THE BLOG
02/12/2012 04:55 pm ET | Updated Apr 13, 2012

Mortgage Settlement: Really? For Whose Benefit?

If the 'settlement' involving mortgage foreclosure practices is supposed to be good news for the country, I must have missed something. To me this is economically detrimental, manifestly unfair to those who did not take on unaffordable mortgages, and a thinly disguised attempt to buy votes (with banks' money) for incumbent politicians.

The unfairness seems quite evident. Persons who were never subject to foreclosure because they never had a mortgage or met their obligations, get nothing in return for their prudence. All of the benefits go to those who failed to meet their obligations. On another level, the unfairness arises because the root cause of the settlement -- lenders' practices regarding foreclosure documentation -- had nothing to do with whether borrowers met their obligations.

The original impetus was to hold banks to account for engaging in robo-signing.

Bad as it was, however, it was a mere handmaiden to the easy credit and eager borrowing that led to financial disaster. Robo-signing marred the foreclosure process at the heart of the settlement. But by itself, it didn't cost anyone his or her home and savings.

If someone at a lender lied about their review of documents or otherwise under oath, they should be prosecuted for perjury. However, this should not obscure the age old legal standard imposing consequences on those who fail to meet their obligations. I have yet to see reported a single case where someone was evicted from their home despite having met their obligations. If any such cases exist, compensation should be provided to those impacted, but not to provide a windfall to those who simply did not pay what they owed. An apt summary of the impact from the preceding source in an editorial entitled "Help for a Lucky Few":

"The limited scope of this deal is likely to draw complaints about fairness. A small number of winners, and not necessarily the homeowners who have the greatest claims that they were victims of banks."

The economic detriment is a bit less evident but probably more significant. Credit availability is going to be reduced. Lenders have always been admonished to make credit decisions based upon the capacity of the borrower to repay on schedule, and value of proposed collateral, if any. Now, we have introduced an element of uncertainty as to repayment by making the obligation subject to review of the lender's practice regarding enforcement. Even where a lender makes a good decision in traditional terms and should not suffer a loss, they are subject to punishment if their collection practices are deemed inappropriate. By definition, this makes repayment of a loan portfolio less likely and requires an increase in underwriting standards and pricing. This is bad for our economy at this time in that it reduces aggregate demand at a time when we still have greatly underutilized capacity, especially labor.

As we have seen, it is hard enough for lenders to make sound credit decisions. When we tell them that even when they do so, they may still suffer losses because of how they run their businesses on unrelated fronts, they have every incentive to avoid consumer lending and deploy funds elsewhere.

It is also bad for the economy in a more subtle manner in that creditworthy borrowers and even cash buyers of real estate are likely to refrain from such transactions because of the random or lottery element which has been introduced. When one behaves in a prudent manner but sees special favors being dispensed to those who failed to do so, one may well lose confidence in the entire process and simply 'stand pat' rather than having the confidence to take action. It is basic economics that a viable legal system which enforces contracts is fundamental for economic development. When one makes repayment of loans subject to examination of the lender's conduct, they greatly deviate from this principle.

If this were just typical election year populist posturing by the President, state AG's and the like, it would be easy enough to dismiss it as such. However, this 'settlement' is likely to have lasting, material economic impact at a time when we can least afford it. I suggest that those who value a strong economy, make their feelings known at the polls this November in all races involving officials who brought about this solution, starting with President Obama and including pertinent state AG's. Private actors have done their share to mess up our economy. Let's make sure government doesn't compound the problems.