In recent weeks, a few state attorneys general and some employees of the United States Department of Justice have met in secret to hammer out a proposed settlement with the mortgage finance industry. The details of the proposed settlement possess serious flaws. If implemented, the proposed mortgage industry settlement would make homeownership more expensive for almost everyone, cause further damage to the overall economy and do very little to help distressed borrowers.
It would rewrite the rules under which mortgage lenders offer products, propose fundamental changes to state foreclosure laws and impose a significant amount of redundant regulatory burden on financial institutions, which have already agreed with their actual regulators (the Federal Reserve and the Office of the Comptroller of Currency) to make changes in the way they process foreclosures and have agreed to review all foreclosures and compensate any borrowers for whom mistakes were made during the foreclosure process. That seems fair. What doesn’t seem fair is to continue to blame these banks for the entirety of the financial crisis, which seems to be the point of the settlement.
What about investors who continued to demand higher-yield, mortgaged-backed securities and failed to perform adequate diligence when making investment purchases? What about homeowners who knowingly bought more house than they could afford and then strategically defaulted on their mortgages? What about regulators who ignored warning signs regarding the housing market, overlooked rules regarding true sale, and didn’t fully comprehend the amount of leverage in the financial system?
There is plenty of blame to go around, but the settlement provides few solutions. It is just delaying the process of actually getting a solution to the crisis. Perhaps those who favor the settlement have failed to see the recent decline in home prices and the persistently high unemployment. Why is this occurring? Home prices will continue to fall until all foreclosures have been processed and the housing market has found its true bottom. What we were observing earlier was a false increase in home prices driven by the fact that the banks were forced to virtually shut down foreclosures. Until we clear the inventory of foreclosed properties, we will not see an increase in new home construction. We also will continue to see a restrictive lending environment, which will continue to be a drag on our economic output. Banks will not lend at full strength until they have cleared their balance sheets. The impact of delays in asset liquidation have been well documented by economists like Federal Reserve Chairman Ben Bernanke, who found that delays in asset liquidation caused bank disintermediation, which helped prolong the Great Depression.
Further delays like those that will be imposed by the settlement are of no benefit and risk prolonging our current economic struggles. It is time to move on and start working toward finding real solutions to the mortgage crisis, such as encouraging banks to responsibly work through the delinquent inventory, finding solutions for those who have options and advancing foreclosure for those who don’t.
Professor Eric Higgins is the head of the Department of Finance at Kansas State University.
