Seize the Moment: Use Settlement Talks to Halt Abuse of Homeowners

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American Banker
By Orson Aguilar and Tunua Thrash

State attorneys general and federal financial regulators are locked in settlement negotiations with U.S. banks that engaged in abusive, often fraudulent, mortgage and foreclosure practices. These negotiations may be the last, best chance to help struggling homeowners, stabilize neighborhoods and strengthen the economy.

It shouldn’t come as a surprise that before it’s even finalized the settlement is under attack by some in Congress who don’t want banks held to account for their actions. But banks should be held accountable, and if anything the proposed terms should be strengthened.

While the deal is still being negotiated, some elements have been leaked. If these proposed terms get more detail, time frames and teeth, they could go far to prevent future abuses. Just as important, they would give loan servicers an incentive to give real help to hard-hit homeowners, something that the Obama administration’s current effort, Home Affordable Modification Program, has mostly been unable to achieve.

First, the settlement could encourage servicers to offer more principal reduction for underwater homeowners. With such a steep drop in home values, especially in states like California, Hamp’s heavy emphasis on reducing interest payments while the principal balance remains out of reach has led too many to walk away from their homes. When walking away from your mortgage is the most sensible option — as it is for many homeowners right now — something is very wrong.

Elements in the potential settlement could help. Provisions such as eliminating the dual-track process that now allows modification and foreclosure to proceed simultaneously will create a path toward principal reduction for more distressed homeowners.

Second, while the actual dollar amount of the monetary settlement remains unclear, a sizable sum could be used to support not only principal reduction, but vital aid for borrowers struggling to keep their homes.

For example, it could bolster support for the understaffed and overwhelmed HUD-approved, nonprofit housing counselors who often expend $1,000 to $1,500 to help each distressed homeowner.

It could also be used to prevent the neighborhood blight that results from foreclosures and is too often concentrated in low-income communities and communities of color. When foreclosures are rampant, entire neighborhoods suffer. The Center for Responsible Lending estimates that between 2009 and 2012, homeowners who keep their homes will lose $273 billion in home value from the impact of foreclosures in their neighborhoods. That’s a staggering loss of assets for families that often started with little in the first place.

All of this, of course, argues for a larger monetary settlement than the $20 billion that has been floated.

Third, the settlement could make the Consumer Financial Protection Bureau the main federal player in addressing mortgage abuses and the foreclosure crisis. In the leaked terms, the CFPB is mentioned frequently, along with state regulators and attorneys general.

This settlement will make a difference if enforcement is energetic, and it is smart to trust the CFPB under Elizabeth Warren’s leadership, rather than other agencies that let us down before.

Still, the final settlement needs to create stronger incentives for loan servicers to opt for mortgage modification rather than foreclosure.

A bill being debated in California, AB 935, offers a good model: When initiating a foreclosure proceeding, loan servicers would have to place a large foreclosure fee in escrow.

That fee would be returned in full to the servicer if foreclosure is successfully avoided; if the foreclosure is executed, the money would go into a homeowner relief fund.

If set at $20,000 per proceeding, such a fee would create a significant disincentive to foreclose and wouldn’t cost taxpayers a dime.

The settlement talks between the AGs, federal regulators and the banks offer an irreplaceable opportunity. Officials should make the most of it.