Photographer: Andrew Harrer/Bloomberg

An anti-foreclosure demonstration outside Fannie Mae headquarters.

Update: Fannie Mae today reported a record 17.2 billion profit for 2012, underlining the dilemma Clea Benson explained in yesterday’s story.

If there’s such a thing as too big to fail, no one qualifies more clearly than Fannie Mae and Freddie Mac. Together the two agencies own or guarantee more than $5 trillion in mortgages. After they were taken over by the government, the consensus was that we’re certainly not going to let the government take the risk of losses on the entire mortgage market again.

Not so fast. Bloomberg’s Clea Benson today reports that the government is trying to figure out what to do with the substantial profits collected by Fannie and Freddie. The two have now given back $50 billion to the government out of $187.5 billion in bailout costs. The question is how the government plans to run a profitable business that it never wanted to be in.

From the beginning, discussions of what to do with Fannie and Freddie have focused on getting the government out of the business of unlimited guarantees. A Treasury report on reforming the housing market two years ago outlined the problems with the agencies succinctly, noting their “profit-maximizing structure undermined their public mission.” Telling the agencies to do anything they could to make a profit, while also asking them to avoid irresponsible risks, plainly didn’t work.

What would be better? As yet, there’s no really good answer. One option is just to split up Fannie and Freddie into smaller pieces. That won’t be enough. It’s often claimed that lenders act recklessly when they’re too big to fail and can count on the government to step in when they get in trouble. The evidence for that is slim: the mass of smaller companies in the subprime industry happily drove themselves into oblivion with no expectations of government help (Roger Lowenstein has made a similar point). The problem with smaller financial companies, whether you talk about subprime lenders or, to go back in history, savings-and-loans, is that most of them make similar mistakes at the same time. When they fail, they all fail at once.

The invisible hand of the market alone isn’t going to fix that. Benson writes that proposals now focus on developing a private mortgage market, with a final backstop of direct government guarantees. Like it or not, some version of that last part is always going to be in play.

Photographer: David Calvert/Bloomberg

The tracks in the Nevada snow? Underwater homeowners walking away from their homes.

Just as the housing market has started to turn up, Fanne Mae and Freddie Mac, the housing guarantee agencies are loosening the rules on homeowners walking away from their mortgages. It used to be that only way to get out of a mortgage was to stop paying and let it go into foreclosure. Now, as Bloomberg’s Kathleen Howley reported yesterday, a few homeowners will be able to walk away from underwater properties, with new policies going into effect in March.

Under the old rules, homeowners who kept up with payments were effectively punished for doing so: stuck in houses worth much less than they paid, they were nonetheless ineligible for foreclosure aid programs. The revised rules give those folks a break — although with a raft of restrictions. They apply only to homeowners faced with hardships such as illness or job changes, and then only if 55 percent of their income goes to debt payments. And in some cases they’ll be asked to pay part of what they owe.

In return, the agencies will not try to collect a “deficiency judgement,” pursuing home owners for the remaining debt. That small accommodation elicits indignation from commentators. As one puts it in Howley’s story, “It’s an extraordinarily generous approach for companies still in debt to the American public.”

Actually, it’s not. In an audit released last October the Federal Housing Finance Agency found that in 2011 Fannie and Freddie pursued deficiency judgements on 35,231 accounts (for comparison, they foreclosed on about 342,000 properties). The total recovery on those accounts was $4.7 million — just $133 for each deficiency, or 0.22 percent of what the agencies were owed. The money Fannie and Freddie get back in the typical case is so small that even a token payment homeowners make as part of a deal is likely to exceed it.

It’s well known that some “non-recourse” states, like Nevada and California, bar deficiency judgements in many cases. Less well understood is that even in cases where they are theoretically possible, the judicial procedure makes them impractical.

The deficiency judgement is a club held over the heads of debtors, a scare tactic far more useful in persuading debtors that they should keep making payments than in recovering money when they don’t. Nonetheless, the idea that homeowners might not be pursued for the money they continue to owe still creates outrage among those who believe it violates the moral principle that debts should be paid.

That outrage has been with us since the early days of the mortgage bust, with guardians of public morals decrying the dangers of letting deadbeats walk away from their loans. Sometimes that’s been accompanied by nostalgic claims that upstanding Americans of the past would never have simply walked away from their debts (not true: even the term “walkaway” dates at least as far back as 1962).

Leave aside that the reason deficiency judgements are so hard to collect in the first place is that states made it that way to avoid (obviously without success) the lending excess of past land booms. Worth asking here is what the deadweight loss to the economy has been of scorched earth efforts to squeeze the last bits of money from foreclosures. Homeowners already sinking into a debt trap end up letting utilities get turned off or cars break down, while options like moving to regions with better job prospects disappear.

So more debtors are pushed to seek direct or indirect support from the government, and ultimately the costs of that can easily a few extra months of house payments or the $133 recovered in a deficiency case. Having gotten $187 billion in taxpayer bailouts, it seems reasonable for Fannie and Freddie to take that cost into account, too.

Photographer: Alessia Pierdomenico/Bloomberg

There's no bucket in the world big enough to fill the sea of mortgage losses.

Can you ever count paying out billions of dollars to settle claims as a victory? When it comes to mortgages, you sure can. Today brought two big mortgage settlements, one for homeowners, and one for Fannie Mae, which is getting billions of dollars from Bank of America Corp. The Market Now has had a bit of time to delve into the Bank of America settlement.

It looks like a good deal for Bank of America when you look at the number of loans involved. And probably an even better deal when you think in terms of the overall damage to the economy that came from bad mortgage loans.

The settlement with Fannie has Bank of America making two payments to Fannie. One, for $3.6 billion, covers losses that Fannie Mae has already realized on loans originated by Bank of America and Countrywide Financial Corp, the mortgage giant Bank of America bought in 2008. The other, $6.75 billion, covers 30,000 loans that Bank of America is buying back, at face value (that is, the total remaining principal of $6.51 billion, plus some interest).

What looks at first glance like a $6.75 billion price-tag is actually lot less. Those loans are certainly worth less than the principal balance, but these are not the worst of the loans that were made in the mortgage boom. Virtually all of the loans that Bank of America is buying back have been modified, are now delinquent, or both (you can see the full breakdown here). But they are not in foreclosure, and Bank of America stands to make back a significant share of what it paid.

The $3.6 billion payment will likely turn out to be the bulk of Bank of America’s cost. That seems like a surprisingly good deal, since it settles Fannie Mae’s claims on loans with an original outstanding balance of $1.4 trillion (yes some of that would already have been paid back or refinanced; still that’s a very big number). That doesn’t seem like much. Think of it this way: Bank of America is buying back 30,000 loans for $6.75 billion, or about $225,000 for each loan. At $3.6 billion the settlement on two million loans costs Bank of America about the same as buying back 16,000 loans that have gone to zero.

What exactly does that $3.6 billion represent? It’s hard to say. Jerry Dubrowski, a spokesman for Bank of America, described it as the outcome of negotiations over how much of the loss came from bad underwriting and how much from the housing bust — as Dubrowski puts it, “What drove these losses? Was it economic? Was it the fact that this person lost their job?”

“It gets to the point,” Dubrowski says, “where I no longer want to sit here and sort through the laundry dividing the hot water from the cold.” So the $3.6 billion is an alternative to going through each individual loan. That’s a fraction of Fannie Mae’s losses; Dubrowski says it’s in line with Bank of America’s other settlements with loan buyers, which Dubrowski says have come in around 10 or 15 cents for each dollar of losses.

Photographer: Jay Mallin/Bloomberg News

Angelo Mozilo, CEO of Countrywide. Most of the loans at issue were originated by Countrywide, bought by Bank of America in 2008.

Is that a fair deal for the bad loans that Fannie Mae bought? If you think simply in terms of how many loans had “underwriting problems,” perhaps it is. Fannie Mae held some of the better quality loans that Countrywide originated; they didn’t include many no-doc liar’s loans that didn’t qualify for Fannie Mae’s backing and were sold to mortgage-bond investors; Bank of America and others still face plenty of liability over those.

There’s a better way to think of the mortgage bust, though, than adding up individual misdeeds. The press tends to concentrate on liar’s loans, bogus subprime teaser rates, and sleazy fees tacked on to the bills of struggling home buyers. All those were indeed scandalous.

However, the whole is a lot more than the sum of the parts. The bottom-line problem here is that virtually every party involved in the housing boom — from banks to mortgage brokers to investors to Alan Greenspan — did their best to drive up housing prices to a point at which they were sure to blow up. The net effect was a lot greater than the damage that can be traced directly to unfair fees or improper underwriting.

Unfortunately, Fannie Mae and other mortgage buyers are not ideally positioned to build a case around the deep damage banks did with all the actions that inflated the housing bubble. Banks and mortgage underwriters may have been cynical and reckless players, but most everyone involved was to some extent a willing participant, sometimes down to the home buyers who were told, “Sure, it’s okay to buy that $500,000 house, it’ll go up in value overnight.” If you add up not just of some particularly egregious loans but the full costs of the bubble, all the banks put together can’t come close to covering the losses.