New York Times.com, July 17, 2011
By: PAUL KRUGMAN

This principle was on display during the final months of the Bush administration, when a huge lifeline for the banks was made available with few strings attached. It was equally on display in the early months of the Obama administration, when President Obama reneged on his campaign pledge to “change our bankruptcy laws to make it easier for families to stay in their homes.” And the principle is still operating right now, as federal officials press state attorneys general to accept a very modest settlement from banks that engaged in abusive mortgage practices.

Why the kid-gloves treatment? Money and influence no doubt play their part; Wall Street is a huge source of campaign donations, and agencies that are supposed to regulate banks often end up serving them instead. But officials have also argued at each point of the process that letting banks off the hook serves the interests of the economy as a whole.

It doesn’t. The failure to seek real mortgage relief early in the Obama administration is one reason we still have 9 percent unemployment. And right now, the arguments that officials are reportedly making for a quick, bank-friendly settlement of the mortgage-abuse scandal don’t make sense.

Before I get to that, a word about the current state of the mortgage mess.

Last fall, we learned that many mortgage lenders were engaging in illegal foreclosures. Most conspicuously, “robo-signers” were attesting that banks had the required documentation to seize homes without checking to see whether they actually had the right to do so — and in many cases they didn’t.

How widespread and serious were the abuses? The answer is that we don’t know. Nine months have passed since the robo-signing scandal broke, yet there still hasn’t been a serious investigation of its reach. That’s because states, suffering from severe budget troubles, lack the resources for a full investigation — and federal officials, who do have the resources, have chosen not to use them.

Instead, these officials are pushing for a settlement with mortgage companies that, reports Shahien Nasiripour of The Huffington Post, “would broadly absolve the firms of wrongdoing in exchange for penalties reaching $30 billion and assurances that the firms will adhere to better practices.”

Why the rush to settle? As far as I can tell, there are two principal arguments being made for letting the banks off easy. The first is the claim that resolving the mortgage mess quickly is the key to getting the housing market back on its feet. The second, less explicitly stated, is the claim that getting tough with the banks would undermine broader prospects for recovery.

Neither of these arguments makes much sense.

The claim that removing the legal cloud over foreclosure would help the housing market — in particular, that it would help support housing prices — leaves me scratching my head. It would just accelerate foreclosures, and if more families were evicted from their homes, that would mean more homes offered for sale — an increase in supply. An increase in the supply of a good usually pushes that good’s price down, not up. Why should the effect on housing go the opposite way?

You might point to the mortgage relief that would supposedly be extracted as part of the settlement. But if mortgage relief is that crucial, why isn’t the administration making a major push to reinvigorate its own Home Affordable Modification Program, which has spent only a small fraction of its money? Or if making that program actually work is hard, why should we believe that any program instituted as part of a mortgage-abuse settlement would work any better?

Sorry, but the case that letting banks off the hook would help the housing market just doesn’t hold together.

What about the argument that getting tough with the banks would threaten the overall economy? Here the question is: What’s holding the economy back?

It’s not the state of the banks. It’s true that fears about bank solvency disrupted financial markets in late 2008 and early 2009. But those markets have long since returned to normal, in large part because everyone now knows that banks will be bailed out if they get in trouble.

The big drag on the economy now is the overhang of household debt, largely created by the $5.6 trillion in mortgage debt that households took on during the bubble years. Serious mortgage relief could make a dent in that problem; a $30 billion settlement from the banks, even if it proved more effective than the government’s modification program, would not.

So when officials tell you that we must rush to settle with the banks for the sake of the economy, don’t believe them. We should do this right, and hold bankers accountable for their actions.