02/07/2012 10:56 am ET | Updated Apr 08, 2012

Will the Attorneys General Sell Out the Pension Funds?

A shocking aspect of the proposed foreclosure fraud settlement among bailed-out banks, the state attorneys general, and the feds has rightly gotten a lot of attention, namely the bailed-out banks' ability to pay their "penalty" with other people's money. I confess, when I first heard about it, I figured it was a testament to the federal government's craven capitulation to the bailed-out banks. (Let's call them the B.O.B.s, rhymes with S.O.B.s) But now I know it's much worse than that, thanks to excellent reporting by David Dayen. The federal government really wants the B.O.B.s to use pension fund money to pay their "penalty."

Now, readers know I'm not exactly a Pollyanna, but I feel like one now. See, I thought our federal government understood that the right way to penalize someone with a fine was to actually make them pay the bill. I thought the feds realized the best way to punish the banks was to have them cough up cash into a BP spill-type fund, and have 50 special masters (one per state) use it to pay down mortgages, thereby punishing banks and helping homeowners. I just figured the feds had rushed things so much, doing essentially no investigation, that they didn't have the goods to leverage a better deal. But no. The feds see the banks' ability to spend firefighters', teachers' and cops' money as a design feature, not a flaw.

(Yes, private investors besides pension funds are affected too. I am fixating on the pension funds because attorneys general usually protect state pension funds from theft.)

See, on a conference call that included Dayen, HUD Secretary Shaun Donovan was boasting about how the settlement would deliver up to $40ish billion in principal reductions. That boast amazed people, because that number's never been on the table; at best it's been $17 billion in principal reduction, plus penalties of $8 billion. Donovan then explained the feds are um, banking on the B.O.B.s using other people's money to pay the penalty. See, the banks only get 50 cents "credit" toward the penalty total for every $1 of other people's money they write down. So when Donovan says the feds are expecting to get $2 or more in principal reductions for every $1 in "penalty" total, he apparently means the feds are hoping every dime of principal reduction comes out of a pocket other than the B.O.B.s'.

How can the AGs wink and nod and sign off on a deal that everyone expects will steal billions from investors, including pension funds? The NY AG's office under Eric Schneiderman's predecessor, Andrew Cuomo, incarcerated people for stealing from the pension fund. Schneiderman himself has sued Bank of New York Mellon for defrauding the pension fund. How can he possibly ink a deal that could take money from the fund for harm the fund didn't cause?

Again, consider the, "Hey B.O.B.s: cough up the billions, we'll pay it out," alternative. Under that scenario, mortgages aren't written down, they're paid down, with B.O.B. money. The investors get their money, and the B.O.B.s are penalized. And if Shaun Donovan wants $40ish billion, then that's what the deal should be for. None of this game playing.

What are the AGs thinking? I mean, it's not just the NY AG that goes after people for stealing from pension funds. Here's a CA example, and a MA one too.

And it's worth noting that the Massachusetts example is a mortgage-backed securities suit against Morgan Stanley, in which AG Martha Coakley also got $58,000 in "principal reduction and other relief" for 1,000 homeowners. $58k versus less than $2k per on the table in this deal financed with other people's money.

One last reason all the AGs should walk because of the B.O.B.s don't pay dimension is this: the deal may get blocked by investors suing over it as an unconstitutional taking. Forget the fact that the suit would hold up the trivial homeowner relief this settlement would bring. Why would an AG want to sign a deal that at a minimum arguably represented an unconstitutional taking from her state pension fund?