The country's banks agreed to change their behavior as part of the robo-mortgage settlement announced earlier this week. The announcement, however, leaves open a central question: Does the settlement include new, pre-defined penalties for banks that fail to uphold their new promises? Since a change in bank behavior is a vital piece of the settlement, the absence of an answer is highly disconcerting.
When the deal was announced, the Associated Press reported, "The conditions will be overseen by Joseph A Smith Jr., North Carolina's banking commissioner. Lenders that violate the deal could face $1 million penalties per violation and up to $5 million for repeat violators." The initial impression on reading this report is that there are real teeth to it. It sounds like the banks are agreeing to pay $1 million dollars each time they fail to perform as promised.
However, the actual press release from the Department of Justice announcing the deal reads (emphasis added):
Compliance with the agreement will be overseen by an independent monitor, Joseph A. Smith Jr. Smith has served as the North Carolina Commissioner of Banks since 2002... The monitor will oversee implementation of the servicing standards required by the agreement; impose penalties of up to $1 million per violation (or up to $5 million for certain repeat violations); and publish regular public reports that identify any quarter in which a servicer fell short of the standards imposed in the settlement.
There are two open questions. First, what does "up to" mean? Does the independent monitor have discretion over the size of each penalty? This could effectively make the million dollar figures announced by the Justice Department meaningless. Banks have argued that the tens of thousands of robo-mortgage signatures and well-documented servicing errors were all technical violations that harmed no one. Undoubtedly, they will argue that any single violation was a meaningless error.
This provision would have real meaning if we applied the same standard our nation has applied in other areas: a zero tolerance rule. What would happen if each bank knew that any violation would result in a minimum fine of $1 million? I suspect bank behavior would change significantly.
Second, can banks contest these fines? Have the banks agreed that they will pay any fines assessed by the independent monitor? If not, then once again the provisions have the potential to be meaningless. The monitor will assess fines for violations and the banks will challenge the fines through whatever venues, the courts or otherwise, have been established by the settlement. The judgment and ability of the independent monitor to set fines will have been eviscerated.
Efforts to determine answers to these and related questions have seemingly been rebuffed. The Huffington Post reported on its efforts to understand the details of the enforcement provisions of the settlement:
Details of how the states will make sure banks follow the deal's guidelines haven't yet been released... The announcement on Thursday did not include any new information on bank penalties. A call to the Smith's office was not immediately returned. A HUD spokesman did not immediately return an e-mailed request for comment.
There appears to be near universal agreement that this settlement will do little for homeowners who have been the victims of past bad bank behavior. But there may be real value in the deal if it successfully changes bank behavior going forward. The New York Times quoted the Attorney General of North Carolina as saying, "This agreement is more important for the foreclosures we're hoping to prevent."
At the same time, The New York Times wrote, "Advocates for homeowners facing foreclosure expressed cautious optimism," but indicated that these same advocates believe rigorous enforcement is essential for the program to work:
"We're hopeful," said Joseph Sant, a lawyer at Staten Island Legal Services' homeowner defense project. "But we had a lot of programs that are good on paper. What will make the difference is that it's vigorously enforced."
The stakes here are enormous. They extend beyond the housing market to the nature of American society itself. The banks' blatant malfeasance with regard to the robo-mortgage scandal and other foreclosure-related activities has been a clear example of unequal justice. The banks have knowingly and repeatedly violated laws (such as providing tens of thousands of false affidavits to the courts) that would have landed an ordinary citizen in jail.
At the same time, successful capitalism itself depends on the enforcement of rules and contracts in a fair bargain. When powerful players are permitted to alter pre-established rules at will, capitalism ultimately collapses. Contracts and the idea of a fair bargain become meaningless as less powerful parties to an agreement know their rights will not be enforced. Over time, citizens lose faith in government and their own ability to thrive in what becomes a corrupt economy.
If the settlement enforcement provisions turn out to lack substance, these forces will be reinforced rather than counteracted. We must wait for the details. Like homeowner defense advocates, I am cautiously optimistic -- but terrified that ultimately I will be disappointed.
Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.