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Understanding the New Mortgage Foreclosure Settlement

The Deal Between the States and the Nation’s Largest Lenders

SOURCE: AP/Mel Evans

A foreclosure sign is seen on the lawn of a home in Egg Harbor Township, New Jersey.

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American homeowners will no longer stand alone shouldering the burden of the housing downturn. Today’s announcement of a $25 billion settlement between a consortium of state attorneys general and the nation’s largest banks over alleged misconduct in the processing of mortgage foreclosures provides important assistance for the struggling housing markets. The settlement also frees up state and federal prosecutors to focus on investigating the root causes of the housing crisis and holding accountable the financial firms responsible.

Today’s settlement provides near-term relief to homeowners who either are in danger of foreclosure or were already evicted from their homes. Importantly, the vast majority of this assistance will be directed to decreasing the outstanding loan balances of approximately 1 million homeowners with mortgages that are “underwater,” or more than the value of their homes. Many analysts, including the Center for American Progress, believe that “principal reductions” are the most effective and sustainable form of foreclosure prevention and have the most positive impact on neighborhoods and markets.

The deal also ensures that the banks primarily responsible for the lending abuses and fraud that were core causes of the housing bubble aren’t allowed off the hook. State attorneys general will now be able to focus their attention on investigating and prosecuting violations that helped cause and exacerbate the housing crisis, as the settlement itself is limited to claims revolving around the so-called “robo-signing” abuses that occurred during foreclosure processing.

Moreover, these state AGs will have significantly more resources to go after wrongdoers, thanks to a new federal mortgage fraud investigation unit led by New York Attorney General Eric Schneiderman, created earlier this year by President Barack Obama.

What does the settlement do?

Today’s settlement between 49 of the 50 states (Oklahoma being the lone holdout) and the nation’s largest mortgage servicers is over allegations that they were “robo-signing” foreclosure documents and engaging in other illegal procedures in foreclosing on millions of American households. The total size of the settlement is $25 billion, broken down as follows:

  • $17 billion fund for principal reductions and other forms of relief. This money will be set aside for the purpose of assisting 1 million homeowners to the tune of about $17,000 each.
  • $3 billion to help homeowners refinance loans to today’s lower market rates.
  • $1.5 billion in cash payments to 750,000 borrowers who were directly impacted by these violations of the foreclosure process.
  • $3.5 billion to federal and state governments to help fund state actions to mitigate the housing crisis, including programs focused on housing, such as housing counseling and legal aid.

The large allocation of funds to principal reductions for 1 million homeowners—an average of $17,000 each—should go a long way toward turning around the housing markets. Many experts believe that reducing the outstanding loan balances of struggling homeowners is the most effective and sustainable way to prevent costly foreclosures. Coupled with the Obama administration’s recent announcement of new programs designed to help responsible homeowners refinance their mortgages and reduce the loan balances of struggling underwater borrowers, this settlement represents an important step toward ending the foreclosure crisis and turning the housing markets around.

The settlement also implements national mortgage servicing standards that require improved communication between servicers and borrowers, formalized processes to protect the rights of homeowners during foreclosure proceedings, and a prohibition against “dual-tracking”—the practice of foreclosing on a homeowner who is negotiating a loan modification.

Importantly, this settlement has teeth. It includes an independent monitor appointed by the state AGs to ensure compliance with the terms of this settlement, who will have the power to issue heavy penalties against banks who violate these terms. The settlement also creates strong incentives for the funds to be disbursed quickly, as there are benchmarks in place against which the banks will be judged (and penalized), with all funds being required to be allocated within three years.

The state attorneys general have also nicely positioned themselves to pursue other wrongdoings that may have been committed by these same banks, as the settlement appears to be limited to claims around the banks’ “robo-signing” of foreclosure claims and related violations of requirements to transfer and record mortgage and title documents during the foreclosure process. As a result, the states reserve their rights to pursue additional investigations and lawsuits against these banks, including all of the issues related to the causes of the mortgage crisis:

  • Loan origination: how lenders provided loans and at what terms
  • Fair lending and fair housing: claims regarding discrimination in lending and housing, as well as predatory lending claims, such as those available under the federal Fair Housing Act
  • Loan securitization: how lenders, investment banks, and others packaged loans into mortgage-backed securities, marketed those securities, and managed them
  • Claims related to improper storing, transfer, and recordation of mortgage and title documentation for loans by the Mortgage Electronic Registration System, or MERS, the electronic mortgage registration system created by the financial industry—loans that were packaged and repackaged between different mortgage securities
  • Criminal acts: individuals and institutions who violated criminal law, not just regulations, will still be subject to prosecution, even with regard to servicing
  • Private claims: litigation brought by individuals, either filing singly or as part of a class action, will still be permitted

The settlement dovetails effectively with the creation of the new interagency Residential Mortgage-Backed Securities Working Group headed up by Schneiderman. The Working Group will have at its disposal 15 Department of Justice attorneys and 10 FBI agents and analysts, along with 30 U.S. Attorneys (federal prosecutors) around the country. Individual state attorneys general will be able to act in concert with DOJ as well as on their own to pursue claims in these areas. These expanded resources will help identify potential wrongdoing that has occurred and support any litigation that may be undertaken, either by the state AGs or by any of the federal agencies involved.

Indeed, we have seen some indications already of the potential scope and impact that this working group might have. Last Friday, Schneiderman filed a claim in New York against MERS, claiming that it violated New York state law by failing to record the transfer of mortgages as they were packaged and repackaged between different securities. It would appear that under Schneiderman’s leadership, the mortgage working group has an ambitious agenda laid out for itself.

The best-case scenario?

The settlement reached by the state AGs should be celebrated for providing enormous relief for struggling homeowners while setting the stage for a broader investigation into potential wrongdoings by the financial sector in causing the housing crisis. The $25 billion in penalties, with $17 billion directed toward principal reductions, should provide meaningful near-term relief for responsible homeowners and, by extension, our still-troubled housing markets. The state AGs are also seeking to settle with additional mortgage servicers, which could grow the total settlement to $30 billion or more.

We should expect to begin seeing modifications and payments as soon as this spring. These funds are potentially even more important with Congress in political deadlock and unlikely to provide any help to the housing markets this year. While this settlement alone will not be a silver bullet for the problems of the U.S. housing market, in which 11 million homeowners owe more than their homes are worth, it will provide a nice boost to the housing sector, while also freeing up state and federal prosecutors to finally begin to seek accountability for the wrongdoings that led to the housing and financial crisis. Most importantly, it should help resuscitate a struggling economy by putting additional money in the pockets of hardworking Americans and their families.

David Min is Associate Director of Financial Markets Policy at the Center for American Progress. Alon Cohen is a consultant to the Center on housing policies.

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