Housing deal set to boost US economy The $40bn settlement between US regulators and banks over their foreclosure practices is good news for the economy - but it could actually drag house prices down in the short term if banks start to seize homes again. There are three main economic effects and all of them cut two ways. The overall result should help the housing market get back to normal, but the immediate consequences are less clear. First, the settlement transfers tens of billions of dollars from banks to borrowers, and that will have a direct, although small, effect on consumption. Even if the entire sum were spent at shops - which will not happen - $40bn is only 0.25 per cent of gross domestic product. At the same time, the money has to come from somewhere: mostly from the pockets of bank investors and savers. The net effect on consumption should be positive, because hard-up borrowers are more likely to spend, but it will be minimal. Second, the settlement will have an effect on bank lending. On the one hand, by draining the coffers of large banks it may reduce their ability to make new loans, although the direct cash value of the deal amounts to only 2 per cent of tier one capital in the US banking system and the banks have had plenty of time to prepare for it. On the other hand, by ending uncertainty about the risk of a much larger liability, the deal should give banks greater confidence to use their capital and lend more. The overall effect on bank lending should be positive. That leaves a third channel: the housing market, which is much the most important. One part of the settlement amount is meant to cut the amount owed by borrowers with houses worth less than the value of their mortgages by as much as $32bn. In some cases, that will allow borrowers to refinance their mortgages with lower payments, and stay in their homes. Whenever that happens, it is good news for the housing market and the economy, because it will reduce the number of forced sales and personal bankruptcies. The trouble is that the $32bn is small relative to estimates of a $700bn gap between house values and underwater mortgages: it is just 5 per cent of that total. "It's just not big enough to deal with the problem of negative equity," says Paul Diggle, who follows housing for Capital Economics in London. The effect on the housing market will also depend on which mortgages banks write down and how they behave now that the deal is done. For example, if the $32bn is used to write down part of mortgages that are already hopelessly underwater, then the chances are they will end up in default and foreclosure anyway. The settlement may also free banks to start foreclosing again. New foreclosure filings slumped once the "robosigning" scandal began in mid-2010, when banks failed to verify basic information about the loan and fabricated documents to present to courts, but the number caught up in the process has changed little. If sales of foreclosed homes pick up again, then that could hold down any recovery in house prices. Clearing away foreclosures and negative equity has to happen for the housing market to bounce back and the settlement is a step forward - but it is just one more step in a long, long journey.