What Mortgage Settlement Lacks in Substance, It Makes Up in Execution

A practical, well-executed plan, even one with disappointingly modest goals, will deliver more than an overly ambitious plan, easily subverted, that, in hindsight probably had no hope of ever succeeding.

When a judge approved the state attorneys general settlement with five mortgage servicers on April 5, the consent decrees issued by federal bank regulators mandating foreclosure reviews at 14 servicers – including the five in the multistate settlement – were already a year old.

The settlement focuses primarily on helping distressed borrowers still in their homes. At least $17 billion of the $25 billion in relief advertised is earmarked for principal reductions and loan modifications. Three billion dollars is for refinancing "underwater" homeowners. Only $1.5 billion will go to homeowners hurt by a foreclosure finalized between Jan. 1, 2008 and Dec. 31, 2011.

The banking regulators’ review process covers borrowers subject to a foreclosure action on a primary home between Jan. 1, 2009 and Dec. 31, 2010. A completed foreclosure and loss of property is not required. The 14 mortgage servicers' potential liability to borrowers under the consent decrees is unlimited and, so far, unknown.

The foreclosure reviews are a "look back" at the past. No one hates admitting and paying for mistakes more than banks. The "independent consultants" selected by the banks in November, after more than six months of contract negotiations, haven't calculated any final damage numbers yet. It wasn't until June of this year that, 15 months after the consent orders were signed, regulators finally issued a "financial remediation framework" prepared by the consultants.

Rest assured the consultants are getting paid, even if borrowers are not. PricewaterhouseCoopers will bill more than $1 billion for four of the 14 ordered reviews, according to my sources. I think banks will spend at least $5 billion in total on consultants just to find out how much they'll owe.

The mortgage settlement monitor left the gate quickly after his appointment, publishing a preliminary report in August, only four months after the settlement was approved. Joseph Smith's team will send an annual report to the court, then a final report in 2016. The foreclosure review under the consent orders has issued two interim reports, in November 2011 and June 2012, but the regulators do not announce in advance when they'll update the public next. The next update may not occur until all the work is done.

The mortgage settlement monitor's interim report cited $10.6 billion of consumer relief activities reported by the banks. Those amounts have not been not audited or confirmed by Smith or his team. The mortgage settlement does, however, provide an incentive to the banks to pay consumers quickly. For each dollar relief of provided since March 1, a servicer gets credit against its settlement commitments. There's an additional 25% credit for any first or second lien principal reductions or credited refinancing activities in the first 12 months and a penalty of at least 125% of any unmet commitment amount if the servicer doesn't hit its total target within three years.

The consent decrees, on the other hand, have no financial incentive for the banks to compensate harmed borrowers quickly. Other than having to pay consultants to go through the motions, there's every incentive to stall on payments. I'm pessimistic that borrowers will see any meaningful compensation under these orders.

The two mortgage harm make-good efforts are organized quite differently. The Office of the Comptroller of the Currency and the Federal Reserve balked at the idea of directly hiring consultants to evaluate liability to borrowers. Regulators told me it was too difficult and would take too long to negotiate the contracts, even though almost all of the firms selected already act as approved vendors to the government for audits, consulting and financial crisis related initiatives like TARP. Under the consent orders, therefore, the banks selected their own "independent consultants" and pay them directly. Regulators were supposed to ensure the consultants' independence and strongly monitor their activities. Instead, the OCC and Fed have been hands-off, allowing independence issues to persist and potentially collusive communications between consultants to continue.