Government: Our Way or Pay $20 Billion

February 24, 2011 (Chris Moore)
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In what some might misconstrue as blackmail, the Wall Street Journal is reporting that the Obama Administration is trying to push through a settlement over mortgage-servicing breakdowns that would force America’s largest banks to pay for principal writedowns in mortgage loans or face penalties of over $20 billion.

According to people familiar with the matter, the administration is seeking a commitment from mortgage servicers to reduce the loan balances of troubled borrowers who owe more than their homes are worth. If a settlement can be reached to the liking of all the state and federal agencies that have been pursuing and considering legal action against the mortgage servicers, the banks would have to pay more than $20 billion in fines or fund a comparable amount of loan modifications for distressed borrowers.

So far most loan modifications have focused on shrinking monthly payments by either lowering interest rates or extending loan terms or both. Forcing the banks to lower principal amounts could result in even more chaos as borrowers who previously have been able to afford there homes could possibly stop paying their mortgages in the hope of being rewarded with a smaller loans.

And as far as we are concerned, it’s morally unfair to the many more homeowners who didn’t allow themselves to get in this position in the first place.

The deal doesn’t create any new government programs to implement the principal writedowns but instead relies on the banking industry to devise their own modifications or use the existing government programs like HAMP to meet the government’s requirements.

So far the deal is considered fluid as any agreement would have to be approved by a litany of government agencies, the state attoneys general, bank regulators, and the banks themselves.

“Nothing has been finalized among the states, and it’s our understanding that the federal agencies we are in discussions with have not finalized their positions,” said a spokesman for Iowa Attorney General Tom Miller, who is spearheading a 50-state investigation of mortgage-servicing practices.

Under the administration’s proposed settlement, banks would have to bear the cost of all writedowns rather than passing them on to other investors. The settlement proposal focuses on pushing servicers who mishandled foreclosure procedures to eat losses by writing down loans that they service on behalf of clients.

Bank executives point out that principal cuts don’t necessarily improve payment patterns and have told parties involved in the talks that reductions could raise new complications. Banks have been overwhelmed by the amount of foreclosures which lead to the so-called “robo-signing” controversy as they tried to process as many foreclosures as quickly as they could to rid themselves of their toxic housing inventories.

And even though the banks have come under increasing criticism for their handling of the foreclosure crisis, let’s not forget that twice as many private loan modifications have taken place through the banks than those through government programs like HAMP. Banks concerns that principal cuts don’t necessarily equate into improved payment performance can be easily justified as nearly 20 percent of all loan modifications have defaulted within the first year of the modification’s completion with some studies suggesting that as many as 60 to 70 percent of all loan modifications will eventually default again. Will lowering a borrower’s principal really change those patterns?

However, if a single settlement can’t be reached, banks could face the prospect of separate civil actions from state attorneys general along with different federal agencies which could seek smaller penalties through regular enforcement channels.

Tags: Obama administration, loan modifications, mortgage servicers, principal writedowns, mortgage loans, foreclosure procedures