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AG mortgage settlement bailout free, mostly

February 17, 2012: 2:17 PM ET

Why it's time to break up the 'too big to fail' banks

No free money in mortgage deal for banks.

UPDATE: 4:10 Pm.

These days, it seems, there is a reflex to call anything that involves the banks and the government a bailout. So perhaps it isn't too much of surprise that as the dust settles on the $26 billion state AG's settlement with the nation's largest mortgage servicers over robo-signing and other abuses that it too is being branded as TARP, part deux (or cent depending on how you are counting).

My general sense is that this is overdone. But Shahien Nasiripour has uncovered an interesting nugget about the AG settlement in today's Financial Times.  Apparently, the banks are eligible to receive from the government (and taxpayers) as much as $3,000 per loan they modify as part of AG settlement. That's potentially a lot of money.

The payments come from the government's existing Home Affordable Modification Program, for which the loans will qualify as well as satisfying the principal reduction portion of the AG settlement. Estimates are that as many as 1,000,000 borrowers could have the amount they owe on their mortgage reduced under the AG's settlement. That means the banks may collect as much as a $3 billion kickback from the Federal government for complying with the AG settlement. Not all of the mortgages modified, though, will qualify for the full $3,000 payment. What's more, some of that money may go to investors. But the biggest point is this: That money was there for the banks all along and few took advantage of it, or relatively little of it. Banks in the past have presumably done the math and decided that the payouts under HAMP were too costly to go for. So that money is anything but free. (UPDATE: A state official close to the settlement refutes the Financial Times' story. He says that banks may indeed get HAMP payouts for the the mortgages they reduce under the AG's settlement, but that the payments will lower how much of the debt reduction they can count against the settlement. For example, if a bank reduces the principal on a loan by $20,000 and then gets a $3,000 payout under HAMP, the bank will only be able to count $17,000 of the reduction against its portion of the $26 billion settlement. Not much of a bailout there.)

How else could the AG settlement be seen as a bailout? TIME.com says mortgage investors are worried that banks will get credit in the AG settlement for forgiving mortgage debt held by investors and not the actual banks. This will make the settlement less costly for the bank, but I'm not sure how that is a bailout. If the banks modify the loans held by investors, the benefit they get from turning a loan that has the potential to default to one that is in good standing is little. Unless that is, as Gretchen Morgenson points out in the New York Times working off a blog post from Naked Capitalism, the banks selectively decide to write down investor loans on which the banks have issued home equity loans. If the primary mortgage is underwater, then the HELOC is dead money as well. Writing down the primary loan could do that. But that's only if banks get credit for modifying investor loans, and not ones that come from their own portfolio. And Paul Miller a bank analyst at FBR Capital Markets says his best guess is that is highly unlikely. Miller is anything but a Wall Street lapdog. He was one of the few analysts warning about the banks going into the financial crisis. So if he thought the banks were getting a better than they should deal here he would say it. What he says is that much of the deal is already baked into bank earnings because the banks reserved for these bad loans. If the banks ended up getting a better deal than they thought they would, Miller and other analysts would now be adjusting their earnings numbers up. But Miller isn't. "This is not a back door bailout," says Miller. "There is no benefit to the banks from this deal."

I think it is fair to think that the AG's could have gotten a better or bigger deal. Afterall, a review revealed this week of loans in California found that more than 80% had foreclosure irregularities. But that would have take a lot more time.  A year is a quick turnaround as these things go. And the value of that settlement for all of us rapidly decreases as the housing market and economy improves. Given that the settlement was always going to be a drop in the ocean - there are $11 trillion in outstanding mortgages - my vote is faster was better.

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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