California should make that mortgage deal

State and federal attorneys have been negotiating with more than a dozen major national banks for months to settle claims that the banks’ mortgage-servicing arms improperly foreclosed on homeowners. The negotiations are approaching a make-or-break point, and success could hinge on whether California Atty. Gen. Kamala Harris signs on to the proposed settlement. Harris has legitimate concerns about the deal’s enforceability and the way it will be divided among the states, but those seem resolvable. As tempting as it may be to try to wring more out of the banks, the surest way to get relief in the near future for thousands of California families is for Harris to join the multi-state coalition and take the deal.

At issue are claims that the banks violated state and federal law by taking shortcuts on foreclosure paperwork — also known as “robosigning” — and otherwise mishandling loans that were defaulting. Also under discussion are the states’ allegations that banks engaged in predatory lending during the housing boom. The latter issue, however, may be outside the reach of state attorneys general because national banks are regulated by federal law.

There’s no doubt that the banks helped create the disastrous housing bubble and exacerbated the damage it caused to property values. They were not, however, responsible for every bad loan, every foreclosure and every dollar of home value that evaporated. The settlement would end the states’ claims related to the banks’ lending and loan servicing, but prosecutors could continue to pursue claims having to do with how the loans were sold to investors — an important factor in the broader collapse of the economy.

Harris pulled out of the talks six weeks ago, contending that the banks weren’t offering enough to settle the claims and pledging to conduct her own investigation. Since then, the banks have increased their offer. The deal now on the table requires the banks to provide up to $30 billion in relief to current and former homeowners over three years. Of that total, up to $20 billion would be used to modify troubled loans, most notably by writing down some of the principal. Another $3 billion to $4 billion would be used to refinance “underwater” borrowers who owe more than their homes are worth. Among the direct beneficiaries would be about half a million California households, including 150,000 to 250,000 who’d receive some relief on their debt, officials estimate.

Considering that slumping property values have left borrowers owing about $750 billion more than their homes are worth, $30 billion doesn’t seem like much. But supporters of the proposed deal estimate that if they took all the cases of robosigning and improper loan servicing to trial and won, they’d collect about $35 billion. Significantly, the settlement wouldn’t stop the federal government from suing the banks for predatory and deceptive lending practices. That investigation is ongoing.

Nevertheless, some consumer advocates and liberal groups, worried that the settlement would absolve lenders from too much liability while requiring them to pay too little, want Harris to go her own way. It’s easy to understand their desire to punish the nation’s biggest banks, most of which took advantage of a taxpayer bailout and rescue efforts by the Federal Reserve to rebound dramatically from the recession they helped trigger. Even more galling, the banks have convinced many Republicans that they’re being victimized by overzealous federal regulation, conveniently forgetting the regulatory failures that enabled the exotic-mortgage mania that inflated the housing bubble.

But while the investigations and negotiations drag on, the housing market continues to flounder, millions of underwater borrowers remain trapped in high-interest loans they can’t refinance, and foreclosures mount. Federal efforts to shore up the market by reducing unnecessary foreclosures and easing the sale of underwater homes have delivered far less help than promised, in part because of market complexities but also because of the banks’ foot-dragging. In particular, they’ve been loath to offer defaulting homeowners the most effective form of loan modification — writing down part of their debt — even when it would reduce the lender’s losses in the long run.

By requiring participating banks to spend a few billion dollars writing down debt when it costs less to do so than foreclosing, the settlement would provide banks with proof that principal write-downs make sense for both sides and can be done without causing a flood of opportunistic defaults by borrowers who aren’t in hardship. The hope is that the settlement would become a template for future loan modifications that would help millions of additional borrowers.

Harris is right to be concerned about California’s share of the settlement. The deal should include mechanisms ensuring that the relief is divided among the states in proportion to the number of claims each could make. And though the settlement has been adjusted to address Harris’ concerns about enforceability, those provisions should leave the banks no wiggle room. Nevertheless, with about $5 billion more offered by the banks and a new commitment to refinancing underwater borrowers, the deal looks significantly better than it did when Harris withdrew. Assuming her concerns about the state’s share and enforceability are met, she should join the rest of the states, wrap up the negotiations and start the settlement dollars flowing. There are too many troubled borrowers in California who can’t afford to wait for a better deal.