Editorial Board

Foreclosure Settlement Falls Short, Still Worth the Wait: View

In any out-of-court settlement for alleged wrongdoing, the test of whether prosecutors got a good deal rests on the answers to three questions: Does it hold the miscreants accountable? Does it make victims whole? And does it prevent similar misconduct in the future?

Thursday’s $25 billion agreement by five banks to end a 16-month investigation of abusive foreclosure practices fails on the first two counts. And we won’t know for some time whether it is successful on the third. Nonetheless, the deal is in the country’s interest because it clarifies the liabilities of banks that filed bogus court documents to speed up repossessions. That could clear the clogged foreclosure process and, more importantly, help bring a moribund real-estate market back to life.

The banks -- Bank of America Corp., Wells Fargo & Co., JPMorgan Chase & Co., Citigroup Inc. and Ally Financial Inc. (the five largest home-loan servicers) -- have committed to spend the bulk of the $25 billion on reducing the principal owed by at-risk homeowners. Smaller amounts will go to people who already lost their homes or are in the foreclosure process. The settlement could help as many as 2 million borrowers, including many whose mortgages are underwater. Cash payments of up to $2,000 will go to those whose homes were repossessed from September 2008 to December 2011.

Since 2007, about 4 million families have lost their homes or are about to, and an additional 11 million owe about $750 billion more on their mortgages than their homes are worth. Even taking into consideration that some borrowers acted irresponsibly and don’t deserve compensation, the settlement amount is a pittance.

As for holding the banks accountable, several state attorneys general thought the deal would come up short. Before signing on, they fought to narrow the banks’ liability releases, and won substantial concessions. California’s Kamala Harris retains the right of her state and its large public-pension funds to sue banks that packaged bad mortgages into securities and sold them as safe investments.

New York’s Eric T. Schneiderman, who recently was named co-chairman of President Barack Obama’s mortgage fraud task force, played a similarly positive role. He won the right to keep going with a Feb. 6 lawsuit that claims banks used a dubious electronic mortgage database to skirt the public recording system and submit false documents to courts, speeding repossessions.

The deal does have teeth. It calls for an outside monitor and for heavy penalties if banks don’t make good on their commitments. More important, banks will be given credit only for what they actually accomplish for homeowners -- and not for any refinancing offers that borrowers refuse. This rightly gives the victims some leverage.

If a bank falls short of its agreed benchmarks, it must pay the difference plus a penalty. And it must meet all its obligations in three years.

The settlement also reverses the banks’ incentives to foreclose on families rather than keep them in their homes with loan forgiveness. Until now, banks had been loath to reduce principal amounts because it meant recognizing losses on their balance sheets. This deal awards more credit for principal reduction and less for lowering interest rates or extending payment terms.

Banks have calculated that the settlement is in their interest, even though it means they may have to continue paying huge mortgage-related litigation costs. The deal enables them to predict their legal exposure.

Even better, it could help the housing market recover. Banks own outright almost half a million homes and have 2 million more in various stages of foreclosure. Such so-called shadow inventory has been a drag on the market, which after six years remains depressed, holding back the overall recovery.

With this settlement, banks can clear out their backlog of stalled foreclosures. In the short run, that may drive prices down even more, but it will also help the housing market find its natural bottom faster. Only then can home prices, which have fallen by more than a third since 2007, begin to rise again. Borrowers can finally start to rebuild equity.

Once banks reduce their real-estate inventory, and their balance sheets recover, they’ll be able to loosen up home-lending standards to create new mortgages. If this is the result of a less-than-satisfactory legal settlement, it will have been worth the wait.