On March 4, 2011, the New York Times described a settlement (“settlement”) proposed by a consortium of state attorneys general (AGs) to large mortgage servicers. The claims to be settled reportedly relate to failures to follow existing procedural rules relating to the foreclosure process. The settlement would make dramatic changes in those rules, and reportedly require a mortgage loan principal reduction program of $20 to 25 billion. The purpose of this study is to review how such a settlement would affect the housing market and the larger economy.
Although the settlement is a long and complex document, two key components stand out. First, it appears lenders would be required to write down principal whenever doing so meets certain criteria, regardless of the level of borrower distress. Although the settlement is silent on the issue, press reports indicate that the AGs would require the servicers to use $20 to $25 billion of their own funds to finance these write downs. Second, the settlement would add a host of additional procedural requirements that must be met before foreclosure may proceed.
For example, each servicer would be given “an affirmative duty to thoroughly evaluate borrowers for all available loss mitigation options prior to foreclosure,” including short sales. In addition, borrowers would be given the “opportunity to provide evidence that the [net present value] or eligibility calculation was in error,” in which case said borrower “can request that a full appraisal be conducted of the property by an independent licensed appraiser. . . .”
We find that a settlement along these lines would generate significant unintended negative consequences for housing and financial markets. In particular, we find that (1) the settlement is unlikely to provide broad or lasting benefits. Several studies and experience with the Home Affordable Modification Program (HAMP) program to date demonstrate that government mandated modifications have not been effective in preventing foreclosure; (2) the settlement would be counterproductive in its overall effect because it would drive up the number of defaults and servicing costs.
We estimate that even a small increase in strategic defaults in response to the settlement could increase the foreclosure inventory by $297 billion; (3) the proposal would slow new home construction and consumer spending, and reduce access to credit; and (4) the increased costs imposed by the settlement could increase mortgage interest rates by 20 to 45 basis points per year. In light of all of these considerations, we conclude that the settlement would serve to extend, rather than end, the foreclosure crisis.
Download
The Economics of the Proposed Mortgage Servicer Settlement
