Obama Overhauls Failed HAMP Loan Modification Program

Underwater houseIt's as good as official: Home Affordable Modification Program, the year-old government program to save homeowners from foreclosure, is a flop.

Today, the Obama administration is set to announce new aid for many homeowners in trouble, who have been beyond help under the limited rules of the old HAMP program.

Using $14 billion more from Troubled Asset Relief Program, or TARP, Treasury for the first time will support reductions of principal that borrowers owe – a crucial step in bringing underwater borrowers back into financial stability. (Ironically, Bank of America beat them to it with a principal reduction program it announced yesterday).

And there's even bigger news in store. The administration may also allow some borrowers who owe more on their mortgages than their homes are worth to refinance into new, smaller mortgages that are based on their actual home values through the Federal Housing Administration.
This is starting to sound like what homeowners have been waiting for since the foreclosure crisis began – a 21st century version of the Home Owner's Loan Corporation, President Franklin Delano Roosevelt's agency that refinanced more than 1 million Depression-era homeowners into new and more affordable mortgages.

Now, $14 billion isn't going to go very far, even though Treasury will have to ask lenders and investors mortgage-backed securities to pay part of the price tag. The success of HAMP, Take 2, will depend on how aggressively Treasury is willing to force investors to take losses. Now that almost all the big banks have paid back their TARP bailout money and have a (supposedly) clean bill of health, they should be able to take some controlled hits from mortgage-securities losses and not end up in the graveyard alongside Lehman Brothers. It's a little comforting to know Treasury is at least this itty bit confident in the financial stability of banks, and insisting that lenders share in the pain with homeowners.

The truth is that with each passing month, it became harder for Treasury to spin its old mortgage modification program as a success. Out of more than 1 million who got trial modifications, just 168,708 borrowers had received permanent modifications. (One reason: those million didn't have to submit documentation proving their income and debts, and many sought the trial modifications as a way to buy a few months of free housing even though they had no intention of paying.) And as some critics have warned before, those loan modifications borrowers did get were not only stingy – usually a couple of points off the interest rate temporarily – but left them owing big payments down the road. At best, they kicked the can down the road.

The administration's announcement is conveniently timed on the heels of a damning report released this week by TARP Special Inspector General Neil Barofsky. It finds that nearly one-third of the modifications under HAMP so far leave borrowers ultimately owing at least 70 percent of their monthly income in debt payments. Seventy percent! The formula used to decide on what borrowers can really pay only looks at housing-related debt, and not whatever they might owe a credit card or student loan company.

Who does it help, when a government program signs up a homeowner to commit to those kinds of debt payments? Not the homeowner, usually. Lenders, and investors in mortgage-backed securities, are the only ones who benefit from committing borrowers to those kind of crushing debt payments month after month. Lenders have been promised they'll get paid – when borrowers have been able to keep up, that is. Not surprisingly, many haven't been able to.

There's a simple equation here. Someone has to pay for massive mortgage losses tied to declining property values and rising unemployment: borrowers, bankers, or government. Until now, borrowers have taken the brunt. Just 2 percent of the loan modifications so far have involved principal reductions, Barofsky found. The rest are just another version of a teaser rate mortgage – eventually, the borrower has to pay. Under the new plan, the administration is telling bankers and investors that they have no choice but to take a hit, too.

Banks know that their day of reckoning will come. This week, Bank of America announced it will now be forgiving principal for some borrowers.

One reason Treasury has waited so long is that it doesn't want to encourage people to stop making mortgage payments in the hope of getting a bailout. Then there's the inevitable backlash from the majority of borrowers out there who were prudent, put down large down payments and didn't take cash-out refinances, wondering why the most reckless borrowers are among the ones getting a bailout.

I hear you. Some homeowners who used their real estate as ATMs will get help here -- along with many others who were a lot more cautious about their borrowing but got roped into using risky mortgage products, or have seen their income drop. It's also smart to worry about putting highly leveraged borrowers into the FHA insurance program.

But responsible mortgage borrowers: How do you feel about the alternative? Are you prepared to see your own property values plummet further as millions more go into foreclosure? Be careful what you wish for.
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