State attorneys general are demanding this sum, but the numbers and legal realities suggest that they are being unreasonable
At this point, we can be fairly confident that banks cut corners and sometimes even broke laws when processing foreclosures over the past couple of years. As a result, they should face whatever fines or penalties -- or even criminal charges -- that should result through the laws in place. Banks should also face civil lawsuits from any borrowers on which they wrongly foreclosed. How much money could those civil lawsuits cost them? According to the state attorneys general, the five big banks could be on the hook for $17 billion. Is this a realistic estimate?
Earlier this week, the Wall Street Journal reported that this $17 billion sum is the one that's being presented to the five biggest banks in settlement talks. The banks, however, think that number is much too high. They are reportedly offering $5 billion. Obviously, there's a big difference between $5 billion and $17 billion. Which number more realistically describes what banks might owe borrowers in civil court?
In order to determine this, you have to figure out the different reasons why banks might have inflicted injury on the potential litigants. There are two scenarios that likely describe most situations where banks botched the process.
The Common Scenario: In many cases, banks cut corners, but ultimately foreclosed on homes where borrowers were severely delinquent and were legitimately facing foreclosure. In most of these cases, the timeline was still longer than the law called for, as the huge flood of foreclosures overwhelmed banks and resulted in a slow process, even with banks skipping steps.
The Uncommon Scenario: In what's likely a very, very small handful of cases, some loan files got mixed up and banks foreclosed on some borrowers' home despite the fact that they were current on their payments. Considering how few accounts we have seen in the media of this sort of thing, the number of people wrongly foreclosed on must be quite low.
In each scenario, what do banks owe the borrowers? In the common scenario, banks probably owe these borrowers little to no damages whatsoever. According to Kenneth E. Scott, a law professor at Stanford who specializes in regulatory and securities law, if borrowers have defaulted on their loan, then banks will likely owe them nothing. Even if there was some damage inflicted on these borrowers, it would merely be subtracted from the debt they still owe the bank. For example, if a person's foreclosed home was auctioned off for $50,000 less than their mortgage balance and a judge awards the person $10,000 in a suit, then the result would merely be the litigant owing the bank $40,000 instead.
In the uncommon scenario, however, some damages could more easily result. Then, any costs or harm resulting from the foreclosure process could result in a monetary award. According to Scott, these damages would likely use the equity that the borrower had in their home at the time of foreclosure as a starting point. In a market where so many homes are underwater, however, it's hard to see how even these damages could be very high.