Sense on Cents

LD – I think you again are hitting the nail on the head…while I believe the confluence of financial excesses contributing to the 2007 crisis and the last several years of global uncertainties and myriad challenges, there can be no doubt that a great deal of the trauma starts right in the backyard of the US residential mortgage market…I think that the 25B fines levied on the big five originators/servicers is a slap on the wrist – the folks that paid and continue to pay the price will see very little relief…yes, the currencies of these sifi banks have been battered – but I don’t see any clawback of the executives’ pay packages – nor does it seem they will be fired , no less serve jail time…and, by the way, the practices that set this process up go on to this day – my unemployed 20-something daughter gets 10 credit card solicitations a month given her great FICO scores…the CEO of a local bank solicits customers to refi into a low cost Arm – but the devil is in the details and the details are very sketchy…too big to fail – indeed …how about too unethical to care for customers! just pay the money and sweep everything under the rug…the banks won’t look back – but the damage done on a personal level is too big to cure!

Tom Brown, a well regarded banking analyst had the following to say about this mortgage settlement,

This mortgage settlement is an abomination. It provides a windfall to many people who don’t deserve one and is a slap in the face to those who’ve worked hard and acted prudently. The deal turns the very concepts of fairness and common sense on their heads. It is bad, bad, bad.

Here are the gruesome details of this madness: First, $17 billion of the settlement will go toward debt forgiveness and other forms of loan modification for borrowers who are delinquent on their loans. Another $1.5 billion will be for cash payments to borrowers who lost their homes to foreclosure “with no requirement to prove financial harm.” Three billion will go to guaranteed refinancing of borrowers who are current but upside-down on their loans.

But why should any of these people get anything? For five years now, we’ve heard how banks blew up the economy by pushing tricked-up mortgages on subprime borrowers who never should have gotten the loans in the first place. Well, guess what? Many of those people never should have gotten the loans in the first place! It makes no sense to reward them now for their folly. Others defaulted because they lost their jobs. They have my sympathy. But why shouldn’t they live up to the terms of the deal that they signed?

As it is, delinquent borrowers have already received a massive windfall. Something like 4 million mortgage borrowers in the U.S. are behind on their loans by 90 days or more. Their average delinquency is 20 months, we estimate. (Some of these delinquent borrowers even have the gall to rent their properties out!) That means these people have been living rent-free for two years and have received something like $70 billion in foregone mortgage interest expense! And now some of them are going to get another $17 billion?

That’s not just nonsensical–it’s unfair. What about the people who scrimped and saved for the standard 20% down payment, and who’ve stayed current on their loans despite the economy’s ups and downs? How is it that the people who played by the rules get nothing, while the ones who gamed the system get the big payout? And what do you think the people who did play by the rules will do the next time they apply for a loan?

Meanwhile, the idea of cash payouts to people who’ve already been foreclosed on is truly insane. No one disputes that those people had defaulted on their loans. No one disputes the lenders’ basic right to take their houses back. The controversy surrounding those foreclosures had to do with paperwork-related issues such as robo-signing (issues that have been corrected, by the way). The foreclosed borrowers suffered no harm whatsoever. They defaulted—and don’t deserve a dime.

And please, spare me your sob stories about how so many of these borrowers are hapless victims. A lot of them aren’t. A recent study by the New York Fed shows that fully one third of mortgages written in 2006 likely went to borrowers who bought their properties as a speculation. In the most bubble-intensive markets like Arizona, California, Florida, and Nevada, that number was closer to 50%. A lot of these people probably committed fraud to get their loans in the first place. They took a gamble and lost. They deserve nothing–either from the lenders or the government. Sure, plenty of other borrowers are honest and hardworking, and have been victims of the bad economy or just plain bad luck. They’ve fallen behind despite their own best efforts. That’s unfortunate. But crisis or not, it’s the kind of thing that happens in life.

Meanwhile, the worst part of this mess is the corrosive effect it has on one of the key pillars of American prosperity: the notion of the sanctity of contract law. The parties to these mortgages—these contracts—were adults who freely entered into the agreements. They knew (or should have known) exactly what they were getting into. Obligations were spelled out on both sides. It shouldn’t be too much to expect that both sides of a contract live up to its terms. The government has no business—no business, in a very fundamental way—swooping in to demand that terms be altered to favor one side of the deal over another. At the very least, this kind of meddling will make credit more expensive in the future and harder to get. At its worst, it undercuts the idea, uniquely American, that free people can be relied upon to make their own decisions and be responsible for the consequences of their actions without relying on help from Big Brother.

There is nothing good to say about this deal. It’s unfair to the banks and it’s unfair to the vast majority of mortgage borrowers. In a profoundly basic, way it’s un-American, too.