Who's Really Paying The Tab For The Mortgage Settlement?

Just who is paying for the big mortgage settlement, anyway?

The Obama administration says it's the banks. Mortgage investors worry it will be them. Taxpayers fear they'll have to pony up.

Unfortunately, until we actually see the settlement terms and watch the process in action, we won't know for sure.

Based on currently available information about the settlement, there's no way to refute the government's claim that banks will bear the brunt of the settlement's costs. But the waters have been muddied by past government statements, and by the government's failure to make the terms of the settlement public even as it rushed to announce that a deal was done.

And there is still plenty of room to argue that banks, which are settling charges that they mishandled thousands of troubled mortgages, are getting off fairly easily in what is supposed to be a deal that punishes them and deters future misdeeds.

The latest controversy involves the charge that banks are getting a taxpayer incentive, through the government's existing Home Affordable Modification Program, or HAMP, to live up to their obligations under the mortgage settlement.

Under the terms of the mortgage deal, the banks will post just $5 billion in cash. The rest of what could ultimately amount to $40 billion in costs will come mainly from mortgage-principal reductions.

Mortgage-bond investors such as Pimco have publicly worried that they will be forced to eat much of that $35 billion. Banks get credit under the settlement for cutting principal balances on mortgages that private investors own. It hurts a lot less to write down a loan that somebody else owns than your own investment, so private investors figure that banks will go after their loans first.

But Housing and Urban Development Secretary Shaun Donovan, who led the settlement negotiations, insists that the vast majority of principal reductions will be on loans owned by the banks, not private investors. In an interview with The Huffington Post on Thursday, Donovan called suggestions to the contrary -- made by what he called "progressive bloggers" -- "fundamentally not true."

Donovan sparked some of these concerns in an interview with several progressive bloggers earlier this month, in which he said that he expected "a substantial amount of principal reduction" would be done on mortgages owned by hedge funds, pension funds and other private investors, rather than on those owned by the big banks.

He subsequently walked back those comments, saying that the majority of the costs of the settlement would be borne by the banks.

Based on what we know now, there is no way to anticipate how the division of pain will be split between the banks and the investors. Maybe there is a mandate written into the agreement requiring banks to write down their own loans, but we have not heard of one. Critics charge that the government is simply assuming that this will be the case, based on the incentives it has given banks.

Meanwhile, questions have also been raised about whether taxpayers will be on the hook for any of the settlement. A front-page story in the Friday Financial Times suggested U.S. taxpayers would subsidize at least part of the mortgage settlement, which is designed to penalize banks for their sloppy foreclosure practices.

Donovan's office vehemently denied the story, and a Treasury Department spokeswoman said the banks could not use federal money to help pay down their obligations.

Here's what sparked the controversy: According to the terms of the mortgage-settlement deal released by officials, banks have a chance to collect cash incentives, paid for by taxpayers, on some loans that they write down.

Those incentives are possible if the principal reduction happens under the umbrella of the government's existing HAMP.

The government hastens to point out that banks don't get credit toward paying off their mortgage-settlement obligations when they tap funds from HAMP.

Here's an example: Say a bank cuts a mortgage principal by $100 under HAMP and the government gives it $20 in cash for that reduction. The other $80 of that loan that the bank is writing down will be counted toward the total reduction the bank must make under the mortgage settlement but not the full $100.

Because the banks don't get any credit for the money that the taxpayers give them, through programs like HAMP, they will ultimately have to pay the entire $20 billion they have promised to spend on homeowner relief, the government says. The taxpayer isn't paying any part of it.

But this hardly seems the stuff of harsh punishment. Banks will get government cash as an incentive to work down mortgages as part of a settlement that is supposed to punish them for their malpractice. Banks have been getting taxpayer money under loan modification programs like HAMP all along: $615 million in modification incentives so far. Those incentives were tripled on Jan. 28 just days before the mortgage settlement was announced, making the deal appear even sweeter for the banks.

"You can't say this settlement has anything to do with deterrence or is punitive in nature if money is flowing into banks from taxpayers as part of the settlement," said New York University Law professor Neil Barofsky, former special inspector-general of the Troubled Asset Relief Program.

Barofsky was quoted in the Financial Times story as describing the subsidy as "scandalous" and told HuffPost he stood by that comment despite the fervent objections of Donovan's office.

Others have pointed out that there are extra incentives under HAMP for banks to write down mortgages early and if modifications are successful. This all puts cash in banks' pockets that they wouldn't have otherwise had, which they can use for whatever they want.

Donovan's office did not respond to requests for further comment on these questions.

The Treasury Department did suggest to the Financial Times that adding government money to the total pot available for mortgage relief helps the banks' money go further. It helps more homeowners.

That may not feel like swift and angry justice, but HAMP money was intended to help homeowners, and the settlement has given banks an incentive to use it in the best way possible, by writing down principal -- something they were loath to do before the settlement.

"Bankers' DNA is hardwired not to like principal write-down," Connecticut Attorney General George Jepsen said in an interview. "It wasn't easy for them to change their perspective. They ultimately realized we weren't going away, and there would be no settlement without it.

"They came around and realized they would rather take a haircut and have someone stay in the home," he said.

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