The proposed $25 billion "settlement" of the mortgage servicing mess, scheduled to be made public any moment, must be a way station to much larger reductions of mortgage principal for underwater homeowners -- and much more serious consequences for the banks and their allies, whose fraudulent actions created the mortgage meltdown. If the settlement turns out to be the final installment of relief for homeowners, it will be a colossal failure, both as economics and as justice.
However, while the settlement talks among state AGs, the Obama administration and bankers were in their final phase last week, New York Attorney General Eric Schneiderman filed a massive lawsuit against three of the largest players, Wells Fargo, Bank of America, and JPMorgan Chase. This bodes well for further enforcement actions, settlement or no settlement.
The lawsuit minces no words in alleging that the big banks fraudulently used the electronic system known as MERS to "evade county recording fees, avoid the need to publicly record mortgage transfers and facilitate the rapid sale and securitization of mortgages en masse." According to Schneiderman, the illegal scheme saved banks $2 billion directly in recording fees, and the banks could be subject to much more money in fines. Schneiderman's suit also seeks to block the ability of the banks to foreclose on some 70 million properties held in the name of MERS.
Much of this same fraudulent misconduct is also the subject of the proposed settlement talks. Schneiderman signed onto the talks, and to a newly activated federal task force on criminal wrongdoing in mortgage securitization. So how can he file this case without blowing up the talks?
The answer is that the suit does blow up the wrong kind of settlement -- one that would protect the banks from further civil and criminal liability. In fact, the settlement now taking final shape would only narrowly insulate banks from federal and state litigation directly related to fake robo-signing. Nothing in it shelters the banks from other liability, such as fraudulently claiming that trust documents contained mortgage notes that in fact weren't there. The proof of the pudding is that Schneiderman's case went forward, and there will be more such cases.
Why would the banks still agree to a settlement? Because the Frankenstein system that they created is such a mess that they need government help in cleaning it up. $25 billion is a small price to pay for the ability to restore a system that clearly establishes titles and liens -- and the right to foreclose.
The question is whether it is too small a price to pay, whether the government is giving up leverage that it could use to extract a much larger settlement, and whether the result will be major principal write-downs -- or expedited foreclosures.
Unfortunately, HUD Secretary Shaun Donovan muddied the waters in a press call on Saturday, when he bragged that the settlement would be bigger than the $20-25 billion previously reported, but that much of the cost would be borne substantially by the investors who bought the subprime securities created by the banks.
While some of these investors are hedge funds speculating in depressed paper, others are pension funds that bought the bonds in good faith based on the very misrepresentations that leave the banks open to prosecution.
As Senator Sherrod Brown has previously warned, it would be a travesty to whack taxpayers once in their capacity as workers and homeowners, and a second time as the value of their pensions takes a hit.
At the same time, it is reasonable that the holders of the bonds be part of settlement discussions. These securities are already worth far less than their book value. The market has discounted them, based on the high mortgage default rates. A settlement that allowed millions of homeowners to stay in their homes and reversed the collapse in housing prices would be good for all concerned, including the pension funds.
But while the penalties on the banks that caused the calamity should be mandatory, those who got stuck with the bonds should be at the write-down negotiations in a voluntary capacity. The risk is that banks will get off too easy. The Treasury's prime goal all along has been to prevent the bank balance sheets from taking too big a hit. Others in the administration, however, seem to belatedly recognize that much deeper mortgage relief should take priority.
We will soon learn two crucial things. First, will the deal be a sellout -- as some fear -- or a down-payment? Will it give banks any protection except from the narrowest litigation related directly to robo-signing? Will it leave prosecutors free to pursue all the other illegalities that have marked the entire mortgage meltdown?
And will the state AGs and the federal agencies pursue other civil and criminal cases that lead to a much larger set of fines that can be used for mortgage relief, more proportional to the damage done by the banks?
There are those who think that the administration has been so in the pocket of the big banks until now that any state AG who collaborates is by definition tainted. There are others who admire the independence and gumption of the AGs who blocked earlier versions of the settlement, and who look to them to lead.
Robert Kuttner is co-editor of "The American Prospect" and a senior fellow at Demos. His latest book is "A Presidency in Peril."