that in our present market, homes have lost nearly 1/3 value since 2007 for an average of over $100,000, that write down doesn't even scratch the surface.  When applied to the nearly 5 million homes in default, that number dwindles away to become inconsequential.  Consider this, last month, I negotiated a second mortgage of nearly $100,000 for a payoff of $10,000 and still failed to bring the home flush, its close, but still not flush.

The economists hired to look at this deal though, have made some gross assumptions that lack reason when comparing write downs to loan modifications.   In my opinion, it shows either a lack of understanding in what is actually being offered by the banks, or blatant disregard for factual circumstances.  Your choice, I either call you ignorant or a liar.  Home loan modifications, as described by the FDIC guidelines and those developed in GSEs, basically say that the bank has to be as well off as if it got its original deal.  The banks are not bending over backwards to write off billions of dollars in mortgages, especially when people are still paying.  Many of the modifications simply add the amount of arrears on to the end of the mortgage, extend the time from a 30 year fixed to a 40 year fixed, and alter the interest rate.  This amounts to no change, no principal write down.  What the AG's are requiring is actual write down.  We take the terms as they stand, and then the lender lops off some portion of the principal.  The problem is that it doesn't go far enough. 

The authors of the ecnomics paper argue taht the changes are going increase strategic default, but it isn't as if there is need for additional incentive.  A home being $100,000 upside down is incentive enough.  The write downs may actually incentivize homeowners to stay and pay.  Which brings me to my reasoning for not linking the settlement.  I am affraid it will limit private action against the banks, and it doesn't go far enough to incentivize homeowners to stay in their homes. If you are going to do it, do it right, make it effective, and by all means, go after every penny of revenue that the banks have stolen from local governments in the forms of excise taxes.  Then, provide a broader forum for individual homeowners to obtain compensation, and by all means, allow them to lop off most if not all of their underwater mortgage.

If homeowners are a little bit underwater, the emotional attachment to the home will allow them to pay the extra money that they will to hold on to the memories of birthdays, anniversaries, births, marriages, and simple day to day glimpses of the past.  But if homeowners are stuck with putting their monthly mortgage payment through a shredder each and every month that their property loses value, strategic default, and simple missed payments will continue.  I personally am happy to help anyone down the path of strategic default and extract the cash from the lenders in anyway possible, but if you can modify and stay, then more power to you but don't count on the AG's Settlement, it simply falls short of real relief.