$26 Billion Mortgage Settlement's Impact on the States

E-newsletter Issue #86 | Feb. 16, 2012

About one in five Americans with mortgages owe more to the bank than their home is worth. On average, they are underwater by $50,000 each. Since the beginning of 2007, around 4 million homeowners have entered into the foreclosure process during the biggest housing downturn since the Great Depression.

A recent settlement between 49 states, the federal government and the nation’s largest mortgage lenders is designed to mitigate some of the damage from foreclosures and to help those struggling with underwater or delinquent mortgages. The banks involved are Ally Financial Inc., Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co., and Wells Fargo & Co. Only Oklahoma did not agree to the settlement.

The settlement is a result of an investigation by 50 state attorneys general into the mortgage servicing practices of major banks, which had allegedly misdated documents, used “robo-signing” and engaged in other fraudulent or semi-fraudulent practices.

David Adkins, executive director/CEO of The Council of State Governments, told Bloomberg News that most states, especially those hit hard by foreclosures, likely will spend the money on related purposes instead of priorities, which the public may not see as fitting the spirit of the settlement.

“If my home were in foreclosure, I would want to make certain that the revenue in my state was directed at ameliorating that specific problem,” Adkins said.

U.S. Attorney General Eric Holder defined the settlement as the “largest joint federal-state civil settlement in the history of this nation.”

The exact value of the settlement could range from $25 billion to upwards of $39 billion. Money will be distributed based on a complex formula set forth in the agreement, and the total settlement value will ultimately depend on a number of factors. The deal does not affect an individual’s ability to pursue private legal action in the future, nor does it prevent state and federal authorities from pursuing criminal enforcement actions or interfere with their ability to move current investigations forward, according to Holder.

The settlement does, however, establish a monitor to track compliance with the terms of the agreement. Banks that violate the terms of the deal face penalties of $1 million per violation and up to $5 million for repeat violators. Three states—New York, California and Massachusetts—have specifically reserved the right to pursue or continue to pursue separate litigation. The deal has four primary components: principal reduction, refinancing, payments to foreclosed homeowners and payments directly to states.

Principal reduction: $17 billion-$32 billion

At least $17 billion will be allocated to mortgage debt forgiveness, forbearance, short sales and other assistance to homeowners, primarily by reducing the principal on mortgages that are both underwater and delinquent. The settlement could provide up to $32 billion in direct benefits to borrowers through settlement-related credits. This component of the settlement could assist up to 1 million homeowners.

Refinancing: $3 billion  

Up to 750,000 homeowners who are underwater but still current on their mortgages will be granted relief in this component of the settlement, worth about $3 billion. Although these homeowners will not see their principal reduced, they will be able to refinance their mortgages at the current, near record low, interest rates.

Payments to foreclosed homeowners: $1.5 billion 

Approximately $1.5 billion is allocated to go to homeowners who had their homes foreclosed upon between Jan. 1, 2008, and Dec. 31, 2011, using the improper procedures for which banks were originally investigated, and who meet certain other criteria. Each homeowner in this category will receive up to $2,000.

Payment to states and the federal government: $3.5 billion 

States will receive $2.75 billion and the federal government will receive $750 million. The state money will help fund consumer protection and state foreclosure protection efforts. How each state will ultimately use their direct payments, however, is unclear. Some states have announced they will use the funds to plug holes in their budgets, rather than specifically on housing-related issues.

For example, Wisconsin Gov. Scott Walker said he plans to use about $26 million of the state’s $140 million share of a settlement to shore up the state general fund, a move that drew criticism from a number of policymakers, including the mayor of Milwaukee.

In Missouri, officials said they plan to use $40 million of their share to ease proposed higher education cuts. If the legislature goes ahead with this plan, colleges and universities could see a 7.8 percent cut in their state funding instead of the already planned 12.5 percent cut.

On the other hand, officials in Illinois have said they plan to use all the money on mortgage-related programs with nothing going toward the budget gap. 

“The dimension of the disaster created by the mortgage industry would quickly eat up that money,” Steve Brown, spokesman for Illinois House Speaker Michael Madigan, said in a press release. “The notion that we might be able to set some of it aside (for other purposes), I'm not hearing that.”

State-by-State Benefit Estimates 

Most state attorneys general have estimated the total benefit their states will receive, including homeowner relief (loan modifications, principal reductions, direct relief etc.), refinancing for underwater borrowers and direct cash payments to state government.  States that were hit harder by the housing downturn—like California, Florida and Nevada—will receive a larger chunk of the settlement.

California, for example, could receive up to $16.5 billion in benefits, more than any other state. Nevada Attorney General Catherine Cortez Masto has estimated her state will receive around $1.5 billion in benefits and Florida is estimated to receive $8.4 billion.

On the other end of the spectrum, states with fewer distressed homeowners and lower foreclosure or underwater mortgage rates will receive less. Wyoming and Alaska, for example, will receive around $10 million each in total benefits.

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