Will $26 billion settlement from big banks repair US housing market?

In the short term, the deal between 49 states and five big banks may actually boost foreclosures, some say. In the longer term, it should clear the inventory of homes that depresses prices and help the middle class.

In a historic settlement, five of America’s largest banks have agreed to pay $26 billion to settle a lawsuit charging poor servicing of mortgages as they went bad and illegal use of automatic signature devices on legal documents for the years 2008-11.

The settlement of the lawsuit, brought by states’ attorneys general in 2010, means many individuals in the midst of foreclosure proceedings will see the principal they owe on their mortgages shrink by as much as $20,000, reducing their monthly payments. The share of the settlement the banks will commit for principal reduction for struggling homeowners is $17 billion.

In addition, the banks agree to give individuals who have lost their jobs a one-year grace period to find a new job before beginning foreclosure proceedings. They also designated $3 billion of the overall settlement to help homeowners refinance their loans at a 5.25 percent interest rate. Some 750,000 people who have already lost their homes may get a check for $1,800 as compensation for the banks’ behavior.

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“This is a vindication for all consumers who experienced poor servicing of their mortgages or wrongful foreclosure,” says David Berenbaum, chief program officer at the Washington-based National Community Reinvestment Coalition, which tries to increase bank services in low- and middle-income communities. “This agreement is also likely to be the basis for national standards set by the new Consumer Finance Protection Bureau.”

A key aspect of the agreement is that the banks will modify not only first mortgages but also second mortgages, says Mr. Berenbaum. “This will help people to keep their homes,” he says, because often borrowers could not get both mortgages modified.

The agreement is being compared with the tobacco settlement in 1998. States' attorneys general had sued the tobacco industry, which agreed to pay the states $105 billion for past infringements in return for ending the lawsuits. The industry also agreed to change its marketing and advertising policies.

The agreement was announced Thursday morning at the Department of Justice, which monitored the talks among the states and the banks. All states but Oklahoma have signed on to the settlement deal. The states themselves will distribute the settlement money to their residents. 

Housing and Urban Development Secretary Shaun Donovan called the agreement a “big victory for those who were harmed the most.” Iowa Attorney General Tom Miller, who coordinated the lawsuit, said it gives the banks an opportunity to change, “to do the right thing.” He noted that the effort was bipartisan.

 President Obama, speaking at the White House, said, “A lot of families are going to be helped across the country.” He added, “No action by itself will entirely heal the housing market, but settlement is a start.” 

Mr. Obama also used the occasion to press Congress to pass legislation that would force banks to refinance mortgages at today’s lower interest rates. The refinancing would be paid for by a fee on the banks. “It will help people save hundreds of dollars a month,” said Obama.

The agreement – involving Bank of America, Wells Fargo, Ally Bank (formerly GMAC), Citibank, and JP Morgan Chase – may not put an end to litigation involving their actions. On Jan. 27, US Attorney General Eric Holder, Mr. Donovan, and other federal and state officials formed a federal group to investigate mortgage fraud and to seek compensation for people who have been wronged. Presumably, the federal officials can use much of the evidence uncovered by the states' attorneys general.

Not all of the agreement's ramifications are positive for homeowners in financial trouble, say foreclosure specialists. For some, it will speed the foreclosure process.

“The settlement should help clear the cloud of uncertainty that’s been hanging over the foreclosure process over the past 16 months, allowing lenders and servicers to more confidently move forward with delayed foreclosures when they have the proper documentation to do so as specified in the settlement,” wrote Daren Blomquist, a vice president of RealtyTrac, an Irvine, Calif., research firm, in an e-mail message.

On the positive side, the settlement also means that lenders and mortgage servicers will likely pursue alternatives to foreclosure – such as loan modifications, short sales (selling the house for less than the value of the mortgage), and deeds in lieu of foreclosure (the borrower gives the house back to the bank) – when they don’t have documentation, Mr. Blomquist says.

In the short term, a likely outcome is a surge in foreclosures in 2012, he says. Last year, according to RealtyTrac, the foreclosure rate fell 34 percent compared with 2010 – the lowest since 2007.

Over the longer term, the settlement should help to clear the so-called “shadow inventory,” the vast number of foreclosed properties hanging over the housing market, says Blomquist.

In fact, the settlement will result in about 20 percent of troubled homeowners – some 2 million, depending on how the loans are modified – seeing the principal on their mortgages reduced. Obama, in a speech Feb. 1 in Falls Church, Va., estimated that at least 10 million homeowners owe more than their homes are worth.

Some consumer groups criticized the agreement as not large enough. “This is a very small drop in a very big bucket,” says Washington-based Jordan Estevao of the National People’s Action, an advocacy group. “It does not go nearly far enough.”

Debt that borrowers owe on homes that are now worth less than the mortgage acts as a drag on the US economy, says Mr. Estevao. “This is money people are paying on mortgages that is not creating jobs,” he argues.

However small the agreement is relative to the problem, it appears it will help America's middle class.

There is some evidence that the nature of foreclosures has changed over the past five years. According to CredAbility, an Atlanta-based credit counseling firm, of its own clients in 2011 more married Caucasian men were facing foreclosure proceedings (up 8.5 percent since 2006). For clients who were single female African-Americans, the share facing foreclosure was down 26.8 percent from 2006.

“What we saw in the early part was a product issue,” says Mark Cole, a vice president at CredAbility, referring to subprime mortgages. “Since 2008 and on, it’s been an employment issue in terms of the loss of jobs or the replacement with ones that pay less.”

In another indication that more middle-class Americans face possible foreclosure, CredAbility says the gross annual income of clients in financial trouble has jumped from $40,534 in 2006 to $51,699 in 2011, a swing of $11,165. In an indication of the shrinking value of houses, the net worth of homeowners facing foreclosure has gone from a positive $19,585 to a negative $55,155, a drop of $74,740.

“It became a part of the culture to buy as much house as you could afford,” says Mr. Cole. “People had very little equity in their homes, and when they did they took out a home equity loan to subsidize their lifestyles and other purchases.”